1.63 Query
(a) Accounting treatment of Works Contract Transactions—1. As per the accounting standard of the Institute ‘Disclosure of Accounting Policies’ (AS-1), if a fundamental accounting assumption is not followed, the fact should be disclosed.
(a)Please clarify whether a mere disclosure that certain expenses/income are accounted for on cash basis can be treated as sufficient compliance of the provisions of the Companies Act? (b)In one of the companies, a note to the accounts was as follows:
‘Sales includes Rs……….. representing value of ……….. equipments (including………… equipments for which tyres of other than appropriate ply were available) awaiting despatch as on…………which were unconditionally appropriated to sales contract as per Accounting Policy……….’ In this connection please clarify : (i) Can sales include works contract?
(ii) Can the auditors report that the accounts give a true and fair view since in this case the revenue has been recognised before the title passed on to the customer and the profit on such sales was not realised?
Opinion August 16, 1980
(a)In the opinion of the Committee a mere disclosure that certain expenses/income are accounted for on cash basis is not enough. The accounting policy by itself should be valid in accordance with trade practice, custom, legal requirement, if any, and materiality. Bearing in mind the concept of materiality, the amount of outstanding expenses or income not provided in the accounts should also be disclosed and its impact on the disclosure of true and fair view of the accounts should also be considered.
(b)(i)Reply to the query whether sales could include works contractor not would depend upon the terms and nature of the contract. A composite contract which includes procurement of materials and some processing or labour charges and stipulated supply of the finished product to the contractee may be included in sales, if the supply of the product is the main term of the contract. Treatment of such transaction under Sales Tax Act and other relevant factors like the nature of transaction and business of the concern should also be given due consideration. (b) (ii) Normally, a sale takes place when the property in the goods passes to the customer. In order to decide the point of time when property passes in case of sale or works contract, relevant provisions of the Sale of Goods Act and the Transfer of Property Act have to be considered. It becomes difficult to answer a general question like this in the absence of knowledge of specific circumstances of the case. For example in the case of long term contracts which are spread over a number of years, income or profit can be taken credit for on a reasonable commercial basis even before the ‘property’ passes to the contractee. Query (b) Accounting treatment of Works Contract Transactions—2
A company purchases goods on behalf of a customer for execution of work under a works contract and against which the company receives full payment and declaration forms under the Central Sales Tax Act to be passed on to the supplier. Whether such purchases can be treated as purchases of the company and shown as a debit in profit and loss account and with a note that the goods are held in ‘trust’ . Opinion August 16, 1980
Where the goods were purchased on behalf of a customer in the capacity of an agent for execution of work under a works contract and against which the company receives full payment, such purchases should not be treated as purchases of the company and debited to profit and loss account. However, if the purchases are not made in the capacity of an agent the same will have to be shown as purchases of the company. In order to decide whether purchases are made in the capacity of an agent or not, the name in which purchases are made, and the name under which the declaration forms under the Sales Tax Act have been issued will have to be taken into consideration. Query
(c) Treatment of surplus on sale of fixed assets in accounts. Whether the amount realised in excess of cost of sale of fixed assets can be included in the profit for the year and whether it can be used for the purpose of declaration of dividend?
Opinion August 16, 1980
There is no specific provision in the Companies Act, 1956, or in Table A embodying model set of Articles of Association which a Company may adopt, in regard to the treatment of amount realised in excess of cost on sale of fixed assets. However, according to the accepted accounting conventions there would be no objection to include the excess amount realised on sale of fixed assets in the profit for the year and to declare dividend, provided the following conditions are fulfilled: -
(1) There is no prohibition in the Articles of Association of the company for such treatment. (2) There is no fall in the value of other assets. (3) ‘Capital Profit’ has been realised. The same should not be on account of revaluation of fixed assets. Query (d) Accounting treatment of receipts/payments arising out of escalation clause/liquidated damages/penalty under works/sales contract.
(a) Where works/sales contract has an escalation clause, can such claim be estimated at the end of the year and included in sales though bill therefore is raised only on completion of the contract and is subject to acceptance by the customer?
(b) Whether liquidated damages/penalty payable under works/sales contract for delivery can be deducted from sales and shown net in the profit and loss account?
Opinion August 16, 1980
(a)Claim under the escalation clause in works/sales contract at the end of the year may be accounted by including the same in sales or closing work-in-progress where accounts are maintained on accrual basis though the bill is raised only on completion of the contract and is subject to acceptance by the customer, provided the claim for escalation is computed within clear and undisputed terms of the contract. (b)In the opinion of the Committee, separate disclosure of liquidated damages/penalty payable under works/sales contract for delayed delivery is necessary if the amount is material and it would not be proper to deduct the same from the sales and show the net amount in the profit and loss account. Query
(e) Physical verification of Work-in-Progress.
(a) Is it a duty of the auditor to qualify his report if in a company the physical inventory of work-in-progress is not taken? If so, mode of qualification may be given.
(b) It has also been observed that the work-in-progress is stated to be valued at cost. However, the same can never be valued at actual cost as it depends upon adjustments made regarding cost of production. For example, where batch costing is adopted, in the case of incomplete batches at the end of the year, total cost is reduced by either standard or estimated cost of production of completed units to arrive at the work-in-progress. In such cases what is the duty of the auditor vis-à-vis valuation of stock, disclosure of the method of valuation.
Opinion August 16, 1980
(a)Answer to this question cannot be given in isolation since it will depend upon the manner of accounting, detailed records kept and internal control exercised. It can, however, be stated that it will be the duty of the auditor to satisfy that the work-in-progress did exist on the balance sheet date and the value placed on it is in accordance with the accepted method of valuation that has been consistently followed.
(b)If the auditor is satisfied with the reasonableness and justification of the adjustments, he can consider that the work-in-progress has been valued at cost even though some adjustments have been made. Query (f) Presentation of amounts received against equity pending allotment, in the balance sheet of Government Companies. Some Government Companies are showing the amount received against equity pending allotment on date of closure of accounts either under ‘Share Capital’ or under a separate head before ‘Secured Loans’. Can such a disclosure be in conformity with the Companies Act? In our opinion the same must be shown under ‘Current Liabilities’. It may be noted that the amount received, under normal circumstances, cannot be refunded and generally shares are allotted at the Board meeting held immediately thereafter.
Opinion August 16, 1980
Disclosure of the amount received by the Government Companies against equity pending allotment on the date of balance sheet does not fit in exactly under any of the heads provided in the form of balance sheet under Part-I of Schedule VI to the Companies Act, 1956. It may be argued that the nature of transaction is of a loan until the equity shares are allotted and as such the same may be shown under the head ‘Unsecured Loans’. However, the Committee is of the opinion that it would be preferable to exhibit the item separately after the head ‘Share Capital’. ___________________________ |