Query No. 7

Subject:

Accounting treatment of installation charges collected by a

telephone company from its customers.¹

A. Facts of the Case

1. A public sector company registered under the Companies Act, 1956, under the Ministry of Telecommunication, Government of India, maintains its accounts on the basis of mercantile system. The main business of the company is to provide wire-line telephone services to the public. When the telephone service is provided to the subscriber, the subscriber’s instrument is connected to the switching equipment by drawing wires from the subscriber’s premises to the company’s network. The exchange equipment and cables are installed as per the projected demand/ requirement and are capitalised in accordance with the accounting policy of the company duly disclosed in the annual accounts as below:

(i) Apparatus and plants principally consisting of telephone exchange equipment and air conditioning plants are capitalised on commissioning of the exchange. The subscribers’ installations are capitalised as and when exchange is commissioned and put to use, either in full or in part.

(ii) Lines and wires are capitalised as and when laid or erected to the extent completion certificates have been issued.

(iii) Cables are capitalised as and when ready for connection to the main system.

2. According to the querist, the company installs the equipment and lays the cable based on demand projection for the future. The capital expenditure is incurred in the year in which such equipments are installed or the cable is laid. The full capacity is not utilised on the first day of the year in which they are capitalised.

3. The querist has stated that the company charges a sum of Rs. 800/- from its customers as installation charges. This is a standard charge fixed by the company. Further, there is an option to the customers to provide their own instrument and/or internal wiring at their premises. In case of the above, a rebate on the installation charges is allowed to the customer to the extent of Rs. 500/- on internal wiring and the instrument (Rs. 250/-, if the customer chooses to use his own instrument and Rs. 250/-, if the internal wiring is carried out by the customer). The equipment, cable, internal wiring and the instrument remain the property of the company. They are recovered when the customer surrenders the connection, and are reused for providing connection at the same premises or at other premises. In other words, Rs. 800/- is an average charge irrespective of the cost of internal wiring at the subscriber’s premises. The above stated income of Rs. 800/- is recognised as revenue receipt under the head, ‘Installation charges’ in the books of account of the company. The installation charges or any part thereof are not refundable to the customers on surrender of the connection.

4. The querist has stated that the average cost of telephone instrument and internal wires as per strategic business planning (SBP) norms are as under:

(a)    Cost of instrument:                                      (Rs.)

As per SBP norms                                    417.00  per line

Freight  0.5%                                                2.08

Establishment                                              41.90

charges  10%

 Store keeping 7%                                        29.20

 Total                                                         490.18

(b)    Cost of lines and wires:                                (Rs.)

As per SBP norms                                  1739.00  per line

Freight  0.5%                                                8.69

Establishment                                            227.19

charges  13%

 Store keeping 7%                                      121.73

 Total                                                       2096.61

Per line cost (a+b)                                  2587.00

  The above includes the cost of internal wiring in the premises of the subscriber.

The cost of the instrument and internal wiring are capitalised in the books of account of the company. Further, the querist has informed that the monthly rental charged from the customers does not relate to the instrument and the wiring.

5. The querist has stated that the installation charge collected is based on an average cost. In one case, the expenditure may be less and in another case, it may be more. This may require additional exercise to adjust the installation charges against the expenditure. Further, the capitalisation of equipment and cable takes place in the financial year as per the policy stated in paragraph 1 above and only a small expenditure is incurred on activation in the same year or a subsequent year. The identification of expenditure for each individual connection is not possible. Moreover, the full capacity utilisation depends upon the demand from the residents of the locality for which such facility is offered. The company has no control on the demand. Thus, the installation charge is not set-off against the capital expenditure and is treated as ‘Miscellaneous Income’. The accounting policy of the company states, “Installation charges recovered from the subscribers at the time of new telephone connection is recognised as income in the year of connection.” Further, the company cannot anticipate the period over which a subscriber will keep his telephone. Therefore, the same cannot be treated as deferred income.

