1.3              Query

Whether transaction of the nature of works

contracts can be treated as sales.

1.A Company undertakes a composite contract involving manufacture, supply and installation of equipment/system at customer’s site. The value of contracts is quoted in lumpusm. The terms of contracts provide for progressive payments upto 90% of contract value based on periodical submission of bills for actual expenditure incurred. However, the company is entitled to send bill for 90% of the contract value on despatch of all materials (parts of equipment/system) in good condition at the customer’s site and the balance of 10% is payable only on completion of installation in all respects and against final inspection report. The company is following the practice of crediting sales as and when materials (parts of equipment/system) are despatched (after preliminary inspection by the customer’s representative) at an estimated value based on the price break-up given in the quotation, and debits 90% thereof to ‘Advances’ and 10% to ‘Sundry Debtors’.

2.In this context, the querists have referred the following issues to the Expert Advisory Committee for its opinion:

                (i) Whether the company’s practice of accounting sales on an estimated basis, without raising a bill and without the                 receipt of final inspection report, is correct. Will it not be proper to show the same under work-in-progress as in the                 case of work contracts.

                (ii) Whether any amount can be shown as sundry debtors without actually raising the bill.

                (iii) If the above accounting practice is acceptable what disclosure, if any, should be made by the company.

                                                       Opinion                                                           February 14, 1983

            The Committee’s opinion on the above issues is given below:

                (i)         A composite contract of the nature described by the querist may be considered as sale, at the time of despatch                of all materials (equipment/system), without raising bill and the receipt of final inspection report, if the following conditions                are fulfilled:     

               (a) Supply of all materials (equipment/system) constitutes substantial performance of the contracts; and

               (b) There is a reasonable expectation of ultimate collection of whole of the contract value.

From the facts of the query, it appears that the supply of all materials (equipments/system) does constitute a substantial performance of the contract since the customer allows the company to raise the bill on despatch of all materials to the extent of 90 per cent of contract value; this also appears to suggest that the final inspection after installation is not of major significance. Also, there appears to be a reasonable expectation of ultimate collection of whole of the contract value since the materials are despatched after preliminary inspection to the satisfaction of customer’s representative. However, these facts in themselves should not be considered conclusive for the purpose of the aforementioned two condition. The past experience of the company regarding rejection of contracts on final inspection; the trade practices; the relevant legal and contractual obligation etc., will also have a bearing in deciding whether these conditions have been fulfilled. These facts have not been supplied by the querist. The opinion of the Committee is, therefore, based on the assumption that the above conditions are fulfilled. If this assumption is correct, the transaction can be treated as a sale and revenue can be recognized subject to necessary provision, wherever required, for performance guarantees and other obligation attached with the supply of materials/equipment /system. If the above conditions are not satisfied, the amount should be treated as work-in-progress and disclosure in respect of the incomplete contract on the date of balance sheet should be made as is normally done in the case of works contracts.

               (ii)        If the conditions described in para (i) above are fulfilled, the amount of 10per cent of the contract value can be                shown as sundry debtors even without actually raising the bill, because, in substance, the sale in respect of the whole                contract value is considered complete at the time of despatch of all materials, and therefore, in the circumstances, raising                the bill is not of prime importance.

               (iii)       In case revenue is recognized as described above, an appropriate disclosure should be made either in the                ‘Statement of Significant Accounting Policies’, or in the notes to the accounts stating that the company is following the                practice of recognizing revenue at the time of despatch of all materials (equipment/system) in respect of the composite                contracts undertaken by it.

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