Customer Incentives
Facts of the case:
Company gives incentives to customer in the form of Gold Scheme, Foreign & Domestic tours on attaining a certain level of revenue with that customer.
Issue/Query:
1. How the transaction price will be calculated and when to recognise the revenue for incentive schemes?
2. What will be accounting entries on Sale to Customer and on transferring Gold / Tour to customer?
Response:
Transaction price will be calculated in the ratio of the stand-alone selling prices of each of the performance obligations in the contract and empirical evidence of customers claiming gold coins or tours. The following are performance obligation in the contract:
Sale of Goods
Sale of Gold coin either on principal or agent basis
Tour services either on principal or agent basis
The following will be the accounting entries on sale to customer:
Customer account dr. To Revenue from Sale of Goods To Contract Liability
The following will be the entries on transferring gold / tour to customer:
Contract Liability dr. To Revenue from Sale of Gold / Tours
The following will be the entries on lapse of claim period, if any:
Contract Liability dr. To Revenue from Sale of Goods
Basis for Response:
The core principle of Ind AS 115, Revenue from Contracts with Customers, is that an entity shall recognise 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.
The following are the five steps that an entity applies under Ind AS 115 when recognising revenue:
a. Identify the contracts with customers
b. Identify the performance obligations in the contract
c. Determine the transaction price
d. Allocate the transaction price to the performance obligations in the contract
e. Recognise revenue when (or as) the entity satisfies a performance obligation
The contract with customer is already identified which is sale of goods with incentives in the form of gold or tours.
Paragraph 22 of Ind AS 115 requires an entity to identify as a performance obligation each promise to transfer to the customer a good or service that is distinct. Paragraph 27 of Ind AS 115 provides the criteria for identifying distinct goods as under:
“A good or service that is promised to a customer is distinct if both of the following conditions are met:
the customer can benefit from the goods or services either on its own or together with other resources that are readily available to the customer (ie the good or service is capable of being distinct)
the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (ie the promise to transfer the good or service is distinct within the context of the contract).”
In the given case, a contract with customer contains the following promises:
Sale of goods
Supply of gold
Tour service
Paragraph 27 of Ind AS 115 states as follows:
“A good or service that is promised to a customer is distinct if both of the following criteria are met:
(a) the customer can benefit from the good or service either on its own or together with other resources that are readily available to the customer (ie the good or service is capable of being distinct); and
(b) the entity’s promise to transfer the good or service to the customer is separately identifiable from other promises in the contract (ie the promise to transfer the good or service is distinct within the context of the contract).”
Paragraph 28 of Ind AS 115 explains when the first condition can be said to have been met as follows:
“A customer can benefit from a good or service in accordance with paragraph 27(a) if the good or service could be used, consumed, sold for an amount that is greater than scrap value or otherwise held in a way that generates economic benefits. For some goods or services, a customer may be able to benefit from a good or service on its own. For other goods or services, a customer may be able to benefit from the good or service only in conjunction with other readily available resources. A readily available resource is a good or service that is sold separately (by the entity or another entity) or a resource that the customer has already obtained from the entity (including goods or services that the entity will have already transferred to the customer under the contract) or from other transactions or events. Various factors may provide evidence that the customer can benefit from a good or service either on its own or in conjunction with other readily available resources. For example, the fact that the entity regularly sells a good or service separately would indicate that a customer can benefit from the good or service on its own or with other readily available resources.”
In the given case, sale of goods, sale of gold and sale of tours are capable of being distinct and therefore, condition (a) in paragraph 27 of Ind AS 115 is met.
Paragraph 29 of Ind AS 115 explains when the promise in a contract can be said to be distinct within the context of the contract as follows:
“In assessing whether an entity’s promises to transfer goods or services to the customer are separately identifiable in accordance with paragraph 27(b), the objective is to determine whether the nature of the promise, within the context of the contract, is to transfer each of those goods or services individually or, instead, to transfer a combined item or items to which the promised goods or services are inputs. Factors that indicate that two or more promises to transfer goods or services to a customer are not separately identifiable include, but are not limited to, the following:
(a) the entity provides a significant service of integrating the goods or services with other goods or services promised in the contract into a bundle of goods or services that represent the combined output or outputs for which the customer has contracted. In other words, the entity is using the goods or services as inputs to produce or deliver the combined output or outputs specified by the customer. A combined output or outputs might include more than one phase, element or unit.
(b) one or more of the goods or services significantly modifies or customises, or are significantly modified or customised by, one or more of the other goods or services promised in the contract.
(c) the goods or services are highly interdependent or highly interrelated. In other words, each of the goods or services is significantly affected by one or more of the other goods or services in the contract. For example, in some cases, two or more goods or services are significantly affected by each other because the entity would not be able to fulfil its promise by transferring each of the goods or services independently.”
In the given case,
The company does integrate the goods, gold and tour service.
There is no significant modification or customisation of the goods sold, the gold supplied or the tour service rendered because of three promises being included in the contract.
The sale of good is not highly interdependent or interrelated with the promise of supply of gold or the rendering of tour service such that there is a transformative relationship between them.
Therefore, the second condition that the promise is distinct within the context of the contract is also met. Therefore, each of promise contained in the contract with customer identified in paragraph 5 above are separate performance obligations.
Paragraph 47 of Ind AS 115 provides the principle for determining transaction price:
“An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which the entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts or both.”
In the given case, the company offers gold and tours along with sale of goods which customers may or may not claim and therefore the consideration becomes variable. Paragraph 50 of Ind AS 115 states as under:
“If the consideration promised in a contract includes a variable amount, an entity shall estimate the amount of consideration to which the entity will be entitled in exchange for transferring the promised goods or services to a customer.”
The company shall estimate the amount of variable consideration by using expected value method which is the sum of probability-weighted amounts in a range of possible consideration amounts. The probability range is based of empirical data or on peer data if the company does not have a population that is representative of sufficient sample size.
Paragraph 74 of Ind AS 115 requires that an entity shall allocate the transaction price to each performance obligation identified in the contract on a relative stand-alone selling price basis. Therefore, the company shall allocate the estimated transaction price to sale of goods, sale of gold and sale of tours based on their stand-alone selling price. Appendix A of Ind AS 115 defines stand-alone selling price as the price at which an entity would sell the promised good or service separately to a customer.
Paragraph 31 of Ind AS 115 states as under:
“An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (ie an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.”
The company shall recognise revenue for sale of goods, sale of gold and sale of tours as it sells each of those goods. Any revenue received in advance shall be presented as contract liability.