1.26 Query
Booking of sales in respect of despatches of materials on F.O.R destination basis in case of a construction contract.
1.A public sector company manufacturing power generating equipments and auxiliaries, manufactures both long production cycle items such as hydro and thermal sets, boilers and compressors, etc. and short production cycle items such as electrical machines, transformers, switchgears, insulators, etc. The accounting policies of the company regarding valuation of turnover are placed at Annexure I. As per Accounting Policy No. 2(A) (i) & (ii), despatches against long production cycle items are valued at 97.5% of the realisable value (or in its absence, quoted price), if the aggregate value of despatches including despatches with customers represent 30% or more of the realisable value. Otherwise, the despatches are valued at actual/ estimated factory cost or 97.5% of the realisable value, whichever is lower. In the case of all other products, sales and despatches with customers are taken at realisable value.
2.This policy of setting up sales on despatch of goods has been followed consistently since 1982-83. No distinction is being made in respect of despatches on F.O.R. Ex-factory or F.O.R. Destination.
3.The company’s production is all against customers’ orders and production for stock purposes accounts for a very small percentage (figures not ascertainable). As such, items are appropriated to specific contracts even while in manufacture right from the beginning. At the time of completion of product, there is no uncertainty/ ambiguity about the destination of the product. Thus, if the goods are once delivered to the transporters, the company does not reserve any right of disposal. Generally, the company has not faced the situation where goods once despatched against F.O.R. destination contracts had to be taken back.
4.In line with the policy stated in para 1, despatches against F.O.R. destination contracts are being taken as sales turnover at the time of delivering the goods to the carriers. According to the querist, this policy is in line with the opinion expressed by the Expert Advisory Committee of the Institute of Chartered Accountants of India on Query No. 1.12, reported at page VII-28 of the Compendium of Opinions, Volume VII (First Edition, 1987).
5.The practice stated above, as per the querist, is also in line with the para 11(i) & (ii) of Accounting Standard (AS) 9 on ‘Revenue Recognition’. The emphasis in this Standard is that:
(i) all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership, and
(ii) no significant uncertainty exists regarding the amount of consideration that will be derived from the sale of the goods.
According to the querist, both these conditions are fulfilled by the company at the time the goods are handed over to the transport carriers.
6.According to the querist, the policy being followed by the company for setting up of sales is also not in contravention of Section 23 of the Sale of Goods Act, 1930, (extract given in Annexure II), where the emphasis is that where there is a contract for the sale of unascertained or future goods by description and goods of that description and in a deliverable state are unconditionally appropriated to the contract, either by the seller with the assent of the buyer or by the buyer with the assent of seller, the property in the goods thereupon passes to the buyer. Where, in pursuance of the contract, the seller delivers the goods to a carrier for the purpose of transmission to the buyer and does not reserve the right of disposal, he is deemed to have unconditionally appropriated the goods to the contract.
7. The Comptroller & Auditor General of India has, however, commented on the Annual Accounts of the company for the year 1987-88 and 1988-89 and objected to this practice (Their comments and company’s reply are given in Annexure III).
8.In view of the Accounting Standard (AS) 9 ‘Revenue Recognition’, opinion expressed by the Expert Advisory Committee of the Institute of Chartered Accountants of India and legal position mentioned in section 23 of the Sale of Goods Act, 1930, it is felt by the querist that the existing accounting policy of the company being followed for accounting of sales is correct.
9.The querist has sought the opinion of the Expert Advisory Committee as to whether booking of sales by the company on delivery of goods to the transporters, is correct where contract for sales is on F.O.R. destination basis. The querist has furnished a copy of the contract in question for the reference of the Committee.
Opinion August 22, 1990
1.The Committee notes that the query is in respect of contracts for manufacture and supply of long production cycle items which are complex pieces of equipment of the type specified in para 1 of the query, although the company is also manufacturing short production cycle items. From the copy of the contract supplied by the querist, the Committee notes, that the company has to complete the contracts in respect of the long production cycle items, in 47 months from the effective date of the contract. The opinion of the Committee is in respect of such long production cycle items.
2. The Committee notes paragraphs 2 and 3 of the Accounting Standard (AS) 7 on ‘Accounting for Construction Contracts’, issued by the Institute of Chartered Accountants of India, which state, inter alia:
“2. The feature which characterises a construction contract dealt with in this statement is the fact that the date at which the contract is secured and the date when the contract activity is completed fall into different accounting periods. The specific duration of the contract performance is not used as a distinguishing feature of a construction contract. Accounting for such contracts is essentially a process of measuring the results of relatively long term events and allocating those results to relatively short term accounting periods.
3.For the purposes of this statement a construction contract is a contract for the construction of an asset or of a combination of assets which together constitute a single project. Examples of activity covered by such contracts include the construction of bridges, dams, ships, buildings and complex pieces of equipment”. [Emphasis given by Committee]
3.The Committee also notes para 2 of Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, which states, inter alia:
“2. This statement does not deal with the following aspects of revenue recognition to which special considerations apply:
(i) Revenue arising from construction constructs; ***.........."
4.On the basis of the above, the Committee is of the view that in case of contracts of manufacture and supply of long production cycle items which are complex pieces of equipment, the recommendations contained in Accounting Standard (AS) 7 on ‘Accounting for Construction Contracts’, issued by the Institute of Chartered Accountants of India, should apply because the date at which the contract is secured and the date when the contract activity is completed fall into different accounting periods. In view of this, the principles of recognition of revenue in case of sale of goods on FOR destination basis are not applicable in this case. Thus, the opinion referred to by the querist in para 4 of the query is not relevant in the context of the contracts in question.
