1.11 Query: Revenue recognition in case of sale of goods on Documents against Payment basis.
1. The querist has sought the opinion of the Expert Advisory Committee in the context of an earlier opinion on the subject*.
2. In the case of sales through Documents against Payment (D.P.) basis, the company has been recognising revenue, the moment the goods have been despatched. The documents are drawn on ‘self’ and endorsed in favour of the party for facilitating negotiation by the intended buyer. In the event, the intended buyer does not retire the documents, the company can cancel the endorsement and endorse it in favour of any other person, or, if the company so chooses, it can recall the goods.
3. The auditors have questioned the recognition of revenue by the company, in the light of the Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, becoming mandatory. According to the querist, the company’s defence has been the three fundamental accounting assumptions, viz., going concern, consistency and accrual, enunciated in Accounting Standard (AS) 1 on ‘Disclosure of Accounting Policies’, issued by the Institute of Chartered Accountants of India.
4. According to the querist, the views of the company are as below:
(i) When accrual basis of accounting is adopted, sales may be accounted for once the seller discharges his obligations by despatching the goods. Based on his experience of the normal trade practice, the seller deems it reasonably certain to collect the proceeds within a reasonable period.
(ii) The company has also placed reliance on Accounting Standard (AS) 9 ‘Revenue Recognition’, Appendix A, Para A 1, concluding therefrom that revenue should be recognised notwithstanding physical delivery is not completed, so long as there is every expectation that delivery will be made.
(iii) The company has also placed reliance on para 17(b) of AS 1 regarding substance over form, i.e., the accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by their legal form.
(iv) The company has been consistently following the policy of recognising revenue in respect of sales invoices negotiated through bank in the year in which the goods are despatched.
5. The querist has informed the auditor’s views as below:
(i) The lorry receipt is in the name of the company and endorsed to the buyer. As the endorsement can be cancelled or transferred in favour of another buyer by the company, the company has, at all time, retained the ownership of the goods. The significant risks and rewards of ownership have not been transferred to the buyer and the seller continues to exercise effective control over the goods.
(ii) It is the intention of the seller to sell the goods and transfer the risks and rewards of ownership only on receipt of the consideration. In effect, it is only a cash sale and revenue must be recognised only when the consideration has been received (Refer AS 9 – Appendix – Para 2(c)).
(iii) The company’s reliance on para 1 A of the Appendix to AS 9 is not correct since delivery was not delayed at the buyer’s request. Therefore, the question of recognising revenue notwithstanding physical delivery not being completed dose not arise.
(iv) Although, the question of realising the sale proceeds was not in doubt based on post balance sheet information and past experience, the point for consideration was at what point of time, the risks and rewards of ownership in the goods had been transferred.
(v) Normal transit time for the goods to reach the intended destination, as also normal time for retiring the document should not prevent revenue from being recognised. But, delays beyond the normal parameters would preclude the company from recognising revenue. As regards substance over form, in substance no sale has been effected, since the seller has retained effective control of the goods.
(vi) Anything interpreted wrongly but consistently should not be the defense for any change in view. ‘Going Concern’ aspect has been considered in AS 9 while pronouncing the Standard in para11 (1).
(vii) The auditors accordingly conclude that sales cannot be reckoned by despatch of goods but only when payment is received and documents delivered to the buyer, when sales are made through Documents against Payment (unlike usance bills) for the following reasons:
(a) It is the intention of the seller to transfer the risks and rewards of ownership in the goods only on receipt of consideration;
(b) The seller retains effective control over the goods inasmuch as he can recall or re-endorse the goods to any other person.
6. The querist has sought the opinion of the Expert Advisory Committee regarding the point of time at which revenue has to be recognised by the company, in view of the provision of Section 209(3) (b) of the Companies Act, 1956.
Opinion September 23, 1997
1. The Committee notes that the facts in the query are broadly the same as that in respect of which the earlier opinion was sought. In other words, no significant change in facts have been introduced in the query.
2. The Committee notes that its earlier opinion was as below:
“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.”
3. The Committee, while reiterating its earlier opinion, wishes to states as below:
(i) The requirements contained in AS 9 are in consonance with accrual basis of accounting, substance over form, going concern, prudence etc., laid down in AS 1. For instance, recognition of revenue at the time the significant risks and rewards of ownership in goods are transferred is in itself a manifestation of substance over from since the legal transfer of property in the goods is not the sole basis. In other words, if legally there is no transfer of property in the goods sold, but significant risks and rewards of ownership in such goods are transferred, revenue can be recognised as per AS 9.
(ii) The case dealt with in Appendix A.1 of AS 9 under the title ‘Delivery is delayed at the buyer’s request and buyer takes title and accepts billing’ is totally different from the case referred to in the query as in the former case the buyer explicitly assumes significant risks and rewards of ownership in the goods.
(iii) While deciding whether significant risks and rewards of ownership in the goods are transferred to the buyer, the examples of the factors, which should be considered are as below:
(a) The right of the seller to stop goods in transit.
(b) Incidence of loss of goods in transit, i.e., who would bear the loss of goods in transit.
It may be mentioned that apart from the above factors, there can be other factors apparent from the specific terms and conditions of the contract which indicate whether or not significant risks and rewards of ownership in the goods have been transferred.
(iv) With regard to the transfer of property in the goods, it will have to be determined, keeping in view the facts and circumstances of each case whether, legally, such a transfer has taken place.
4. The Committee is, accordingly, of the opinion that at what time the transfer of property or significant risks and rewards in the goods have been transferred to the buyer is a question of fact to be determined on the basis of facts and circumstances in each case, e.g., the factors indicated above.
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*Compendium of Opinions, Volume XVI, p. XVI-19 |