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A. Facts of the Case
1. A company is a public sector enterprise under the
administrative control of the Ministry of Defence. It is a leading
engineering product company and is a market leader in earthmoving
and mining products. The query pertains to the issue of revenue
recognition pending physical delivery based on same facts as of
an earlier query (Query No. 10 of Compendium of Opinions Volume
XXVIII) referred by the same querist for the opinion of the
Committee. According to the querist, the Committee has stated in
its opinion for the earlier query that booking of sales on the basis
of goods consignment (GC) Notes is not in line with Accounting
Standard (AS) 9, ‘Revenue Recognition’, unless risks and rewards
of ownership are passed on to the buyer even before the actual
delivery to the transporter. The querist has once again sent a fresh query with some additional arguments and copies of some
additional documents. According to the querist, any opinion has to
be based on facts and also on law. The applicable law needs to be
analysed, interpreted and applied to the facts presented. To
substantiate the facts, copies of the following documents relating
to order received from a customer have been furnished by the
querist for the perusal of the Committee:
(i) Notice Inviting Tender by the customer in respect of
supply of three BD 155 (410 HP) Crawler Dozer.
(ii) Order released by the customer to the company.
(iii) Sale order/order acceptance issued by the company.
The purpose of this document is to intimate:
(a) The production division to take necessary action
regarding production of the equipment;
(b) Finance and shipping and various offices of
production division and research and development
(R & D) division regarding acceptance of order;
(c) Detailed technical features;
(d) The price and various commercial clauses.
(iv) Work order Opening and Closing Advice.
(v) Pre-despatch inspection report (issued by the Inspection
Engineer of the customer) towards acceptance and
despatch of the equipment.
(vi) Despatch Advice raised by the shipping department of
the company, giving the details, like equipment number,
engine number, Excise Despatch Advice Note, GC Note
number, etc. By a copy of this despatch advice, Finance
department is intimated to raise the bill or invoice on the
customer.
(vii) Goods consignment (GC) Note issued by the transporter.
This document indicates the handing over of the
equipment to the transporter.
(viii) Invoice raised by the company on the customer in
respect of one dozer out of three dozers ordered, as a
sample for understanding the flow of transaction.
2. As per the querist, the above documents show that the
company normally responds to tender enquiry. The company makes
an offer based on the tender parameters which is followed up by
certain correspondence. After techno-commercial evaluation, orders
are placed on the company provided the company satisfies the
tenderer techno-commercially.
3. The querist has informed that normally the terms relating to
price and delivery are as follows:
Prices: price is F.O.R. (Free-on-Rail) ex-works, XYZ unit
inclusive of packing and forwarding charges. However, the
transit insurance and transportation is arranged by the
company wherever the terms of contract so provide. The
amount(s) of insurance premium and freight charges are
reimbursed by the customer in such cases. This is a trade
practice normally followed in this nature of industry to enhance
the customer satisfaction and loyalty.
Delivery is ex-works, XYZ unit. Further, pre-despatch inspection
at the company’s works and final inspection at destination are
also stipulated.
As per the querist, most of the orders for earth moving machinery
are with similar stipulation.
4. The querist has furnished the following information and
arguments:
(i) On receipt of customer order, a sale order is generally
generated containing time schedule and other significant
contents of the contract. This sale order is a document
which enables the production department of the company
to plan and start production of the equipment.
(ii) On completion of the production, a call letter is issued
to the inspecting authority of the customer and predespatch
inspection is carried out and report is prepared which clearly certifies that the equipment offered for
inspection has undergone all functional checks and is
meeting the specification of the supply order and also
clearance is accorded for the despatch of the equipment.
(iii) Also, the Pre-despatch Inspection Note makes it clear
that the equipment may be despatched after dismantling,
if necessary, for convenience of transportation.
(iv) Based on the pre-despatch inspection certification, a
Despatch Advice is generated by the shipping
department. Such Despatch Advice clearly identifies
equipment regarding its model, make and serial number,
customer order and the sale order raised thereafter. It
also stipulates chassis number, the machine number
and the number of packing cases.
(v) Thereafter, the goods are handed over to the carrier(s)
which is evidenced by issuance of GC Notes.
