1.20 Query
Revenue recognition of equipments manufactured against customers’ orders 1. A company manufacturing equipments against customers’ orders has, at the close of the year, some finished equipments in the stock. The company is of the view that as these equipments were made for a particular customer, these should be valued at sales price. The querist has verified the stock on the last date and found that tags were put on some of the items of the finished stock mentioning that these have been sold to a particular party. In most of the cases, the company is also collecting advances against these orders. The items manufactured by the company attract excise duty.
The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from the above:
(i) Whether by putting tags of sale, the company can treat it as sales for the year though the equipment is not shipped. If not, can the finished goods be valued as per order price minus selling and other incidental expenses?
(ii) As per the Exposure Draft issued by the Research Committee on the Accounting Treatment for Excise Duty, in “The Chartered Accountant” November, 1985 issue, the excise duty on finished goods should be included in the value of finished goods. The company is not having sufficient debit balance in excise duty account as on the last day of the year. In these circumstances what entry should be passed at the close of the year and in the subsequent year as opening entry? As company is valuing finished stock at cost price, whether valuing finished stock at cost plus excise duty or at order value plus excise duty, will amount to change of accounting policy?
(iii) How these facts should be shown in accounts and what qualification in the auditor’s report is required?
Opinion June 20, 1986
1.The Committee notes that paras 10 and 11 of Accounting Standard 9 on ‘Revenue Recognition’ issued by the Institute of Chartered Accountants of India, state as below:
“10. Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraph 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.” 2.The Committee also notes that Accounting Standard 2 (AS-2) on “Valuation of Inventories,” issued by the Institute of Chartered Accountants of India states that “inventories should be valued at lower of historical cost and net realisable value”.
3.On the basis of the above, with regard to the query raised in para 2 (i), the Committee is of the opinion that equipments which are not shipped and on which only tags of sale have been put, cannot be treated as sales for the year. The finished goods should be valued at lower of historical cost and net realisable value and not at order price minus selling and other incidental expenses.
4. With regard to inclusion of excise duty for the purpose of valuation of finished goods, the Committee notes that query in para 2 (ii) is in respect of goods, which are not cleared and on which excise duty has not been paid. In this context, the Committee notes that the Research Committee of the Institute of Chartered Accountants of India has issued a Guidance Note on Accounting treatment of Excise Duties,* which recommends as below:
“28. The Research Committee has given consideration to the above arguments. If it is accepted that liability for excise duty arises when manufacture is completed but only its recovery is delayed, then clearly provision becomes necessary. While it is true that the exact amount of the liability may subsequently change, this would be true of many other items (for example, provision for retiring gratuity) and cannot be an argument for not making a provision on an estimated basis. At the same time it cannot be denied that in circumstances where excise duty is not fully expensed out failure to make provision does not vitiate a true and fair view of the profits. It is also true that when provision is made for a significant amount of excise duty payable on goods lying in the factory or in bond it may have a significant effect on the financial ratios as also on the inventory figures disclosed to financial institutions. A company may therefore prefer not to provide for the liability.
29. When provision for excise duty is not made for goods which have not been cleared from the factory premises or which are lying in bond, it will be necessary to make adequate disclosure of the fact in the accounts.”
5.In view of the above, the Committee is of the opinion that in case a provision for excise duty is made in respect of the amount remaining unpaid on goods which have not been cleared or are in bond, no disclosure in accounts need be made. For making such a provision debit is to be made to Excise Duty Account (and in turn to Profit and Loss Account) and credit is to be given to provision for excise duty and this amount is also to be added to the value of closing stocks. However, if it is decided not to make such a provision it will be necessary to make adequate disclosure of the fact in the accounts.
6.The Committee is of the opinion that in case the company decides to include excise duty as an inventoriable cost, it may not amount to a change in accounting policy in case the company is valuing its inventories at lower of historical cost and net realisable value. However inventories cannot be valued at order value plus excise duty as it would not be in accordance with the accounting principle laid down in para 24 of AS-2 (reproduced in para 2 above).
7.In case the accounting treatments are not in accordance with the opinion of the Committee mentioned in the above paras, the auditor should qualify his report in the manner suggested in the Institute’s Statement on Qualifications in Auditor’s Report. _________________________ * The Committee has referred to the Guidance Note since the proposed Statement referred to by the querist is at Exposure Draft stage. |