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Query No. 15
Subject:
Accounting
treatment of deduction allowed from invoiced amount.1
A. Facts of the
Case
1. A public
sector undertaking is
engaged in the
business of ship building and ship repair.
2. For a ship
repair job, the company submits a quotation based on the work specification
sent by the ship owner to the company. The work is awarded to the company on
the basis of the quotation submitted. As the work progresses,
some additional work,
not covered by
the quotation, may also be
required to be done on the ship.
3. On
completion of the repair work, a ‘work completion certificate’ is prepared
which is counter-signed by the representative of the ship owner. Subsequently,
invoice is prepared based on the work completion certificate, describing the
nature of the work done
together with the
rate and the
amount. The rate charged in the invoice for additional work
would not have been quoted earlier.
4. The ship
owner scrutinises the invoice vis-a-vis the work completion certificate and
the rates quoted.
The variation in
rates and quantities noticed by
the ship owner
are intimated to
the company seeking clarifications and
adjustments in the invoice. The
main areas where objections are generally raised are:
(a) Disagreement
with rates charged for additional work.
(b) Cost of
components invoiced on cost-plus basis not agreeable to the ship owner on
account of non-production of satisfactory proof.
(c) Any
sub-contract performed by outside specialists invoiced on cost-plus basis, the
cost of which is not fully acceptable to the ship owner.
(d) Variations in the quantities between the work completion certificate and the invoice.
(e) Other errors
in billing.
5. The results
of the scrutiny forwarded to the company by the ship owner are examined and the comments of
the company are communicated
to the ship owner. Finally, negotiations take place between
the ship owner and the company
on the basis
of the results
of the scrutiny.
The negotiations may result in a deduction being allowed from the
invoiced amount either as a lump sum or as a percentage of the invoiced amount, as the case
may be. The deduction
is treated by the
company as trade discount.
6. The company
had earlier sought the opinion 2 of the
Expert Advisory
Committee on the following accounting treatment:
Trade discount referred to in paragraph 5 above, is reduced
from the ship repair income
by debiting ‘ship
repair income’ account
and crediting the ship
owner’s account. A
‘provision for anticipated losses and expenditure’ is
credited in respect of invoices, the final settlement of
which is pending
at the close
of the year,
based on past experience,
by debiting the
profit and loss
account, and is disclosed under the head ‘Provisions’ in
the balance sheet.
7. In response
to the above query, the Expert Advisory Committee had expressed its
view that the
factors on account
of which the
difference between the invoiced amount and the amount finally settled
between the ship owner and the company arises (as listed in paragraph 4 above),
can be classified into the following two categories:
(a) Errors in
billing (arising on account of variations between the quantities as per the
work completion certificate and the invoice, and other clerical errors in
preparing the invoice), and
(b) Disagreement
between the company and the ship owner about rates/costs on
which prior agreement
had not been
reached between them.
The Committee was
of the view
that as far
as the difference attributable to (a) above is
concerned, it is in the nature of an error. The difference attributable
to (b) above,
arises because of
absence of prior agreement between the parties on
certain rates/costs. Thus, in respect of these rates/costs, the rates/costs
charged in the invoice are provisional in nature and the differences on this
account represent a price adjustment.
8. In respect
of the above, the Committee had opined as below:
(a) The
adjustment of the difference between the invoiced amount and the
amount finally settled
against ‘ship repair
income’ account is in order. Events occurring up to the date of approval
of the accounts by the board of directors should be taken into consideration in
determining the amount of the adjustment to be
made in this
regard. The description of
the difference as‘trade discount’ is not appropriate.
(b) In respect
of ship repair jobs for which negotiations between the ship owners and the
company are not over, the accounting treatment and manner of disclosure
followed by the company, as described in paragraph 6 above, is not appropriate.
Instead, the amount of difference between the invoiced amount and the amount
likely to be finally settled (as estimated on the basis of past experience)
should be adjusted in the ‘ship repair income’ by a
corresponding credit to
the accounts of
the respective ship owners.
Consequently, the figure
of sundry debtors included in the balance sheet would
be net of adjustment for such difference. In other words, the amount of the
difference would be neither shown under the head ‘provisions’ nor shown as a
deduction from the sundry debtors in the balance sheet.
9. After obtaining
the above opinion
from the Expert
Advisory Committee, the company disclosed its accounting policy in this
regard in the year 1999-2000 as below:
“Income from
ship repair is net
of discounts. In
case of unsettled invoices, the
income recognised is
net of probable
reductions/ discounts”.
In the notes
on accounts, the
company stated that
“Income from ship repair
is net of
discounts
allowed/anticipated
amounting to Rs.547.67 lakh
(previous year Rs.927.24 lakh) against the invoiced amount of Rs.11,118.15 lakh
(previous year Rs.11,794.83 lakh)”.