Incidentally, all the equipments are heavy earth moving
machinery which are transported in disassembled
condition by either low bed or semi low bed trailers
only. Normally, these vehicles (low bed/semi low bed
trailers) are in short supply. Even most of the renowned
transporters do not own such vehicles in adequate
numbers. It is a well known fact that the concerned
vehicles, especially low bed and wide bodies vehicles
are in great demand, especially during the last quarter
of the year, with premium price and thus, the transporters
make available to the company, vehicles at contracted
rate much later. Hence, such vehicles are perennially in
short supply. Also, these transporters do not have
adequate storage space and lifting tackles for loading
and un-loading in their premises. Hence, the transporter
uses the finished goods inventory stores of the company
and the equipments are often in the premises of the
company even though the receipt thereof is
acknowledged by way of GC Notes.
(vi) Based on the above documents, the company issues
invoice addressed to the purchaser giving full particulars of the equipment and referring thereon GC Note number
(date and particulars of the transporter, etc.), thus,
transferring the ownership of the equipment to the buyer.
(vii) Equipment(s) in question meets the definition of goods
as defined in clause (7) of section 2 of the Sale of
Goods Act, 1930 which states, “‘goods’ means every
kind of movable property…”.
(viii) Thus, there is no doubt, whatsoever that the
equipment(s) in question are movable property.
(ix) Section 4 of the Sale of Goods Act, 1930 provides that
a contract of sale of goods is a contract whereby the
seller transfers or agrees to transfer the property in the
goods to the buyer for a price. According to the querist,
where under a contract of sale, the ownership of property
in goods is transferred, the contract is called a sale;
whereas when the transfer of goods takes place at a
future time or date, the said contract is called an
agreement to sell. In the instant case, the tender
invitation and the response thereto is in the nature of
invitation to bid on an offer. The Purchase Order issued
by the customer is acceptance of the offer and has to
be construed as agreement to sell. Since the goods are
generally manufactured by the company after making
of the contract, the said would be an agreement to sell
unascertained or future goods.
(x) Section 23(1) provides that in the case of contract for
the sale of unascertained or future goods by description
and goods of that description are in deliverable state
and are unconditionally appropriated to the contract,
either by the seller with the assent of the buyer or by
the buyer with the assent of the seller, the property in
the goods thereupon passes on to the buyer. The assent
may be given either before or after the appropriation.
(xi) Section 23(2) provides that in pursuance of the contract,
the delivery of the goods to the buyer or carrier or other
bailee (whether named by the buyer or not) for the purpose of transmission to the buyer, constitutes
appropriation of goods to the contract.
(xii) Section 39 also, inter alia, provides that the delivery of
goods to carrier is prima facie deemed to be a delivery
to the buyer.
(xiii) In the case of Marwar Tent Factory vs. Union of India,
the Hon’ble Supreme Court had decided that in the
case of F.O.R. (Free on Rail) ex-works contract, the
transfer of property in the goods takes place by delivery
of goods to the carrier and accordingly the significant
risks and rewards of ownership pass on to the buyer.
(xiv) The Committee, in the Compendium of Opinions, Volume
XXII (Query No. 16) has also, inter alia, opined that the
accounting policy of a seller, to recognise sales under
“Godown Storage Facility” scheme when the goods are
delivered to the transporter for despatch to the
customer’s godown and the relevant sale invoice is
issued, appears to be proper and in accordance with
AS 9. The Committee is also of the opinion that the
seller is transferring the property in the goods for a
price and all significant risks and rewards of ownership
are also transferred though the lock and key of the
godown are very much with the seller and also the
insurance of the godown is obtained by the seller.
Further, the Committee has specifically stated that in
such cases of deemed possession of goods, the contract
of sale does not adversely affect the parameters
prescribed by AS 9.
5. As per the querist, in view of the above, the company’s action
of recognising revenue on delivery of equipment to the transporter
does not vitiate the parameters laid down by AS 9.
6. The querist has also obtained a legal opinion in this regard. In
the opinion, there is a discussion on the provisions of the Sale of
Goods Act, 1930 and the judgement of the Supreme Court in
Marwar Tent Factory vs. Union of India reported in 1990 AIR (SC)
1753. Further, some of the documents mentioned in paragraph 4 above have also been discussed. After making some remarks on
the Committee’s opinion on the earlier query raised by the querist,
the legal opinion concluded that the company can recognise
revenue as sales upon issuance of GC Notes and that the opinion
of the Committee is not sustainable and not in conformity with law.
