Prepared by: CA Arun Babu Ghimire

NFRS 15 REVENUE FROM CONTRACTS WITH CUSTOMERS

When to recognize revenue? This simple question is one of the most controversial issues in
today’s accounting. Why? Because it’s simple and easy when you sell goods, but how about
long-term contracts or some sort of services?

You need to have some rules on When to recognize the revenue from all these things,
because all your profits and losses, your reputation in front of the outside world and your
taxes depend on this. Revenue recognition rules have just changed from NAS 18 & NAS 11
to NFRS 15 and here in this note you can find the impact of this change. The main
differences are analyzed as follows:

S.No. NAS 18 NFRS 15

1 Focused on transfer of significant Focused on transfer of control. Transfer of

risk and rewards. Control includes transfer of significant risk &
rewards.

2 Covered sales of goods, rendering Covered every part which generates revenue
of services, royalties, interest and along with multiple element arrangements
dividends. except interest and dividends. (Interest and
dividend shall be covered under NFRS 09 as
there does not exist customer and contract with
customer.)

3 Firstly identifying activities and No classification of activities but single model

classifying them, then applying for all activities based on satisfaction of
revenue recognition model like Performance Obligations either over time or at
CC, Goods, services, Interest, a point of time.
Dividend, Royalties.

4 Limited guidance on multiple More guidance on separating element (if more

element arrangement and than one revenue element), allocation of
variable consideration. Transaction Price, variable consideration and so
on.

The core principle of NFRS 15 is that an entity will recognize revenue to depict the transfer
of promised goods or services to customers in an amount that reflects the consideration
(payment) to which the entity expects to be entitled in exchange for those goods or
services. Under NFRS 15, the transfer of goods and services is based upon the transfer of
control. Control of an asset is described in the standard as the ability to direct the use of,
obtain substantially all of the remaining benefits from the asset. To apply this principle, you
need to follow a five-step model framework described below.

Definitions
1. Income: Increases in economic benefits during the accounting period in the form of
inflows or enhancement of assets or decrease in liabilities that result in an increase in

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equity, other than those relating to contributions from equity participants. (Income
includes the concept of revenue and gains).
2. Revenue: Income arising in the course of an entity’s ordinary activities. (If excess cash
deposited in bank and interest earned then not classified as revenue)
3. Receivable: An entity’s right to consideration that is unconditional i.e. only the passage of
time is required before payment is due.
4. Transaction price: The amount of consideration to which an entity expects to be entitled
in exchange for transferring promised goods or services to a customer, excluding
amounts collected on behalf of third parties. Revenue does not include sales tax, value
added tax or goods and service tax which are only collected for third parties because they
do not represent an economic benefit flowing to the entity.

Who is a customer?
An entity shall apply this standard to a contract only if the counterparty to the contract is a
customer. A customer is a party that has contracted with an entity to obtain goods or
services that are an output of the entity’s ordinary activities in exchange for consideration.

REVENUE RECOGNITION
Five-Step Model Framework
Every company must follow the five-step model in order to comply with NFRS 15.

Step 1: Identify the contract(s) with a customer.

NFRS 15 defines a contract as an agreement between two or more parties that creates
enforceable rights and obligations and sets out the following criteria for every contract that
must be met.
a. The parties to the contract have approved the contract (written or verbal or implied) and
are committed to fulfilling the terms of contract. (For Eg: If first party gave offer and
second party did not accept then no contract)
b. The entity can identify each party’s rights regarding the goods or services to be
transferred. (i.e. First Party’s rights shall be Second Party’s obligation)
c. Clear identification of the payment terms for the goods and services. (May be in cash or
credit or discount given or not)
d. The contract has commercial substance i.e. an exchange transaction has commercial
substance if the configuration (risk, timing and amount) of the cash flows of the asset
received differs from the configuration of the cash flows of the asset transferred. (i.e. If I
am giving something free of cost, it cannot be classified as revenue)
e. It is probable that the entity will collect the consideration to which it will be entitled. (If
at the time of transaction, no probability of recovery then revenue cannot be
recognized).

Example 1: Aluna has a year end of 31st December 20X1. On 30th September 20X1, Aluna
signed a contract with a customer to provide them with an asset on 31st December 20X1.
Control over the asset passed to the customer on 31 st December 20X1. The customer will
pay Rs.1 milion on 30th June 20X2.

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By 31st December 20X1, as a result of changes in the economic climate, Aluna did not
believe it was probable that it would collect the consideration that it was entitled to.
Therefore, the contract cannot be accounted for and no revenue should be recognized. Also,
it could not be shown as inventory because physical possession / contract have already been
transferred. So, the effect of the cost of inventory ultimately leads to loss.

