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A. Facts of the Case
1. A company in the field of telecommunications, is engaged in manufacturing and supply of various telecom products, providing network solutions, manufacturing of mobile infrastructure equipment, etc. The company is having manufacturing facilities at various locations, viz., Mankapur, Raebareli, Bangalore, Palakkad, Naini, Srinagar and has various regional and area offices in all major cities besides a Network System Unit for extending various service support to customers. The supplies and services of the company are mainly to customers, like, public sector telecommunication enterprises, Defence, Railways, etc. All the supplies and services are executed through purchase orders received from the above customers, which are generally based on tenders. Most of the tenders call for quotes which are all inclusive (inclusive of freight, insurance, etc.). In respect of orders from public sector telecommunication enterprises, equipment undergoes quality check by the customer at the manufacturing unit before the same is handed over to carrier for despatch to the destination as per the customer’s requirement.
2. The querist has stated that upto the financial year 2007-08, the company was consistently following the practice of accounting for such sales and services as per its accounting policy for revenue recognition which reads as under:
“Significant Accounting Policy No.9
Revenue from customer accepted sale of goods/other sale of goods is recognised on the date of despatch of goods from the company’s premises to the customer. Goods ready for despatch but held in the company’s premises at the customers’ specific requests are also recognised as sale of goods.”
3. As per the querist, based on the said accounting policy, sales were accounted if the materials were handed over to carriers on or before 31st March. This is evident from the date of Lorry Receipt (L/R) or Railway Receipt (R/R). Even though materials reach the customer after the end of the accounting period, sales were accounted for based on the date of carrier receipt, viz., lorry receipt date or railway receipt date. This practice of accounting for sales was not acceptable to the Comptroller and Auditor General of India (C&AG) for F.O.R. destination contracts. During the audit of accounts for the financial year 2007-08, C&AG raised an audit query stating that since such contracts are F.O.R. destination, it is necessary that materials should reach the customer before the closure of accounting period if these are to be accounted for as sales. Their contention was that as materials have not reached the customer before 31st March, such despatches cannot be considered for revenue recognition as sales, since the risks and rewards of ownership are not passed on to the customer on the date of such despatches. As per the auditor, such despatches which are not likely to reach the customer before the end of the accounting period should not be accounted for as sales and should be treated as finished goods inventory (stock- in-transit). During the audit, the company gave an assurance to C&AG that the accounting policy on revenue recognition will be reviewed during the financial year 2008-09 and suitable modification in the accounting policy will be made. In view of the said assurance, during the financial year 2008-09, the company has modified its accounting policy as follows:
“Revenue from customer accepted sale of goods/other sale of goods is recognised on the date of despatch of goods from the company’s premises to the customer. In the case of F.O.R. destination contracts, if there is a reasonable expectation of the goods reaching destination within the accounting period, revenue is recognised. Goods ready for despatch but held in the company’s premises at the customer’s specific request are also recognised as sale of goods”.
4. According to the querist, in view of the said modification, revenue is recognised based on reasonable estimation of the materials reaching the destination. This process of assessing the reasonable expectation of goods reaching the destination is creating a practical difficulty. Besides, since goods have already moved out of the manufacturing area before 31st March, excise duty has to be paid and many states insist for payment of sales tax also. Hence, paying these amounts and not accounting for as sales may create issues concerned with sales tax assessment. The querist has also pointed out that in his opinion, the requirements as to performance (reproduced below) as set out in paragraph 11 of Accounting Standard (AS) 9, ‘Revenue Recognition’, were satisfied in the earlier accounting policy itself:
“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.”
5. The querist has also referred to an earlier opinion given by the Expert Advisory Committee (Query No. 1.21 of Volume VIII of the Compendium of Opinions) wherein, the Committee has opined that the company can book sales as soon as the goods are delivered to transporters if the entity does not retain significant risks and rewards of ownership in the goods. In the instant case, according to the querist, even though the company has taken the responsibility for transit insurance, it does not retain any significant risks and rewards of ownership in the goods.
B. Query
6. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee on following issues:
(i) Whether the present (modified) accounting policy of the company is in order and if so, how assessment of the reasonable expectation of materials reaching the destination can be made.
(ii) Whether the company can revert to the earlier accounting policy of recognition of revenue based on the date of despatch of materials to the carrier.
C. Points considered by the Committee
7. The Committee notes that the querist has raised the query in respect of its accounting policy in case of F.O.R. destination contracts with respect to which the auditor has raised a query during the audit of accounts for the financial year 2007-08. The Committee has therefore, considered only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, accounting for goods ready for despatch but held in the company’s premises at the customer’s specific request, revenue recognition in case of customer accepted sale of goods/other sale of goods, etc. Further, the Committee’s opinion contained herein is only from the accounting point of view and not from the point of view of interpreting any provisions of law or statute, e.g., those relating to excise duty or sales tax, etc. The Committee also notes that there is no specific contract or case referred to by the querist in the extant case, for instance, it is stated in the Facts that most of the tenders call for quotes which are all inclusive (inclusive of freight, insurance, etc.). It is also stated that all the supplies and services are executed through purchase orders received from the customers, which are generally based on tenders. Further, in respect of orders from public sector telecommunication enterprises, equipment undergoes quality check by the customer at the manufacturing unit before the same is handed over to carrier for despatch to the destination as per the customer’s requirement. Thus, from the Facts of the Case, all contracts do not seem to be identical. Accordingly, the opinion expressed hereinafter is based on the general principles to be followed while recognising revenue in respect of F.O.R. destination contracts.
8. The Committee notes the following paragraphs from AS 9:
“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.” (Emphasis supplied by the Committee.)
“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.”
9. The Committee notes from the above that the time of transfer of all significant risks and rewards of ownership may be different from the time of transfer of legal ownership, and that for accounting purposes, revenue in such cases should be recognised at the time of transfer of significant risks and rewards of ownership to the buyer. The Committee is of the view that the question when the transfer of significant risks and rewards of ownership takes place depends on particular facts and circumstances of the case, including the terms of the contract, express and/or implied, and the conduct of the parties. Various factors should be considered for ascertaining the timing of passing of significant risks and rewards of ownership. For example, factors like, who bears the risk of damage during transit, whether the goods produced are substantially complete, whether the company can sell the goods to another party or pledge the same after handing over of the goods to the carrier, etc., will have to be taken into account in determining the timing of transfer of significant risks and rewards of ownership. Accordingly, the Committee is of the view that revenue should be recognised as soon as the significant risks and rewards of ownership of goods have been passed on to the buyer and other conditions as stipulated in AS 9 have been fulfilled. In the view of the Committee, for recognising revenue, the date of despatch of materials to the carrier or receipt of the material by the customer are not relevant, as being argued in the Facts of the Case.
D. Opinion
10. On the basis of the above and subject to the considerations stated in paragraph 7 above, the Committee is of the following opinion on the issues raised in paragraph 6 above:
(i) Revenue should be recognised as soon as the significant risks and rewards of ownership of goods have been passed on to the buyer and other conditions as stipulated in AS 9 have been fulfilled. For recognising revenue, the date of despatch of materials to the carrier or receipt of the material by the customer are not relevant as discussed in paragraph 9 above. Accordingly, the wording of the present (modified) accounting policy of the company is not in order in respect of F.O.R. destination contracts. In view of the above, the question of making assessment of the reasonable expectation of materials reaching the destination does not arise.
(ii) The company can revert to the earlier accounting policy of the company, provided on the date of despatch of materials to the carrier, the significant risks and rewards of ownership in respect of materials are transferred to the buyer. See paragraph 9 above.
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