B. Query
7. The querist has requested the Expert Advisory Committee to
reconsider its earlier opinion on the subject in the light of the facts
and law set out above.
C. Points considered by the Committee
8. The Committee notes that copies of some additional
documents (mentioned in paragraph 1 above) have been furnished
by the querist for the perusal of the Committee and flow of a
sample transaction has been explained by the querist by way of
such additional documents. Further, reliance has been placed on
the judgement of the Hon’ble Supreme Court in Marwar Tent
Factory vs. Union of India. The querist has also drawn the attention
of the Committee to one of its earlier opinion published in Volume
XXII of the Compendium of Opinions (mentioned in paragraph
4(xiv) above).
9. The Committee notes that actually, two issues were raised by
the querist in the earlier query referred in paragraph 1 above. As
per the facts of that query, the company recognised revenue merely
on the receipt of GC Note from the transport carrier without physical
delivery, since adequate trailers are generally not available at the
time of issue of GC Notes. Further, in some cases, at the request
of some customers, delivery was delayed but revenue was
recognised.
10. As regards the first issue, the Committee notes that the Facts
of the Case and the copies of documents furnished (mentioned in
paragraph 1 above) do not clearly indicate the point of time at
which all significant risks and rewards of ownership are passed on
to the customer. For instance, it is stated in the Facts of the Case
(paragraph 3 above) that normally, the price terms are ‘F.O.R.
(Free on Rail), ex-works, XYZ unit’ and delivery terms are ‘exworks,
XYZ unit’. It is also stated that the transit insurance and transportation is arranged by the company
wherever the terms of
contract so provide. The amount(s) of insurance premium and
freight charges are reimbursed by the customer in such cases.
Further, pre-despatch inspection at the company’s works is also
stipulated and final inspection at destination is also stipulated. It is
also stated that most of the orders for earth moving machinery are
with similar stipulation. Thus, all contracts may not be identical.
11. The Committee notes that for the sample transaction explained
by the querist in paragraph 1 above, in both the purchase order
and sale order, price was mentioned as ‘F.O.R. ex-works, XYZ
unit basis, inclusive of packing and forwarding charges while place
of delivery was mentioned as ‘ex-works, XYZ unit’. Further, both
freight and transit insurance charges were to be paid to the
company in addition at actuals subject to a ceiling. The Committee
also notes that in the copy of pre-despatch inspection report
furnished by the querist, it is mentioned that the dozer is found to
meet the specifications of the relevant supply order and clearance
was accorded for despatch of the equipment to the consignee
without delay. In that report, it was further mentioned that the
dozer may be despatched after suitably dismantling, if necessary,
for the convenience of transportation. However, the Committee
notes that apart from pre-despatch inspection mentioned by the
querist, there is one more inspection, viz., final inspection. Clause
11 of the Terms and Conditions of the purchase order placed by
the customer on the company (furnished by the querist for the
perusal of the Committee) states that on final inspection, stores
found defective or not in accordance with the supply order’s
specification will be rejected and intimated for free replacement
within 30 days from the date of intimation. Performance guarantee
is also involved. A portion of the price (20%) is payable within 21
days of successful installing, commissioning and final acceptance
of the equipment/ accessories at site. Further, it is not clear as to
who bears the risk of damage between the date of obtaining the
GC Note and the date of actual placement of dozers on the trailers.
The Committee also notes a very important clause in the purchase
order released by the customer. Clause 1 of the Terms and
Conditions of the purchase order states, inter alia, that safe delivery
of materials to destination shall be the responsibility of the company.
The Committee is of the view that this is an indication that all significant risks and rewards of ownership in the goods do not
pass on to the customer at least until the safe delivery of the
goods to the destination. In addition, final inspection and acceptance
at site may also be relevant in determining the timing of transfer of
all the significant risks and rewards of ownership to the customer.
Hence, mere mentioning of place of delivery as ‘ex-works, XYZ
unit’ in the purchase order and sale order does not establish that
all significant risks and rewards of ownership are passed on to the
customer on mere obtaining of the GC Notes without even
placement of the trailers by the transporter.