Step 2: Identify the separate performance obligations in the

contract.
The key point is distinct goods or services. A contract includes promises to provide goods or
services to a customer. Those promises are called performance obligations. A company
would account for a performance obligation separately only if the promised good or service
is distinct. A good or service is distinct if it is sold separately or if it could be sold separately
because it has distinct function and a distinct profit margin.

Some contracts contain more than one performance obligation. For example: An entity may
enter into a contract with a customer to sell a car, which includes one year’s free servicing
and maintenance. An entity might enter into a contract with a customer to provide 5
lectures, as well as to provide a text book on the first day of course.

Principal and Agent

An entity must decide the nature of each performance obligation. This might be:
i. To provide the specified goods or service itself (i.e. it is the principal), or
ii. To arrange for another party to provide goods or services (i.e. it is an agent).
If an entity is an agent, then revenue will be recognized based on the fee it is entitled to.

Warranties
Most of the time, a warranty is assurance that a product will function as intended. If this is
the case, then warranty will be accounted for in accordance with NAS 37 “Provision,
Contingent Liabilities and Contingent Assets”.

If the customer has the option to purchase the warranty separately, then it should be
treated as a distinct performance obligation. This means that a portion of transaction price
must be allocated to it.

Step 3: Determine the transaction price.

The transaction price is the amount of consideration (for example, payment) to which an
entity expects to be entitled in exchange for transferring promised goods or services to a
customer, excluding amounts collected on behalf of third parties. Also, variable contingent
amounts like discount, rebates, refunds, price concessions & credits are included in revenue
where it is highly probable that there will not be a reversal of revenue.

When determining the transaction price, the following must be considered:

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 Variable consideration
 Significant financing components
 Non-cash consideration
 Consideration payable to a customer

In determining the transaction price, the entity must adjust the consideration for the effects
of time value of money if the timing of payments means that a transaction contains a
significant financing component.

Complication arises where elements of variable consideration exists (for Eg: if paid within 7
days or 30 days, then this type of discount available and so on), then the entity will estimate
amount of variable consideration (VC) to which it will be entitled under a contract. Also,
these type of change shall be treated as change in accounting estimate as per NAS 08.

A. Variable Consideration (At the time of determining transaction price)

If the consideration promised in a contract includes a variable amount, an entity shall
estimate the amount of consideration. An amount of consideration can vary because of
discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses,
penalties or other similar items. The promised consideration can also vary if an entity’s
entitlement to the consideration is contingent on the occurrence or non-occurrence of a
future event. For Eg: an amount of consideration would be variable if either a product was
sold with a right of return or a fixed amount is promised as a performance bonus on
achievement of a specified milestone.

How to identify whether promised consideration is variable? Is it explicitly stated in the

contract? Or can involve any circumstances?
The variability relating to the consideration promised by a customer may be explicitly stated
in the contract. In addition to the terms of the contract, the promised consideration is
variable if either of the following circumstances exists:
a. The customer has a valid expectation arising from entity’s business practices,
published policies or specific statements that the entity will accept an amount of
consideration that is less than the price stated in the contract i.e. it is expected that
the entity will offer a price concession as discount, rebate, refund or credit.
b. Other facts and circumstances indicate that the entity’s intention, when entering
into the contract with customer, is to offer a price concession to the customer.

How to estimate the amount of variable consideration?

An entity shall estimate an amount of VC by using either of the following methods,
depending on which method the entity expects to better predict the amount of
consideration to which it will be entitled:
a. The expected value: The expected value is the sum of probability weighted amounts
in a range of possible consideration amounts. It may be an appropriate estimate of
the amount of VC if an entity has a larger number of contracts with similar
characteristics.
b. The most likely amount: The most likely amount is the single most likely amount in a
range of possible consideration amounts. It may be an appropriate estimate of the

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amount of VC if the contract has only two possible outcomes (For eg: an entity either
achieves a performance bonus or not).

Constraining estimates of variable consideration (VVI)

An entity shall include in the transaction price some or all of an amount of variable
consideration estimated only to the extent that it is highly probable that a significant
reversal in the amount of cumulative revenue recognized will not occur when the
uncertainty associated with the variable consideration is subsequently resolved.

Example 1: Determining the transaction price

ABG supplies small tools to large businesses. On 1 July 20X5, ABG entered into a contract
with Bhardhowj, under which Bhardhowj was to purchase the tools at Rs.500 per unit. The
contract states that if Bhardhowj purchases more than 500 tools in a year, the price per unit
is reduced retrospectively to Rs.450 per unit. ABG’s year end is 30th June.
a. As at 30th September 20X5, Bhardhowj had bought 70 tools from ABG. ABG therefore
estimated that Bhardhowj’s purchases would not exceed 500 in the year to 30 th June
20X6, and Bhardhowj would therefore not be entitled to volume discount.
b. During the quarter ended 31st December 20X5, Bhardhowj expanded rapidly as a result of
a substantial acquisition, and purchased an additional 250 tools from ABG. ABG then
estimated that Bhardhowj’s purchases would exceed the threshold for the volume
discount in the year to 30th June 20X6.
Required:
Calculate the revenue ABG would recognize in:
a. Quarter ended 30th September 20X5
b. Quarter ended 31st December 20X5.

