Did you know that the Revenue Model of the Automobile Industry has completely changed due to the implementation of IND AS 115 and IFRS 15? This has impacted the Net Profits of major Automobile Companies like Tata Motors, M&M and Ashok Leyland. Let us find out how!
What are Multiple Element Contracts?
Multiple-element contracts are when the seller provides more than one or a combination of products or services to the buyer.
What was the Revenue Recognition of Multiple Element Contracts as per IGAAP?
Under IGAAP there was no specific requirement of unbundling of services. Entire revenue was recognized upfront.
How are Multiple Element Contracts accounted as per the new Revenue Recognition Standard?
As per IND AS 115 and IFRS 15, “components of sale are to be UNBUNDLED and recognized SEPARATELY at the Time of the Performance if the goods or services are DISTINCT”.
How to assess whether a good or service is distinct? – Determine through the below 2-step model:
Step 1– The customer can benefit from the good or service individually or with other readily available resources.
Step 2– The goods or services are NOT highly interrelated with other promised goods or services in the contract.
Coming back to how this changed the entire revenue recognition of the automobile industry, let us understand with the help of an example:
In April 2021, Ashok Leyland sold 50 trucks to a UPS Logistics, a leading transport company at INR 15 lakhs each. Below were the terms agreed upon between Ashok Leyland and UPS Logistics while finalizing the sale:
- A 5-year warranty at an additional charge of INR 1 lakh per truck. (This is optional at the buyer’s end, UPS chose to purchase the 5-year warranty)
- Maintenance of trucks after every 6 months for the next 2 years included in the sale price (which would have otherwise cost INR 50,000 from a third party)
- As per IND AS 115, Ashok Leyland will first determine if each component of the sale is “DISTINCT”.
The sale components in the above transaction are:
- Sale of Actual trucks
- Sale of 5-year Warranty
- Sale of Maintenance Contract
Applying the above 2 steps, it can be concluded that the 5-year warranty and Maintenance Contract can be “used to the benefit of the Customer individually” and are “not highly dependent on other promised goods or services in the contract”.
Which implies that each component will be unbundled and recognized SEPARATELY at the Time of the Performance.
Therefore, Revenue Recognition by Ashok Leyland will be as below:
- April 2021: Sale of Trucks.
- Warranty: A contract asset of INR 1 lakh per truck will be created for Warranty which will be deferred over a period of 5 years
- Maintenance Contract: Maintenance Service is provided after every 6 months for two years i.e., a total of 4 times.
Therefore, after every 6-months INR 12,500 (50,000/4) will be recognized at the time of provision of such maintenance service.
What is the impact of this changed Revenue Recognition Model on the bottom-line of the Organization?
This changed way of Revenue Recognition as per IND AS 115 and IFRS 15 will lead to a DEFERRED Revenue recognition(Warranty over 5 years and Maintenance Contract at over 2 years) rather than upfront recognition as per IGAAP leading to a direct impact on the EBITDA and Net Profits of Ashok Leyland!
Let me know in the comments below if you found this insightful!
To know more on how the new Revenue Recognition Standard will have an impact on the bottom-line of the organization & to Once & for all uncomplicate the technically daunting IFRS 15 standard on Revenue from Contracts with Customers, attend my 2.5 hour breakthrough workshop on “IFRS 15: Deep Dive- to Practically Understand Revenue Recognition! Register Here
