Intro on Revenue
Revenue is income. Especially in any organization revenue holds a substantial nature and significance. IFRS 15 “Revenue from Customers” deals with most common form of revenue that is “revenue from customers”. Lease revenues, Insurance Contract revenues, Contractual rights and obligations with the scope of Financial Instruments or some non-monetary exchanges are not covered by the application of IFRS 15.
IFRS 15 mainly deals with:
• Identification, combination and modification of revenue contracts
• Identification and satisfaction of performance obligation
• Determination, allocation and changes in the transaction price
• Costs of obtaining a contract, fulfilling a contract, amortization and impairment of such costs
• Disclosure requirement on contract with customers, recognition of costs to obtain/fulfill the contract as asset and other significant judgements
Full content of: IFRS 15 Revenue from Contracts with Customers
It’s a vast-vast topic, but here we will limit our discussion on “Determination, allocation and changes in the transaction price” and mainly on what is variable consideration and relevant case laws relating to this issue.
Determination of 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 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 (for example, some sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.
Allocation of the transaction price
Stand-alone selling prices: Under IFRS 15, a company allocates the transaction price to each performance obligation identified on a relative stand-alone selling price basis. The stand-alone selling price is the price at which a company would sell a promised good or service separately to a customer. When the stand-alone selling price is not directly observable, a company estimates it considering all reasonably available information and maximising the use of observable inputs. [IFRS 15.74, 77–78] Companies need to ensure they use up-to-date estimates to allocate the transaction price for new contracts. However, after contract inception the transaction price is not reallocated to reflect subsequent changes in stand-alone selling prices. [IFRS 15.88]
Revenue recognition over time: When a company transfers control of a good or service over time, revenue is recognised by measuring the progress towards complete satisfaction of that performance obligation. This is common in sectors such as real estate, construction, engineering, aerospace and defence. A company applies a single method of measuring progress to depict its performance in transferring control of goods or services, using an output or an input method. [IFRS 15.39–41] When a company uses an input method to measure progress – e.g. costs incurred as a percentage of expected total costs – it needs to estimate the total expected inputs that will be needed to satisfy the performance obligation. Companies need to ensure that the estimated progress and revenue recognised reflect the latest expectations. Any changes in this estimate are accounted for prospectively.
What is "Variable Consideration"?
Variable consideration includes discounts, rebates, refunds, credits, price concessions, incentives, performance bonuses, penalties and other similar items. It may be explicit or implicit – e.g. based on the company’s customary business practices or specific statements. Under IFRS 15, if a contract includes variable consideration, then a company estimates the amount of consideration to which it will be entitled.
A company estimates variable consideration but includes it in the transaction price only to the extent that it is highly probable that a significant reversal of revenue will not occur (‘the constraint’). [IFRS 15.56]. For example, falling demand may impact whether customers will qualify for rebates or volume discounts. Further, transport companies may need to update estimated revenue for an increase in refunds to customers for cancelled or delayed journeys. Companies need to reassess the estimated transaction price at each reporting date. [IFRS 15.59]
The promised consideration can also vary if an entity’s entitlement to the consideration is contingent on the occurrence or nonoccurrence of a future event. For example, 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.
What may indicate "variable considerations"?
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 an entity’s customary 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. That is, it is expected that the entity will offer a price concession. Depending on the jurisdiction, industry or customer this offer may be referred to as a discount, rebate, refund or credit.
(b) other facts and circumstances indicate that the entity’s intention, when entering into the contract with the customer, is to offer a price concession to the customer.
An entity estimates an amount of variable consideration 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.
(b) The most likely amount—the most likely amount is the single most likely amount in a range of possible consideration amounts (ie the single most likely outcome of the contract).
Under IFRS 15 an entity shall apply one method consistently throughout the contract when estimating the effect of an uncertainty on an amount of variable consideration to which the entity will be entitled. In addition, an entity shall consider all the information (historical, current and forecast) that is reasonably available to the entity and shall identify a reasonable number of possible consideration amounts. The information that an entity uses to estimate the amount of variable consideration would typically be similar to the information that the entity’s management uses during the bid-and-proposal process and in establishing prices for promised goods or services.
When not to consider variable consideration into transaction price?
An entity shall include in the transaction price some or all of an amount of variable consideration estimated in accordance with IFRS 15 only to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur when the uncertainty associated with the variable consideration is subsequently resolved.
In assessing whether it is highly probable that a significant reversal in the amount of cumulative revenue recognised will not occur once the uncertainty related to the variable consideration is subsequently resolved, an entity shall consider both the likelihood and the magnitude of the revenue reversal.
