Query No. 25

Subject:           Accounting for discount allowed to dealers.[1]
A.        Facts of the Case  

1.         A company (hereinafter referred as the ‘company’) was incorporated on 30.11.1972 under section 25 of the Companies Act, 1956 as a not-for-profit company with the main objective of benefiting the disabled persons to the maximum extent possible by manufacturing and supplying quality rehabilitation aids and appliances. The company is a Schedule ‘C’ Central Public Sector Enterprise (CPSE) in consumer goods sector under the administrative control of Ministry of Social Justice and Empowerment with 100% shareholding by the Government of India. The registered office and the main production plant of the company are located in Kanpur, Uttar Pradesh. The company started its manufacturing activities from October, 1976.

2.         The authorised capital of the company is Rs. 300.00 lakh and its paid up capital is Rs. 196.50 lakh. Other production units of the company are located at Bhubaneshwar, Jabalpur, Bangalore and Chanalon (Punjab). Apart from the above places, regional marketing centers are at New Delhi, Mumbai, Kolkata and Guwahati.

3.         The company is major implementing agency of the Government of India’s scheme ‘Assistance to Disabled Persons (ADIP)’ since 1981 and is sole implementing agency of ‘Assistance to Disabled Persons under Sarva Shiksha Abhiyan (ADIP-SSA)’ since 2004.

4.         The accounts of the company are subjected to audit by the Comptroller and Auditor General of India (C&AG) under section 619(3) of the Companies Act, 1956 and the turnover of the company for the year 2012-13 has been Rs. 130.23 crore.

5.         Apart from sale of aids and appliances under the scheme, the company sells its products to National Institutes, State Governments, fabricating agencies and also through its dealer network.

6.         The company does not have a system of credit sales. Credit sales, however, are within the delegation of power of Chairman and Managing Director (CMD) only under exceptional circumstances. There was no provision of any cash discount in the financial years 2012-13 and 2013-14. The company mainly resorts to turnover discounts.

7.         The querist has provided the following information with regard to the discount policy:

            Discount based on order value

(i) Discount as above shall only be payable to dealers against every individual order/invoice.

 

(ii)  Dealer will also be entitled to incremental discount of 1% or 2% or 3% depending on the cumulative value of all the orders placed by the dealer during the financial year exceeding Rs. 10 lakh or Rs. 20 lakh or Rs. 50 lakh. For example, the first sales made during a financial year amounted to Rs. 8 lakh and after 5% discount, i.e., net of discount, Rs. 7,60,000. Another sale for Rs. 8 lakh is further made in the same financial year, 5% discount will be given on invoice/ order value as per discount policy. Incremental discount will be given at the end of the year on cumulative sales during the year. The incremental discount shall be payable to the dealers by the end of 1st quarter of the succeeding financial year after computing annual sales. For example, if the total value of all the invoices raised in a financial year exceeds Rs. 50 lakh (say 5 invoices each of around Rs. 10 lakh), the dealer shall be entitled for additional discount of 3 % at the end of the year in addition to 5% discount already availed against each invoice. However, the sum of both discounts cannot exceed the maximum limit as mentioned in discount policy. 

The querist has stated that from the above, it may be seen that the discount, as per the table, strictly speaking, is a turnover discount where the company encourages its dealers to book single order of higher values. Any order placed by the dealer is entitled to discount as per the rates mentioned in the above table which are reflected in the invoice. However, as per (ii) above, a calculation is done at the end of the financial year and the total discount including the incremental discount is determined, from which discount already given in invoice is deducted and credit note for residual amount is raised.

8.         The disclosure, at present, is that the gross sales value is shown as part of income from operations and is included as turnover.  The discount appears as  discount expenses under ‘Other Expenses’ as per  the Schedule VI to the Companies Act, 1956.

9.         While carrying out the supplementary audit under section 619(3)(b) of the Companies Act, 1956, the audit party on behalf of the C&AG raised the following audit point :

“Other expenses -  sales discount
Above head includes an amount of Rs. 109.04 lakh pertaining to sales discount given by the company to dealers. Scrutiny of related records as made available to audit revealed that the bills are raised on dealers net of discount. As such, the same should have been shown as a deduction from the revenue.

This has resulted in overstatement of revenue and expenditure by Rs. 109.04 lakh.”

