1.22 Query
Confirmation of debtors’ balances by auditors, in case percentage of completion method is followed.
1. A Govt. of India consultancy organisation provides consultancy in all fields of telecommunications in India and abroad. The company is following the accounting practice as per the opinion given in the Compendium of Opinions, by the Expert Advisory Committee, regarding accounting for income on percentage of completion method in respect of construction/service contracts. While payment terms are separately provided in the respective agreements, which normally do not coincide with the percentage of completion, invoices are raised for payment in accordance with the terms in the agreement.
2. On the basis of percentage of completion method, the organisation accounts for income for the year. The corresponding amounts are shown as ‘Sundry Debtors’. As and when clients make the payment to the organisation, till the total work is completed and handed over to them they (i.e. the customers) treat it as advance to the organisation in accordance with the terms of agreement. As per auditing practices, auditors insist for confirmation of balances shown in the Sundry Debtors Account. According to the querist, this confirmation of balances is not practical in this organisation which accounts for its income on percentage of completion method and shows the corresponding amounts as debtors, while in clients’ books, nothing is shown as liability towards the organisation and they, in fact, treat whole of the amount paid to it as advance, till the completion and handing over of the work. In such cases, issuance of routine letters for confirmation of balances shown as ‘Sundry Debtors’ only creates a confusion among the valuable clients, most of which are in foreign countries. The statutory auditors of the company have appreciated this fact and no such reference is being made by them in this regard in their main audit report. However, they have been making reference in their report under section 619 (3) (a) to the Comptroller and Auditor General of India every year. For the purposes of annual report, disclosure in statement of significant accounting policies and practices about recognition of income and expenditure has been considered sufficient by statutory auditors, which reads as under: -
“In the case of consultancy contracts, fee on the basis of actual services rendered substantially up to the end of the project expenditure by adjustment on pro-rata basis through work-in-progress, is accounted for.”
“In the case of service contracts, fee on the basis of actual services rendered substantially up to the end of the year by correlating with expenditure incurred there against, is accounted for.”
“In the case of Cost plus Turnkey Contracts where agreement provides for Company’s margin on percentage basis of stores procured together with the installation works, revenue is accounted for on proportionate value of work completed substantially and the project expenditure by adjustment on pro-rata basis through work-in–progress of cost of stores (materials) and installation works.”
3. On the basis of the reference of the statutory auditors in their report under section 619 (3) (a), it has been opined by the Office of the CAG that the organisation should issue letters for calling of confirmation of debts from the customers about outstanding amounts and if there is any lacuna in the system, they have suggested that the organisation should change the same suitably.
4. The querist is of the view that, under the present practice of accounting for income on percentage of completion method and considering the practice of the clients to treat the advances paid to the organisation as advances till handing over of the work to them, confirmation of balances by the clients is not possible as it would confuse the matter at their end only. Clients can, at best, confirm awarding of the work and also the advance paid to the organisation. Amounts due from them on the basis of percentage of completion method cannot be confirmed by them. As recognition of income on percentage of completion method is being accepted as correct accounting practice, the querist feels that no change in accounting practice is called for and audit need not insist, in such cases, for getting confirmation of balances. Alternatively, instead of debiting debtors account, “Income Accrued” or like account may be debited to avoid confirmation of balances.
5. In the above context, the opinion of the Expert Advisory Committee has been sought about the practicability of obtaining confirmation of balances of ‘Sundry Debtors’ where percentage of completion method is followed.
Opinion September 7, 1988
The Committee notes from the facts of the query that certain invoices are raised as per the terms of contract and, accordingly, the clients make payments to the company. The Committee is, therefore, of the opinion that the auditors are within their rights to obtain confirmation of balances arising from the issue of invoices and payments received from clients against them. In respect of the verification of value of uncertified work-in-progress, the auditor should obtain other evidence. As far as accounting for construction contracts is concerned, Accounting Standard 7 (AS-7) on the said subject, issued by the Institute of Chartered Accountants of India, should be followed.
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