Factors that could increase the likelihood or the magnitude of a revenue reversal include, but are not limited to, any of the following:
(a) the amount of consideration is highly susceptible to factors outside the entity’s influence. Those factors may include volatility in a market, the judgement or actions of third parties, weather conditions and a high risk of obsolescence of the promised good or service.
(b) the uncertainty about the amount of consideration is not expected to be resolved for a long period of time.
(c) the entity’s experience (or other evidence) with similar types of contracts is limited, or that experience (or other evidence) has limited predictive value.
(d) the entity has a practice of either offering a broad range of price concessions or changing the payment terms and conditions of similar contracts in similar circumstances.
(e) the contract has a large number and broad range of possible consideration amounts.
Reassessment of Variable Consideration
Under IFRS 15, at the end of each reporting period, an entity shall update the estimated transaction price (including updating its assessment of whether an estimate of variable consideration is constrained) to represent faithfully the circumstances present at the end of the reporting period and the changes in circumstances during the reporting period. The entity shall account for such changes as a change in the transaction price.
Tax Impact of Variable Consideration in Long Term Contract
Income Tax Directive, 2066 (Third Amendment 2077) in chapter 20 deals with the Long Term Contract. Directive has discussed the Long Term Contract in line with IAS 11 Construction Contract. Construction Contract has now been replaced by IFRS 15 Revenue from Contract with Customers. It is now time to revisit the chapter 20 of the Income Tax Directive in line with IFRS 15 for more correct and modern application.
Under IFRS 15, When a company transfers control of a good or service over time, revenue is recognised by measuring the progress towards complete satisfaction of that performance obligation. This is common in sectors such as real estate, construction, engineering, aerospace and defence. A company applies a single method of measuring progress to depict its performance in transferring control of goods or services, using an output or an input method. [IFRS 15.39–41] When a company uses an input method to measure progress – e.g. costs incurred as a percentage of expected total costs – it needs to estimate the total expected inputs that will be needed to satisfy the performance obligation. Companies need to ensure that the estimated progress and revenue recognised reflect the latest expectations. Any changes in this estimate are accounted for prospectively.
A curious case of Prime International Pvt. Ltd.
Facts of the Case
The facts of the case are:
१. प्रत्यर्थी प्राईम इन्टरनेशनल प्रा.लि. ले आ.व. २०५७/५८ को विभिन्न मितिमा अन्य व्यापारिक पक्षसँग व्यापारिक सम्झौता गरेको ।
२. सम्झौता पत्रमा प्रत्यर्थी कम्पनीबाट उधारो कारोवार गर्ने व्यापारिक पक्षले त्यसरी उधारो कारोवारबाट भुक्तानी दिन बाँकी रहेको रकम ३० दिन भित्र भुक्तानी नगरेमा सो समयपछि बाँकी रकमको १३% व्याज समेत थप गरी त्यस्ता व्यापारिक पार्टीले राखेको बैंङ्क ग्यारेन्टी रकमबाट प्रत्यर्थी कम्पनीले असुल उपर गरी लिन सक्ने भन्ने शर्त उल्लेख भएको ।
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Decision of Supreme Court