10.       To the above audit query, the company gave explanations as given in paragraphs 6 and 7 above. Ultimately, the company assured C&AG that the opinion in this regard would be obtained from the Institute of Chartered Accountants of India (ICAI) and hence, the query has been forwarded to the Expert Advisory Committee of the ICAI for its comments and guidance.

B.        Query

11.       Based on the treatment being made by the company as explained above, the querist has sought the opinion of the Committee as to whether the disclosure made by the company is in conformity with Schedule VI to the Companies Act, 1956 and the Generally Accepted Accounting Principles (GAAPs).

C.        Points considered by the Committee

12.       The Committee notes that the basic issue raised by the querist relates to the accounting treatment of the discount(s) allowed by the company to the dealers and whether the accounting treatment followed by the company is as per Schedule VI to the Companies Act, 1956, and Indian GAAPs. Accordingly, the Committee has considered only this issue and has not considered any other issue that may arise from the Facts of the Case. At the outset, the Committee notes that Schedule VI to the Companies Act, 1956, does not contain any specific requirements in respect of presentation and disclosure of discount in the financial statements. However, it prescribes that in addition to its disclosure requirements, disclosure requirements specified in the Accounting Standards should be followed. Accordingly, the accounting for discount is examined  from the perspective of compliance with the Accounting Standards.

13.       The Committee notes that in order to determine the accounting treatment of the discount(s) allowed and its disclosure requirements, the nature of discount being allowed in the extant case needs to be determined. For this purpose, the Committee notes the  definitions of ‘cash discount’ and ‘trade discount’ given in the Guidance Note on Terms Used in Financial Statements, issued by the ICAI:

“3.13   Cash Discount
A reduction granted by a supplier from the invoiced price in consideration of immediate payment or payment within a stipulated period.”

“16.04 Trade Discount
A reduction granted by a supplier from the list price of goods or services on business considerations other than for prompt payment.”

14.       In accordance with the above definitions, any discount allowed on invoice price for prompt payment or for payment within stipulated time is a cash discount and any other discount allowed on invoice price including discount based on volume of sales is a trade discount. The Committee notes from the Facts of the Case that the company does not have the policy of making credit sales and the payment is always received in advance, i.e., prior to despatches. Further, the Committee notes that the discount as per the table in paragraph 7 above is allowed to dealers against every individual order/invoice and the same is shown as deduction in the invoice. The Committee also notes that in addition to the discount already allowed, the company allows an incremental discount of 1%/2%/3% at the end of the financial year depending upon the cumulative value of order placed by the dealer during the financial year. Thus, the discount in the extant case is allowed for increasing its turnover rather than for prompt payment as the payment is always received in advance. Therefore, the nature of the discount being allowed by the company is not of cash discount but is that of volume-based discount.

15.       With regard to accounting and disclosure of volume-based discount, the Committee notes the definition of ‘revenue’ from Accounting Standard (AS) 9, ‘Revenue Recognition’, notified under the Companies (Accounting Standards) Rules, 2006 and Illuatration A.9 thereof, illustrating the application of AS 9, which provide as follows:

“4.1 Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise  from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.”

“9. Trade discounts and volume rebates
Trade discounts and volume rebates received are not encompassed within the definition of revenue, since they represent a reduction of cost. Trade discounts and volume rebates given should be deducted in determining revenue.”

The Committee notes from the above that volume discount/rebate is not encompassed within the definition of ‘revenue’, since ‘revenue’ is the charge made to customers, which in case of volume discount, is the amount net of discount. Accordingly, the Committee is of the view that the policy of the company of recognising revenue at gross amount and showing discount allowed as an expense is not in accordance with the requirements of Indian GAAPs and Schedule VI to the Companies Act, 1956.

D.        Opinion

16.       With regard to the issue raised, the Committee is of the opinion that the discount allowed by the company is volume-based discount and, therefore, the revenue should be recognised net of volume discount, as discussed in paragraphs 14 and 15 above. Accordingly, the accounting treatment being followed by the company of recording turnover at the gross amount and showing discount allowed as an expense is not as per the requirements of Indian GAAPs and Schedule VI to the Companies Act, 1956, as discussed in paragraph 15 above

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[1]Opinion finalised by the Committee on 5.9.2014.