10. The C&AG
commented on the accounts for the financial year 1999-2000 as follows:
“Profit and Loss Account – income – ship repairs –
Rs.10,570.48 lakh – The current year provision for anticipated discount
amounting to Rs.547.66 lakh
has been shown
as deduction from
ship repair income instead
of exhibiting provision
separately. This is in
contravention of paragraph
9.3 of Accounting
Standard (AS) 9,‘Revenue Recognition’.”
11. The company
replied to the
comment of C&AG
defending the accounting
treatment as below:
“The accounting policy adopted is in accordance with the
opinion obtained from the
Expert Advisory Committee
of the Institute
of Chartered Accountants of
India and is
as per paragraph
9.2 of Accounting Standard (AS) 9
on ‘Revenue Recognition’. The ultimate collection of
the ship repair
income, to the
extent of probable discount, is not certain
at the time of raising invoice and revenue recognition is postponed to that
extent as required under paragraph 9.2 of AS 9. Accordingly, paragraph 9.3 of AS 9 is not
applicable. The deduction of discount from ship repair income is disclosed vide
note no. 2 of Schedule 19B, forming part of the accounts.”
B.Queries
12. The querist has
sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the
company should continue to follow the accounting treatment which
is in accordance
with the opinion
already expressed by the Expert Advisory Committee.
(b) Any other
alternative method which may be followed by the company taking into account the
comments of C&AG.
C. Points
considered by the Committee
13. The Committee
is of the
view that the
wording of the
company’s accounting policy is not in accordance with its opinion issued
earlier, as reproduced in paragraph 8 above, viz., the use of the term ‘trade
discount’
is not appropriate
for the adjustments
in the invoice
caused by the variations indicated
in paragraph 4
above, since these
adjustments are not of
the nature of
a ‘trade discount’.
In this context,
the Committee had, while
expressing the earlier opinion, noted the following definition of the term
‘trade discount’ as given
in the ‘Guidance
Note on Terms Used
in Financial Statements’,
issued by the
Institute of Chartered Accountants of India:
“Trade discount A reduction granted
by a supplier
from the list price
of goods or services on business considerations other than for prompt
payment.”
The Committee had expressed the view that considering the
nature of the difference between invoiced amount and the amount finally settled,
the same cannot be said to be trade discount. As such, its description as a
trade discount is not appropriate. The Committee had also expressed the view
that keeping in view the nature of factors giving rise to the differences
between the invoiced amount
and the amount
finally settled, it
is the finally settled amount
(and not the invoiced amount) that properly reflects the revenue of the company
from ship repair operations. If the amount finally settled between the parties
were known at the time of raising of the invoice, the invoice itself would have
been raised for such amount.
14. From the
above, the Committee
notes that the
issue relates to accounting for the effect of uncertainty
on the amount of consideration for
the purpose of
revenue recognition. In
this context, the
Committee notes paragraph 9.4 of AS 9 which states as below:
“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.”
The Committee notes that paragraphs 9.2 and 9.3 of AS 9,
referred to in paragraphs 10 and
11 above, relate
to recognition of
revenue in the situations of uncertainty of
collectability. These paragraphs are not relevant in the view
of the Committee,
since, as per
paragraph 13 above,
the present case relates to uncertainty in measurement of consideration.
15. From the above,
the Committee notes that it is a prime pre-condition for recognition
of revenue that
consideration should be
determinable within
reasonable limits. In
order to ascertain
whether the amount
of consideration is determinable
within reasonable limits,
it should be determined
whether a reasonable
estimate of the
consideration to be received can be made on rational basis, for
example, the past experience about the reduction in the amount of the bills. In
case such an estimate can be made,
revenue should be
recognised on the
basis of the
said estimated value. From the facts of the case, it appears to the
Committee that a reasonable estimate of the revenue can be made by adjusting
the amount of expected variations in the invoiced amount. The Committee had in
its earlier opinion also concluded that the amount of the variations,
actual as well
as estimated, should
be considered as
adjustment in the amount of revenue, i.e., ship repair
income.
D. Opinion
16. On the basis of
the above, the Committee is of the following opinion on the issues raised in
paragraph 12:
(a) As far
as the amount
of revenue booked
is concerned, the accounting policy
is proper. However,
the wording of the
accounting policy stating that it is net of reduction/discount is not proper.
The Committee is,
therefore, of the
opinion that the wording of the
accounting policy and the relevant note to the accounts should be changed to
the effect that the income from
ship repair is
adjusted on account
of actual/expected price
variations.
(b) The
accounting policy should be worded as suggested in (a) above.
__________________________________________________________________________________
1Opinion finalised
by the Committee on 14.4.2001.
2Published in Compendium of opinions, Volume XIX, page -71. |