Query No. 17

 

Subject:  

Recognition of revenue arising from freight

and handling income. 1

 

A. Facts  of  the  Case

 

1. A government  company,  within  the  meaning  of section  617  of  the Companies Act, 1956, is working under the administrative control of the Ministry of Railways (MoR), Government of India.  In respect of the affairs of the company, the principal decisions are taken by the MoR. These decisions are implemented by the board of directors of the company after necessary deliberations and passing necessary resolutions in respect of such decisions.

 

2. The company is engaged in the business of handling and transportation of containerised cargo.  The containers are transported by road, rail and air. The company provides these services to shipping lines, clearing and forwarding agents  and other  customers.   The company operates container  terminals across the country to cater to the needs of the trade which includes export- import business as well as domestic business. Accordingly, the activities of the company have been divided into International Traffic (export and import business) and Domestic Traffic (domestic business). The operating activities of the company are mainly carried out at its Inland Container Depots (ICDs), Container Stations and Port Side Container Terminals (PSCTs) spread all over the country.

 

3. The main sources of revenue of the company are from freight, handling charges, transportation charges, ground rent and wharfage, etc.  The querist has provided the following brief description of these revenues:

 

          ·           Freight and transportation revenues are the rail and road haulage charges respectively, charged from the customers.

 

          ·           The revenue from handling is the amount received for handling of the containers.

 

          ·           Ground rent is the parking charges for the time period during which a container remains parked in an ICD of the company                     after the expiry of the permissible free time limit.  The revenue also includes charges for safety and security of                                         containers/cargo.

 

          ·           Wharfage is the amount collected for cargo, which remains in the warehouse beyond its permissible free time limit.

 

Major expenditure of the company is towards freight payment to Railways and payments made to contractors for handling and transportation of containers.

 

4. The  company  has  adopted  the  following  accounting  policies  for recognition of revenue/expenses during the financial year 2000-2001:

 

Policy  no.  1  in  Schedule  10:  Accounting  conventions  & concepts

 

“The financial statements are prepared under the historical cost convention generally on accrual basis and in accordance with applicable mandatory accounting standards and relevant presentational requirements of the Companies Act, 1956.  Accounting policies not referred to otherwise are consistent with generally accepted accounting principles.”

 

Policy  no.  11  in  Schedule  10:  Terminal  and  other  service  charges

 

“Freight and handling income/expenses are accounted for at the ti me of booking of containers. Ground rent and wharfage are accounted for at the time of release of containers on ‘completed service contract method’. Claims/penalties are accounted for at the time of settlement.”

 

5. The statutory auditors of the company have qualified their audit report for the financial year ended on 31st  March, 2001, as follows:

 

“Accounting for freight and handling income/expenses has been done on cash basis which is not in compliance with section 209 of the Companies Act, 1956, and Accounting Standard (AS) 9, ‘Revenu e Recognition’, issued by the Institute of Chartered Accountants of India.”

 

As per the querist, a similar kind of qualification had also appeared in the Auditor ’s Report of the company for the financial year ended on 31st  March, 2000.

 

6. The management of the company had given the following reply to the auditor’s qualification on accounting for freight/handling income and expenses in the Directors’ Report for the financial year ended on 31st  March, 2000:  

“As per paragraph 7.1 of Accounting Standard (AS) 9, revenue fro m service transactions is usually recognised as the service is performed, either by the proportionate completion method or by the completed service contract method.

 

If the completed service contract method is adopted, it may not be possible to account for revenue even after the service has almost been completed in case a container starting from Terminal A does not reach its destination at Terminal B even after a month or more.  In such cases, accounts will not indicate a true and fair view of the state of affairs of the company. Similarly, if the proportionate completion method of accounting is adopted, all the trains carrying containers will have to be stopped at midnight of the last day of the accounting period just to assess the proportion of the service rendered. This method of accounting is neither possible nor desirable as this will result in chaos on the whole of the railway network.

 

As per paragraph 9.2 of AS 9, where there is no uncertainty as t o ultimate collection, revenue is recognised at the time of sale or rendering of service even though payments are made in instalments. Paragraph 12 of AS 9 reads as under:

“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.”

 

At the time of booking containers for transportation, the revenue is clearly measurable and there is no significant uncertainty regarding rendering of the service.  Hence, the company has adopted a system of accounting for freight and handling income/expenses as declared in Accounting Policy No. 1 and 11 of Schedule 10 to the annual accounts, which gives a true and fair view of the affairs of the company. Maintenance of accounts of the company is consistent with the provisions of the Companies Act, 1956, and AS 9.”

 

7. The management has given the following reply in Directors’ Report for the financial year ended on 31st  March, 2001 to the qualification in the Auditor’s Report:  

“The statutory auditors had made a similar qualification in the previous year.  A very detailed reply by way of addendum to the Directors’ Report 1999-2000 was issued.  The extracts of the concluding para of the reply are reproduced below:

 

At the time of booking containers for transportation, the revenue is clearly measurable and there is no significant uncertainty regarding rendering of the service.  Hence, the company has adopted a system of accounting for freight and handling income/expenses as declared in Accounting policy No. 1 and 11 of Schedule 10 to the annual accounts, which gives a true and fair view of the affairs of the company. Maintenance of accounts of the company is consistent with the provisions of the Companies Act, 1956, and AS 9.

