How Reliance will record its new phone in the books of accounts!

A couple of days back, emerging telecom giant Reliance Jio has announced that it will come up with its own 4G enabled feature phones to capture estimated $154 million feature phone market.

The company announced that the customer needs to pay a sum of INR 1500 as an initial deposit and the company will pay back INR 1500 back after 3 years if being returned by the customer.

Now here arises the accounting discussion that how the R-Jio will record this transaction into its books of account. Whether will it show the money received as deposits on the assets side of the balance sheet or it will recognize it as revenue? Or if it recognizes it as revenue than whether it will recognize partially or fully?

So, first of all, let's understand the term 'Deposit'

As per Investopedia the term 'Deposit' means-

1. A transaction involving a transfer of funds to another party for safekeeping.
2. A portion of funds that are used as security or collateral for the delivery of a good.

Here in the case of R-Jio, it is a combination of both.

What is the accounting standard saying?

As per Ind-AS 18: Revenue Recognition-

Revenue from the sale of goods shall be recognized when all the following conditions have been satisfied:

(a) the entity has transferred to the buyer the significant risks and rewards of ownership of the goods;
(b) the entity retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;
(c) the amount of revenue can be measured reliably;
(d) it is probable that the economic benefits associated with the transaction will flow to the entity; and
(e) the costs incurred or to be incurred in respect of the transaction can be measured reliably.

Interpretation of this Accounting Standard in case of R-Jio-

For point no. (a)
Yes, the significant risks and rewards of ownership lie with the buyer in case of a feature phone, if the buyer safely returns the phone then only he/she will be able to get back the money.

For point no. (b)
Yes, there will be no effective control on the phone by the company.

For point no. (c)
Yes, the amount can be measured reasonably

For point no. (d)
Yes, the economic benefits are flowing to the entity.

For point no. (e)
Yes, the cost can also be measured reliably.

So, it satisfies all the five conditions of revenue recognition.

Whether can it be termed as 'Operating Lease'?

As per business dictionary definition, an operating lease is a-

Cancellable short-term (a period shorter than the economic life of the leased asset) lease written commonly by landlords and equipment manufacturers who expect to take back the leased asset after the lease term and re-lease it to other users. The lessor gives the lessee the exclusive right to possess and use the leased asset for a specific period and under specified conditions but retains almost all risks and rewards of the ownership. The full amount of lease payments is charged as an expense on the lessee's income statement but no associated asset or liability (other than the liability of the accrued lease payment or rent) appears on the lessee's balance sheet.

The feature phone transaction could have fallen into the category of the operating lease if the ownership and risk rewards would have remained with the Reliance but here it is not the case so, it is not an operating lease transaction.

What about the expenses?

Yes, here comes the Matching concept of the accounting which says that -

'Matching Principle requires that expenses incurred by an organization must be charged to the income statement in the accounting period in which the revenue, to which those expenses relate, is earned.”So, if the company shows the expenses of the feature phone in its books of account than it has to recognize the revenue against the same.

What about the liability after three years?

As per Ind-AS 37:

A provision shall be recognized when:

(a) an entity has a present obligation (legal or constructive) as a result of a past event;
(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and
(c) a reliable estimate can be made of the amount of the obligation. If these conditions are not met, no provision shall be recognized

What can be the final treatment in the books?

Based on the above analysis the entity should record the revenue in the first year itself and all the cost associated with it in the first year and it should make a provision for the expected liability to be incurred at the year end (since all the conditions of Ind-AS 37 are being fulfilled). The amount of actual return should be first charged to the provisions and the remaining amount if any, should be charged to the profit and loss statement of the third year.

The author is a Chartered Accountant, currently pursuing two years' full-time MBA program at IIM Udaipur.

Note: This article is written based on my own understanding of the topic, please feel free to comment your views about the same