1.17     Query

Accrual System of Accounting.

 1.A Government of India Corporation, registered under the Companies Act, is engaged in;

                        (a) Production and distribution and exhibition of Indian films, and

                        (b)Import and distribution and exhibition of foreign films in India.

2.The cost of production of Indian films (as defined in explanation (ii) to Rule 9A(1) of Income-tax Rules 1962) is amortised following the provisions of Rule 9-A of Income-tax Rules.

3.As regards the cost of acquisition of distribution rights of foreign films, the corporation follows the following policy of amortisation, which is different from the provisions of Rule 9-B of the Income-tax Rules.

(a) (i) If  the  film  is  released  for   less   than   90  days  in   a  year, amortisation is made to the extent of revenue earned during the period, writing off the balance cost equally over next two years.

(ii) If the film is released for more than 90 days in a year, amortisation is made by writing off the cost equally over three years.

(b) The non-theatrical rights where revenue expected over next two years after the film is released can be estimated with certainty, amortization is adjusted in the first year so as to leave the cost of these films at the end of the said year equal to the expected revenue over next two years.

  4.As revenue accrues to the corporation by exhibition of foreign films, distribution rights of which are acquired by the corporation normally for a period of 5 to 7 years, the cost of acquisition of distribution rights is shown as ‘inventory’ under ‘Current Assets’ in the balance sheet, till it is amortised fully over a period of three years. The accrual of income to the corporation by exhibiting a film/print over a period of time, normally 5 to 7 years is ordinarily high in the earlier years of exploitation tapering down in the subsequent years. This is not comparable with the cases where income accrues only once immediately on sale of goods.

5.According to the recent amendments made in section 209 of the Companies Act, vide the Companies (Amendment) Act, 1988, proper books of account shall not be deemed to be kept if such books are not kept on accrual basis.

6.In the above context, the querist has referred the following queries for the opinion of the Expert Advisory Committee:

(a) Would it become necessary to amortize, with effect from financial year 1988-89, 100% of the cost of production on Indian films/cost of acquisition of distribution rights of foreign films in the year of release as per Censor Board Certificate/acquisition of distribution rights, irrespective of the revenue earned by exhibiting the film or through sale of rights of exhibition?

(b) If the answer to the above mentioned query is in affirmative, whether the same will not be against the otherwise accepted principle of matching cost with revenue?

(c) Considering the point that income from sale (exploitation of exhibition rights of a film) is spread over a number of years, whether amortisation of cost should also be spread over a certain period so as to match the costs with revenue? The querist has expressed his view that amortization of inventory as a current asset can be compared with depreciation of fixed assets as an annual charge for depletion in the value of fixed assets/obsolescence of the fixed asset.

                                                                         Opinion                                     October 11, 1989

1.The Committee notes that paragraph 2.3 of the Guidance Note on Accrual Basis of Accounting which, inter alia, states that:

“Accrual basis of accounting, thus, attempts to record the financial effects of the transactions, events, and circumstances of an enterprise in the period in which they occur rather than recording them in the period(s) in which cash is received or paid by the enterprise. It recognises that the buying, producing, selling and other economic events that affect enterprise’s performance often do not coincide with the cash receipts and payments of the period. The goal of accrual basis of accounting is to relate the accomplishments (measured in the form of revenue) and the efforts (measured in terms of cost) so that reported net income measures an enterprise’s performance during a period instead of merely listing its cash receipts and payments. Apart from income measurement, accrual basis of accounting recognizes assets, liabilities or components of revenues and expenses for amounts received or paid in cash in past, and amounts expected to be received or paid in cash in the future.”

2.The Committee also notes paragraph 2.5 of the Guidance Note on Accrual Basis of Accounting which is as follows:

                        “The following are the essential features of accrual basis of accounting:

                        (i)            Revenue is recognized as it is earned.

(ii) Costs are matched either against revenues so recognized or against the relevant time period to determine periodic income, and

(iii) Costs which are not charged to income are carried forward and are kept under continuous review. Any cost that appears to have lost its utility or its power to generate future revenue is written-off as a loss.”

3.The Committee also notes paragraph 4.3 of the Guidance Note on Accrual Basis of Accounting which, inter alia, states as follows:

“Under accrual basis of accounting, expenses are recognized by the following approaches:

(i) Identification with revenue transactions         

Costs directly associated with the revenue recognized during the relevant period (in respect of which whether money has been paid or not) are considered as expenses and are charged to income for the period.

            (ii) Identification with a period of time

In many cases, although some costs may have connection with the revenue for the period, the relationship is so indirect that it is impracticable to attempt to establish it. However, there is a clear identification with a period of time. Such costs are regarded as ‘period costs’ and are expensed in the relevant period, e.g., salaries, telephone, travelling, depreciation on office building etc. Similarly, the costs the benefits of which do not clearly extend beyond the accounting period are also charged as expenses.”

4.On the basis of the above, the opinion of the Expert Advisory Committee is as under:

(a)        In those cases in which the corporation sells the distribution rights entirely for a fixed consideration, the entire cost should be charged to revenue in the year of its sale. This is in accordance with the matching concept.

(b)        However, where the sale price is based on future earnings of the sub-distributor or the film is exhibited by the corporation itself, and in case of sale of non-theatrical rights, i.e., the cases where the revenue is to be realised in future, the cost of production/acquisition has to be matched with the relevant revenues as discussed in (c) below. The committee is further of the view that the cost of production of a film or the acquisition of a film, as the case may be, in such cases should be treated as a fixed asset and not as inventory.

(c)        The matching of costs with revenues in cases other than outright sale and sale price based on future earnings should be as below:

(i) Where the film is exhibited by the corporation or distribution rights are sold and the price is based on earnings of the sub-distributor exclusively.

The corporation should established a pattern of revenue earning over the life of different categories of films, e.g., Regional films, Hindi and Urdu films and foreign films, on a rational basis, such as, the past experience in this regard. Cost of production/acquisition may be matched in proportion to the pattern so established. The pattern may be reviewed after a period of time. Alternatively, the cost of production/acquisition of films may be amortised over the estimated life of the film at a written down value rate as it would broadly match the costs with revenue in view of the fact that revenue from exhibition is higher in initial years and tapers of in later years. The written down value method of depreciation will ensure that the cost charged to the revenue is higher initially and goes down in later years.

                        (ii)            Where the corporation sells non-theatrical rights only.

Since the querist has mentioned that the revenue can be estimated with certainty for the next two years, the cost should be amortised on the basis of actual and estimated revenue of the current year and the future two years only.

(iii) Where the corporation sells distribution right as well as non-theatrical rights.

The corporation should ascertain the proportion of revenue from sale of theatrical rights of distribution and sale of non-theatrical rights, and the cost of production/acquisition should be apportioned accordingly. The costs so apportioned should be matched with revenue as recommended in the above paragraphs.

(iv) Where corporation exhibits as well as distributes the rights and also sells non-theatrical rights.   

The corporation should estimate, on rational basis, e.g., the past experience, revenue from exhibition, distribution of theatrical and non-theatrical rights. The cost should then be apportioned on the above mentioned basis to the activity of exhibition, distribution of theatrical and non-theatrical rights. The cost apportioned to each activity should then be amortised as discussed in the above paragraphs.

The Committee wishes to clarify that the above opinion is for the purpose of preparation of accounts as per section 209 of the Companies Act, 1956. Thus, for income-tax purposes, the company will have to follow the relevant method(s) prescribed under the law of tax.

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