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Query No. 9
Subject:
Accounting for maintenance spares supplied free
of
cost along with the main equipment.1
A. Facts of the Case
1. A company is a leading engineering product company in public
sector under the Ministry of Defence, catering to the vital sectors
of the economy, such as, infrastructure, surface transportation,
mining and defence. As per the querist, with a turnover of Rs.
2601.79 crore for the financial year 2006-07, the company is market
leader in earthmoving and mining equipments and consistently
making profits right from its inception. For the financial year 2006-
07, the company earned a profit before tax of Rs. 316.04 crore
registering a growth of 10.73% over previous year. The company
is a fast growing engineering product company with export presence
in as many as 42 countries spanning over Asia, Africa, and South
American countries. For the financial year 2006-07, the export
turnover was Rs. 110.73 crore and, according to the querist, it is
expected to increase manifold in the future.
2. The company has three manufacturing units located at Kolar
Gold Fields (KGF), Bangalore and Mysore. It has marketing and
service centres spread all over India. The KGF unit manufactures
dozers, excavators, loaders, walking draglines, rope shovels and
sophisticated aggregates catering to the needs of mining and
defence sectors. The Bangalore unit manufactures rail coaches,
EMU’s wagons, overhead inspection vehicles for Indian Railways
and also logistics vehicles (tatra variants), mechanised pontoon
bridges, ground support system for the integrated guided missiles
for use by the Ministry of Defence. In addition, Bangalore unit is
manufacturing for the first time in India, metro rail coaches under
license from a company of Korea. The Mysore unit manufactures
highly sophisticated dumpers, graders, aircraft towing tractors, the
weapon loading systems and high powered internal combustion
engines. All these products are highly technology intensive and
call for an array of manufacturing technologies.
3. The querist has stated that one of the usual terms of sale is
that the price of the equipment includes certain specified quantity
of maintenance spares supplied free of cost. In other words, the
company agrees to supply certain spares free of cost, i.e., without
charging anything in excess of the agreed price of the equipment,
purely as a marketing strategy.
4. The querist has illustrated the accounting treatment being
followed by the company with the help of the accounting entries as
follows:
(i) Debit: Sundry Debtors/Customers
Credit: Sales Account-Equipment (value of equipment + value of spares to be supplied free of cost)
Credit: Sales Tax.
(ii) The value of spares supplied/to be supplied free of cost
as per the terms of the customer order is intimated
through the issuance of a credit note, a copy of which is
marked to the concerned sales office located at various
states. The accounting entry passed is as follows:
(a) Debit: Sales Account (Equipment) – To the
extent of the value of free spares.
Debit: Depot Sales Tax Account – Pro-rata
Credit: Deposit – Customer Account
(b) Thus, the equipment sold is recorded at a net
value, i.e., value as per customer order as
reduced by the value of free spares.
(iii) The free spares may be supplied either from the
production units located at Karnataka or from the
concerned sales office(s) located at various places in
India. To the extent the free spares are supplied from
Karnataka, i.e., in case of inter-state sale, the accounting
entry passed is as follows:
Debit: Deposit - Customer Account
Credit: Sales Account - Spare Parts
Credit: Sales Tax
To the extent free spares are supplied from the sales
offices, i.e., intra state sales, the accounting entry passed is
as follows:
Debit: Deposit - Customer Account
Credit: Sales Account - Spare Parts
Credit: Sales Tax at the appropriate rate as per the
statute of the concerned State.
Thus, in the view of the querist, with the passing of the above
accounting entries, the total sale value as per the customer
order is restored.
5. According to the querist, this is done purely to reflect correctly
the value of spare parts sold to customers (either at a price or free
of charge or as a part of equipment), as the company has a
strategic business unit for spare parts. Also, in the view of the
querist, by doing this, the company is not violating Accounting
Standard (AS) 9, ‘Revenue Recognition’, in any manner whatsoever.
As per the querist, this method enables the company to fix the
price of the equipment as per the market dynamics.
6. The querist has further stated that the statutory auditors of
the company are of the opinion that raising invoice separately for
spare parts supplied free of cost and accounting thereof by reducing
the value of the equipment (to the extent of the value of spares
supplied free of cost) is not in order.
