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Query No. 20
Subject:
Recognition
of income from consultancy fee.1
A. Facts of the
Case
1. A company,
incorporated under the
Companies Act, 1956,
is a specialised consultancy
organisation. The company is wholly owned by the Government of India under the
administrative control of the Ministry
of Health and
Family Welfare. The
company provides professional consultancy services in the
healthcare and social sector. The company’s service spectrum comprises the following:
l Conceptual
studies and management consultancy;
l health care
facility design;
l project
management;
l procurement;
and
l logistics
and installation.
2. As per the
querist, the company has made substantial investment in state-of-art technology
and computerisation which
has positioned the company as a leader in the planning,
design and engineering of healthcare centres, research laboratories and infrastructure
facilities that help reduce costs, improve quality and increase efficiency.
3. The company
has followed the
following accounting policies consistently for recognition of
revenue from consultancy fees:
(a) Design
Engineering
(i) Turnkey
Projects
In respect of turnkey projects which extend to more than
one accounting year,
60% of the
fees is recognised
as income in the year of completion of design engineering in case
of civil work
and in the
year of completion
of specification in case of equipments. 30% of the fees is recognised as
income in the subsequent year and 10% in the year of completion of the project.
(ii) Other than
Turnkey Projects
Consultancy fee is recognised as income on the basis of
bills raised for work completed in stages as scheduled in agreement with
the client. No income is
recognised in respect of
work-in-progress in incomplete stages.
(b) Procurement
Projects (other than Turnkey Projects) Consultancy fee is recognised as income to the extent of 15%
on approval of estimate, 55% on placement of orders and 30% on receipt of
supplies/installation of equipments.
(c) Project
Management (including Turnkey Projects) Project Management fee is recognised as income on the basis
of work executed and billed by the contractors. No income is recognised in
respect of unbilled works-in-progress.Where there is
a revision in
the cost of
the projects, the consultancy income is reflected in the
accounting year in which such fact is known.
4. According to
the querist, the
management of the
company has adopted the above
accounting policies on the following basis:
(a) Design
Engineering (Turnkey Projects)
(1) The projects
which extend to more than one accounting year
require a lot of design
efforts/detailing. Further
changes are also required to be done during the execution stage of a project.
(2) In terms of
agreement with the clients, different clients have different
structure of their
payment stages which normally include the following:
(i) Preparation of
conceptual architectural plans.
(ii) Engineering design and drawings.
(iii) Bills of quantities, technical specification, and
tender documents.
(iv) Detailed structural engineering drawings – civil and
structural.
(v) Internal/external
services drawings.
(3) Activities
from (i) to (iii) at (2) above are completed in the year
in which design
engineering is completed; considering the
involvement of work
60% of the total
fee is
accounted for in the first
year. For activity
(iv) efforts are mainly in the second year of operation and for activity
(v) efforts are partly in the second year and partly in the year of completion;
as such fee is booked for 30% in the second year and 10% in the year of
completion.
(b) Procurement
projects (other than Turnkey Projects) The percentage of fees to be recognised as revenue at
different stages has been
arrived at considering
the amount of
work involved in each activity. Substantial work is completed upto the
stage of placement of orders. The following activities are involved in
procurement projects:
(i) Collecting
the specifications, preparation of an estimate on the
basis of information
available in data
bank and information collected
from market and
getting the estimates approved.
(ii) Preparation
of tender documents.
(iii) Getting
approval of tender documents from the client.
(iv) Making an
advertisement in the newspaper/sending the inquiry.
(v) Sale of
tender documents.
(vi) Collection of
bid documents.
(vii) Opening of bid
documents.
(viii) Scrutiny of bid document s and preparation of
recommendation for award of work.
(ix) Getting
approval of clients of the recommendation.
(x) Placement of
orders.
(xi) (1) Receipt of the supplies of drugs, etc.
(2) Installation of equipments by the supplier at the
client’s place.
(xii) Verification of
bills.
(xiii) Payment to the supplier.
(xiv) Return of performance guarantee.
Activities from (i) to (x) above are substantial and involve more efforts, therefore, 70% of the fee is recognised as revenue
upon the placement of order and the balance 30% of the fee is recognised as
income on completion of activities (xi) to (xiv) above.
