1.8: Query: Revenue recognition.
1. A limited company was established in 1873, and was, until 1942, a trading organisation. In 1942, the company was acquired by amalgamation and transformed into a major manufacturing organisation. The company is manufacturing and exporting metal cutting tools. The company has also machine tools, machine tool accessories and foundry divisions activities. The company’s manufacturing units are located at Madras. Domestic marketing is based on its own branches. In the overseas market, it operates through authorised distributors.
2. The querist has stated that in the interpretation of Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, statutory auditors have taken the view that insofar as condition (1) of Para 11 of AS 9 is not fulfilled in toto, revenue recognition from sales should be postponed. In other words, the auditors are laying more emphasis on the stipulation “and the seller retains no effective control of the goods transferred to a degree usually associated with ownership” in respect of sales transactions of documents through bank at sight terms.
3. The querist has also stated that the auditors have asked them to reverse such transactions of sales recorded in the books of account, if such documents are not cleared within say 15 days from the close of the accounting year. In their view since documents of title to goods are lying with banks and can be recalled at the instance of the seller, condition of para 11 of AS 9 is not satisfied for recording such transactions as sales and hence revenue recognition is to be postponed. The auditors are of the view that this position will not be different even where the clients have paid excise duty applicable and declared such transactions as sales and paid relevant sales tax and filed returns as such.
4. As per the querist, this view of the auditors would require closer examination for the following reasons:
(i) When accrual basis is adopted for accounting, a sale may be recorded once the seller discharges his obligations in transferring the property in the goods and the seller, based on his experience of normal trade practice, finds it reasonably certain to collect the proceeds as per the agreed terms or within a reasonable period (emphasis supplied by the querist).
(ii) Revenue should be recognised notwithstanding that physical delivery has not been completed so long as there is every expectation that delivery will be made (Refer Appendix (A) (i) of AS 9).
(iii) The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form (Refer Para 17 (b) of AS-1) so long as they are based on the fundamental accounting assumptions, i.e., ‘going concern’, ‘consistency’ and ‘accrual’. Extension of legal interpretation of sale for an accounting treatment and recording of sales would be cumbersome in practice.
(iv) Therefore, as long as a transaction of sale of goods is in the normal course of business, a genuine commercial transaction, in accordance with normal trade practices, and certainty of realisation is reasonable, for accounting purposes, the same may be considered as ‘sale’ even though, legally, property in the goods may not have passed. Such accounting based on normal trade practice and on ‘going concern basis’ would reflect true and fair view of accounting of sales transactions.
5. The querist has sought the opinion of the Expert Advisory Committee of the Institute after taking into account the above points in the context of auditors emphasising on the strict application of conditions laid down in para 11 of AS 9, on the following issue:
Whether sales effected by documents through bank by a company and not cleared by parties within such time as may be stipulated by statutory auditors, have to be reversed in the books of account for the year under audit.
Opinion April 19, 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, provide 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.
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.”
2. The Committee is of the view that there are many factors, e.g., intention of the parties for retaining the shipping documents, any explicit term in the contract signifying control over the goods etc., which should be considered before deciding whether there has been a transfer of property in the goods or transfer of significant risks and rewards of ownership in the goods. The Committee is of the view that since these factors may differ from case to case, it is not practicable to lay down any specific rule(s) in this regard, which would be applicable in all situations. The Committee is, therefore, of the opinion that in such type of situations, whether transfer of property or transfer of all significant risks and rewards of ownership take place before the delivery of all the documents under the contract, is a question of fact to be determined keeping in view the circumstances of each case. ___________________________
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