Query No. 7

 

Subject:          

  Accounting Treatment of sales on FOR destination basis.1

 

A  Facts  of  the  Case

 

1. A company is one of the leading steel producers in the country with a turnover of over Rs.16,000 crore. The company’s vast portfolio of long, flat and tubular products are marketed within and outside India by its Central Marketing Organisation (CMO).  CMO operates through a wide network of regional offices, sales offices, authorised dealers, stockyards and consignment agents. It has 38 branch offices and 47 stockyards located in major cities and towns throughout India.  There is a close co-ordination between CMO and the plants and orders are monitored on a day-to-day basis.   On an annual basis, it markets about 76.8 lakh tonnes of iron and steel products in the domestic market and about 4.8 lakh tonnes in the export market, with the total value exceeding Rs. 13,000 crore.

 

2. Sales are effected through CMO either as a direct despatch from the plants to the customers or from the stockyards to the customers.   Direct despatches to customers are made where the requirements are large in terms of wagon/rake load and are based on specific orders from the customers. The direct despatches to the customers can either be to the private siding of the customers or to the public booking point. The invoices are always drawn in the name of the customers for such direct despatches on handing over the material to the Railways. The Railway Receipts (RRs) are obtained evidencing transport of materials.  In case of deliveries to the customers at the private sidings, RRs are in the name of the buyer and constitute the bulk of sales to the major industrial consumers.  In case of delivery to the public booking points, the RRs and other relevant documents are sent to the nearest Branch Sales Office.  In the RRs, the consignees’ name is invariably shown as ‘the company - A/c (Name of the customer)’.  The documents are handed over to the customers against payment or against the credit arrangement made by the customers after endorsing the RR in favour of the customers. In respect of stockyard sales, the materials are kept at different stockyards for meeting requirements of the customers where the requirements are less than rake load.

 

3. The querist states that as per the consistent practice and the company’s accounting policy which, inter-alia, states that ‘materials sold in domestic market’ are treated as sales on delivery to carriers including the cases where delivery documents are in the company’s name, pending collection of payments. Export sales are treated as sales on issue of Bills of Lading.  Thus, in respect of direct despatches the sales are recognised based on the date of RR and in respect of stockyard sales based on the date of actual delivery based on the challan at the respective stockyard.

 

4. The Comptroller & Auditor General of India (C&AG), while reviewing the accounts of the company under section 619(4) of the Companies Act, 1956, for the year ended 31st  March, 2001, issued the following comment:

 

“Income of the company is overstated by Rs. 24.20 crore due to accounting of material worth Rs. 132.17 crore as sales although despatch documents were held under the custody of the company/materials returned by the customers.

 

In reply, the company stated that sales are accounted for consistently based on the delivery of goods to the carriers wherein significant risks and rewards of ownership have been passed on to the customers.  In the cases referred, the despatches have been made to the customers and accordingly included in the sales.  However, the documents were held in the custody of the company for securing the payments. The accounting policy of the company also states that “materials sold in domestic markets are treated as sales on delivery to carriers including the cases where delivery documents are in the company’s name, pending collection of payments”.

 

5. The querist has further informed that the detailed memo of C&AG also stated that “the RRs in respect of direct sales, although consigned to the purchasers, the same along with invoices, etc., are sent to the respective Branch Sales Office stockyards. The stockyards release the RRs along with invoices  to  the  purchasers  after  the  receipt  of  the  payments  from  the purchasers.  The process of preparation of invoices after the receipt of RRs, sending the same to respective stockyards, informing the parties/purchasers, and releasing of the RR including invoices to the purchasers take a minimum of 5-6 days. During the period, in respect of all RRs which are not released to the  purchasers,  the  ownership  in  the  goods  remains  with  the  company. Similarly, the risk involved in the above sales also belonged to the company. Under the circumstances, treating such despatches as sales is not justified as the  ownership  in  goods  was  not  transferred  on  31.3.2001  in  respect  of despatches referred to above. As such, these should not have been considered as sales and should have been valued at cost/price considering the same as inventory at plant or in-transit”.

