Expert Advisory Committee

1.21 Query:

Revenue recognition for exports on CIF basis.

1 A public sector company manufacturing and supplying instrumentation and process control equipments received an order for export of control and instrumentation on CIF basis. The part of the material against the aforesaid order was dispatched/consigned favouring the buyer in accordance with the terms of the order. The above despatches took place on 28^th and 29^th March, 1990, as evidenced by the Bill of Lading/Air Way bill issued on these dates and the company booked export sales in its accounts for the year ending 31.3.90.

2. According to the querist, the company accounted for the sales in its books of accounts based on the principle enunciated in the Accounting Standard 9 (AS-9), issued by the Institute of Chartered Accountants of India. The querist is of the view that the transaction fulfilled the conditions stated in para 11 of the said Accounting Standard as explained hereunder: -

(a) The company transferred to the buyer the property in the goods for a price by delivering the goods to the carriers, i.e., shipping authorities/Airlines before the end of the financial year.

(b) All significant risks and rewards of ownership were transferred to the buyer and no effective control of the goods was kept by the company as the goods were consigned favouring the buyer.

(c) No significant uncertainty existed regarding the realisation of sale proceeds on the date of transfer of property as the goods were consigned in accordance with the order and with the prior consent of the buyer.

3. The company also took into consideration the views expressed by Shri Kamal Gupta in his book ‘Contemporary Auditing’ which read as under: -

“Sale of Goods

The standard recommends that revenue from sale of goods should be recognised when the following conditions have been fulfilled:

(a) The seller of the goods has transferred to the buyer, the significant risks and rewards of ownership.

(b) no significant uncertainty exists regarding the following:

(i) the consideration that will be derived from the sale of goods.

(ii) The associated costs incurred or to be incurred in producing or purchasing the goods; and

(iii) The extent to which the goods may be retained.

It may be noted that the criteria laid in the standard may involve recognising a transaction as ‘sale’ even though no sale has taken place in the legal sense of the term, i.e., before the title in the goods is transferred from the seller to the buyer under the provisions of the law governing such a transaction (Sale of Goods Act in our country). The criteria laid down in the standard are based on the consideration of substance over form, i.e., if in substance, a sale has taken place, it should be recognised in the accounts, irrespective of whether or not the legal title in the goods has been transferred.

In the following cases, significant risks and rewards of ownership would not be deemed to have been transferred to the buyer:

(a) If any significant acts of performance remain to be completed.

(b) If the seller retains any continuing managerial involvement in, or effective control of, the goods transferred, to an extent usually associated with the ownership of such a goods; and

(c) If the payment by buyer to the seller in respect of the goods is dependent on the buyer deriving revenue therefrom, e.g., if the buyer receives goods from the seller but pays the latter only when he is able to sell the goods himself.

Where a seller retains only a non-significant risks of ownership (e.g., liability covered under normal trade warranties or retention of legal title merely to protect the collectability of the amount due), a sale may be recognised.”

3. The auditors did not agree with the contention of the company and commented that the sales and profits were overstated to the extent of above transaction. Their opinion was based on the opinion of the Institute at Query No 5.9 published in Compendium of Opinions, Volume I, the relevant portion, which reads as under:

“Under a CIF contract, the property passes to the buyer as the shipping documents (if they are considered to be “documents of the title to the goods” according to the section 2(4) of the Sale of Goods Act) are handed over to them.”

In the above case, documents were handed over to bankers for collection after 31.3.1990.

4.The querist has sought the opinion of the Expert Advisory Committee as to whether it is necessary to hand over the documents of title of the “goods” to the buyer or his banker on or before 31^st March of the year in order to recognise the revenue in the accounts of that year. Further, whether retention of documents (favouring the buyer) and presenting of them to the bankers for collection after 31^st March in the normal course of trade and business can be construed as retention of risks and rewards of ownership and hence does not amount to transfer of property to the buyer within the accounting period.

Opinion May 29, 1991

1.The Committee notes that para 10 and 11 of Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, provide as follows:

“10. Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.

11. In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled:

(i) the seller of goods has transferred to the buyer the property in the goods for a price or 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 the consideration that will be derived from the sale of the goods.”

2. The Committee notes that an ordinary c.i.f. contract is a contract:

(a) to ship at the port of shipment, goods of the description contained in the contract,

(b) to procure contract of affreightment under which goods will be delivered at the destination contemplated by the contract,

(d) to make out proper invoice, and

(e) to tender these documents to the buyer, so that he can obtain delivery of goods on arrival or recover for their loss if they are lost on the voyage.

3. In a c.i.f. contract, the question whether the property in the goods passes to the buyer depends entirely on the question whether the seller has parted with the control over the disposal of the goods. It is not an unconditional contract because in commercial parlance, c.i.f. presumes an undertaking by the seller to do something more, namely, to put the goods on a ship and this postpones the passing of property until the goods are shipped by the seller. But the presumption that the property passes on shipment is a presumption as to the intention of the parties, and may be excluded either by the express terms of the contract or by other circumstances [section 19 (3) of the Sale of Goods Act]. For example, the presumption is rebutted where the seller reserves the right of disposal of the goods until certain conditions laid down in the contract are fulfilled. Until such time the property in the goods does not pass to the buyer. Since, on shipment, the goods pass out of the physical possession of the seller, his intention to reserve the right of disposal is usually evidenced by his treatment of the bill of lading. For instance, if the seller endorses the bill of landing in blank and hands it over to his agent not be delivered to the buyer until the goods are paid for, then the seller has shown his intention to retain the disposal of the goods under his control (Mehta v. Heureux, A.I.R. 1924 Bom. 422: Mohanlal V Krishna 1928 30 Bom. L.R. 415). The Committee is, therefore, of the view that the question whether the property in the goods passes on to the buyer under a c.i.f. contract, before the latter receives all the documents under the contract, is a question of fact, which is to be determined keeping in view the circumstances of each case.

4. The question whether 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, even though the property in goods has not been transferred, before the documents under the c.i.f. contract are tendered to the buyer, is once again a question of fact. For instance, retention of bill of lading merely to protect the collectability of amount due, where all other aspects of c.i.f. contract have been fulfilled properly, would indicate that significant risks and rewards of ownership have been transferred to the buyer. The Committee also notes that although, in a c.i.f. contract, the buyer is in effect the insurer and the risk prima facie attaches to him as and after shipment of goods, yet it is subject to the condition to tender the shipping documents, including insurance policy, as contemplated by the contract or as per the terms of trade.

5. The Committee concludes from the above that there are many factors, e.g., intention of the parties for retaining the shipping documents, any explicit term in the contract signifying control over the goods etc., which should be considered before deciding whether there has been a transfer of property in the goods or transfer of significant risks and rewards of ownership in the goods. The Committee is of the view that since these factors may differ from case to case, it is not practicable to lay down any specific rule(s) in this regard, which would be applicable in all situations. The Committee is, therefore, of the opinion that in a c.i.f. contract, whether transfer of property or transfer of all significant risks and rewards of ownership take place before the delivery of all the documents under the contract, is a question of fact to be determined keeping in view the circumstances of each case.

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