5. The
auditors, while conducting the audit for the year ended 31.3.2000, expressed
the following reservations:
(a) The company
should recognise income in respect of work-in- progress also so as to comply
with Accounting Standard (AS) 7, ‘Accounting for Construction Contracts’, and as such qualified their report to that extent.
(b) 15% of the
fees for procurement projects (other than turnkey projects) has been recognised
on approval of estimates whereas the same should be recognised only when the work has progressed to a reasonable extent.
(c) The basis of
applying various percentages to account for income
is not satisfactory as other relevant factors should also be considered like the proportion of the costs incurred to date bear to the estimated total costs of contracts, etc.
6. The company
is of the view that consultancy fee is recognised as income on proportionate
completion method, i.e., the proportionate job
of consultancy work completed by the company and it is not
required to recognise on the basis of completion of the job by
contractors/suppliers.In respect of consultancy fees for Project
Management/Procurement, the existing practice of recognising consultancy fees
as income on the basis of work executed and billed by the contractors/suppliers at
the year-end is correct.
B. Queries
7. The querist
has sought the opinion of the Expert Advisory Committee on the following
issues:
(a) If the
accounting policy described
in paragraph 6
and sub- paragraph 3(c)
above with regard
to project management
is revised to the extent that fee will be recognised as income to the
extent of work executed and measured/goods delivered at the consignee’s
place, whether this
revision would meet
the requirements of AS 7.
(b) If 70 % of
consultancy fees in respect of procurement projects
(other than turnkey projects) is recognised as income on placement of orders instead of 15% on
approval of estimates and 55% on placement of orders, whether this revision
would meet the requirements, as the major involvement of the company as a consultant is upto the stage of placement of orders as explained in paragraph 4(b) above.
(c) If the
accounting policy described in paragraph 3 is changed so as to recognise the consultancy fee as income for stage- wise work completed (either for design engineering or for procurement or for project
management) as per the agreement with the clients irrespective of the work involvement of the company at different stages, whether it would meet the requirements of AS 7.
(d) Whether the
policy adopted by the company as explained in paragraphs 3 and 4 above would
meet the requirements of AS
7, if the policy is changed as per sub-paragraphs 7(a) and
7(b). Whether it would meet requirements of AS 7, by making changes mentioned in sub-paragraph 7(c).
C. Points
considered by the Committee
8. The Committee
notes that paragraph
4 of AS
7 provides the following:
“4. Contracts for
the provision of services come within the scope of this
Statement to the
extent that they
are directly related
to a contract for the
construction of an asset. Examples of such service contracts are
contracts for the
services of project
managers and architects and
for technical engineering
services related to the
construction of an asset.”
9. On the
basis of above,
the Committee is
of the view
that AS 7 would apply to revenue recognition from
consultancy fees received only for
design engineering and
project management directly
related to construction of an
asset whereas revenue from consultancy fees received for design
engineering and project
management not directly
related to construction of an
asset would be recognised as per the principles in this regard enunciated in
Accounting Standard (AS) 9, ‘Revenue Recognition’. Revenue from
consultancy fees received
for the procurement
projects should be recognised
in accordance with
the principles in
this regard enunciated in AS 9.
10. The Committee
notes that the
company is recognising
revenue in respect of various
projects when the contracts reach specific milestones, as the work on a contract progresses. The Committee presumes
that the conditions required to
be fulfilled for
adoption of the
percentage of completion method,
as laid down in AS 7, have been complied with.
11. The Committee
notes that paragraphs 9.1, 9.2, 9.8 and 19 of AS 7 provide the following with regard to the percentage of
completion method:
“9.1 Under the
percentage of completion
method, the amount
of revenue recognised is
determined by reference
to the stage
of completion of the
contract activity at
the end of
each accounting period. The
advantage of this
method of accounting
for contract revenue is that it
reflects revenue in the accounting period during which activity is undertaken
to earn such revenue.”
