1.10 Query
Application of MAOCARO, 1988 to a service company.
1. A company is engaged in servicing of T.V. sets. Mainly two types of services are rendered by it:
a) Annual Contract Basis The company undertakes contracts for servicing a T.V. set for one year and charges a lumpsum amount for the same ranging between Rs. 200/- to Rs. 300/- per contract, per year, depending upon the models. During the period of contract, the company does not charge for technicians’ visits and components are replaced free of charge.
b) Casual Visit Charges The company charges a customer on visit basis including for the components replaced by them.
2.For the purpose of rendering the above services, the company has employed nearly 50 technicians who have to use large number of various components ranging between 500 to 600. A technician attends nearly 5 to 6 complaints in a day. The complaints attended to by the technicians may be from the two categories of services stated in para 1 above. Generally, the services are rendered at the customers’ houses. The technicians have to undertake a lot of travelling and, therefore, it is difficult to allocate time to a particular job attended to by a technician.
3.The querist has stated that due to the large variety of components, it is not practicable and economical for the company to maintain records for consumption of components and, therefore, it intends to write off the entire purchases of components in the year in which they are purchased.
4.Keeping in view the provisions of MAOCARO, the company wants to put a note to the accounts as under:
“No records have been maintained for receipts and consumption of components used in service activities of the company. The components purchased by the company during the year have been treated as consumed, thereby not showing any closing stock of components as at the end of the accounting year.”
5.The querist has referred the following issues for the opinion of Expert Advisory Committee:
a) Whether such an accounting practice is in accordance with the normally accepted accounting principles?
b) What should be the auditor’s comments about such practices in his audit report?
Opinion April 12, 1990
1.The Committee is of the view that paragraphs 4(A)(iii), 4A(iv), 4A(v), 4A(vi) and 4A(xii) of the MAOCARO, 1988 are applicable to the company as far as stock of components is concerned. The Committee is also of the view that the company being a service company, paragraphs 4B(ii), 4B(iii) and 4B(iv) of the abovesaid Order are also applicable to the company.
2.The Committee notes paragraphs 29,31,48 and 49 of ‘Statement on the Manufacturing and Other Companies (Auditor’s Report) Order, 1988’, issued by the Institute of Chartered Accountants of India, which state, as below:
“29. Whether physical verification has been conducted by the management at reasonable intervals in respect of finished goods, stores, spare parts and raw materials. [Paragraph 4(A) (iii)]
Comments
Physical verification of stocks is the responsibility of the management of the company which should verify all material items atleast once in a year and more often in appropriate cases. It may be useful for the company to determine the frequency of verification by ‘A-B-C’ classification of stocks, ‘A’ category items being verified more frequently than ‘B’ category and the latter more frequently than ‘C’ category items.
31. Whether any material discrepancies have been noticed on physical verification of stocks as compared to book records, and if so, whether the same have been properly dealt with in the books of account? [Paragraph 4(A)(v)]
Comments
The Order requires the auditor to examine if material discrepancies have been noticed on verification of stocks when compared with book records1. Such an examination is possible when quantity records are maintained but there are many companies where records of individual issues (particularly for stores items) are not separately maintained and the closing stock is established only on the basis of a year-end physical verification. Where such day-to-day records are not maintained, the auditor will not be able to arrive at book stocks except on the basis of an annual reconciliation of opening stock, purchases and consumption. This reconciliation is possible when consumption in units can be correlated to the production, or can be established with reasonable accuracy. Where such reconciliation is not possible, the auditor would be unable to determine the discrepancies. If the item for which the discrepancy cannot be established is not material, the discrepancy, if any, will also not be material. In other cases, however, the auditor will have to report that he is unable to determine the discrepancy, if any, on physical verification for the item or class of items to be specified.
48. Whether the company has a reasonable system of recording receipts, issues and consumption of material and stores and allocating materials consumed to the relative jobs, commensurate with its size and nature of its business. [Paragraph 4(B) (ii)]
Comments
(a) The system for recording transactions regarding materials and stores and allocating materials consumed to the relative jobs should be reasonable having regard to the size of the company and the nature of its business. In deciding about the reasonableness of the system, the following are some of the important factors to be considered:
(i) The total cost of materials and stores consumed- both in absolute terms and as a percentage of the total turnover of the company. Having regard to the nature of the service rendered, it is possible that the total cost may be too small to require any elaborate system.
(ii) The number of sites at which the company operates and the nature and location of the materials and stores.
(iii) The ownership of the materials and stores. It is possible that the company which renders the service may not be the owner of the material or stores, the ownership remaining with the customer. Even in such cases, where custody is with the company, reasonable records should be maintained.
(iv) The extent to which materials can be identified with individual jobs.
(b) The purpose of recording of receipts, issues and consumption of materials and stores and allocation of materials consumed to the relative jobs is to ensure that all materials and stores are accounted for and that there is a reasonable basis of ascertainment of costs of individual jobs. If, in the circumstances of the case, the auditor is satisfied that these objectives are achieved by the system in force, he should not make an adverse report. An example of such a report would be the following:
“There is a reasonable system for recording receipts, issues and consumption of materials and stores commensurate with the size of the company and the nature of its business. Though allocation of materials is not made to relative jobs, there is, in our opinion, an adequate system for control of the total material consumed and for determination of costs of individual jobs.”
49. Whether the company has a reasonable system of allocating man-hours utilised to the relative jobs, commensurate with its size and nature of its business. [Paragraph 4(B)(iii)]
Comments
(a) Under this clause, the auditor is required to report on the system of allocation of manhours utilized to the relative jobs. The term “manhours” in the clause seems to refer to labour cost incurred by the company. There can be various bases of allocating labour costs to the relative jobs. The auditor should satisfy himself that the basis adopted by the company ensures that all labour costs are accounted for and that there is a reasonable basis of ascertainment of costs of individual jobs.
(b) The comments made in paragraph 48 would be applicable, to the extent relevant, to this clause also.”
3.The Committee is of the view, that in the present case, the company should maintain records for receipt of various components.
4.The Committee is also of the view that the company should classify the various components according to ABC Analysis into A, B and C categories. Appropriate records for issues of ‘A’ and ‘B’ category components should be maintained. However, no records for issue of ‘C’ category components may be maintained if their value is insignificant and the number of issues are very large and it is not practicable and economical to maintain such records. However, in the view of the Committee, there should be adequate system of authorisation and control on the issue of such components also.
5.The Committee is of the view that ‘A’ category items should be verified more frequently than ‘B’ category and the latter more frequently than ‘C’ category. However, since in the case of ‘C’ category items, no records need be kept for issue thereof, for the purpose of valuation of stock of such items, it is necessary for the management to carry out physical stock taking at the end of the year and at such periodical intervals as the management may deem proper.
6.The Committee is also of the view that the company should have a reasonable system of allocating manhours urtilized to various jobs as stated in para 49 of the ‘Statement on Manufacturing and Other Companies (Auditor’s Report) Order, 1988’, issued by the Institute of Chartered Accountants of India.
7.The Committee is accordingly of the following opinion:
a) The accounting practice sought to be adopted by the company is not correct. b) The auditor should qualify his report as to non-compliance by the company of paragraphs 4(A)(iii), 4A(iv), 4A(v), 4A(vi), 4A(xii), 4B(ii), 4B(iii) and 4B(iv) of MAOCARO, 1988. The auditor should not qualify his report in case the procedures on the lines of the above mentioned paragraphs are followed by the company and the auditor is satisfied with reasonableness of such procedures.
__________________________ 1 The corresponding clause in the earlier Order used the word “significant” in place of the word “material”. |