Query A consulting company provides
project management and design services to customers on very large
projects that take significant time to complete. The company raises
monthly bills for work done, which are promptly paid by the customers.
However, the customers retain 10% as retention money, which is released
one year after the contract is satisfactorily completed. The 10%
retention money is a normal feature in the industry, and is more akin to
providing a security to the customer rather than a financing
transaction.
Under Ind-AS, is the consulting company required to discount retention monies?
Response
Technical Literature
1.
Under Ind AS 18 Revenue is measured at the fair value of consideration
received or receivable. Further, Ind AS 18 states as below:
“In
most cases, the consideration is in the form of cash or cash equivalents
and the amount of revenue is the amount of cash or cash equivalents
received or receivable. However, when the inflow of cash or cash
equivalents is deferred, the fair value of the consideration may be less
than the nominal amount of cash received or receivable. For example, an
entity may provide interest-free credit to the buyer or accept a note
receivable bearing a below-market interest rate from the buyer as
consideration for the sale of goods. When the arrangement effectively
constitutes a financing transaction, the fair value of the consideration
is determined by discounting all future receipts using an imputed rate
of interest…………….The difference between the fair value and the nominal
amount of the consideration is recognised as interest revenue in
accordance with Ind AS 109.”
2. Further IAS 18 provides an example with respect to instalment sales when consideration is receivable in instalments.
“Revenue
attributable to the sales price, exclusive of interest, is recognised
at the date of sale. The sale price is the present value of the
consideration, determined by discounting the instalments receivable at
the imputed rate of interest. The interest element is recognised as
revenue as it is earned, using the effective interest method.”
3.
Ind AS 115 Revenue from Contracts with Customers prohibits discounting
of retention monies when the retention monies do not reflect a financing
arrangement. For example, the retention money provides the customer
with protection from the supplier failing to adequately complete some or
all of its obligations under the contract. Further even in arrangements
where there is significant financing component, practical expediency
not to discount was allowed, provided the financing was for a period
less than one year. Ind AS 109 Financial Instruments was aligned to Ind
AS 115, and did not require any discounting if the trade receivables did
not contain a significant financing component or when the practical
expediency was available.
4. On withdrawal of Ind AS 115, the alignment paragraph in Ind AS 109 discussed above was also removed.
Possible Views
View 1: No discounting is required
The
arrangement does not entail instalment payments nor is a financing
transaction under Ind AS 18, and hence discounting of retention money is
not required. Though Ind AS 18 does not provide further elaboration on
what constitutes a financing arrangement, guidance is available in Ind
AS 115. Based on this guidance, retention money is on normal terms and
common to the industry and represents a source of protection with
respect to contract performance rather than a source of financing.
Though Ind AS 115 is withdrawn, the guidance on what constitutes a
financing transaction, in the absence of any guidance in Ind AS 18, is
useful and may be applied.
Though Ind AS 109 requires discounting of retention money, one may argue that Ind AS 18 should be allowed to trump Ind AS 109.
View 2: Discounting is required
The
requirement in Ind AS 18 to determine revenue at the fair value of
consideration received or receivable would necessitate the discounting
of retention money. The provisions in IFRS 13 Fair Value, and Ind AS 109
Financial Instruments would also require discounting of retention
money. In essence, in any arrangement where money is not paid
instantly, there will be a time value of money, which needs to be
recognized. The reason for which the payment is not made instantly or delayed is not relevant.
Author’s View
View
2 is the preferred view. However, View 1 should not be ruled out
because Ind AS 18 does not require discounting when the arrangement does
not effectively constitute a financing arrangement. View 1 can be ruled
out, only if Ind AS 18 is suitably amended to remove the reference to
financing arrangements. Suggest Institute should issue a clarification.
