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A four-year service contract allows the customer to cancel without cause at the end of each year but requires payment of a SUBSTANTIVE termination penalty (one that decreases each year). Under Ind AS 115, the contract term is:
AThe weighted average of historical contract durations with comparable customers
BIndeterminate — Ind AS 115 cannot be applied to penalty-laden contracts
CFour years — a substantive termination penalty is evidence of enforceable rights and obligations over the full period covered by the penalty
DOne year only, with annual renewals re-assessed at each anniversary
Answer & Solution
Correct answer: C. Four years — a substantive termination penalty is evidence of enforceable rights and obligations over the full period covered by the penalty
A substantive termination penalty payable by the customer is evidence that both parties have enforceable rights and obligations over the full period covered by the penalty. The contract is treated as a four-year arrangement, unless past experience with the customer (or class of customer) demonstrates that early termination is actually likely — in which case the assessed term may be shorter.
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