“9.2 The stage
of completion used
to determine revenue
to be recognised in the financial
statements is measured in an appropriate manner. For this purpose no special
weightage should be given to a single
factor; instead, all
relevant factors should
be taken into consideration; for
example, the proportion
that costs incurred
to date bear to
the estimated total
costs of the
contract, by surveys which
measure work performed
and completion of
a physical proportion of the
contract work.”
“9.8 Normally, the
profit is not recognised in fixed price contracts unless the work on a contract
has progressed to a reasonable extent. Ordinarily, this test is not considered
as having been satisfied unless 20 to 25% of the work is completed.”
“19. A foreseeable
loss on the
entire contract should
be provided for in the
financial statements
irrespective of the amount of
work done and the method of accounting followed.”
12. On the basis of
above, the Committee is of the view that recognition of revenue from design engineering on turnkey projects
directly related to construction of
an asset on
a predetermined fixed
percentage basis would be
appropriate provided it
represents the stage
of completion achieved on
the relevant project
at the end
of each year. The
stage of completion on the contract
should be determined
by considering all relevant factors as stated in the above
paragraphs of AS 7 and no special weightage should be given to a single factor.
13. With regard to
recognition of revenue from consultancy fees received for design
engineering on other
than turnkey projects
and for project management directly related to
construction contracts, the Committee is
of the view that the
recognition of revenue on the basis of
bills raised may not be
appropriate since there
may be cases
where the work
has been completed upto the relevant stage but the bill has not been
raised. Accordingly, it is
suggested that the
raising of bills
should not be the
criteria for recognition of revenue.
14. The Committee
is, however, of the view that the profit arising from recognition of revenue in
respect of the projects covered by paragraphs
12 and 13 above, should be recognised only where the work
has progressed to a reasonable
extent on the
project. However, provision
for all the foreseeable losses on the project should
be made irrespective of the stage of completion achieved on the contract.
15. Revenue from
consultancy fees received in respect of procurement projects and for design
engineering and project management not directly related to construction of an
asset should be recognised as per AS 9. The Committee notes
that paragraphs 7.1
(i) and 12
of AS 9
provide the following:
“7.1(i) Proportionate
completion method—Performance consists of
the execution of
more than one
act. Revenue is
recognised proportionately
by reference to
the performance of
each act. The revenue recognised under this method would be determined on
the basis of contract
value, associated costs,
number of acts
or other suitable basis.
For practical purposes,
when services are
provided by an indeterminate number of acts over a specific period of
time, revenue is recognised on a straight line basis over the specific period
unless there is
evidence that some
other method better
represents the pattern of performance.”
“12. In a transaction
involving the rendering of services, performance should be
measured either under
the completed service
contract method or under
the proportionate completion
method, whichever relates the
revenue to the
work accomplished. Such
performance should be regarded as being achieved when no significant
uncertainty exists regarding the amount of the consideration that will be
derived from rendering the service.”
16. The Committee
is of the
view that revenue
in respect of
the said projects should be
recognised on a suitable basis at a particular stage of rendering of services
that would relate the revenue to the services rendered provided no
significant uncertainty exists
regarding the amount
of the consideration that will be
derived from rendering the service at the time
of recognition. The stage of services rendered should be
determined on the basis of consideration receivable, associated costs and
performance made upto the end of the year.
17. The Committee is
of the view that the revenue arising from revision
in the cost of the projects could be recognised in the
accounting year in which the fact is known to the extent to which it relates to
the stage of completion provided no significant uncertainty exists regarding
the amount of consideration receivable.
D. Opinion
18. On the basis of
the above and subject to the presumption stated in paragraph 10, the Committee
is of the following opinion
on the issues raised in paragraph 7:
(a) The revised
accounting policy as per paragraph
7(a) would meet the requirements
of AS 7 provided the revenue recognised represents the stage of completion
achieved on the project at the end of each year.
(b) Principles
of AS 9 would apply to recognition of revenue from procurement projects and the requirements of AS 9, in this regard, would be met provided percentages adopted by the company represent the
pattern of performance of services.
(c) No. The
accounting policy adopted for recognition of revenue should represent stage of completion achieved/pattern of performance
of service by the company.
(d) See (a), (b)
and (c) above.
1Opinion finalised
by the Committee on 26.5.2001.
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