Query No. 30

Subject:

Revenue recognition in respect of mould sold by the company, but retained

in its premises for use in further production.1

A. Facts of the Case

1. A limited company has integrated capabilities of manufacturing both the mould and the plastic components. Mould manufacturing acts as the backbone of the organisation and this is augmented with the state of art machines to manufacture the plastic components. Normally, a mould takes about 3-9 months, depending upon the size and technicalities involved, to be fully completed and ready to produce plastic moulded components.

2. Mould revenue is recognised by the company on acceptance of sample components manufactured by using the moulds. Sample components are billed to the customer as ‘Mould Trial Charges’. On acceptance of sample moulded components, the mould accounting is done based on the nature of understanding with the customers as follows:

For outright sale of mould to the customer

 

The company raises invoice by debiting the customer and crediting ‘Sale of mould’.

 

For cost of mould fully borne by the company

Considering business potential, sometimes the company decides to develop a mould on its own and bear its full cost which is capitalised in its books.

 

For mould amortisation

Under this business practice, either part or full amount of the mould invoice value is mutually agreed between the company and its customer, to be recovered at a fixed rate per component as and when ordered by the customer in future and supplied to him. The customer is not bound to order the components in a fixed time period (emphasis supplied by the querist). Sometimes, orders from customer against mould amortisation are not received for several years.

 

3. The present procedure of accounting followed by the company for mould amortisation is as under:

(a) A separate ‘Mould amortisation receivable account’ is created for each party.

 

(b) ‘Mould amortisation receivable account’ is debited and ‘Sale of mould account’ is credited by raising a separate commercial invoice, i.e., the entire revenue is recognised at this point even though the receipt of revenue is contingent upon receiving orders from the customer in future, which may or may not materialise and no time period is fixed within which orders must be executed.

 

(c) Rate of recovery is fixed to recover the amortised amount and is added to the sale value of components. At the end of a period, say a month or a quarter, an entry is passed by debiting  ‘Sale of plastic components account’ and crediting ‘Mould amortisation receivable account’ to show the recovery of the amortised amount.

 

(d) In some cases, where the customer agrees to pay separately for the mould amortisation, then step (c) is not followed and  ‘Mould amortisation receivable account’ is credited on actual receipt of money from the customer.

4. According to the querist, though significant risks and rewards of ownership of the moulds amortised vest with the customer, i.e., loss or damages to the moulds are to be borne by the customer, the company sometimes suffers as the terms of amortisation are open ended, i.e., rate of recovery of mould amortisation is solely dependent on receipt of orders from the customer and supplies of components at future date. In case the plastic product for which the moulds were manufactured and amortised is discontinued permanently or becomes obsolete, the company will have to suffer loss to the extent of the amount remaining unpaid on account of mould amortisation.

5. The querist has separately furnished a declaration to the Committee that there is no formal agreement between the company and its customers for the sale of moulds. However, the querist has provided a copy of the purchase order issued by the customer, which mentions only the rate and quantity over which the total mould cost, borne by the company, will be amortised.

B . Query

6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether the adopted accounting practice for ‘mould amortisation’, i.e. recognising total income in the year of manufacture of mould, irrespective of recovery of the amount which may spread over many years and is contingent upon the receipt of orders for which there is no certainty, is in accordance with the generally accepted accounting principles in India.

 

(b) Whether it is proper to book the entire income, arising out of  ‘mould amortisation’, when there is no obligation on the part of the customer to order components within a specific time frame.

 

(c) Whether the company can continue with the present accounting practice for ‘mould amortisation’ by stipulating a time span of two years from the date of manufacture of mould to recover mould amortisation, i.e., the recovery should be on future supplies at the predetermined rate or expiry of two years, whichever is earlier.

 

(d) Whether the company can treat ‘mould amortisation debtors’ at par with other normal debtors, particularly when obligation to pay is not there.

 

(e) Whether the following alternative methods of accounting would be more in accordance with the accounting principles:

(i) Treating moulds to be amortised as part of fixed assets

(a) The expenditure incurred on the mould by the company is capitalised.

 

(b) Income from moulds is recognised as and when supplies are made to the customer against orders.

 

(c) The mould is depreciated on the basis of its estimated useful life.

 

(d) The balance in the mould account is written off when orders for components to be made from the mould cease.

(ii) Treating moulds to be amortised as stock

(a) Actual cost of manufacturing mould is treated as stock-in-trade.

 

(b) On supplies of components, out of the ‘moulds amortised’, proportionate income is recognised when components are supplied and stock is reduced accordingly.

 

(c) When the product is discontinued or becomes obsolete, the balance amount remaining as stock is charged to the profit and loss account.

C. Points considered by the Committee

7. The Committee notes that since the query has been raised with regard to the situation where the mould manufactured by the company remains with the company for use in production of plastic components and the value of the mould, in respect of which a separate invoice is raised, is agreed to be recovered along with the sale of plastic components manufactured by using the mould as and when these components are ordered by the customer in future and supplied to him, the Committee has dealt with that issue only. The Committee has, accordingly, not considered the accounting aspects with regard to outright sale of the mould and the situation where the cost of mould is borne by the company.

8. To determine whether the moulds in question should be treated as sales on raising of the invoice, the Committee notes paragraphs 10 and 11 of Accounting Standard (AS) 9, ‘Revenue Recognition’, which, inter alia,state as follows:

"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.

 

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 paragraph 4 of the Facts of the Case that the querist has mentioned that significant risks and rewards of ownership of the mould vest with the customer. However, the querist has also mentioned that the company has to suffer loss to the extent of the amount remaining unpaid on account of mould in case the plastic components manufactured by using mould become obsolete or are discontinued permanently. In the view of the Committee, these two statements appear to be contradictory since if the seller has to suffer a loss in case the plastic components become obsolete or are discontinued permanently, all significant risks cannot be considered to have been transferred to the buyer. Moreover, the querist has stated that the customer is not bound to order the components in a fixed time period and the rate of recovery of ‘mould amortisation’ is solely dependent on receipt of orders from the customers. Considering the aforesaid factors, the Committee is of the view that all significant risks and rewards of ownership are not transferred to the buyer and, accordingly, sale cannot be booked in this case.

10. The Committee notes the definition of the term ‘fixed asset’ given by Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, which is as follows:

"6.1 Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business."

 

The Committee is of the view that the moulds held by the company for their use in the manufacture of plastic components fully satisfies the requirements of the above definition and, therefore, should be treated as a fixed asset. The Committee is further of the view that depreciation should also be charged on such moulds as per the requirements of Accounting Standard (AS) 6, ‘Depreciation Accounting’, over the useful life of the mould.

D. Opinion

11. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6 above:

(a) No, the adopted accounting practice for ‘mould amortisation’ is not in accordance with the generally accepted accounting principles in India.

 

(b) No, it is not proper to book entire income arising out of ‘mould amortisation’, as it cannot be considered as ‘sale’ in the present case.

 

(c) No, the stipulation of two years has no basis.

 

(d) No, the question of treatment as debtors does not arise as the transaction is not regarded as ‘sale’.

 

(e) The mould should be treated as a fixed asset and depreciation thereon should be provided for as per paragraph 10 above. In no case, it should be treated as stock, since the mould itself is not treated as being sold.

1 Opinion finalised by the Committee on 27.12.2004