Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 3

Subject:

Date for booking of the purchase of imported material. 1

A. Facts of the Case

 

1.  A government company is engaged in the business of construction of ships, offshore fabrication and ship repairs.

 

2. The company imports various equipments.  The import contracts are concluded on FOB/foreign port or CIF/Indian port basis.  The querist has mentioned that the contracts invariably contain a clause that the supplier should send a clear bill of lading/airway bill blank endorsed and made to the order of the shippers along with other shipping documents.  The bill of lading along with other documents stipulated in the contract is negotiated by the overseas supplier against at-sight letter of credit opened by the company.  The foreign bank after effecting the payment to the supplier forwards the documents for reimbursement to the Indian bank with whome the company has opened an irrevocable letter of credit.  The Indian bank after reimbursing the amount to the overseas bank debits the account and releases the document.  In the case of FOB contract, the company on receipt of cable advice from the overseas suppliers about the quantity and value of the goods to be loaded on the ship covers the insurance.

 

3. The company has been following the procedure of debiting the imports on the date of the payment i.e., the date on which documents are retired at the bank. According to the querist, this procedure is being followed based on an opinion issued by the Expert Advisory Committee of the Institute of Chartered Accountants of India (Query No. 5.7, Compendium of Opinions, Vol. I).

 

4.  As per the querist, till the year 1997-98, the above method of accounting was accepted by the statutory auditors as well as the government auditors.  However, in respect of accounts for the year 1998-99, the statutory auditors did not accept the above method of accounting for booking of purchases of imported material and qualified their report.  They were of the opinion that Accounting Standard (AS) 11, ‘Accounting for the Effects of Changes in Foreign Exchange Rates’ and Accounting Standard (AS) 9, ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India had not been followed by the company.  The querist has stated the statutory auditors' observations and the management’s reply which are as below:

 

Statutory Auditors' Observations

“The method of accounting followed in respect of recognition of transactions of import of materials is as per note no. 37 of Schedule 24.  As per this method, the transactions are recognised at the time of retirement of documents by the bank irrespective of the terms of contract and are accounted at the exchange rates prevailing on such dates.  In our opinion, this method of accounting is not in consonance with Accounting Standard (AS) 11 on ‘Accounting for the Effects of Changes in Foreign Exchange Rates’ and also Accounting Standard (AS) 9 on ‘Revenue Recognition’.  Accounting Standard (AS) 11 requires that the rate prevailing on the date of transactions should be considered for accounting such transactions and gain or loss on settlement of transactions should be reflected in the profit and loss account.  As per AS 9, the date of transaction will be the date on which the risks and rewards of ownership in the goods are transferred. The above has no impact on overall profit of the company.”

 

Management’s Clarification in the Notes to Accounts

“The import of material for production is by sight letter of credit/sight draft and is accounted on actual payment basis at the time of retirement of documents with the bank except in case of imports for which buyers’ credit, usance letter of credit or credit arrangements have been availed.  The company has adopted the above method based on the opinion issued by the Expert Advisory Committee of the Institute of Chartered Accountants of India in Volume I (Query No. 5.7) of the Compendium of Opinions.  In that opinion it is mentioned that the shipments covered under Bill of Lading should not be considered as purchase until such time the documents are transferred to the company through bank.  As such gain or loss on settlement of transactions does not arise for disclosure in the profit and loss account.”

 

5. According to the querist, as per Accounting Standard (AS) 9, the date of transaction will be the date on which significant risks and rewards of ownership in the goods are transferred.  A Bill of Lading is made to the order of the shipper.  The property in the goods will not pass until the negotiation of the Bill of Lading by the bank in India is complete.  The querist is of the view that the method of accounting followed by the company is in accordance with normal accounting practice for such transactions.

 

B. Queries

 

6.  The querist has sought the opinion of the Expert Advisory Committee on the following issues:

 

(a) Whether the company has complied with the requirements of Accounting Standard (AS) 9 and Accounting Standard (AS) 11.

 

(b)If not, whether purchase should be booked on the date of bill of lading or the date of retirement of documents irrespective of the nature of contract.

