Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.26 Query:      

      Service charges in respect of repairs/replacement of vehicles in transit.

 

1. A Government company, registered under the Companies Act, 1956, is engaged in the business of manufacturing of passenger vehicles. A copy of Memorandum of Association /Articles of Association has been submitted by the querist. The company has appointed authorised dealers all over India for sale, service and spares of its vehicles.

 

2. Relationship between the company and the dealers comes into existence by signing a formal dealership agreement; a copy of which has been submitted by the querist. Accordingly, this is the basic document/charter governing the relationship between the company and the dealer.

 

3. As per clause 7(a) of the above agreement, the company will sell its vehicles on “Ex-works” terms. However, the company is empowered [under clause 7(b)] to determine “Shipping, transport and insurance arrangements” for the products sold by the company to the dealers. The vehicles are presently being sold and the company undertakes responsibility for safe transportation of vehicles against a transportation price which consists of (a) freight charges and (b) service charges.

 

4.  The company has entered into separate transport contracts with various truck/ trailor owners (individuals/firms/companies etc.) for transportation of the vehicles.

 

5. There is no transit insurance for vehicles from any insurance company.

 

6. As the company undertakes additional responsibility for safe transportation of vehicles at a price, it bears the cost of repair/replacement of transit damages.

 

7. Part (a) of the transportation price, i.e., freight, is for weighted average compensation of the company’s expenditure on payment to transporters. Part (b) of transportation price, i.e., service charges is for weighted average/ approximate compensation of expenditure on repair/ replacement of transit damages.

 

8. According to the querist, the sale is complete as soon as a sale invoice is prepared and vehicles are handed over to transporters against an L.R. Thus, cut-off point of sale is L.R. date. ‘Sale’ is booked/accounted for in the books of account, accordingly.

 

9. During the period from the day/moment, sale transaction is complete, to the day/moment vehicles are physically received by the dealer, status of the company and of transporting firm is that of “Bailee” and “Sub-bailee”, who has undertaken responsibility of transportation, respectively.

 

10. In the sale invoice (i) ex-factory price; (ii) (a) freight charges, and (b) service charges, are shown separately. However, all the three elements are clubbed and shown as “Sale” in credit side of Profit and Loss Account.

 

11. In the background of above facts, the querist has sought the opinion on the following points: - 

 

(a) Whether above charging of “Service Charges” and subsequent payment for transit damages, if any, is equivalent to doing insurance business and, thus violating the Insurance Act?

           

(b) Whether above activity is ultra vires of the “Memorandum and Articles of Association”?

 

(c) Whether the company should disclose recovery of service charges as separate item in the Profit and Loss Account and should not club the same with “Sale”?

 

                                                                               Opinion                             April 8, 1991

 

1. The Committee notes that the querist has not sought opinion on whether the accounting practice followed by the company with regard to booking of sales is proper. The Committee, therefore, presumes that the company has recognised revenue on sale of vehicles in accordance with the principles of revenue recognition, as laid down in Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India. The opinion of the Committee is, therefore, restricted on matters specifically raised by the querist in para 11 of the query.

 

2. The Committee is of the view that the company’s undertaking to repair/replace vehicles damaged in transit (from the company’s premises to the dealers’ premises) in return of service charges, is incidental to the business of the company and it is integral to its operations. The Committee further notes that the company is bearing the risk itself relating to its own products for which it is charging its customers. Accordingly, the same may not be considered to be violative of the relevant provisions, viz., section 24 of the General Insurance Business (Nationalisation) Act, 1972, which prohibit carrying on of business of insurance by entities other than those specified in the said provision.

 

3. The Committee notes from the Memorandum of Association of the company that the bearing of the risk of damage of vehicles in transit in return of service charges is not specifically included in the ‘Object clause’. The Committee is of the view that it is not practicable to include in the ‘Object clause’, all aspects of a business. Thus, it should be seen whether the activity carried on is incidental to the objects contained in the ‘Object clause’ of the Memorandum. The Committee is of the view that since the said activity is intimately connected with the distribution of vehicles to its dealers, it can be considered to be within the objectives of the company as per the ‘Object clause’ of the Memorandum of Association of the company.

 

4. The Committee is of the view that since the service charges recovered from the dealers (which are separately disclosed in the invoice) for covering cost of repairs/ replacement of vehicles damaged in transit, cannot be considered as part of consideration for sale of vehicles, these receipts should be shown separately as ‘Other income’ in the Profit and Loss Account of the company. In this regard, the Committee also notes the following paras 5.4 and 5.5 of the Statement on the Amendments to Schedule VI to the Companies Act, 1956, issued by the Institute of Chartered Accountants of India:

 

“5.4 As regards the value of turnover, a question which may arise is with reference to various extra and ancillary charges. The invoice may involve various extra and ancillary charges such as those relating to packing, freight, forwarding, interest, commission, etc. It is suggested that, ordinarily, the value of turnover should be disclosed exclusive of such ancillary and extra charges, except in those cases where because of the accounting system followed by the company, separate demarcation of such charges is not possible from the accounts or where, the company’s billing procedure involves a composite charge inclusive of various services rather than a separate charge for each service.

 

5.5 In the case of composite charge invoices, it would not ordinarily be proper to attempt a demarcation of ancillary charges on a proportionate or estimated basis. For example, if a company makes a composite charge to its customer inclusive of freight and despatch, the charge so made should ordinarily be regarded as the invoice price of the goods sold, and should accordingly be disclosed as the value of the turnover. It would not be proper to reduce the value of the turnover by reference to the approximate value of the service relating to freight and despatch. On the other hand, if the company makes a separate charge for freight and despatch, and for other similar services, it would be quite proper to ignore such charges when computing the value of the turnover to be disclosed in the Profit and Loss Account. In other words, the disclosure may well be determined by reference to the company’s invoicing and accounting policy and may thereby vary from company to company. For reasons of consistency, as far as possible a company should adhere to the same basic policy from year to year and if there is any change in the policy, the effect of that change may need to be disclosed if it is material, so that a comparison of the turnover figures from year to year does not become misleading.”

 

5. On the basis of the above, the opinion of the Expert Advisory Committee on the issues raised by the querist in para 11 of the query is as follows:

 

(a) In the facts and circumstances of the query, charging of ‘service charges’ and subsequent payment for transit damages, if any, may not be considered to be equivalent to doing insurance business, and, therefore, not violative of the General Insurance Business (Nationalisation) Act, 1972.

 

(b) The activity in question does not appear to be ultra vires the ‘Object clause’ of the Memorandum of Association of the company.

 

(c) The recovery of service charges should be disclosed as a separate item under ‘Other income’ in the Profit and Loss Account and should not be clubbed with sales.

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