Solution:
a. Revenue to be recognized = 70 tools x Rs.500 = Rs.35,000
b. Revenue to be recognized = 250 tools x Rs.450 – 70 tools x Rs.50 = Rs.109,000.

Example 2: On 1st December 20X1, ABC Ltd provides a service to customer for the next 12
months. The consideration is Rs.12 million. ABC is entitled to an extra Rs.3 million if after
twelve months, the number of mistakes made falls below a certain threshold.

Required: Discuss the accounting treatment of the above in ABC Ltd’s financial statements
for the year ended 31st December 20X1 if:
a. ABC has experience of providing identical services in the past and it is highly probable
that the number of mistakes made will fall below the acceptable threshold.
b. ABC has no experience of providing this service and is unsure if the number of mistakes
made fall below the threshold.

Solution:
The Rs.12 million consideration is fixed. The Rs.3 million consideration that is dependent on
the number of mistakes made is variable. ABC must estimate the variable consideration. It
could use an expected value method or most likely amount. Since, there are only two
outcomes, Rs.0 million or Rs.3 million, the most likely amount would better predict the
entitled consideration.

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a. ABC expects to hit the target. Using a most likely amount, the variable consideration
would be valued at Rs.3 million. ABC must then decide whether to include the estimate of
VC in the transaction price. Based on past experience, it seems highly probable that a
significant reversal in revenue recognized would not occur. This means that transaction
price is Rs.15 million (Rs.12 million + Rs. 3 million). As a service, it is likely that the
performance obligation would be satisfied over time. The revenue recognized in the year
ended 31st December 20X1 would be Rs.1.25 million (Rs.15 mio x 1/12).

b. Depending on the estimated likelihood of hitting the target, the variable consideration
would either be estimated to be Rs.0 or Rs.3 million. Whatever the amount, the
estimated variable consideration cannot be included in the transaction price because it is
not highly probable that a significant reversal in revenue would not occur. This is because
it has no experience of providing the service. Therefore, the transaction price is Rs.12
million. As a service, it is likely that the performance obligation would be satisfied over
time. The revenue recognized in the year ended 31st December 20X1 would be Rs. 1
million (Rs 12 million x 1/12).

 PRODUCT SOLD WITH THE RIGHT TO RETURN

If a product is sold with a right to return it then the consideration is variable. The entity
must estimate the variable consideration and decide whether or not to include it in the
transaction price. The refund liability should equal the consideration received or
receivable that the entity does not expect to be entitled to.

Example: Raj enters into 50 contracts with customers. Each contract includes the sale of
one product at Rs.1,000. The cost of Raj of each product is Rs.400. Cash is received
upfront and control of the product transfers on delivery. Customers can return the
product within 30 days to receive a full refund. Raj can sell the returned products at a
profit. Raj has significant experience in estimating returns for this product. It estimates
that 48 products will not be returned.
Required: How should the above transaction be accounted by?

Solution:
The fact that the customer can return the product means that the consideration is
variable. Using an expected value method, the estimated variable consideration is
Rs.48,000 (48 products x Rs.1000). The variable consideration should be included in the
transaction price because based on Raj’s experience, it is highly probable that a
significant reversal in the cumulative amount of revenue recognized will not occur.
Therefore, revenue of Rs.48,000 and a refund liability of Rs.2,000 should be recognized.

Also, Raj will derecognize the inventory transferred to its customers (i.e. no inventory
shall be shown as it won’t be in the control of entity). However, it should recognize an
asset of Rs.800 (2 products x Rs.400) as well as corresponding credit to cost of sales (i.e.
in order not to have the effect of Rs.800 in profit/loss of Raj) for its right to recover the
products from customers on settling the refund liability.

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B. Significant financing component (FINANCING)

In determining the transaction price, an entity must consider if the timing of payments
provide the customer or the entity with a financing benefit. NFRS 15 provides the following
indications of a significant financing component.
 The difference between the amount of promised consideration and the cash selling
price of the promised goods or services and
 The length of time between the transfer of the promised goods or services to the
customer and the payment date.
If there is a financing component, then the consideration receivable need to be discounted
to present value using the rate at which customer borrows money.

Example 1: Rud enters into a contract with a customer to sell equipment on 31 st December
20X1. Control of the equipment transfers to the customer on that date. The price stated in
the contract is Rs.1 million and is due on 31st December 20X3. Market rates of interest
available to this particular customer are 10%.
Required: Explain how this transaction should be accounted for in the financial statements
of Rud for the year ended 31st December 20X1.