व्यापारिक पक्षहरु बीच हुने सम्झौतामा यस्तो व्याज समेत थपी लिन पाउने शर्तहरु राख्नुको कारण उधारो दिने पक्षले वित्तिय संस्थाहरुबाट आफ्नो कारोवारको सिलसिलामा नपुग हुने रकम ऋणको रुपमा लिने र चुक्ता गर्न बाँकी त्यस्तो ऋणको व्याज आफूले बुझाउनु पर्ने भएकोले हो । वित्तिय संस्थाबाट लिएको चुक्ता गर्न बाँकी ऋणमा तिरेको व्याज रकम त्यस्तो उधारो बिक्री गर्ने व्यापारिक कम्पनीले आयकर ऐन, २०३१ को दफा १२(ग) बमोजिम सम्बन्धित आयवर्षको आयमा कटाई खुद आय कायम गर्न दावी गर्न सक्ने भएकोले त्यसरी आफूले तिर्ने व्याज आयबाट कट्टा गर्न दावी गर्ने पक्षले आफूले उठाउनु पर्ने उधारो कारोवारमा पनि बाँकी रहेको रकमको त्यही अनुपातमा व्याज असुल उपर गरी आयमा देखाउनु वाञ्छनिय हुन्छ । तिर्नुपर्ने रकमको ब्याज तिरेको भनी आयबाट कट्टा गर्ने तर लिनुपर्ने रकम लामो समयसम्म असुल नगरी प्रतिफल प्राप्त नगर्ने कार्यबाट उक्त ऐनको दफा १२(ग) को कानूनी व्यवस्थाको दुरुपयोग गरेको भन्ने देखिनुका साथै कर दायित्व कम गर्ने वा कर दायित्व छल्ने षडयन्त्रको रुपमा उक्त दफा १२(ग) को व्यवस्था प्रयोग गरेको भन्ने देखिन जान्छ । लेखाको सामान्य सिद्धान्त अनुसार कुनै आय वर्षमा प्राप्त हुनुपर्ने रकम प्राप्त भई नसकेको भएपनि त्यसै बर्षको आयमा समावेश गरिने भएकोले भुक्तानी प्राप्त गर्ने अधिकार श्रृजना भएपछि भुक्तानी प्राप्त नभएता पनि भुक्तानी प्राप्त गरेको मानी आय गणनामा समावेश गर्नुपर्ने हुन्छ । यसप्रकार प्रत्यर्थी कम्पनीले आ.व. २०५७/०५८ मा भएका सम्झौता अनुरुप उधारो कारोवारमा अन्य पक्षबाट भुक्तानी लिन बाँकी रकमको व्याज सम्झौतामा उल्लेखित म्यादपछि स्वतः प्राप्त गरेको मान्नु हुन्छ । यस्तो अवस्थामा प्रत्यर्थी कम्पनीले सम्झौतामा उल्लेखित म्याद पछि भुक्तानी पाउन बाँकी रकमको व्याज स्वतः प्राप्त गरेको मान्नु पर्ने भएकोले त्यस्तो व्याज रकम स्वतः प्रत्यर्थीको आ.व. २०५७/०५८ को आयमा समावेश गर्नुपर्ने हुन्छ । साथै आयकर ऐन, २०३१ को दफा ७ ले कुनै व्यक्तिको उद्योग, व्यापार, पेशा व्यवसायबाट भएको आय निर्धारण गर्दा सो व्यक्तिको आयवर्ष भित्र कुनै उद्योग, व्यापार, पेशा, व्यवसायबाट प्राप्त गरेको सबै किसिमको मुनाफा वा लाभ समावेश गरी आय निर्धारण गर्नुपर्ने भन्ने कानूनी व्यवस्था गरेको देखिएबाट प्रत्यर्थी कम्पनीले उधारो कारोवारमा भुक्तानी लिन बाँकी रकमको सम्झौता बमोजिम प्राप्त हुने व्याज पनि कम्पनीको आय भित्रै पर्ने देखियो । त्यस्तै वित्तिय संस्थाबाट ऋण लिई तिर्नुपर्ने व्याज सम्बन्धित आर्थिक वर्षको आयबा कटाई आयकर निर्धारण गर्न चाहने करदाताले अन्य कुनै व्यक्ति वा फर्मलाई दिएको सापटी, अधिक वर्ष सुविधा वा उधारोमा सामान विक्री गरेको वा उधारो विक्री (Credit Sales) दिएको अवस्थामा त्यसरी दिएको सापटी वा उधारो रकम बराबरको हुने व्याज रकमलाई त्यस्तो करदाताको आय मान्नु पर्ने अथवा त्यस्तो करदाताले आयबाट छुट पाउने रकममा त्यस्तो सापटी वा उधारो दिएको रकमको व्याज बराबरको रकम समावेश गर्न नमिल्ने भनी यस अदालतबाट २०६४–CR–०५२९ को ठूला करदाता कार्यालय ललितपुर विरुद्ध मल्टि फाईवसर् लि. भएको मुद्दामा सिद्धान्त कायम भैसकेको देखिँदा यी प्रत्यर्थी प्राईम इन्टरनेशनल प्रा.लि. ले आ.व. २०५७/०५८ मा अन्य विभिन्न व्यापारिक फर्मलाई विक्री गरेको उधारो कारोवारबाट प्राप्त हुनुपर्ने व्याज समेत कम्पनीको सो आ.व. को करयोग्य आयमा समावेश गर्नुपर्ने देखियो ।
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As discussed above, does all variable consideration qualify to be recognized as income? No. It depends. Variable considerations are subject to influences that may or may not be within the influence of the company. There may be elements of uncertainty and entity’s experience and practice on collection of the past revenues There may be large number of possible situations which may not require the recognition of variable consideration as income. Surely, the case of ठूला करदाता कार्यालय हरिहरभवन विरुद्ध प्राईम इन्टरनेशनल प्रा.लि. and ठूला करदाता कार्यालय ललितपुर विरुद्ध मल्टि फाईवसर् लि. had an opportunity for dissecting the concept of variable consideration as not all contractual rights qualifies for recognition as revenue.