AS 9 - REVENUE rECOGNITION

1. Presented by CA Sandip Chandarana AS 9 - REVENUE rECOGNITION

2. OBJECTIVES • Recognition of revenue in the statement of profit and loss account arising in the ordinary course of business i.e. from • The Sale of Goods • The Rendering of Services ; and • The use by Others of enterprise resources yielding interest, royalties and dividends.

3. APPLICABILITY • This standard does not apply to • Revenue arising from Construction Contracts. • Revenue arising from Hire Purchase or Lease Agreements. • Revenue arising from Government Grants or Other Similar subsidies. • Revenue of Insurance Companies arising from insurance business.

4. DEFINITIONS • REVENUE Revenue is the gross inflow of cash, receivables or other consideration arising in the course of 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, royalty and dividend. 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, receivable or other consideration.

5. DEFINITIONS • COMPLETED SERVICE CONTRACT Completed Service Contract method is a method of accounting which recognises revenue in the statement of profit and loss only when the rendering of services under a contract is completed or substantially completed. • PROPORTIONATE COMPLETION METHOD Proportionate completion method is a method of accounting which recognises revenue in the statement of profit and loss proportionately with the degree of completion of services under a contract.

6. A. SALE OF GOODS • 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 risk and reward of ownership to the buyer. • There may be the case where transfer of property in goods does not coincide, the transfer of significant risk and rewards of ownership. • The time for recognising the revenue in both the point no. 2 and 3 above, is only when the risks and reward of ownership is transferred to the buyer.

7. When to recognise the revenue in following cases? • Sales against advance payment received. When full or partial payment is received for the goods not presently held in stock i.e. stock is still to be manufactured or is to be received directly by the customer from a third party. Revenue from such sales should not be recognised until goods are manufactured, identified and ready for delivery to the buyer by the third party.

8. When to recognise the revenue in following cases? • Delivery delayed at buyer’s request but buyer accepts title/billing. The seller should recognise the revenue even if goods are not dispatched provided the goods are ready, buyer takes title and accepts billing and the seller holds the goods in his premises on behalf of buyer i.e. revenue is recognised when risk and reward of ownership are transferred.

9. When to recognise the revenue in following cases? • Barter transactions As per IAS 18 “Revenue” – When goods or services are exchanged or swapped for goods or services which are of a similar nature and value, the exchange is not recorded as transaction which generates revenue but when goods are sold or services are rendered in exchange for dissimilar goods or services, the exchange is regarded as transaction which generates revenue and the revenue is measured at the fair value of goods or services received, adjusted by the amount of any cash or cash equivalent transferred. When the fair

10. When to recognise the revenue in following cases? value of goods or services received can not be measured reliably, the revenue is measured at the fair value of the goods or services given up, adjusted by the amount of any cash or cash equivalent transferred. Example : A hotel commissioned a consultant to conduct a supply chain study. Instead of paying the fees in cash to the consultant, it was agreed that the fees would be paid by granting the consultant or his

11. When to recognise the revenue in following cases? designate 1000 days free stay in any of its chain in India. The consultant agreed because in a normal year his firm require at least 1500 days stay in a hotel. How should the hotel account for this swap, assuming that hotel charges an average of Rs. 5000 per day and believes that it is a fair consideration for the service of the consultant? Explanation : In the above case, the goods or services exchanged are of a dissimilar nature and value hence the above case is identified as transactions and revenue from such transactions needs to be accounted.

12. When to recognise the revenue in following cases? In the above case, the fair value of the transaction shall be calculated as given below from the hotel point of view ; Fair Value = Rs. 500,000 i.e. Rs. 5,000 per day x 1000 free days) Also the corresponding consultation cost Rs. 50 lakhs shall be accounted by the hotel.

13. When to recognise the revenue in following cases? • Delivery subject to conditions • Installation and inspection Normally revenue should not be recognised until the customer accepts the delivery of the goods and installation & inspection are complete. However, in some cases the installation process are simple, in such cases it is appropriate to recognise the revenue even if installation is not complete. E.g. Installation of Television or Refrigerator.

14. When to recognise the revenue in following cases? • Approval Revenue should not be recognised until the goods have been formally approved and accepted by the buyer or the buyer has done the act adopting the transactions or the time period for rejection has elapsed or where no such time is fixed, a reasonable time has elapsed. • Guaranteed Sales i.e. delivery is made giving the buyer unlimited right of return. Recognition of revenue in this case depends on the substance of transactions/agreement. E.g. in case of retail sales offering a guarantee of “Money back if not completely satisfied”, it may be appropriate to recognise the sale but suitable provision for returns based on the past experience is made.