Solution:
Due to the length of time between the transfer of control of the asset and the payment
date, this contract includes significant financing component. The consideration must be
adjusted for the impact of the financing transaction. Revenue should be recognized when
the performance obligation is satisfied. As such, revenue and a corresponding receivable
should be recognized at Rs.826,446 (Rs.1 million x 1/(1/10)^2) on 31 st December 20X1. The
receivable is subsequently accounted for in accordance with Financial Instruments.

Example 2: On 31st December 20X7, Sandesh sold Product X to a customer for Rs.12,100
payable 24 months after delivery. The customer obtained control of the product at contract
inception. The cash selling price of Product X is Rs.10,000, which represents the amount that
the customer would pay upon delivery of the same product sold. The cost of the product to
Sandesh is Rs.8,000.
Required: Explain how Sandesh should account for this transaction.

Solution:
The contract includes a significant financing component since there is difference between
the amounts of promised consideration of Rs.12,100 and the cash selling price of Rs.10,000
at the date the goods are transferred to the customer.

In the year ended 31st December 20X7, Sandesh should record revenue and related
receivable of Rs.10,000 for the sale of Product X. Interest income on the receivable should
then be recognized in the year ended 31st Dec 20X8 and 20X9 at the effective interest rate in
accordance with NFRS 9.

C. Non-cash consideration
To determine the transaction price for contracts in which a customer promises
consideration in a form other than cash, an entity shall measure the non-cash consideration
(or promise of non-cash consideration) at fair value. If an entity cannot reasonably estimate

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the fair value of the non-cash consideration, the entity shall measure the consideration
indirectly by reference to the stand-alone selling price of the goods or services promised to
the customer.

The fair value of the non-cash consideration may vary because of the form of consideration
(for Eg: a change in the price of a share to which an entity is entitled to receive from a
customer). If the fair value of the non-cash consideration promised by a customer varies
then an entity shall include in the transaction price the amount of variable consideration
estimated only to the extent that it is highly probable that a significant reversal in the
amount of cumulative revenue recognized will not occur.

Example: Danish sells a good to Shiva. Control over the good is transferred on 1st January
20X1. The consideration received by Danish is 1,000 shares in Shiva with a fair value of
Rs.400 each. By 31st December 20X1, the shares in Shiva have a fair value of Rs.500 each.
Required: How much revenue should be recognized from this transaction in the financial
statements of Danish for the year ended 31st December 20X1?

Solution:
This is the case of non-cash consideration which is measured at fair value. Revenue should
be recognized at Rs.4,00,000 (1,000 shares x Rs.400) on 1st January 20X1. Any subsequent
change in the fair value of the shares received is not recognized within revenue but instead
accounted for in accordance with NFRS 9 Financial Instruments.

D. Consideration payable to a customer

First, for a payment to fall into the scope of this guidance, the payment must be to parties
that directly purchase the entity’s products or other parties within the distribution chain
that purchase the entity’s products later on. For example, a retail partner and the end
consumer would both be considered a manufacturer’s customer. The term “payment”
includes equity instruments and credits or other items that can be used by the customer to
offset the amount owed to the entity, in addition to cash consideration.
Second, the company must determine whether or not a distinct good or service is purchased
from the customer. If the entity does not receive a distinct good or service, the amount
payable to the customer should be a reduction of the transaction price of the related
revenue contract. Companies should consider whether the same benefit could have been
acquired from a party that does not purchase the company’s goods or services. For
example, assume an entity gives its retail partner a discount if the retail partner provides
space for the entity’s goods on its shelves. This service is of no value to the entity if the
retailer is not selling the entity’s goods. Thus, the entity should conclude that it is not
receiving a distinct service and should account for the payment to the customer as a
reduction of the transaction price.
Third, if it is determined that a distinct good or service is being transferred, the entity must
be able to reasonably estimate the fair value of that good or service in order for the
consideration payable to be ignored as a reduction of the sales price.
Fourth, if the fair value can be reasonably estimated, the amount of consideration that can
be accounted for as a normal purchase from a supplier is limited to the fair value of the

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distinct goods or services that were received. Any excess consideration payable over the fair
value of the distinct goods or services received should be accounted for as a reduction of
the transaction price. If the fair value cannot be reasonably estimated, the entire
consideration payable results in a reduction of the transaction price.
The following figure illustrates the process an entity should go through to account for
consideration payable to a customer.

