Query No. 28

Subject:

Recognition of revenue for providing containerised cargo services.1

A. Facts of the Case

1. A government company, within the meaning of section 617 of the Companies Act, 1956, works under the direct 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 providing complete logistics services for containerised cargo (emphasis supplied by the querist). The company has been licensed at several locations by the Customs Department of Government of India to provide customs bonding services to customers in the export and import (EXIM) business. The operating activities of the company are mainly carried out at its Inland Container Depots (ICDs), Container Freight Stations (CFSs) and Port Side Container Terminals (PSCTs) spread all over the country including remote areas.

3. The main services provided by the company to its customers, as per the querist, are as follows:

(i) Establish inland ports to enable customers to avoid trips to sea side ports in order to acquire customs clearance;

 

(ii) Custodian of goods sealed in containers;

 

(iii) Enable customs bonding;

 

(iv) Providing single window facility to the customers for import and export trade;

 

(v) Undertake guarantee on behalf of customers to the customs authorities regarding goods sealed in containers;

 

(vi) Safety of goods as long as they are in the custody of the company;

 

(vii) Transport the goods to the destination by rail and road;

 

(viii) Door-to-door service; and

 

(ix) Handling and storage facilities.

4. The company has adopted the following accounting policies for recognition of revenues/expenses:

Policy no.11 in Schedule 10:

 

"Freight & handling income/expenses are accounted for at the time of booking of containers".

5. The querist has emphasised that although the charges are collected from the customers under the head ‘freight & handling income’ as shown in the Inward Way Bill (IW Bill), the freight and handling income includes amount collected from the customers towards the guarantees provided by the company on the entire value of the goods stuffed in the container against any mishap. The liability against the company in case of non-performance will amount to reimbursement of the entire value of the goods in the container as well as revenue towards freight and handling collected. Thus, the liability of the company will be much more than the revenue collected (emphasis supplied by the querist).

6. The statutory auditor of the company has qualified the audit report for the financial year ended on 31st March, 2004, as follows:

"Accounting for freight & 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), ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India".

7 . Modus operandi and consistent practice of the company as described by the querist is as below:

A. Income towards the bundle of services provided by the company:

(a) The company books its revenue on the basis of IW Bill and when an IW Bill is issued to the customer, the company in fact provides a bundle of services to the customers listed as under:

(i)Custodian of goods sealed in containers.

 

(ii) Enable customs bonding.

 

(iii) Undertake guarantee on behalf of customers to the customs authorities regarding goods sealed in containers.

 

(iv) Safety of goods as long as they are in custody of the company.

 

(v) Transport the goods to the destination by rail and road.

 

(vi) Door-to-door service.

 

(vii) Handling and storage facilities.

(b) The first three services listed above are completed immediately on issuance of IW Bill and the customer goes back with the satisfaction that he has received a document, which is recognised in the market as a negotiable instrument.

 

(c) The customer looks for assurance that the entire responsibility of the goods in the container is transferred to the company and he gets this assurance in the form of an IW Bill. The IW Bill is the counterpart of the railway receipt issued by the Indian Railways and one copy of the IW Bill is submitted to the Indian Railways on the basis of which the Indian Railways books its revenue.

B. Railway freight, handling charges etc., being fully provided against the income:

 

The railway freight becomes payable to the Indian Railways by the company on the basis of this IW Bill as laid down in the agreement with the Railways. Therefore, the company provides for the railway freight as soon as IW Bill is issued. All other provisions for handling charges are made in accounts fully to the same extent in the light of the income credited.

8. In the view of the querist, the recognition of revenue is in accordance with AS 9 as below:

(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.

 

(ii) 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.

 

(iii) The completed service contract method as stated in AS 9 emphasises the expression substantially completed (emphasis supplied by the querist). 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.

 

(iv) In addition, the querist reiterates that in terms of AS 9, the revenue from rendering of services should be recognised when the performance as specified in paragraph 12 of AS 9 is completed and it is reasonable to expect ultimate collection of the revenue. The company meets both the conditions at the time of issue of its IW Bills, accordingly, the recognition of revenue at the time of issue of IW Bill is in line with the requirements of AS 9.

 

9. The querist states that the business environment of the company is unique particularly due to its close relationship with the Indian Railways. The revenue from IW Bill is recognised not only for services rendered in respect of the goods to the destination by rail and road, but for custodianship of goods as well as for undertaking the guarantee on behalf of the customers to the custom authorities for safety of the goods and for handling and storage facilities etc., which together can be called ‘ bundle of services’. The expenditure for freight/handling charges etc., are also fully provided for by the company. It is further stated by the querist that, at the time of issuance of IW Bill, as the substantial portion of ‘bundle of services’ is complete, there is no significant uncertainty regarding the completion of service. In view of this, according to the querist, recognition of revenue by the company at the time of issue of IW Bill fully complies with the condition laid down in AS 9.

10. The querist has drawn the attention of the Expert Advisory Committee to the fact that it had earlier obtained the opinion of the Committee on the issue of recognition of revenue in the situation of rendering of services relating to freight and handling charges. The querist has also referred to the rejoinders sent by him for the consideration of the Committee and the views of the Committee thereon. A copy each of the aforesaid papers has been supplied by the querist for the reference of the Committee. The querist has now sent the case afresh stating that it is not only the service of transporting the container which is rendered by the company in question but certain other services also such as custodianship of goods, guarantee on behalf of customers to the customs authorities regarding goods sealed in container etc., although the amount charged by the company is a composite amount.

