Background
Company A sells handsets—either for upfront cash or for payment in installments. Until recently, its pricing was:
• Rs. 810 for upfront cash; or
• 36 monthly installments of Rs. 25 (total Rs. 900), implying an interest rate of 7% pa on the cash price of Rs. 810.
New competitors that sell handsets for cash but not on credit have entered the market—this has led to a drop in the cash sale price to Rs. 621 but A still makes most of its sales on credit on the same terms as before (i.e. Rs. 25 a month for 36 months).
This gives an imputed interest rate of 29% pa on the installment contract relative to the new cash price of Rs. 621. A believes this implied interest rate is unreasonably high. It sells some receivables on a non-recourse basis at yields approximating 7-8% pa.
How should A measure its revenues from handsets?
Options under Indian GAAP
View 1-The fair value of the consideration is the cash sale price (i.e. Revenue Rs. 621)
Since the handsets sold have a cash alternative price that is clearly determinable, revenue should be recognised at this price. In addition, even if the fair value of the consideration were higher than the cash sale price, this premium represents a payment for services to be received (financing services) that should be recognised over the service period as part of finance income rather than immediately as part of revenue from selling the handset.
The support for this view can be found in AS-9 itself. As per the illustration in AS 9 Revenue Recognition, “When the consideration is receivable in installments, revenue attributable to the sales price exclusive of interest should be recognised at the date of sale. The interest element should be recognised as revenue, proportionately to the unpaid balance due to the seller.” Though this paragraph supports the discounting of the installments, it does not provide any guidance on how the interest is determined. Therefore it is possible to determine the cash sale price based on an observable market and to treat the residue as interest, though that interest amount is much higher than the market.
View 2-The fair value of the consideration is the price derived by discounting the installment payments using market-based interest rates (i.e. Revenue Rs. 810)
The support for this view can be found in AS-9 itself. As per the illustration in AS 9 Revenue Recognition, “When the consideration is receivable in installments, revenue attributable to the sales price exclusive of interest should be recognised at the date of sale. The interest element should be recognised as revenue, proportionately to the unpaid balance due to the seller.” Though this paragraph supports the discounting of the installments, it does not provide any guidance on how the interest is determined. Therefore, it is possible to determine the cash sale price by discounting the installments at the market yield of 7% p.a.
In addition, Paragraph 47 of AS 30 Financial Instruments Recognition and Measurement (not yet mandatory) states that the initial measurement of financial assets should be based on their fair value and the receivables are the consideration being valued. Therefore, under this view the fair value of the consideration should be derived by discounting the future cash flows using market-related interest rates.
View 3–No discounting (i.e. Revenue Rs. 900)
The illustration in AS-9 requires discounting in the case of installment sales. If the fact pattern was somewhat different, so that the payment was not based on installments, but the sales were on deferred payment terms, then discounting may not be required. For example, sale was made at Rs. 900 but entire payment of Rs. 900 is collected after six months. In such a case, it may be argued that the illustration in AS-9 which applies to installment sales does not apply in this case. This may be particularly true in schemes where a customer paying upfront or a customer paying over a short period, say 6 months, ends up paying the same amount. In other words, there is no interest amount to be imputed or the interest amount is immaterial. An interesting point to note is that under IAS 18 Revenue, revenue is always recognised at fair value of the consideration, and hence discounting is mandatory unless immaterial. Unlike IAS 18, under AS-9 there is no requirement to recognise revenue at fair value. The illustration in AS 9 to discount and separate revenue and finance income is only applicable when the sales are made purely on an installment payment scheme.
View 4-Accounting policy choice
In the absence of any detailed guidance, the author believes that either of the views above can be accepted. I suggest that the Institute should provide guidance as the object of an accounting standard is to eliminate diverse accounting practices.