Example:
A consumer goods manufacturer enters into a one-year contract to sell goods to a large
retail company. The customer commits to buy at least Rs. 250,000 of products during the
year. The contract also requires the entity to make a non-refundable payment of Rs. 25,000
to the customer at the inception of the contract. The Rs. 25,000 payment will compensate
the customer for the changes it needs to make to its shelving to accommodate the entity’s
products.
The entity concludes that the payment to the customer is not in exchange for a distinct good
or service that transfers to the entity. This is because the entity does not obtain control of
any rights to the customer’s shelves and the shelving is of no value to the entity absent the
revenue relationship. Consequently, the entity determines that the payment is a reduction
of the transaction price. The entity concludes that the consideration payable is accounted
for as a reduction in the transaction price when the entity recognizes revenue for the

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transfer of the goods. Consequently, as the entity transfers goods to the customer, the
entity reduces the transaction price for each good by 10 percent (Rs.25,000 ÷ Rs.250,000).
Example 1: Golden Gate enters into a contract with a major chain of retail stores. The
customer commits to buy at least Rs.20 million of products over the next 12 months. The
terms of the contract require Golden Gate to make a payment of Rs.1 million to compensate
the customer for changes that it will need to make to its retail stores to accommodate the
products. By the 31st December 20X1, Golden Gate has transferred products with a sales
value of Rs. 4 million to the customer.
Required: How much revenue should be recognized by Golden Gate in the year ended 31 st
December 20X1?

Solution:
The payment made to the customer is not in exchange for a distinct goods or service.
Therefore, the Rs. 1 million paid to the customer must be treated as a reduction in the
transaction price. The total transaction price should be reduced by 5% i.e. (Rs 1
million/Rs.20 million). Therefore, Golden Gate should reduce the price allocated to each
good by 5% as it is transferred. By 31st December 20X1, Golden Gate should recognize
revenue of Rs.3.8 million (Rs.4 million x 95%).

Step 4: Allocate the transaction price to the performance

obligations in the contract.
For a contract that has more than one performance obligations, an entity should allocate
the transaction price to each performance obligation in an amount that depicts the amount
of consideration to which the entity expects to be entitled in exchange for satisfying each
performance obligation i.e. in proportion to the stand-alone selling price of the good or
service underlying each performance obligation.

Example 1: Allocating the transaction price to the performance obligations

A mobile phone company gives customers a free handset when they sign a two-year
contract for provision of network services. The handset has a stand-alone price of Rs. 10,000
and the contract is for Rs.2,000 per month.

Prior to IFRS 15, the company would recognize no revenue in relation to the handset and a
total of Rs.24,000 per annum in relation to the contract because NAS 18 does not give any
guidance on how to identify these components and how to allocate selling price and as a
result, there were different practices applied.

Under IFRS 15, revenue must be allocated to the handset because delivery of the handset
constitutes a performance obligation. This will be calculated as follows:
Rs. %
Handset 10,000.00 17%
Contract-two years 48,000.00 83%
Total 58,000.00 100%

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As the total receipts are Rs.48,000 this is the amount which must be allocated to the
separate performance obligations. Revenue will be recognized as follows:
Rs.
Year 1
Handset (48000 x 17%) 8,160.00
Contract (48000 - 8160)/2 19,920.00
28,080.00
Year 2
Contract as above 19,920.00

So, application of IFRS 15 has moved revenue of Rs.4,080 from Year 2 to Year 1.

Example 2: Sony sells a machine and one year’s free technical support for Rs.100,000. The
sale of the machine and the provision of technical support have been identified as separate
performance obligations. Sony usually sells the machine for Rs.95,000 but it has not yet
started selling technical support for this machine as a stand-alone product. Other support
services offered by Sony attract mark up of 50%. It is expected that the technical support
will cost Sony Rs.20,000.
Required: How much of the transaction price should be allocated to the machine and how
much should be allocated to the technical support?

Solution:
The selling price of the machine is Rs.95,000 based observable evidence. There is no
observable selling price for the technical support. Therefore, the stand alone selling price
needs to be estimated. A residual approach would attribute Rs.5,000 (Rs.100,000 –
Rs.95,000) to the technical support. However, this does not approximate the stand alone
selling price of the similar service. So, a better approach for estimating the selling price of
the support would be an expected cost plus margin. Based on this, the selling price of the
service would be Rs.30,000 (Rs.20,000 x 150%).

The total of stand alone selling price of machine and support is Rs.125,000
(Rs.95,000+Rs.30,000). The transaction price allocated the machine is Rs.76,000 (Rs.100,000
x 95,000/125,000). Also, the transaction price allocated to the support is Rs.24,000
(Rs.100,000 x 30,000/125,000). The revenue will be recognized when the performance
obligations are satisfied.

Step 5: Recognize revenue when (or as) the entity satisfies a

performance obligation.
The entity satisfies a performance obligation by transferring control of a promised goods or
service to the customer. A performance obligation can be satisfied at a point of time, such
as when goods are delivered to the customer, or over time. When a contract contains a
performance obligation satisfied over time (like that of long term contracts studied in NAS
11), an entity often has an enforceable right to payment for the performance completed to
date.