6. The auditors of the company have qualified the accounts as follows:

“The installation charges received from the subscribers are accounted for as income and not adjusted against cost thereof. This practice followed by the company in respect of fixed assets is not in accordance with Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India.”

The auditors are of the opinion that this revenue should not be accounted for as revenue receipt and should be set-off against the capital expenditure incurred on this account.

B. Query

7. The querist has sought the opinion of the Expert Advisory Committee as to whether the company is justified in accounting for as income, the sum of Rs. 800 received from its customers, being one time payment of ‘Installation charges’, at the time of installation of telephone.

C. Points considered by the Committee

8. The Committee notes that the company in question recovers the cost of the telephone instrument and internal wiring installed in the premises of the customer by way of installation charges at the time when the telephone connection is provided to the customer. The Committee further notes that the costs of the instrument and the internal wiring are capitalised in the books of the company and presumably considered as fixed assets in accordance with the generally accepted accounting principles laid down in this regard. The Committee has not gone into the question of whether the said treatment is appropriate since the issue has not been raised. The Committee has, accordingly, considered the issue raised by the querist relating to the recognition of the installation charges received from the customers towards the cost of the internal wiring and the instrument installed with the customer at the time of the installation itself.

9. The Committee notes that the auditors of the company have argued that the installation charges received from the customer are towards the recovery of the cost of instrument and internal wiring and, therefore, should be adjusted against the capitalised cost thereof rather than recognising the same as revenue on installation. Accordingly, in the view of the auditors, this practice is not in accordance with Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India.

10. The Committee notes that paragraphs 19 and 20 of AS 10 provide as below:

“19. The gross book value of a fixed asset should be either historical cost or a revaluation computed in accordance with this Standard. The method of accounting for fixed assets included at historical cost is set out in paragraphs 20 to 26; the method of accounting of revalued assets is set out in paragraphs 27 to 32.

 

20. The cost of a fixed asset should comprise its purchase price and any attributable cost of bringing the asset to its working condition for its intended use.”

11. On the basis of the above, the Committee is of the view that the cost of the fixed asset cannot be arrived at after adjusting any amount recovered in this regard from the customer. In the view of the Committee, the contention of the auditor that the installation charges should be reduced from the cost of the capitalised telephone instruments and related wiring, is not correct.

12. The Committee notes that the company is recognising as revenue, the entire amount of installation charges which includes recovery of the cost of the instrument and internal wiring on installation of a connection. The Committee is of the view that this practice is against the matching principle of accounting, whereby revenue and the costs incurred to earn the revenue are matched to arrive at the periodic income. The Committee is of the view that to the extent the installation charges relate to recovery of the cost of the instrument and internal wiring, the same should not be recognised as revenue rather, should be recognised as deferred income at the time of installation of the connection. Out of the said deferred income, an appropriate amount equivalent to the periodic charge of depreciation on the instrument and internal wiring should be recognised as income in the profit and loss account of the company for the relevant year. For this purpose, it is not necessary to identify the depreciation and the relevant portion of deferred income to be recognised as revenue for an individual connection. It would be sufficient if such details are worked out on the basis of the block of connections provided during a particular year. Thus, the company will have to keep a track of the depreciation on the instruments and internal wiring capitalised during a particular year so that an appropriate amount could be recognised as income out of the deferred income. However, to the extent, the installation charges do not relate to the recovery of the cost of the internal wiring and the instrument, the same can be recognised at the time of the installation of the telephone connection in the premises of the subscriber provided that part of the installation charges relates to the revenue expenditure incurred by the company in providing the connection.

D. Opinion

13. On the basis of the above, the Committee is of the opinion that the company should recognise the amount of installation charges, to the extent it represents the cost of internal wiring and instruments, as deferred income. Periodic income should be recognised, out of the deferred income, in proportion to the periodic depreciation charge on the instruments and the internal wiring in the profit and loss account of the company for the relevant year, as discussed in paragraph 12 above.

¹ Opinion finalised by the Committee on 28.4.2005