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A. Facts of the Case
1. A company is engaged in the business of manufacture, erection and commissioning of Wind Electric Generators (WEGs). The company is also engaged in the business of providing sales services for the WEGs besides earning revenue from generation of electricity from its own WEGs.
2. Based on negotiations by the company, the customers agreeing to place orders with the company, issue the following three separate Purchase/Work Orders (a copy each of the formats for these orders have been furnished by the querist for the perusal of the Committee):
(i) Purchase Order for supply of WEGs.
(ii) Work Order for civil, electrical and infrastructure work.
(iii) Order for erection and commissioning of WEGs.
3. The company has been recognising revenue based on the completion of an activity covered in the above mentioned three Purchase/Work Orders separately. As per the querist, the reasons for taking this view are the following:
(i) Each activity is an independent activity governed by a separate Purchase/Work Order.
(ii) Each Purchase/Work Order has a different payment schedule.
(iii) The taxes, as applicable for each Purchase/Work Order, are different and are deposited by the company on completion of the specific activity of the said Purchase/Work Order.
(iv) Accounting Standard (AS) 9, ‘Revenue Recognition’, requires that the amount of revenue arising on a transaction is usually determined by an agreement between the parties involved in the transaction. The company enters into separate Purchase/Work Orders and hence, complies with the requirement.
(v) AS 9 requires that the key criterion to recognise revenue from a transaction involving the sale of goods is that the seller has transferred the property to the buyer for a consideration.
4. As per the querist, the accounting policy now suggested by the company for adoption in respect of revenue recognition is as under:
Revenue Recognition
- Revenue comprises sale of WEGs and its spare parts, project income being installation and commissioning of WEGs, income from maintenance services, power generation from own WEGs and interest income. Revenue is recognised to the extent it is probable that the economic benefits will flow to the company and that the revenue can be reliably measured and is expected to be received. Revenue is disclosed net of taxes.
- Sale of WEGs and spare parts are recognised when the significant risks and rewards in respect of ownership of goods have been transferred to the buyer as per the terms of the respective sale orders. Income from project involving installation, commissioning and other incidental works is recognised on completion of the respective work, as per the terms of the work orders.
- Revenue from annual maintenance contracts is recognised on a proportionate basis over the period of the contract on a straight line basis. Income from support services is recognised upon completion of the services.
- Power generation income is recognised on the basis of electricity units generated, net of wheeling and transmission loss.
- Interest income is recognised on a time proportion basis.”
5. The querist has informed that the time required for supply of WEGs, completion of civil, electrical and infrastructure works and erection and commissioning normally varies between 4 to 6 months from the date of receipt of purchase order by the company. The period may vary depending on the total capacity of the project and the location of the project. The querist has stated that there are certain situations when part of the activities are completed as at the end of the financial year, e.g., as on March 31, only delivery of WEGs takes place while all other activities, i.e., installation, erection and commissioning gets shifted to the next financial year. Insofar as the company is concerned, major cost of the project is already incurred by the company and supply of WEGs is completed as per supply order and accordingly, as per the querist, it should be possible to fully book the revenue of the same as on 31st March. The querist has stated that it has been indicated to the company that if revenue for supply of WEGs is to be booked, a letter be obtained from the customer certifying receipt of WEGs and confirming that risks and rewards in respect of ownership of goods have been transferred to the customer.
6. The querist has further stated that the following background needs to be kept in view with respect to the requirement of obtaining the above-mentioned letter:
(a) The policy followed by the company is that after manufacturing the WEGs, these are transferred by the company on a stock transfer basis to a particular site in a particular State and as and when order is received by the company from any customer, the WEGs are allocated to that customer and invoice is raised from that particular site and State in the name of the customer. The WEGs after allocation continue to be in the possession of the company for installation, erection and commissioning. The site is handed over to the customer after commissioning of the WEGs.
