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A. Facts of the Case
1. A company is a public sector undertaking in the field of telecommunications and 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 and 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 to them are executed through purchase orders, 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 respective manufacturing unit before the same is handed over to the carrier for despatch to the destination as per customer’s requirement.
2. The querist has stated that the company received a Purchase Order (P.O.) from a public sector telecommunication enterprise for supply and installation, testing and commissioning of cellular mobile phone network for an amount of Rs. 6,57,68,57,955 (copy of which has been supplied by the querist for the perusal of the Committee). Customer P.O. price is inclusive of all levies and taxes, packing, forwarding, freight and insurance, etc. The scope of P.O. includes supply of equipments (which shall be imported and supplied on high sea sales basis), installation and commissioning of the equipment, maintenance during warranty period and Annual Maintenance Contracts (AMC) after warranty period. Customer’s P.O. contains itemized rates for supply, testing, installation, etc.
3. The querist has further stated that before the materials reached Indian Territory, High Sea Sales agreement was entered into with the customer and the sale is effected in favour of the customer. The equipments are directly delivered to customer’s designated sites. Based on the High Sea Sales agreement, the documents during the course of transit are endorsed in favour of customer. In this way, the main features of a High Sea Sales are ensured, viz.,
(i) the sale is effected by a transfer of document,
(ii) the document transferred is the document of title of goods,
(iii) and such transfer is effected before the goods have crossed the customs frontier of India.
In this process, ownership of such equipment is transferred to the customer during the course of transit and the required customs duty is paid directly by the customer. The company coordinates all activities in delivering the equipment to their destination.
4. According to the querist, as soon as the High Sea Sales agreement is entered into, the company recognises revenue for the sale value of the equipment (as per separate value given in the customer’s P.O.). During the financial year 2008-09, the company made supplies amounting to Rs. 73.84 crore and revenue was recognised in the accounts to that extent. However, this accounting treatment was not acceptable to the Government Audit on account of the following:
(a) Materials which were supplied on High Sea Sales basis on 30.03.2009 were received by customer after the accounting year 2008-09.
(b) As per P.O., delivery to the ultimate site in satisfactory condition will remain supplier’s responsibility.
(c) Delivery of materials and services, its installation and commissioning shall be made by supplier in accordance with the terms and conditions specified in schedule of requirements and special conditions of the contract and the goods shall remain at the risk of the supplier until delivery of the network as a turnkey job has been completed even if there is a transfer of title of the goods earlier on account of High Sea Sales.
5. According to the querist, the company has not agreed to the auditors’ views due to the following reasons:
(a) The ownership/title is already passed on to the customer by way of subsequent High Sea Sales agreement.
(b) Separate value is available in P.O. for sale value of equipment and other activities.
(c) With High Sea Sales agreement, the risks and rewards are getting transferred to the customer after endorsement of the documents and there is no uncertainty of realising the sale proceeds.
(d) The customer has paid the bills (as per payment terms) for the value of supplies made without linking to activity of completion of installation, commissioning and testing.
B. Query
6. In view of the above, the querist has sought the opinion of the Expert Advisory Committee as to whether accounting for the sale value of equipment immediately on entering into High Sea Sales Agreement and endorsement of the documents of title without linking to the date of receipt of equipment by customer and also before completion of the activity of installation and commissioning of the equipment is in order and in accordance with Accounting Standard (AS) 9, ‘Revenue Recognition’.
C. Points considered by the Committee.
7. The Committee notes that the basic issue raised in the query relates to timing of recognition of revenue in respect of supply of equipments under High Sea Sales Agreement in accordance with the principles of AS 9. 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, recognition of revenue in respect of services rendered by the company, such as, installation, testing, commissioning, etc., accounting for maintenance during warranty period and AMC after warranty period, etc. Further, while expressing its opinion, the Committee has not examined whether the principles of Accounting Standard (AS) 7, ‘Construction Contracts’ are applicable in the present case as this issue has not been raised and accordingly, the opinion of the Committee is based on the presumption that the principles of AS 9 are applicable in the extant case. Also, the Committee’s opinion contained hereinafter 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 customs duty or sales tax, etc.
8. As far as timing of recognition of revenue in case of sale of goods, 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.” (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 supplied are substantially complete, 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, mere availability of separate value in the P.O. for sale value of equipment or even receipt of payment from the customer does not indicate the transfer of significant risks and rewards of ownership of the goods supplied, as being argued in the Facts of the Case.
10. The Committee notes from the Facts of the Case that the company recognises revenue for the sale value of the equipment immediately on entering into the High Sea Sales Agreement and endorsement of the documents of title. It is also noted that as per clause 16.2 of the customer’s P.O., “ Delivery of the goods and services, its installation and commissioning shall be made by the supplier in accordance with the terms and conditions specified in the schedule of requirements and special conditions of the contract and the goods shall remain at the risk of the supplier until delivery of the network as a turn-key job has been completed, even if there is transfer of title of the goods/materials earlier on account of high sea sales”. Thus, the Committee is of the view that risks and rewards of ownership of the goods under High Sea Sales are not transferred at the time of entering into such an agreement or endorsement of the documents of title. Accordingly, the accounting policy followed by the company in this respect is not appropriate.
D. Opinion
11. On the basis of the above, the Committee is of the opinion that accounting for the sale value of equipment immediately on entering into High Sea Sales Agreement and endorsement of the documents of title as revenue is not in order and in accordance with AS 9. Refer to paragraph 10 above.
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