B. Query
7. The querist has sought the opinion of the Expert Advisory
Committee as to whether the accounting for sale of equipment
duly reducing the value of free supply of spares and accounting as
sale the value of spares at the time of supply is in line with
Accounting Standard (AS) 9, ‘Revenue Recognition’.
C. Points considered by the Committee
8. The Committee notes that the basic issue raised in the query
relates to whether or not the accounting of maintenance spares
supplied free of cost by reducing the value of equipment (to the
extent of the value of the spares) and recording the sale of spares
at the time of supply thereof is in order. The Committee has,
therefore, restricted its opinion to this issue and has not touched
upon any other issue arising from the Facts of the Case, such as,
the accounting and valuation of inventories of maintenance spares,
accounting for sales tax, basis of measurement of the amount at
which revenue from sale of spares should be booked, etc. Further,
the opinion expressed by the Committee is purely from accounting
point of view and the Committee has not gone into legal
interpretation of various enactments, such as those relating to
sales tax, etc.
9. The Committee notes on the perusal of the query that the
entries passed by the company are not clear in respect of the
values at which the entries are passed. Accordingly, the
understanding of the Committee in this regard has been illustrated
with the help of the following entries:
(a) Assuming the value of sales order of equipment is
Rs. 100, inclusive of the value of spares to be supplied
along with the equipment Rs. 10; ignoring the effect of
sales tax, the entry passed by the company is:
Sundry Debtors A/c Dr. 100
To Sales A/c (Equipment) 100
(b) For issuing credit note to the concerned sales office:
Sales A/c (Equipment) Dr. 10
To Deposit – Customer A/c 10
(With passing of this entry, the equipment sold is recorded at
the net value, i.e., value as per customer order as reduced by
the value of free spares)
(c) At the time of supply of free spares from the concerned
sales office:
Deposit – Customer A/c Dr. 10
To Sales A/c (Spare parts) 10
(With the passing of this entry, the total sales value as per the
customer order is restored)
10. The Committee notes from the Facts of the Case that though
the company, in the instant case, is supplying spares free of cost,
since the spares have a value which otherwise would have been
recovered had these spares not been supplied under the agreement
of selling of main equipment, in substance, in the view of the
Committee, the company is selling two products under one
composite selling arrangement. The Committee is, therefore, of
the view that principles of revenue recognition, as enunciated in
AS 9, should be applied separately to each element of the
composite arrangement with a view to recognise revenue. In this
context, the Committee notes paragraphs 6.1, 10 and 11 of AS 9,
which provide as follows:
“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 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.”
11. The Committee further notes from paragraph 4(iii) above that
free spares may be supplied either from the production units located
at Karnataka or from the concerned sales offices located at various
places. Thus, there can be a time lag between the recognition of
revenue on account of sale of equipment and that for spares in
case significant risks and rewards in respect thereof are transferred
to the buyer on different dates, e.g., significant risks and rewards
in respect of spares are transferred at the time of delivery thereof
to the buyer whereas those of equipment are transferred at the
time of the delivery of equipment which might have taken place at
an earlier date. In such a situation, passing of a separate entry for
spares would be justified.
12. The Committee notes from the above-reproduced paragraphs
of AS 9 that the Standard requires recognition of revenue when
the significant risks and rewards of ownership in respect of the
goods have been transferred to the buyer. Thus, the Committee is
of the view that in case the significant risks and rewards in respect
of spares are transferred at a time different from the time of
transfer of the risks and rewards of the concerned equipment, the revenue in respect of that equipment should not be recognised at
a gross amount, inclusive of value of spares. The revenue in
respect of spares should be separately recognised at the time of
transfer of significant risks and rewards of ownership of the spares.
Therefore, it is not appropriate to first pass the entry for sale of
equipment at the gross amount and then to pass a reversal entry
for recognising revenue from spares.
D. Opinion
13. On the basis of the above, the Committee is of the opinion
that the accounting for sale of equipment duly reducing the value
of free supply of spares would be in line with AS 9 provided
significant risks and rewards of ownership in respect of free spares
are transferred at the time of the delivery of spares to the buyer.
However, separate entries should be passed for (a) booking
recognition of revenue from sale of equipment net of the amount
related to revenue from spares when the risks and rewards of
ownership of the equipment are transferred and (b) booking
recognition of revenue from spares when the risks and rewards of
ownership of spares are transferred.
1Opinion finalised by the Committee on 30.4.2008 |