Revenue recognition

Revenue is the number most looked at and the most judged. Ind AS 115, Revenue from Contracts with Customers, replaced a patchwork of rules with one procedure applying to every industry.

The core principle

ICAI states it as: an entity recognises revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.

Two ideas are doing the work. Revenue follows transfer, not invoicing and not collection. And the amount is what the entity expects to be entitled to, not what it hopes or has billed.

The five steps

1. Identify the contract with a customer

The standard defines a contract and a customer and sets five mandatory criteria for one to exist. If they are not met, there is no contract and no revenue — whatever cash has arrived.

2. Identify the performance obligations in the contract

At contract inception, assess the promised goods or services and identify as a separate performance obligation each promise to transfer either:

• a good or service that is distinct, or
• a series of distinct goods or services that are substantially the same and transfer in the same pattern.

This is the step that decides the answer in almost every interesting case. A single contract and a single price can contain several obligations, and each is recognised as it is satisfied.

3. Determine the transaction price

The consideration the entity expects to be entitled to, excluding amounts collected for third parties such as some sales taxes. It may be fixed, variable, or both — and variable consideration must be estimated rather than ignored. The price is also adjusted for the time value of money where the contract contains a significant financing component.

4. Allocate the transaction price to the performance obligations

Normally on the basis of relative stand-alone selling prices of each distinct good or service. Where a stand-alone price is not observable, the entity estimates it.

This is why bundling does not let a company choose its own split: the allocation follows what each piece would sell for separately, not what the contract says.

5. Recognise revenue as each obligation is satisfied

As control transfers to the customer — either over time or at a point in time.

Working the software problem

Licence, installation, support and upgrades for one upfront fee.

Step 2 asks how many distinct promises there are. Installation is likely distinct if another vendor could do it. Support and upgrades are delivered over three years, so they transfer over time, not at inception.

Step 4 allocates the single fee across them by relative stand-alone selling price — what each would cost if bought alone.

Step 5 then recognises the licence portion when control passes, the installation when performed, and the support and upgrade portions across three years.

So only part of a single upfront fee can be revenue on day one, and a company claiming all of it has either argued there is one performance obligation or mispriced the allocation. Both are visible in the notes, and both are the first thing to check in a company with fast-growing revenue and slow-growing cash.

Where the room is

Step	The lever
1	Does a contract exist yet — has it been approved, is collection probable?
2	Fewer obligations means more revenue sooner
3	Optimistic estimates of variable consideration
4	Stand-alone prices that are "not observable" and therefore estimated
5	Over time versus at a point in time

None of these is fraud. Each is a judgement the standard requires somebody to make, and each moves revenue between periods. Chapter 15 is about the point where judgement becomes something else.

What to read in a real report

The accounting policy note states how the company applies each step — in particular what it treats as a performance obligation and when it considers control to transfer. For a company whose revenue you doubt, that note is the document, not the income statement.

Compare it with: receivables growth against revenue growth (chapter 5), contract assets and contract liabilities on the balance sheet, and whether any revenue is recognised over time on estimates of progress.

The point

Ind AS 115 recognises revenue when promised goods or services transfer to the customer, in the amount the entity expects to be entitled to. Five steps: identify the contract, identify the distinct performance obligations in it, determine the transaction price, allocate it across the obligations by relative stand-alone selling price, and recognise as each is satisfied. Step 2 decides most real cases, and a single upfront fee for a bundle is almost never all revenue on day one.