1.34 Query: Accounting for notional loss/premium on sales.
1. A company is an integrated iron and steel producer. It has adopted different marketing methods for its products. One of these methods is ‘Forward Package Deals’. Under this system, sale of all products, whether slow-moving, non-moving or fast-moving, is recorded and invoiced at the stockyard-based fixed price. In case of the slow moving materials, however, since the product is not easily saleable at fixed stockyard price, the company asks bidders to quote the amount of ‘notional loss’ for sale of such products. The amount of such ‘notional loss’ is credited to account named ‘compensation liability account’ of the bidder/holder. Similarly, the fast-moving products are also sold at the stockyard-based fixed price. However, since these products are of fast-moving nature, they fetch a premium in the market. Therefore, the company asks bidders to quote the amount of ‘notional premium’ for sale of such products. The accepted bid amount of ‘notional premium’ is debited to ‘compensation liability account’ of the holder. As per the querist, the amount of ‘notional loss’ accumulated earlier is adjusted by the ‘notional premium’ in the current or subsequent years. The compensation liability accounts are maintained party-wise in separate register, therefore, the transactions of the ‘notional loss/ notional premium’ are neither accounted for by the company, nor they are reported in the balance sheet.
2. The querist has explained the impact of the aforesaid policy by way of the following example:
Example -The sale price of a product (slow-moving) of the company is fixed at Rs. 12,000/- per mt. It calls bidders to quote the amount of ‘notional loss’ for 200 mt. The accepted quotation of ‘notional loss’ of Rs. 1,500/- per mt., aggregating Rs. 300,000/- is credited to compensation liability account of the bidder, while invoice is raised at Rs. 12,000/- mt. Similarly, the accepted quotation of another product (fast-moving), on which ‘notional premium’ is asked, fetches Rs. 800/- per mt. in a bid of 50 mt., aggregating Rs. 40,000/- is debited to the account, while invoice is raised at stockyard price. Balance amount of Rs. 2,60,000/- remains at the credit of the account of compensation liability holder. It is not disclosed in the company’s balance sheet.
3. The querist has argued that the monetary transactions of ‘notional loss/notional premium’ relate to the fixed sale price of the company. The sale is effected on the price of ‘notional loss/notional premium’, although the invoicing and recording of sale is at fixed sale price of the company. Therefore, the querist feels that they are not distinct. The true picture of the gain or loss which is to be credited/debited to profit and loss account emerges only if the two transactions are linked. In the view of the querist, the company, under secret accounting system is concealing actual losses/profits, and also that such method can be used to inflate/deflate profits.
4. The querist has sought the opinion of the Expert Advisory Committee as to whether the said monetary transactions of ‘notional loss/notional premium’ should be accounted for in conformity with standard accounting norms, and whether the accounting treatment being followed is fair from the tax point of view.
Opinion February 28, 1994
1. The Committee notes that section 209 of the Companies Act, 1956, requires every company to keep “proper books of accounts”, inter alia, with respect to “all sales and purchases of goods by the company”, and “the assets and liabilities of the company”. It further stipulates that “proper books of accounts” shall not be deemed to be kept with respect to such matters “(a) if there are not kept such books as are necessary to give a true and fair view of the state of affairs of the company or branch office, as the case may be, and to explain its transactions; and (b) if such books are not kept on accrual basis and according to double entry system of accounting.” The Committee also notes that section 211 of the Companies Act, 1956, provides, inter alia, that “every balance sheet of a company shall give a true and fair view of the state of affairs of the company as at the end of the financial year”, and “every profit and loss account of a company shall give a true and fair view of the profit or loss of the company for the financial year”.
2. The Committee is of the view that the accounting policy of the company to account for sales at the ‘stockyard-based fixed prices’, which are different from actual selling prices, is not proper since it results into sales being booked at notional amount. Consequently, the ‘turnover’ is being recorded at amount which does not give a true and fair view thereof, which, in turn, would mean that
(i) the books of account of the company are not being kept properly in accordance with the requirements of section 209;
(ii) the true and fair view of the profit or loss, for the reporting period, is being adversely affected; and
(iii) the true and fair view of the financial position of the company is being adversely affected insofar as the balance of accounts receivable is concerned.
3. The Committee is also of the view that the policy of accounting for sales followed by the company may also prejudicially affect the determination of liabilities of the company under various statutes, e.g., Income-tax Act, Sales-tax Act etc., which may have other legal consequences.
4. On the basis of the above, the Committee is of the opinion that the accounting policy of the company regarding accounting for sales is not as per the generally accepted accounting norms. The company should raise invoices and book sales at the actual prices, i.e., fixed price net of so-called discount/ premium quoted by the respective customers. ___________________________ |