 

However, as the statutory auditors have made similar qualification this year as well, the company has decided to constitute a committee to study the issue in consultation with the Institute of Chartered Accountants of India so that the matter is settled finally.”

 

8. The company constituted a committee of its three senior officers to study the case and seek the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India on the matter. The committee of the officers deliberated on the matter and observed as under:

 

         (i)         In terms of paragraph 7 of AS 9, in case of service industry, revenue from service transactions is usually recognised as the                      service is performed, either using proportionate completion method or using completed service contract method.  Paragraph                      4.2 of AS 9 further states that completed service contract method is a method of accounting which recognises revenue in                      the statement of profit and loss only when the rendering of services under a contract is completed or substantially                               completed.

 

         (ii)        The completed service contract method as stated in AS 9 emphasises the expression ‘substantially completed’. In line with                      this provision of AS 9, the company has been recognising freight/handling income at the point of time when all                                       documentary procedures for booking of the cargo/containers for its onward transportation have been completed and the                      payment from the customers has also been received, which leaves no significant uncertainty regarding the amount of                               consideration that will be derived from rendering of service.

 

        (iii)        Revenue from freight/handling is always certain to accrue because the company is not required to refund the same unless                     the consignor withdraws the cargo which takes place only in rare circumstances.  The contracts entered into by the                            company for transportation of containers are with the consignors, which conclude at the stage of handing over of                                    containers, documents and money to the company and collection of charges by the company and issuance of Inland Way                     Bills (IWBs) to them. Under such circumstances, it becomes essential for the company to recover charges from consignors                     and recognise the same as revenue which is the standard trade practice.

 

As per the querist, the committee constituted by the company is of the view that in view of the above observations the company has been recognising income/expenses from freight/handling at the point of time when the contract is substantially completed and there exists no uncertainty regarding the amount of  consideration  that will  be  derived  from rendering the  service,  as per paragraph 12 of AS 9.

 

B. Query

 

9. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting policies being followed by the company for recognition of revenue arising from freight and handling are in accordance with the provisions of the Companies Act, 1956, and AS 9.

 

C.  Points  considered  by  the  Committee

 

10. The Committee notes that the querist has sought the opinion only on recognition  of  revenue  arising from freight  and  handling of  containers. Accordingly, the Committee has not considered the other issues that may be contained in the facts of the case such as recognition of expenses arising from freight and handling and recognition of revenue arising from sources other than freight and handling of containers.

 

11. The Committee notes that the provisions of AS 9 are based on the accrual basis of accounting as required under section 209 of the Companies Act, 1956.  This fact is recognised in the ‘Guidance Note on Accrual Basis of Accounting’, issued by the Institute of Chartered Accountants of India, paragraph 8.1 of which, inter alia, states as below:  

“The Council of the ICAI and its various committees have issued various Guidance Notes, Statements and Accounting Standards. The accounting treatments contained in these documents are primarily based on accrual accounting. Thus, adoption of accounting treatments recommended in these documents would ensure that a company has followed accrual basis of accounting. ...”

 

12. The Committee notes that freight income is the rail haulage charge charged from the customers, i.e., it is the amount received for providing facility of transporting goods through railways from one destination to another. The Committee further notes that handling income is the amount received from customers for handling of the containers.

 

13. The Committee notes paragraphs 10 and 12 of AS 9 which provide as below:  

“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.”  

“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.”

 

The Committee notes from the above that in order to recognise revenue from service  transactions  two  conditions  have  to  be  satisfied,  viz.,  (i) performance as specified in paragraph 12 is completed and (ii) it should be reasonable to expect ultimate collection, i.e., no significant uncertainty exists regarding collectability.  With regard to completion of performance as per the proportionate completion method and completed service contract method, the Committee notes paragraph 7.1 of AS 9 as reproduced below:

 

“7.1  Revenue from service transactions is usually recognised as the service is performed, either by the proportionate completion method or by the completed service contract method.

 

         (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.

 

         (ii)       Completed service contract method—Performance consists of the execution of a single act.  Alternatively, services are                     performed in more than a single act, and the services yet to be performed are so significant in relation to the transaction                     taken as a whole that performance cannot be deemed to have been completed until the execution of those acts.  The                              completed service contract method is relevant to these patterns of performance and accordingly revenue is recognised when                     the sole or final act takes place and the service becomes chargeable.”

 

14. The Committee is of the view that in the present case, the performance of service consists of execution of a single act, i.e., providing transportation facility/handling of the containers. Accordingly, revenue from these services should be recognised on the basis of the completed service contract method. According to this method, revenue should be recognised, only when the rendering of service, i.e., transportation of goods/handling of containers, is complete or substantially complete.   The Committee is, therefore, of the view  that  booking  of  containers  cannot  be  construed  as  completion  or substantial completion of rendering of services.  The fact that no significant uncertainty exists regarding collectability satisfies only one of the conditions specified in paragraph 13 above.  The Committee is, therefore, of the view that revenue from freight and handling cannot be recognised at the time of booking of containers.

 

D. Opinion

 

15. On the basis of the above, the Committee is of the opinion that the accounting policies being followed by the company for recognition of revenue arising from freight and handling income are not in accordance with AS 9 and section 209 of the Companies Act, 1956.