1.39 Query: Booking of sales in respect of short production cycle items on F.O.R. destination basis.
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 querist had earlier obtained the opinion of the Expert Advisory Committee in respect of long production cycle items. This query pertains to short production cycle items.
2. 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.
3.The above 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.
4.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 production, there is no uncertainty/ ambiguity about the destination of the products. 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.
5. In line with the policy stated in para 2, 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).
6. According to the querist, the practice stated above in line with para 11 (i) & (ii) of Accounting Standard (AS) 9 on ‘Revenue Recognition’ reproduced in Annexure II. 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
7. The querist is also of the view that the policy being followed by the company for setting up of sales is not in contravention of Section 23 of the Sale of Goods Act, 1930, (extract given in Annexure III), 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.
8. The Comptroller & Auditor General of India, 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 IV).
9. In view of the Accounting Standard (AS) 9 on ‘Revenue Recognition’, opinion expressed by the Expert Advisory Committee of the Institute of Chartered Accountants of India and the 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.
10. The querist has sought the opinion of the Expert Advisory Committee as to whether booking of sales by the company, in respect of the short production cycle items, on delivery of goods to the transporters is correct where contract for sales is on F.O.R. destination basis.
Opinion November 7, 1991
1. The Committee notes that it has already expressed an opinion in respect of contracts for manufacture and supply of long production-cycle items which are complex pieces of equipment of type specified in para 1 of this query treating them as long term construction contracts in view of paragraphs 2 and 3 of the Accounting Standard (AS) 7 on ‘Accounting for Construction Contracts’, issued by the Institute of Chartered Accountants of India (Refer Page X-98 of Compendium of Opinions, Volume X).
2. The Committee is of the view that in case the contract activity is spread over different accounting periods even in respect of short production cycle items, AS 7 would be applicable. In such cases, the earlier opinion of the Committee as mentioned in para 1 above would be applicable. However, where the contract activity is not spread over different accounting periods, such cases would be considered as sale of goods and revenue will be recognised in accordance with Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India.
3. The Committee does not express any opinion on the propriety or otherwise of the valuation practices followed by the company with regard to despatches, turnover etc., as the matter has not been raised by the querist.
4. The Committee notes paragraphs no. 6.1, 10 and 11 of AS 9, which state as below:
“6.1 A key criterion for determining when to recognise revenue from a transaction involving the sale of goods is that the seller has transferred the property in the goods to the buyer for a consideration. The transfer of property in goods, in most cases, results in or coincides with the transfer of significant risks and rewards of ownership to the buyer. However, there may be situations where transfer of property in goods, does not coincide with the transfer of significant risks and rewards of ownership. Revenue in such situations is recognised at the time of transfer of significant risks and rewards of ownership to the buyer. Such cases may arise where delivery has been delayed through the fault of either the buyer or the seller and the goods are at the risk of the party at fault as regards any loss which might not have occurred but for such fault. Further, sometimes the parties may agree that the risk will pass at a time different from the time when ownership passes.
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”. [Emphasis supplied by the Committee].
5. The Committee notes from the above that the time of transfer of all significant risks and rewards of ownership may be different from the time of transfer of legal ownership, and the revenue in such cases should be recognised at the time of transfer of significant risks and rewards of ownership to the buyer. The Committee is of the view that whether risks and rewards of ownership in the goods have been transferred is a question of fact which should be determined from the circumstances of each case.
6. The Committee is, therefore, of the opinion that in respect of short production cycle items to which AS 7 does not apply, the company in question can book sales in case of an F.O.R. contract as soon as goods are delivered to the transporters, if in the facts of the case, significant risks and rewards of ownership in the goods do not remain with the company.
Annexure I 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 value 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
“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 the 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 goods.”
Annexure III
“23. 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 IV
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