Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.18  Query:  

  Booking of sale/purchase transactions of exports made by business associates.

 

1.  A Government Trading House under the administrative control of Ministry of Commerce has been exporting minerals like iron ore, manganese ore, chrome ore, gems and jewellery, agro products like rice, wheat, soyameal, etc. it has also been importing metals, fertilisers, strategic industrial raw-materials, gold, etc. It has been handling these transactions as a bulk buyer and seller. Since the company is a bulk importer of various commodities, it has been using its bulk buying strength with the sellers in overseas countries to generate counter trade and boost India’s exports.

 

2.  It is a trading company and does not have any manufacturing and processing facilities of its own. In order to service counter trade exports, it enters into agreements with the manufacturers and processors of commodities required for counter trade and other exports. The foreign parties are also given the option to buy Indian goods either through the company or from any other Indian party directly. All these transactions, however, have to be routed through the company, which keeps a complete account of the counter trade and other such exports. These transactions can be divided into two categories: -

 

(a)        The company enters into export sale contracts directly with the foreign party and also obtains transferable letters of credit in its name. In some cases, however, in order to facilitate payment transactions and also to insulate itself against quantity and quality aspects, letters of credit are transferred and assigned by the company in favour of a local Indian manufacturer and producer who are supporting associates of the company. The supporting manufacturers are provided necessary assistance by the company to facilitate production of goods to meet its export obligations. Although, it makes efforts that goods produced by the supporting manufacturers are upto the standards and specifications of the foreign buyer, it takes steps that in case of rejection of any goods, the liability will exclusively lie on the supporting manufacturer. Under this category, the company has sale contracts with the foreign buyers on principal to principal basis and also there is a letter of credit received by the company which is transferred and assigned by it to the Indian party. The Indian party makes the actual exports, draws invoice in its own name, realises the foreign exchange in its own account and passes on the service charges to the company. The sale invoices and other related shipping documents are marked “Account Company”. The associate manufacturer having drawn the invoice and documents will not in any case jeopardise the claim of the company that it is the real exporter since the export contract and letter of credit are on principal to principal basis between the company and the foreign buyer.

 

(b)        The company’s associate manufacturers and processors, on the advice of it, enter into export contracts directly with the foreign countertrade obligant. The Indian party also gets letter of credit in its own name, files GR-I Form in its own name, raises its own invoice, receives the foreign currency on its own account and does all other acts as are necessary for the purpose of fulfillment of such exports. The Indian party shall be fully accountable and responsible for the quantities and quality of goods exported and no responsibility on that account lies on the company since the Indian party itself is a manufacturer of the goods and has absolute control on the quantities and qualities of the goods. In fact, the company enters into this type of arrangement mainly from the point of view to insulate itself from quantity and quality claims of overseas buyers. While all actions required for completing the exports are done by the Indian party, for the purpose of accounting of these exports, the export documents are marked “Account Company”. It has been construed that since Indian party has mentioned “Account company”, he is acting as an agent of the company and for such agency, the Indian party passes on service charges to the company.

 

3. The company, for about a decade, has been handling such counter trade exports and imports of business associates. It has been making disclosure in its accounting policies as follows:

 

(i)         Purchase and sales are booked where the company or its authorised party has entered into a purchase and sales contract and agreements directly with the sellers and buyers for performance of the contract either wholly or partly.

 

(ii)        Purchase and sales include exports made by business associates etc., against counter trade arrangements for imports.

 

(iii)       Purchase and sales include transactions and shipments where export letters of credit are assigned in favour of business associates of where shipping documents marked “Account company” are received and accepted by the company.

 

4. The value of such exports is also declared in the annual accounts at relevant place.

 

5. Similar accounting policies also exist in certain other public sector trading companies. The statutory auditors and the Government Auditors have been from time to time observing that sales and purchase of associates are being booked by these public sector units while, in fact, they are entitled to only service margin and commission on these sales. Consequently, the turnover of these companies is being artificially inflated and the extent of their trade activities is being misrepresented. They have opined that accounting policies of these public sector units are incorrect as the benefit of exports and imports are accrued or availed of by the business associates. The Government Auditors have also noted that accounting policies are against the mandatory Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India. They have, therefore, asked the Ministry of Commerce and the Department of Public Enterprises to advise these PSUs to amend the accounting policies with regard to the accounting of turnover of business associates falling in categories (a) and (b), referred to in para 2 above and covered by the accounting policies of the company under para 3(i), (ii) and (iii) above.

 

6. The matter has been re-examined by the company. It strongly feels that it is not a commission agent of the Indian manufacturers/producers whose goods are exported through the company. Although, it is not the producer/manufacturer of the goods, it plays an important marketing role to facilitate and boost the exports of the country. The key question according to the querist is: Could the business, under reference, be done without the assistance and intervention and support of the company? If the answer is “no”, then the manner of contracting and preparation of export invoices and transfer and assignment of letter of credit, receipt of foreign exchange are matters of marketing convenience between the foreign importer and the Indian manufacturer duly recognising the company’s trading role into it. It is for this reason that the querist feels that its accounting policies are not against the trade practices and should be allowed to continue to account the same as at present in the books of account of the company.

 

7. The querist has sought the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India as to whether the accounting policies of the company at para 3 (i), (ii) and (iii) above should be continued as at present or the company should modify and if so, the extent of such modification.

 

                                                                              Opinion                             December 9, 1996

 

 

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

 

“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 usual 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. As per the above requirements, it is an essential condition for recognition of revenue from sale of goods that significant risks and rewards of ownership in the goods should be transferred to the buyer. In other words, significant risks and rewards of ownership at the time of effecting the sale should vest in the (designated) seller (and not in another party). Unless this condition is satisfied, a sale cannot be recognised by the seller. Therefore, in determining the proper accounting treatment of an export transaction which is handled by a trading company, it must be ascertained whether the significant risks and rewards of ownership first get transferred from the associate to the company in question and then from such company to the overseas buyer. If it is not so, the transaction does not constitute a sale (export) of the trading company and should not be so recognised; instead, the company should recognise only the service margin/commissions earned by it for effecting the transaction.

 

3. The Committee is of the opinion that the question whether significant risks and rewards of ownership are transferred to the trading company and thereafter to the buyer is to be determined on the basis of the facts and circumstances of the particular case. For instance, the mere fact that certain documents like contracts with the overseas buyer, letters of credit, bills of lading, and insurance documents are marked “Account (name of the concerned trading company)” does not by itself establish that the significant risks and rewards of ownership are transferred first to the trading company and then to the overseas buyer. The company, therefore, can not book sales in such cases and should only recognise its service charges/commission as the turnover.

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