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Methods of measuring the amount of performance completed to date encompass output

methods and input methods. Output methods recognize revenue on the basis of the value
to the customer of the goods or services transferred. They include surveys of performance
completed, appraisal of units produced or delivered etc. Input methods recognize revenue
on the basis of the entity’s inputs such as labour hours, resources consumed, cost incurred.
As circumstances change over time, an entity shall update its measure of progress to reflect
any changes in the outcome of the PO. Such changes to an entity’s measure of progress shall
be accounted for as a change in accounting estimates in accordance with NAS 8 Accounting
Policies, Changes in Accounting Estimates and Errors.

Students please be noted that these output and input methods are similar to percentage of
completion methods as mentioned in NAS 11. Also, contract revenue and contract profit
computation as per IFRS 15 is similar to NAS 11.

Case I: Performance obligations satisfied over time

An entity transfers control of a good or service over time and therefore satisfies a
performance obligation and recognizes revenue over time, if one of the following criteria is
met:
a. The customer simultaneously receives and consumes the benefits provided by the
entity’s performance as the entity performs;
b. The entity’s performance creates or enhances an asset (for example, work in progress)
that a customer controls as the asset is created or enhanced;
c. The entity’s performance does not create an asset with an alternative use to the entity
and the entity has an enforceable right to payment for performance completed to date.

Note 1: In assessing whether an asset has an alternative use to an entity, an entity shall
consider the effects of contractual restrictions and practical limitations on the entity’s
ability to readily direct that asset for another use such as selling it to a different
customer. The possibility of the contract with the customer being terminated is not a
relevant consideration in assessing whether the entity would be able to readily direct the
asset for another use.
A practical limitation on an entity’s ability to direct an asset for another use exists if an
entity would incur significant economic losses to direct the asset for another use. A
significant economic loss could arise because the entity either would incur significant cost
to rework the asset or would only be able to sell the asset at a significant loss. For eg: An
entity may be practically limited from redirecting assets that either have design
specifications that are unique to a customer or are located in remote areas.

Note 2: An entity has a right to payment for performance completed to date if the entity
would be entitled to an amount that at least compensates the entity for its performance
completed to date in the event that the customer or another party terminates the
contract for reasons other than the entity’s failure to perform as promised. An amount
that would compensate an entity for performance completed to date would be an
amount that approximates the selling price of goods or services transferred to date.

Case II: Performance obligations satisfied at a point of time

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To determine the point in time at which a customer obtains control of a promised asset and
the entity satisfies a PO, the entity shall consider the requirements for control as defined
above. In addition, an entity shall consider indicators of the transfer of control, which
include, but are not limited to the following:
a. The entity (seller) has a present right to payment for the asset.
b. The customer has legal title to the asset.
c. The entity has transferred physical possession of the asset.
d. The customer has the significant risk and rewards of ownership of the asset.
e. The customer has accepted the asset.
If all these criteria are made in making 5 steps model a successful one, you can pass double
entry and recognize revenue i.e. Revenue is recognized as control is passed over. Control
means ability to direct the use of and obtain substantially all of the remaining benefits of
from the assets. Students please be noted that is the seller has the option to take economic
benefits from particular item, then it is not considered to be sold. If such option passed to
customer then only control is said to be passed. If entity passes PO at a point of time, then
shall be recognized when control is passed and if over period of time then recognized over
time.

Example 1: On 1st December 20X1, Wade receives an order from a customer for a computer
as well as 12 months of technical support. Wade delivers the computer and transfers its
legal title to the customer on the same day.
The customer paid Rs.420 upfront. If sold individually, the selling price of the computer is
Rs.300 and the selling price of the technical support is Rs.120. (Fig – 000)
Required:
Apply the 5 stages of revenue recognition as per NFRS 15 to determine how much revenue
Wade should recognize in the year ended 31st December 20X1.
Solution:
Step 1: Identify the contract
There is an agreement between Wade and its customer for the provision of goods and
services.

Step 2: Identify the separate performance obligations within a contract

There are two performance obligations (promises) within the contract:
i. The supply of a computer
ii. The supply of technical support

Step 3: Determine the transaction price

The total transaction price is Rs.420.
Step 4: Allocate the transaction price to the performance obligations in the contract
Based on standalone selling prices, Rs.300 should be allocated to the sale of computer and
Rs.120 should be allocated to the technical support.

Step 5: Recognize revenue when (or as) a performance obligation is satisfied.

Control over the computer has been passed to the customer so the full revenue of Rs.300
allocated to the supply of the computer should be recognized on 1st December 20X1.