5.The Committee notes from the facts of the query that the company is following the method of revenue recognition in respect of the said long production cycle items, which is somewhat akin to the percentage of completion method. The Committee is of the opinion that the company can follow this method for revenue recognition if conditions laid down in this regard in para 17 (including sub-paras 17.1 to 17.4) of AS 7 are fulfilled and provisions for foreseeable and unforeseeable losses are made in accordance with para 19 of AS-7. The said paragraphs are reproduced below:
“17. The percentage of completion method can be used if the outcome of the contract can be reliably estimated.
17.1 In the case of fixed price contracts, this degree of reliability would be provided if the following conditions are satisfied:
(i) total contract revenues to be received can be reliably estimated,
(ii) both the costs to complete the contract and the stage of contract performance completed at the reporting date can be reasonably estimated; and
(iii) the costs attributable to the contract can be clearly identified so that actual experience can be compared with prior estimates.
17.2 Profit in the case of fixed price contracts, normally should not be recognised unless the work on a contract has progressed to a reasonable extent.
17.3 In the case of cost of cost plus contracts, this degree of reliability would be provided only if both the following conditions are satisfied:
(i) costs attributable to the contract can be clearly identified; and
(ii) costs other than those that are specifically reimbursable under the contract can be reliably estimated.
17.4 While recognising the profit under percentage of completion method, an appropriate allowance for future unforeseeable factors should be made on either a specific or a percentage basis.
19. A foreseeable losses on the entire contract should be provided for in the financial statements irrespective of the amount of work done and the method of accounting followed.”
ANNEXURE I
2. VALUATION
(A) Despatches including despatches with customers, finished stock and work in progress.
(i) long production cycle items viz.,
Hydro and thermal sets, boilers, boiler auxiliaries, compressors, industrial turbo sets.
The contract values in respect of piecemeal despatches are assigned on technical estimates. When the aggregate value of despatches including despatches with customers represents 30% or more of the realisable value, they are valued at 97.5% of the realisable value or in its absence, quoted price. Otherwise, they are valued at actual/estimated factory cost or 97.5% of the realisable value, whichever is lower.
Finished goods in plant and work in progress are valued at actual/estimated factory cost or 97.5% of the realisable value, whichever is lower.
The balance of 2.5% will be reckoned as income on completion of the supplies under the contract.
(ii) Other products
In the case of all other products (including spares of all products), sales and despatches with customers are taken at realisable value.
Work in progress/finished stock in plant are valued at actual/estimated factory cost or realisable value, whichever is lower.
Factory cost/estimated factory cost includes excise duty payable on manufactured goods.
(iii) The components and other materials purchased/manufactured against production orders but declared surplus are charged off to revenue. As and when these materials are consumed or sold, the value thereof is credited to revenue.
(iv) Raw material, components, stores and spares are valued at weighted average cost.
(v) Inter-division transfers are valued at market price/the prices agreed to between the divisions.
(B) (i) Inter-division transfers of stores for capital work of expansion project are valued at cost or market price, whichever is lower.
(ii) Jobs done internally for use in capital works are valued at actual/estimated factory cost or market price, whichever is lower.
(C) Where current estimates of cost and selling price of a contract indicates loss, the WIP is so valued as to provide for the full anticipated loss in respect of the part of the contract on which work has commenced (material launched in the shop). Loss is provided by derating WIP or by making necessary provision. In assessing the loss, total income from the contract including incentives on exports/deemed exports is taken into account.
5. TURNOVER
(i) Piecemeal despatches to customers are billed in terms of the contract, primarily to recover the dues against the contract price and the billing does not represent the value of despatches. This is adjusted to equal intrinsic value on basis adopted for valuation as stated in 2(A)(i) and (ii) above and shown as despatches made to customers to form part of turnover.
(ii) Piecemeal despatches, which as per relevant terms of payment cannot be billed, till the entire equipment is despatched, are shown under the heading “despatches with customers”. These are treated/accounted as sales when the last major shipment is made and invoices are raised on the customers.
Products which can be despatched in single consignments are billed on despatches and accounted as sales.
(iii) Income from erection and project management services is taken credit in respect of work done and billed in certain cases based on the intrinsic value related to 97.5% of the contract value and in other cases dependent on percentage of completion. The balance of 2.5% is reckoned as income when the contract is completed.
(iv) Income from engineering services rendered is reckoned at realisable value based on the certified percentage of work completed and billed.
(v) Income from supply/erection of non-company equipment/Systems and civil works is reckoned on the basis of invoices for despatches to customer/work done at project site.
ANNEXURE II
Sale of unascertained goods and appropriation
1.Where there is a contract for the sale of unascertained or future goods by description and goods of that description and in a deliverable state are unconditionally appropriated to the contract, either by the seller with the assent of the buyer or by the buyer with the assent of the seller, the property in the goods thereupon passes to the buyer. Such assent may be expressed or implied and may be given either before or after the appropriation is made.
2.Delivery to carrier: - Where, in pursuance of the contract, the seller delivers the goods to the buyer or to a carrier or other bailee (whether named by the buyer or not) for the purpose of transmission to the buyer and does not reserve the right of disposal he is deemed to have unconditionally appropriated the goods to the contract.
ANNEXURE III
____________________________ *** Refer to AS-7 on “Accounting for Construction Contracts” |
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