(b) Since the WEGs are taken over by the customer after commissioning alongwith relevant papers at site, there is reluctance on the part of the customer to give any kind of letter confirming passing of significant risks and rewards in respect of ownership of goods prior to that stage. It is, however, a fact that WEGs are installed at remote sites, where no representative of the customer is present and as such question of obtaining any letter is, therefore, difficult. On the company’s part, it is important to recognise revenue as manufactured goods leave the premises and are invoiced in the name of the customer as on 31st March.
B. Query
7. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the accounting policy for revenue recognition presently suggested to the company is in line with AS 9 or any change is required to be made.
(b) Whether the company can adopt the policy on revenue recognition independently for all the three orders, without insisting on obtaining a letter from the customers regarding transfer of significant risks and rewards, on account of peculiar nature of the situation.
C. Points considered by the Committee
8. The Committee notes that the basic issue raised by the querist relates to whether the accounting policy suggested to the company in respect of recognition of revenue from sale of WEGs and performance of related activities, such as, installation, erection and commissioning in respect thereof is in order. The Committee has, therefore, considered only this issue and has not touched upon any other issue that may be contained in the Facts of the Case, such as, revenue from sale of spare parts, generation of electricity, annual maintenance contract, support services, interest income, etc. Further, the Committee has not examined the accounting for cost of land, path way rights etc. as mentioned in the format for work order for civil, electrical and infrastructural work as the adequate details in respect of the same have not been provided.
9. The Committee notes from the Facts of the Case that the querist has stated that based on negotiations by the company, the customers agreeing to place orders with the company issue three separate purchase/work orders for supply of WEGs and related activities, implying that there are common negotiations for all the three orders. Further, on a perusal of the formats for the said three orders, the Committee notes that the activities performed under the three orders are inter-connected and for all the three orders, commissioning of the WEG is an essential part. From the above, the Committee is of the view that the three separate contracts entered into by the company with its customers are in fact one composite contract which has been broken into three separate agreements.
10. The Committee further notes from the Facts of the Case that the WEGs are manufactured by the company and kept in stock for allocation to the customers upon receiving an order. Further, as stated by the querist, as far as the company is concerned, the major cost of the project is incurred upto the supply of the WEGs. Accordingly, in the view of the Committee, the contract in the present case basically relates to sale of WEGs.
11. The Committee notes the following paragraphs from AS 9 which provide as below:
“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.”
12. The Committee notes from the above that in the instant case, the performance in respect of sale of WEGs is not complete until the commissioning of the WEGs as commissioning is an essential part of all the agreements. The company retains its effective control over the WEGs till the handing over thereof to the customer after commissioning. The Committee is of the view that mere allocation of WEGs to a particular customer/site, or raising of invoice in the name of customer, or delivery of WEGs at the customer’s site, do not result in transfer of significant risks and rewards relating to ownership of goods. In this connection, the Committee wishes to point out that the reluctance on the part of the customer to give any kind of letter confirming passing of significant risks and rewards in respect of ownership of goods before commissioning and handing over of the WEGs to the customer, also gives an indication that significant risks and rewards of ownership of goods do not pass to the customer before commissioning of WEGs. Thus, revenue in the present case should be recognised only on the commissioning of the WEGs. Accordingly, in the view of the Committee, the accounting policy of the company in respect of recognition of revenue from sale of WEGs and performance of various activities, such as, erection, installation, commissioning and other incidental works, on completion of the respective activities as per the terms of the respective purchase/work order is not correct and the same should be rectified on the lines discussed above.
13. As regards obtaining a letter of confirmation from the customer with respect to passing of the significant risks and rewards of ownership, the Committee is of the view that although AS 9 does not contemplate obtaining such a confirmation, the auditor, while gathering audit evidences can consider obtaining such confirmations.
D. Opinion
14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7 above:
(a) Subject to paragraph 8 above, the accounting policy for revenue recognition presently suggested to the company is not in line with AS 9 and the same should be rectified on the lines discussed in paragraph 12 above.
(b) No, the company cannot adopt the policy on revenue recognition independently for the three orders as these form part of a single composite contract as discussed in paragraph 9 above. As regards obtaining a letter from the customers regarding passing of significant risks and rewards of ownership, refer paragraph 13 above.
1Opinion finalised by the Committee on 8.5.2009
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