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The technical support is provided over time, so the revenue allocated to this should be
recognized over time. In the year ended 31st December 20X1, revenue of Rs.10 (1/12*120)
should be recognized from the provision of technical support.

Example 2: Contract Revenue

Suppose that a contract is started on 1st January 20X5, with an estimated completion date of
31st December 20X6. The final contract price is Rs.1500,000. In the first year, to 31 st
December 20X5:
a. Costs incurred amounted to Rs.600,000.
b. Half of the work on the contract was completed.
c. Certificates of work completed have been issued, to the value of Rs.750,000.
d. It is estimated with reasonable certainty that further costs to completion in 20X6 will be
Rs.600,000.
What is the contract profit in 20X5?
Solution:
This is a contract in which the performance obligation is satisfied over time. The entity is
carrying out the work for the benefit of the customer rather than creating an asset for its
own use and in this case it has an enforceable right to payment for work completed to date.

The amount of payment that the entity is entitled is the amount of performance completion
to date. In this case, the contract is certified as 50% complete, measuring the progress
under output method. At December 20X5, the entity will recognize revenue of Rs.750,000
and cost of sales of Rs.600,000, leaving profit of Rs.150,000. The contract asset will be
revenue recognized to date i.e Rs.750,000.

Example 3: Contract Revenue (Percentage of completion)

Raksha Co has the following contract in progress: ( in mio)
Total Contract Price 750
Costs incurred to date 225
Estimated costs to completion 340
Payments invoiced and received 290
Raksha Co uses the input method to measure the satisfaction of performance obligations
based on costs incurred as a proportion of total expected costs.
Required:
Calculate the amount to be recognized for the contract in the statement of Profit or Loss
and statement of financial position.
Solution:
a. Costs incurred as a proportion of total costs = 225/(225+340) = 40%
b. Statement of Profit or Loss:
Revenue (40% of Rs.750m) 300m
Cost of sales (cost incurred) (225m)
Profit 75m
c. Statement of Financial Position
Contract Asset (Revenue recognized Rs.300m less amount invoiced 290m) 10 m

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Example 4:
On 31st March 20X1, Chunney enters into a contract to construct a specialized factory for a
customer. The customer paid an upfront deposit which is only refundable if Chunney fails to
complete construction in line with the contract. The remainder of the price is payable when
the customer takes possession of the factory. If the customer defaults on the contract
before completion of the factory, Chunney only has the right to retain the deposit.
Required: Should Chunney recognize revenue from the above transaction over time or at a
point of time?

Solution:
[Hints: You can observe clause (C) of performance obligation satisfied over time i.e. “The
entity’s performance does not create an asset with an alternative use to the entity and the
entity has an enforceable right to payment for performance completed to date.”].

In assessing whether revenue is recognized over time, it is important to note that the
factory under construction is specialized. Therefore, the asset being created has no
alternative use to the entity. However, Chunney only has an enforceable right to the deposit
received and thus does not have the right to payment for work completed to date. Hence,
Chunney must account for the sale of the unit as a performance obligation satisfied at a
point of time rather than over time. Revenue will most likely be recognized when the
customer takes possession of the factory.

Example 5:
On 1st January 20X1, Banku enters into a contract with a customer to construct a specialized
building for consideration of Rs.2 million plus a bonus of Rs.0.4 million if the building is
completed within 18 months. Estimated costs to construct the building are Rs.1.5 million. If
the contract is terminated by the customer, Banku can demand payment for the costs
incurred to date plus a mark up of 30%. On 1 st January 20X1, as a result of factors outside of
its control, such as the weather and regulatory approval, Banku is not sure whether the
bonus will be achieved.

At 31st December 20X1, Banku is still unsure whether bonus target will be met. Banku
decides to measure progress towards completion based on cost incurred. Costs incurred on
the contract to date are Rs.1 million.
Required: How should Banku account for this transaction in the year ended 31 st December
20X1?

Solution:
Construction of building is a single performance obligation. The bonus is variable
consideration. Whatever be its estimated value, it must be excluded from the transaction
price because it is not highly probable that a significant reversal in the amount of cumulative
revenue recognized will not occur. The construction of the building should be accounted for
as an obligation satisfied over time. This is because the building has no alternative uses for
Banku and also the payment can be enforced for the work completed to date.

Banku should recognize revenue based on progress towards satisfaction of the construction
of the building. Using costs incurred, the performance obligation is 66.67% complete.