 

(c) Whether provision for liability at the year-end in the case of CIF and FOB contracts should be based on the date of bill of lading or the date of retirement of documents or the rate prevailing on the last day of the accounting year.

 

(d) If the date for booking of purchases is the date when the goods are delivered to the shipper, whether the exchange rate difference between the date of booking of purchase and the date on which the payment is made should be treated as an exchange loss or exchange gain.

 

C. Points Considered by the Committee

 

7.  Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’, states (paragraph 17) that one of the major considerations governing the selection and application of accounting policies is ‘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 the legal form”.

 

8.  Accounting Standard (AS) 9, ‘Revenue Recognition’, lays down certain conditions for recognition of revenue.  In respect of sale of goods, the Standard requires that revenue should be recognised when (apart from fulfillment of other conditions laid down in this behalf) the seller 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.

 

9.  The Committee is of the view that from the view-point of the buyer also, a transaction of purchase of goods should be recognised when the property in the goods 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.  In case the transfer of property in the goods and the transfer of all significant risks and rewards of ownership do not take place concurrently, the timing of recognition of the purchase should be determined considering the substance of the transaction, i.e., the purchase should be recognised when all significant risks and rewards of ownership are transferred to the buyer.

 

10. The point of time when all significant risks and rewards of ownership pass on to the buyer depends on the terms and conditions of the contract.  In this regard, the Committee takes note of the observations made by the statutory auditors as reproduced in paragraph 4 above which imply that the terms of different contracts are not identical.  In view of this, the Committee does not express any opinion as to the point of time when the transaction of purchase should be recognised by the company.  However, the Committee wishes to reiterate that the timing of recognition of purchases should be such when all significant risks and rewards of ownership pass on to the buyer (provided the amount of consideration is measurable reliably).

 

11. Accounting Standard (AS) 11, Accounting for the Effects of Changes in Foreign Exchange Rates, states the following with regard to recognition of exchange differences.

 

“9.   Exchange differences arising on foreign currency transactions should be recognised as income or as expense in the period in which they arise, except as stated in paragraphs 10 and 11 below.”

 

“10.  Exchange differences arising on repayment of liabilities incurred for the purpose of acquiring fixed assets, which are carried in terms of historical cost, should be adjusted in the carrying amount of the respective fixed assets. The carrying amount of such fixed assets should, to the extent not already so adjusted or otherwise accounted for, also be adjusted to account for any increase or decrease in the liability of the enterprise, as expressed in the reporting currency by applying the closing rate, for making payment towards the whole or a part of the cost of the assets or for repayment of the whole or a part of the monies borrowed by the enterprise from any person, directly or indirectly, in foreign currency specifically for the purpose of acquiring those assets.”

 

“11. The carrying amount of fixed assets which are carried in terms of revalued amounts should also be adjusted in the manner described in paragraph 10 above. However, such adjustment should not result in the net book value of a class of revalued fixed assets exceeding the recoverable amount of assets of that class, the remaining amount of the increase in liability, if any, being debited to the revaluation reserve, or to the profit and loss statement in the event of inadequacy or absence of the revaluation reserve.”

 

12. From the above, it can be seen that AS 11 requires the exchange differences to be recognised as income or expense or as an adjustment to the carrying amount of related fixed assets, depending on the nature of the item to which the exchange differences pertain.

 

D. Opinion

 

13.  Based on the above, the Committee is of the view that the transactions of import should be recognised when all significant risks and rewards of ownership pass on to the company.  Considering that the terms of different contracts are not identical, the Committee does not express any opinion as to the point of time when imports covered by a particular contract should be recognised.  The Committee accordingly does not answer the queries raised in sub-paragraphs (a), (b) and (c) of paragraph 6.  With regard to the query raised in sub-paragraph (d) of paragraph 6, the Committee is of the opinion that the difference between the exchange rate as at the date of the transaction and as at the date of settlement thereof should be recognised as income or expense for the period or as adjustment to the carrying amount of the related fixed asset, depending on the nature of the item imported.

 

1Opinion finalised by the Committee on 22.4.2000.