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A. Facts of the Case
1. A Limited is a manufacturing company and is listed in Bombay Stock Exchange and National Stock Exchange as a public listed company. The company has domestic sales as well as export sales (physical exports) and the company has the following forex hedging strategy for currency risk:
(a) The hedged exposures/forecasted cash flows are highly probable because these are always based on signed contracts, sales orders and purchase orders (and not on budgets, intentions, etc.).
(b) The hedge documentation (such as, the forex policy/procedure, the documentation for each individual hedge, selection of the hedge instruments, etc.) is in place.
(c) There is always a one-to-one relation between the hedged exposure and the hedge instrument (no netting, no clubbing together of hedged items).
(d) The relation of hedged item versus hedge instrument is 100% effective and can be measured accordingly.
(Emphasis supplied by the querist.)
2. After entering into an export order, the company takes forward cover for the full amount of the sales invoice which is receivable in US Dollars normally after sixty days. The forward cover is also taken for sixty days.
B. Query
3. In the light of the above, the querist has sought the opinion of the Expert Advisory Committee regarding revenue recognition on the following issues:
(i) The rate at which the sales should be accounted:
(a)Whether it is the rate on the date of bill of lading, on which date the property in the goods has passed on to the customer as per the contract.
(b)Whether it is correct to apply the forward contract rate and account the sales at that rate as finally, the company will be realising from the customer at the forward rate on the due date.
(ii) It is assumed that the customer will not fail on the due date for the purpose of the above. If customer fails to pay on the due date what will be the opinion of the Committee.
(iii) Will the company be complying with following accounting standards, if it follows accounting for revenue (sales) at the forward contract rate:
(a) Accounting Standard (AS) 9, ‘Revenue Recognition’,
(b) Accounting Standard (AS) 11, ‘Effects of Changes in Foreign Exchange Rates’, and
(c) Accounting Standard (AS)30,‘Financial Instruments:Recognition and Measurement’,AS 31, ‘Financial Instruments: Presentation’ and AS 32, ‘Financial Instruments: Disclosure’ dealing with hedge accounting.
C. Points considered by the Committee
4. The Committee notes from the Facts of the Case that the basic issues raised in the query relates to the rate at which sales should be recognised and the treatment to be followed if the customer fails to pay on due date. The Committee has, therefore, considered only these issues and has not touched upon any other issue that may arise from the Facts of the Case, such as, accounting treatment of forward exchange contract taken to hedge the foreign exchange exposure of the sale amount, treatment of changes in foreign exchange rates after initial recognition, etc.
5. The Committee notes paragraph 9 of Accounting Standard (AS) 11, ‘The Effects of Changes in Foreign Exchange Rates’, which provides as follows:
“9. A foreign currency transaction should be recorded, on initial recognition in the reporting currency, by applying to the foreign currency amount the exchange rate between the reporting currency and the foreign currency at the date of the transaction.”
From the above, the Committee is of the view that the sales in the instant case should be recorded by applying the exchange rate at the date of the transaction. The transaction date for the purposes of recognition of revenue would be the date on which the significant risks and rewards of ownership of goods are transferred to the buyer. In this regard, the Committee notes paragraph 6.1 of Accounting Standard (AS) 9, ‘Revenue Recognition’:
“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.”
6. The Committee further notes paragraphs 9.1 to 9.3 of AS 9, which provide as follows:
“9.1 Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection.
9.2 Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest etc., revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. Where there is no uncertainty as to ultimate collection, revenue is recognised at the time of sale or rendering of service even though payments are made by instalments.
9.3 When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded.”
From the above, the Committee is of the view that revenue should not be recognised unless it is reasonably certain that the ultimate collection of the revenue will be made. However, if the uncertainty relating to collectability arises subsequent to recognition of revenue, a separate provision for the uncertainty should be recognised. In this context, the Committee notes that the impairment of receivables is covered by Accounting Standard (AS) 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, which, inter alia, provides as follows:
“10. The amount of a contingent loss should be provided for by a charge in the statement of profit and loss if:
(a) it is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the balance sheet date, and
(b) a reasonable estimate of the amount of the resulting loss can be made.”
The Committee notes that an event is regarded as ‘probable’ if the event is more likely than not to occur, i.e., the probability that the event will occur is greater than the probability that it will not. Thus in case, at the balance sheet date, it is probable that the receivables would not be recovered in future, a provision in that respect should be made as per the provisions of AS 4.
7. As regards the question raised by the querist relating to compliance with AS 9, AS 11, AS 30, AS 31 and AS 32 in case the company records revenue at the forward contract rate, the Committee clarifies that for accounting purposes, the issue of recognition of revenue is independent of the accounting for foreign exchange transactions including hedging. Accounting for sale, i.e., recognition of revenue in the present case would be governed by the provisions of AS 9 as stated in paragraphs 5 and 6 above. Accounting for foreign exchange transactions including hedging is governed by AS 11 and/or AS 30 depending upon the nature of transaction. In the instant case, since the transactions undertaken by the company have been stated by the querist to be highly probable forecast transactions, forward exchange contracts in respect of these transactions can be accounted for as a cash flow hedge considering the provisions of AS 30 as AS 11 does not deal with accounting for forward contracts for such transactions. AS 31 is not relevant in the present case. In case of highly probable forecast transactions, where forward exchange contract is considered as cash flow hedge, the company should make disclosures as per the requirements of AS 32.
D. Opinion
8. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 3 above:
(i) The sales should be recognised at the rate on the date of the transaction, i.e., the date on which the significant risks and rewards of ownership of goods have been transferred to the buyer and not at the rate of forward exchange contract, as discussed in paragraph 5 above.
(ii) The revenue should not be recognised unless it is reasonably certain that the ultimate collection of the revenue will be made. However, if the uncertainty relating to collectability arises subsequent to recognition of revenue, a separate provision for the uncertainty should be recognised. Refer to paragraph 6 above.
(iii) If the company accounts for revenue (sales) at forward contract rate, it will not be complying with the requirements of AS 9, AS 11, AS 30 and AS 32. AS 31 is not relevant in the present case. Refer to paragraph 7 above.
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