1.26    Query:

Applicability of Accounting Standard

(AS) 9 to dredging ontracts.

1.  A company carries out dredging operations at various major ports, minor ports, Navy, etc., both for maintenance dredging as well as capital dredging by deploying its dredgers. Basically, dredging is an operation of removing material, (soil/clay/rock etc.) from the seabed (underwater). When dredging is undertaken to maintain existing depths, it is referred to as maintenance dredging. When the existing depth is increased the dredging is referred to as capital dredging.

2. The rates for service charges for dredging are on the basis of dredging time (days/hours) of per cubicmetre of material removed or based on hooper loads etc., depending on the particular assignment. In addition, there are charges for mobilisation and demobilisation of the dredger and dredger equipment, rates for idle time of dredger when dredging is held up for specific reasons in accordance with the relevant agreements.

3. Maintenance dredging is required to be carried throughout the year. All the major ports, who are the main customers of the company, come under the Ministry of Surface Transport. So far all the maintenance dredging work at major ports is being entrusted to the company at mutually agreed rates and terms and conditions.

4. The querist has informed that normally the agreement is concluded for a specific assignment but in some cases where continuous dredging is required every year, the period of agreement could be upto two years, fresh agreement being concluded every two years providing for revised rates and other terms and conditions as may be deemed necessary by both parties.

5. As the major customers of the company are the various major and minor ports and Navy, all of which are Government bodies/agencies under the Ministry of Surface Transport, State Governments, and Ministry of Defence, respectively, therefore, dredging work is sometimes required to be carried out even before a formal agreement is concluded. In such cases, a draft agreement indicating the rates and terms and conditions is forwarded to the customers. Since entering into a firm agreement takes time, pending discussions with the customers in time, bills/Debit notes for the work done, are submitted based on the rates and terms and conditions of the draft agreement forwarded to the customers and, based on these bills, accounting entries are passed by the company by debiting sundry debtors and crediting income. However, in some cases it so happens that regarding rates and terms and conditions, a conclusion is not reached even by the end of the financial year, i.e., 31^st March. Further, the customers also raise certain disputes regarding dredging time and/or quantity dredged, deficiencies in the working of the dredger, etc., for which they seek reduction in claims preferred on them by the company which sometimes remain unresolved by the time the accounts of the corporation for the year are closed. The amounts involved could be in lakhs of rupees.

6. The company feels that recognition of income in such cases, which could involve several lakhs of rupees where significant uncertainties remain unresolved on the balance sheet date, may not be prudent, and accordingly, income, to the extent of uncertainty, is reversed. The accounting entry passed at this stage is:

                        Income                                     Dr

                        To Sundry Debtors.

Under the General Ledger code, sundry debtors are shown in the following Detailed Ledger Codes:

General Ledger Codes                      Detailed Ledger Codes

25 Sundry Debtors                               2501 — Major ports

                                                            2502 — Public Sector Units

                                                            2503 — Govt. Organisations

                                                            2504 — Private Parties

                                                            2505 — Income Suspense.

In the abovesaid transaction, i.e., in case of reversal of income, which is already accounted for, the credit to the sundry debtors is given under a separate detailed ledger code (under General Ledger Code-Sundry Debtors) termed as “Income Suspense”. This, by its nature, always remains a credit balance. This system is adopted to have a control through review of balances. In effect, income and sundry debtors get automatically reduced and appear at net figures in balance sheet and the disclosure of income suspense as a Detailed Ledger Code is only for the purpose of control. A suitable disclosure is also made as a footnote in the Schedule of “Current Assets, Loans & Advances” that “the sundry debtors figure is net of Income Suspense of Rs.__________” (Please refer to note No. 2 (c) of Schedule VI of the published accounts for 1994-95 enclosed for ready reference).

7. The querist is of the view that operation of “Income Suspense” account and disclosure as referred to above does not contravene any Accounting Standard on recognition of income, especially keeping in view the fact that initial recognition of income in these cases is not, strictly speaking, final, as the same is not supported by agreed rates and terms and conditions, and realisation of the income so booked is uncertain, till final agreement is reached with the customers.

8. The querist has sought the opinion of the Expert Advisory Committee on the abovesaid issue.

                                                               Opinion                                              February 2, 1996

1. The activities involved in dredging operations in the present query are to remove material (soil/clay/rock etc.) from the seabed (underwater) to maintain and/or increase the existing depth of sea. The Committee is of the view that where the existing depth of sea is increased thereby resulting in creation of enhanced facilities at ports, i.e., capital dredging activities, then Accounting Standard (AS) 7 on ‘Accounting for Construction Contracts’, would be applicable. However, the Committee notes from the facts of the query that the emphasis is on maintenance dredging. Accordingly, the opinion given hereafter deals with the recognition of revenue from performance of dredging operations as a service activity not involving construction of any asset. The Committee is of the view that revenue recognition of such service activities is covered under Accounting Standard (AS) 9.

2.  The Committee notes paras 9.1 to 9.4 of Accounting Standard (AS) 9 ‘Revenue Recognition’ under the heading ‘Effect of Uncertainties on Revenue Recognition’, which state as follows:

“9.1      Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection.

 

9.2       Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest etc. revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. Where there is no uncertainty as to ultimate collection, revenue is recognised at the time of sale or rendering of service even though payments are made by installments.

 

9.3       When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded.

 

9.4       An essential criterion for the recognition of revenue is that the consideration receivable for the sale of goods, the rendering of services or from the use by others of enterprise resources is reasonably determinable. When such consideration is not determinable within reasonable limits, the recognition of revenue is postponed.”

3. The Committee further notes Paras 10, 12 and 14 of Accounting Standard (AS) 9, which read 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.

 

12.       In a transaction involving the rendering of services performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service.

 

14.       In addition to the disclosures required by Accounting Standard – 1 on Disclosure of Accounting Policies (AS-1), an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.”

4. The Committee is of the view from the above that assessment of uncertainty should be made at the time when performance of the service is completed, the revenue in respect of which is recorded in the books. However, from the facts of the query it appears that the company is making the said assessment at the balance sheet date and reversing the revenue earlier recorded to the extent of uncertainty involved.

5. The Committee is, therefore, of the opinion that revenue should be recognised at the time of its booking only to the extent that uncertainty of collection is not involved. If the uncertainty arises subsequent to the booking of revenue, an appropriate provision should be made.

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