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(1mio/1.5mio) i.e. total cost incurred/total estimated costs. Accordingly, the revenue and
costs recognized at the end of the year are as follows:
Revenue ( Rs.2 million x 66.67%) Rs. 1.3 million
Costs (Rs. 1.5 million x 66.67%) Rs. 1.0 million
Profit Rs. 0.3 million

Example 6:
On 31st December 20X1, Kalki delivered the January edition of a magazine (with total sales
value of Rs. 100,000) to a supermarket chain. Legal title remains with Kalki until the
supermarket sells a magazine to the end consumer. The supermarket will start selling the
magazines to its customers on 1st January 20X2. Any magazines that remain unsold by the
supermarket on 31st December are returned to Kalki. The supermarket will be invoiced by
Kalki in February 20X2 based on the difference between the number of issues they received
and the number of issues that they return.
Required: Should Kalki recognize revenue from the above transaction in the year ended
31st December 20X1?

Solution:
[Hints: Performance obligation satisfied at a point of time – Its 5 conditions mentioned
above.]

The performance obligation is not satisfied over time because the supermarket does not
simultaneously receive and benefit from the asset. Kaki therefore satisfies the performance
obligation at a point in time and will recognize revenue when it transfers control over the
assets to the supermarket.

The fact that the supermarket has physical possession of the magazines at 31st December
20X1 is an indicator that control has passed. Also, Kalki will invoice the supermarket for any
issues that are stolen and so the supermarket does bear some of the risks of ownership.
However, as at 31st December 20X1, legal title of the magazines has not passed to the
supermarket. Moreover, Kalki has no right to receive the payment until the supermarket
sells the magazines to the end consumer. Finally, Kalki will be sent any unsold magazines
and so bears significant risks of ownership such as risk of obsolescence. All things
considered, it would seem that control of the magazines has not passed from Kalki to the
supermarket chain. Therefore, Kalki should not recognize revenue from this contract in its
financial statements for the year ended 31st December 20X1.

Special cases discussed in NFRS 15:

1. Contract Costs
Incremental costs of obtaining a contract
 An entity shall recognize as an asset the incremental costs of obtaining a contract with
a customer if the entity expects to recover those costs. Once recognized as asset,
these cost needs to be amortized on systematic basis. The incremental costs of
obtaining a contract are those costs that an entity incurs to obtain a contract with a
customer that it would not have incurred if the contract had not been obtained (for
example: sales commission).

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 Also, the costs to obtain a contract that would have been incurred regardless of
whether the contract was obtained shall be recognized as an expense when incurred,
unless those costs are explicitly chargeable to the customer.

Costs to fulfil contract

An entity shall recognize an asset from the costs incurred to fulfil a contract only if
those costs meet all of the following criteria:
a. The costs relate directly to a contract or to an anticipated contract that an entity
can specifically identify (for example: costs relating to services to be provided
under renewal of an existing contract or costs of designing an asset to be
transferred under a specific contract that has not yet been approved);
b. The costs generate or enhance resources of the entity that will be used in
satisfying (or in continuing to satisfy) performance obligations in the future; and
c. The costs are expected to be recovered.

Costs that relate directly to a contract (or a specific anticipated contract) include any
of the following:
a. Direct labour (for example: salaries and wages of employees who provide the
promised services directly to the customer);
b. Direct materials (for example: supplies used in providing the promised services to a
customer);
c. Allocations of costs that relate directly to the contract or to contract activities (for
example: cost of contract management and supervision, insurance and
depreciation of tools, equipment and right of use assets used in fulfilling the
contract);
d. Costs that are explicitly chargeable to the customer under the contract; and
e. Other costs that are incurred only because an entity entered into the contract (for
example: payments to subcontractors).

An entity shall recognize the following costs as expenses when incurred:

a. General and administration costs (unless those costs are explicitly chargeable to
the customer under the contract)
b. Cost of wasted materials, labour or other resources to fulfil the contract that was
not reflected in the price of the contract.
c. Costs that relate to satisfied performance obligations or partially satisfied
performance obligations in the contract (i.e. costs that relate to past performance);
and
d. Costs for which an entity cannot distinguish whether the costs relate to unsatisfied
performance obligations or to satisfied performance obligations (or partially
satisfied performance obligations).

2. Impairment
An entity shall recognize an impairment loss in profit or loss to the extent that the
carrying amount of an asset (contract asset) exceeds:
a. The remaining amount of consideration that the entity expects to receive in
exchange for the goods or services to which the assets relates (for this entity shall

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use the principles for determining transaction price and adjust that amount to
reflect the effects of the customer’s credit risk); less
b. The costs that relate directly to providing those goods or services and that have
not been recognized as expenses.

An entity shall recognize in profit or loss as a reversal of some or all of the impairment
loss previously recognized when the impairment conditions no longer exist or have
improved. The increased carrying amount of the asset shall not exceed the amount
that would have been determined (net of amortization) if no impairment loss had
been recognized previously.

3. Disclosures
An entity shall disclose qualitative and quantitative information about the following:
a. Its contract with customers;
b. The significant judgments, changes in the judgment made in applying this
standard;
c. Any assets recognized from the costs to obtain or fulfil a contract with a
customer.

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