 

6.  In the view of the company, accounting of sales based on the date of RR is in order, in view of the following:

 

(i)This treatment of booking ‘sales’ based on delivery of goods to carrier on 31  (6 a.m. when the plant’s shift gets over) has been consistently followed by the company over the years.The significant risks and rewards of ownership have been passed on to the customers. It is a settled position in law that transfer of risk need not be co-terminus with the transfer ofproperty.Risk can be transferred at a point different from the transfer of property.

(ii) The Railway Receipt (RR), etc., is usually drawn on ‘The company A/c Party’ for facilitating negotiation and ensuring receipt of payment against the same.  The party is definite and the company reserves no right to appropriate the goods.The title cannot be passed on to any other customer.Instead, in the event of non- payment, penal interest is leviable. Further, any demurrage or wharfage and other incidental charges that may accrue in respect of wagons at the destination point is borne by the customer.  In most of the cases, the default by the buyer is extremely rare and the delivery of the goods is taken by the concerned customer and proceeds are collected within a reasonable period. There is an intention on the part of the company as well as the customer to treat the material sold from the RR date.  Even otherwise, if the sales invoices were negotiated through a bank, sales would have been recognised in the books in the year in which goods were despatched.

 

(iii)In the normal course, once materials are despatched on account of a customer, the company has no right to divert the material either to other customers or to stockyards unless the customer has defaulted by not making the payment This is more so if thereis a change in price subsequently. However, the customer is entitled to get the materials at the price applicable on the date of despatch from the plant, i.e., the RR date. Further, the invoice contains the RR number

.

(iv) The transit risks as per the terms and conditions of the sale order are passed on to the consignee as soon as materials are delivered to the Railways. Further, as per section 39(1) of the Sale of Goods Act, 1930, delivery of the goods to a carrier, whether named by the buyer or not, for the purpose of transmission to the buyer, is prima facie deemed to be a delivery of the goods to the buyer.

Section 19 of the Sale of Goods Act, 1930, reads as under

 

“19(1)   Where there is a contract for the sale of specific or ascertained goods the property in them is transferred to the buyer at such time as the parties to the contract intend it to be transferred.

 19(2)  For the purpose of ascertaining the intention of the parties, regard shall be had to the terms of the contract, the conduct of the parties and the circumstances of the case.”

 

As the goods supplied by the company’s plants are specific and ascertained, the property in them is transferred at the time of delivery to the carriers.

 

(vi)   Further, section 20 of the Sale of Goods Act, 1930, reads as under:

“Where there is an unconditional contract for the sale of specific goods in a deliverable state, the property in the goods passes to the buyer when the contract is made, and it is immaterial whether the time of payment of the price or the time of delivery of the goods, or both, is postponed.”

 

As per the querist, this section provides that the property in the goods passes to the buyer when the contract is made, if the following conditions are satisfied.

 

- the goods are specific or ascertained,

- the goods are in a deliverable state,

- the sale contract is unconditional.

 

Further, this section also provides that if these conditions are satisfied then it is immaterial whether the time of payment of the price or the time of delivery of the goods, or both, is postponed.

 

According to the querist, from the above it follows that the time of payment of price or the time of delivery is not material to ascertain whether the sale has taken place in respect of specific goods.  As in the case of the company, though sale takes place from the RR date, the time of payment and delivery are postponed to suit the buyer.

 

(vii)  As per Accounting Standard (AS) 9, ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, there can be situations where the timing of transfer of property and transfer of significant risks and rewards of ownership are different. In such a case revenue is required to be recognised at the latter date. According to the system the company is following regarding booking of orders and despatch, the risk passes to the customer the moment the materials are despatched on account of the customer and the documents of title, viz., Railway Receipt/Lorry Receipt is obtained by the company. Further, paragraph 6 of AS 9 states that parties may agree that the risk will pass at a time different from the time when ownership passes.  Paragraph 11 of the Standard states that in transactions involving sale of goods, performance should be regarded as being achieved when no significant uncertainty exists regarding amount of consideration that will be derived from the sale of goods.

 

(viii) As per the querist, while despatching the goods, the plant raises the invoice on the party along with sales tax applicable (local tax for sales within the State and Central Sales Tax for inter-state sales).  This is yet another point to prove that despatch is a final sale.  The Sales Tax Authorities at the plant locations have also taken a view that where the materials are despatched specifically earmarked for a particular customer, the sale is complete when the material leaves the plant premises and the sales tax is payable to the government of the state where the plant is located.