B . Query

11. The querist has sought the opinion of the Expert Advisory Committee as to whether the practice of the company to recognise revenue from providing ‘bundle of services’ on issuance of IW Bill is in compliance with the requirements of AS 9.

C. Points considered by the Committee

12. The Committee notes that the querist had earlier sought an opinion on recognition of revenue with regard to handling and transportation of containerised cargo. The Committee also notes that it had expressed its view that since in that case the performance of service consists of execution of a single act, i.e., providing transportation facility/handling of the containers, revenue from these services should be recognised on the basis of completed service contract method and that the act of booking of containers cannot be construed as completion or substantial completion of rendering of services. The Committee had accordingly opined that the freight and handling charges cannot be recognised as revenue at the time of booking of containers and, therefore, the policy followed by the company in this regard is not in accordance with AS 9 and section 209 of the Companies Act, 1956. The Committee also notes that in a subsequent rejoinder to the aforesaid opinion, the querist had argued that since there was no uncertainty with regard to measurability of consideration and collectability thereof at the time of booking of containers, performance in relation to rendering of services was complete at the time of the booking of containers. The Committee further notes that in its reply, the Committee had expressed its view that it is not correct to state that where there is no uncertainty of measurability of consideration and collectability thereof, the performance should be considered to be complete; the performance of services is a separate aspect to be considered. Accordingly, the Committee had reiterated its opinion.

13. The Committee notes that in the present case the querist has stated that apart from transporting the goods to the destination by rail or road as mentioned in the facts of the earlier case, the company in question is also rendering other services stated in paragraph 3 of the facts of the case. The querist has sought the opinion of the Committee as to whether the opinion of the Committee changes in view of the aforesaid additional information supplied by the querist.

14. The Committee wishes to emphasise that for the purpose of meeting the requirements as prescribed in AS 9, it is of foremost importance that revenue is considered to be earned only when the seller of the services performs his part of the contract (often referred to as the ‘performance criterion’). Under AS 9, this performance can be considered to be completed on proportionate basis or completed service basis, as may be appropriate. The Committee is further of the view that once it is considered that service has been performed, for the purpose of recognition of revenue, the consideration of prudence, as specified in AS 9 with regard to uncertainties related to measurability of consideration and collectability have to be satisfied. Thus, the principal criterion is the ‘performance’ criterion which has to be applied in conjunction with the consideration of prudence for the purpose of recognition of revenue under AS 9.

15. The Committee notes that the aforesaid criteria have been enshrined in paragraphs 7.1, 10 and 12 of AS 9 as 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 — P er f o r man c e 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."

"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."

 

16. The Committee notes from the Facts of the Case that the railway freight becomes payable to the Indian Railways by the company on the basis of IW Bill as laid down in the agreement with the Railways. Therefore, the company provides for the railway freight as soon as IW Bill is issued. The Committee notes from the copy of the Inland Way Bill issued by the company to its customers (sent by the querist along with his earlier query) that the services referred to by the querist in paragraph 3 of the ‘Facts of the Case’ are not stated therein. Apparently, therefore, either there may be a separate agreement with the customers with regard to the services specified in paragraph 3 or there are different types of contracts with different customers. The Committee further notes that in the terms and conditions mentioned in the copy of the Inland Way Bill, one of the conditions is that "This Inland Way Bill is issued subject to the conditions and liabilities as specified in the Railways Act, 1989". It is obvious that this condition will be applicable where carrier of the containers is Indian Railways. However, where the company is sending goods by road, the conditions and liabilities, in this regard, have not been specified. Thus, terms and conditions specifying the liabilities of the company in case of non-performance of service(s) are not available to the Committee. Further, where the company in question is rendering a number of services as mentioned in paragraph 3 of the Facts of the Case to its customers, apart from transporting the goods to the destination by rail or road, apparently the company is charging a composite price for rendering all these services. The Committee is of the view that, for the purpose of applying proportionate completion method and completed service contract method, the company may have to ascertain whether it is feasible to segregate the consideration attributable to each of the services rendered by the company. If it is feasible to do so, for each of the services, it should be determined whether proportionate completion method or the completed service contract method should be applied. In case it is not feasible to segregate the consideration between the different services rendered by the company in question, the Committee is of the view that the company will have to determine whether the liabilities for risks related to non-performance of various services, borne by the company after the time of handing over the containers to the carrier are significant or not. In case it is determined, on the basis of various factors (for example, the risk of liability with regard to damages borne by the company in case of damage to goods during transit) that the liabilities for risks related to non- performance insofar as the company is concerned are not significant at the time of handing over the containers to the carrier, the company may consider the performance as substantially complete and, accordingly, recognise revenue at the time of handing over the containers to the carriers.

D. Opinion

17. On the basis of the above, the Committee is of the opinion that revenue from providing ‘bundle of services’ should be recognised on the basis of the considerations specified in paragraph 16 above.

1 Opinion finalised by the Committee on 27.12.2004