Revenue or the ‘top line' is one of the most closely monitored measures in financial performance. It is a key metric that is subject to considerable focus by investors, analyst and other stakeholders.

In India, revenue recognition is mainly governed by Accounting Standard (AS) 9 issued in 1985, which is primarily based on International Accounting Standard (IAS) 18 issued in 1982. AS 9 provides guidance on recognition of revenue but it provides limited guidance on measurement of revenue. The standard was relevant when transactions were simple.

In the present time, with structured and complex transactions, companies are interpreting the standard to their best of ability and may sometime refer to international standards.

For example, with similar fact pattern, some entities recognise revenue on dispatch of goods while others recognise revenue on delivery of goods to the buyer, wherein both have strong arguments for justifying the risk and rewards transfer at a different point of time.

The global scene

Even globally, revenue recognition has been a matter of debate and changes. IAS 18 was reissued in 1993 followed by industry-specific guidance and interpretations at later dates, resulting in a tangled web of special rules and exceptions created to address specific industries, transactions and business models.

Now, the IASB and the FASB are working jointly to replace the existing IFRS and US GAAP revenue guidance with a new global accounting standard.

This will apply a single set of principles to all revenue transactions, regardless of industry and business models. The boards published an exposure draft (ED) in June 2010 and received extensive feedback. This led to re-issue of ED in November 2011.

Under the proposed model, a company would need to apply five steps to recognise revenue, namely;

Identify a contract with the customer;

Identify separate performance obligations in the contract;

Determine the transaction price;

Allocate the transaction price among separate performance obligations;

Recognise revenue when a performance obligation is satisfied.

The impact of the change to the revenue model could affect key financial measures and ratios. The examples below represent only a small sample of affected transaction or companies.

Impact of the change

For technology companies, multiple performance obligations (such as hardware, extended maintenance and other service elements) will be accounted for separately, impacting the timing of revenue recognition, which is accounted differently by different companies.

Companies having construction-type contracts usually recognise revenue based on percentage of completion, record contract costs, and account for change orders.

The new model has similar concepts but there are nuances that could catch someone by surprise.

There could be differences in the costs that are capitalised or how progress of completion is measured. At the extreme, some arrangements might not result in revenue until the project is complete.

In a contract for development of an asset, revenue recognition will occur only if the customer controls the asset as it is developed.

Each company will have to assess its own specific facts under the new model. Further accounting for warranties and other post-delivery services may change, which are very common in the automotive, manufacturing, FMCG, pharmaceuticals and technology industries.

Currently, these are accounted for as cost accruals rather than as ‘deliverables' in or ‘components' of a contract. In the proposed model, entities may have to account for those obligations as performance obligations and would recognise revenue as they are satisfied.

What does this mean

From an India perspective, it would have to catch up from its basic standard to the proposed new standard.

The most fundamental change would be to review the underlying substance of the transaction; and companies with structured and complex transaction could see significant changes to the way revenue transactions are accounted and to the related processes and systems.

Management should evaluate existing business practices under the new model, including how products or service offerings are bundled and priced, and begin assessing the need to negotiate revised contract terms and/or impact on the current data capturing system.

(The author is Executive Director, PwC India. With inputs from Parth Maheshwari, Assistant Manager.)

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