 

(ix) The querist has stated that the basis for calculation of assessable value for payment of excise duty is different in case of direct despatches as compared to the basis for stockyards sales.  In case of direct despatches excise duty is paid on ex-works price and in case of stockyards sales, excise duty is paid on ex-works price plus freight and distribution charges.  A customer who has booked material for direct despatch would not agree to payment of excise duty other than excise duty calculated on ex-works price.  Therefore, excise duty is paid at the time of removal of materials from the plant on ex-works basis.

 

(x) The querist has referred to the case of Agricultural Market Committee Vs. Shalimar Chemical Works Ltd. (JT 1997 (5) SC 272), where the Supreme Court held that the title to goods passes to purchaser as soon as the contract is made in respect of specific goods in a deliverable state and does not depend on payment of price or the time of delivery of the goods.

 

B . Query

 

7. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting policy followed by the company with regard to accounting of sales based on issue of RR is proper.

 

C. Points  considered  by  the  Committee

8.  The Committee notes paragraphs 6.1, 10 and 11 of Accounting Standard (AS)  9,   ‘Revenue  Recognition’,  issued  by  the  Institute  of  Chartered

Accountants of India, which state as below:

 

“6.1  A key criterion for determining when to recognise revenue from a transaction involving the sale of goods is that the seller has transferred the property in the goods to the buyer for a consideration. The transfer of property in goods, in most cases, results in or coincides with the transfer of significant risks and rewards of ownership to the buyer. However, there may be situations where transfer of property in goods does not coincide with the transfer of significant risks and rewards of ownership. Revenue in such situations is recognised at the time of transfer of significant risks and rewards of ownership to the buyer. Such cases may arise where delivery has been delayed through the fault of either the buyer or the seller and the goods are at the risk of the party at fault as regards any loss which might not have occurred but for such fault. Further, sometimes the parties may agree that the risk will pass at a time different from the time when ownership passes.”

 

“ 10 . Revenue  fromsales 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.”

 

“ 11 .   In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have  been  fulfilled:

(i) the  seller  of  goods  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;  and

 

(ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the  goods.”

9.  The Committee notes from the above that the time of transfer of all significant risks and rewards of ownership may be different from the time of transfer  of  legal  ownership,  and  that  revenue  in  such  cases  should  be recognised at the time of transfer of significant risks and rewards of ownership in the goods to the buyer. The Committee is of the view that whether risks and rewards of ownership in the goods have been transferred is a question of fact which should be determined from the circumstances of each case.  For this purpose, factors such as who will bear the loss in case the goods are destroyed while they are in transit, the rights of the unpaid seller, etc., will have to be considered in each case of sale.

 

10. The Committee notes from the facts of the case that the company in question is recognising revenue as soon as goods are delivered to the carrier, namely, Railways and the Railway Receipts (RRs) are either in the name of the buyer or in the name of ‘The Company – A/c Party’.  It is also noted that the risk of loss in transit is borne by the buyer.  Keeping in view the facts of the case, where the RRs are in the name of ‘The Company -  A/c Party’, the Committee is of the view that revenue can be recognised as soon as RRs are endorsed in the name of the buyer unless other terms and conditions of the contract indicate that the risks and rewards of ownership in goods have not been transferred to the buyer.   The Committee is further of the view that where the RRs are in the name of the buyer revenue can be booked as soon as goods are delivered to Railways unless other terms and conditions of the contract indicate that the risks and rewards of ownership of goods have not been transferred to the buyer.

 

D.        Opinion

 

11. On the basis of the above, the Committee is of the opinion that in the facts and circumstances of the case as indicated in the query, significant risks and rewards of ownership in goods may be considered to have been transferred to the buyer, where the RRs are in the name of ‘the Company – A/c Party’, as soon as the RRs are endorsed in the name of the buyer even though these are kept in the custody of the company with the only purpose to ensure payment unless other terms and conditions of the contract indicate that significant risks and rewards of ownership in the goods have not been transferred.  Similarly, where the RRs are in the name of the buyer, revenue can be recognised on delivery of goods to the Railways unless other terms and conditions to the contract indicate that the risks and rewards of ownership

in the goods have not been transferred to the buyer.

   

1 Opinion finalised by the Committee on 26.4.2002.