12. The Committee notes that the opinion expressed by the
Committee in ‘Compendium of Opinions’, Volume XXII, mentioned
by the querist in paragraph 4(xiv) above was based on facts
which were different from the present facts of the case. In that
case, it was clearly mentioned that the goods were under the lock
and key of the selling company only to secure payment from the
buyer. Further, it was clearly mentioned that all the significant
risks and rewards of ownership were transferred to the buyer. It
was also mentioned in that case that risk of loss of goods while
they were in the buyers’ godowns though under lock and key of
the seller, was in substance, borne by the buyer. Excess or
shortage of insurance proceeds over the amount of loss was paid
to, or recovered from, the buyer, as the case may be. If the buyer
defaulted to take delivery and a resale was made, any profit/loss
arising on the resale was paid to, or recovered from, the buyer, as
the case may be. Since these factors clearly indicated that all the
significant risks and rewards of ownership were transferred to the
buyer, the Committee expressed its opinion in that case that
recognition of sales was proper on delivery of goods to the
transporters for despatch to the godowns of the buyers, provided
no uncertainty existed regarding the amount of the consideration
that will be derived from the sale of the goods and it is not
unreasonable to expect ultimate collection of the consideration.
The querist has not stated that all the above situations prevail in
the present case also. Further, in the case quoted by the querist
from Volume XXII of the ‘Compendium of Opinions’, it was not
mentioned that GC Notes were obtained even before the goods
were placed on the trailers. The querist has only stated in the
previous query referred for the opinion of the Committee (mentioned in paragraph 1 above) that there was no uncertainty in
expecting the ultimate collection of sale proceeds. Other information
clearly indicating timing of passing of all significant risks and
rewards of ownership to the customer were not furnished by the
querist. Hence, the Committee could not express an unreserved
opinion for the case of the querist.
13. As regards the provisions of the Sale of Goods Act, 1930 and
the judgement of the Hon’ble Supreme Court in the case of Marwar
Tent Factory cited in paragraph 4(xiii) above, the Committee notes
that as per Rule 2 of the Advisory Service Rules, the Committee is
prohibited from answering queries which involve legal interpretation
of various enactments. The Committee also notes the principle of
‘Substance over Form’, according to which the accounting treatment
and presentation in financial statements of transactions and events
should be governed by their substance and not merely by their
legal form. Thus, for example, a finance lease is treated as a sale
in the books of the lessor and a purchase in the books of the
lessee as per the provisions of Accounting Standard (AS) 19,
‘Leases’, even though legal ownership is not transferred at the
inception and even if it is not intended to be transferred at the end
of the lease period. Similarly, as per paragraph 9 read with
paragraph 10 of AS 9, even if all the significant risks and rewards
of ownership of goods are transferred to the buyer, revenue
recognition is not permitted, if it is not reasonable to expect ultimate
collection or if significant uncertainty exists regarding the amount
of the consideration that will be derived from the sale of the goods.
This is despite the legal effect of the sale transaction.
14. As regards the legal opinion obtained by the querist, the
Committee notes that that opinion also deals primarily with the
provisions of the Sale of Goods Act, 1930 and the aforecited
judgement of the Hon’ble Supreme Court. The Committee’s views
in this regard have already been stated in paragraph 13 above.
The legal opinion, inter alia, states that paragraph A1 of Appendix
to AS 9 was not considered by the Committee. The Committee
wishes to point out that the said portion of AS 9 was duly discussed
in paragraphs 22 and 23 of its earlier opinion. This portion of AS 9
is relevant only for the second issue raised by the querist, viz.,
delivery delayed at the request of the customer.
15. As regards the second issue (viz., delivery delayed at the
request of the customer), the Committee notes that the querist
has neither furnished any documents nor given any fresh
arguments. The querist has, thus, not raised the second issue.
16. The Committee also wishes to make it clear that in its earlier
opinion, the Committee has not simply expressed the view that
recognition of sales was inappropriate. It has added the qualifying
remarks implying that if the necessary conditions were met, sales
could be recognised.
D. Opinion
17. On the basis of the above, the Committee reiterates its earlier
opinion in the case referred to by the querist.
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