15. When to recognise the revenue in following cases? • Consignment Sales Revenue is not recognised until the goods are sold to the third party. • Cash on delivery sales Revenue should not be recognised until cash is received by the seller or his agent from buyer. • Sale by installment payment – Delivery of goods on final payment Revenue from such sales should not be recognised until goods are delivered. However, when experience indicates that most such sales have been consummated, revenue may be recognised when a significant deposit is received.

16. When to recognise the revenue in following cases? • Installment Sales When the consideration is receivable in installments, revenue attributable to the sales price exclusive of interest should be recognised at the date of sale. The interest element should be recognised as revenue, proportionately to the unpaid balance due to the seller. • Sale/Repurchase Agreement When seller concurrently agrees to repurchase the same goods at a later date. - For such transactions that are in substance a financing agreement, the resulting cash inflow is not revenue as defined and should not be recognized as revenue. The same treatment would apply when the seller has a call option to repurchase or

17. When to recognise the revenue in following cases? the buyer has put option to require the repurchase by the seller of the goods. Under IAS and US GAAP, the recognition criteria are applied to tow or more transactions together when they are linked in such a way that the commercial effect cannot be understood without reference to the series of transactions as a whole. E.g. an enterprise may sell goods and, at the same time enter into a separate agreement to repurchase the goods at a later date, thus negating the substantive effect of the transaction; in such a case, the two transactions are dealt with together. The provision under all three GAAPs on this issue is similar.

18. When to recognise the revenue in following cases? • Sales to intermediate parties Revenue from such sales can generally be recognised if significant risks of ownership have passed. However, in some situation the buyer may in substance be an agent and in such cases the sale should be treated as consignment sales. • Subscription for publication Revenue received or billed should be deferred and recognised either on a straight line basis over time or, where items delivered vary in value from period to period, revenue should be based on sales value of the the items delivered in relation to the total sales value of all items covered by the subscription.

19. When to recognise the revenue in following cases? • Sale of immovable property Case : A company entered into a sale deed of its immovable property before the end of the year, though the deed was registered with the registrar only subsequent to the balance sheet date because of approval from Housing Urban Development Authority (HUDA) was not yet received. Can sale and gain be recognised at the balance sheet date?

20. When to recognise the revenue in following cases? Response : Both sales and gain should be recognised (in accordance with AS 9) at the balance sheet date if significant risk and reward of ownership has passed before the balance sheet date and what was pending was merely to receive HUDA approval and register the deed. It is important that at least the deed should have been executed before the balance sheet date and HUDA approval and registration did infect happened subsequent to the balance sheet date. One may have to assess if the HUDA approval is a critical formality for transferring the significant risk and reward of ownership.

21. When to recognise the revenue in following cases? One may have to look at the agreement clauses in details to identify if there is transfer of risk and rewards. For e.g. if there is no significant penalty for cancellation of the agreement because approval is not received from HUDA, it may be interpreted to mean that significant risk and reward pass only on approval from HUDA. If after considering the above fact it is decided to recognise revenue, it would be appropriate to state in the notes to accounts of the purchasing/selling company, the immovable property was not registered at the balance sheet date but was registered subsequently.

22. When to recognise the revenue in following cases? • Revenue recognition for export sales on CIF basis. Case : Export made on CIF basis were dispatched on 28th and 29th March, as evidenced by the Bill of Lading/Air way bill issued on these dates. Accordingly, sales were recognized for the year ended 31 March. The auditors did not agree with the contention of the company and commented that the sales and profit were overstated to the extent of above transaction. Their opinion was based on the following logic ; "Under a CIF contract, the property passes to the buyer as the shipping documents (if they are considered to be documents of the title to the goods according to the section 2(14) of the Sales of Goods Act) are handed over to them. In the above case documents were handed over to the bankers for collection after March 31.

23. When to recognise the revenue in following cases? Whether retention of documents (favoring the buyer) and presenting of them to the bankers for collection after 31st March in the normal course of trade and business can be construed as retention of risks and rewards of ownership and hence does not amount to transfer of property to the buyer within accounting period. Response : An ordinary CIF contract is a contract (a) to ship at the port of shipment, goods of the description contained in the contract (b) to procure contract of affreightment under which goods will be delivered at the destination contemplated by the contract ; (c) to arrange for an insurance upon terms current in the trade which will be available to the buyer, (d) to make out proper invoice ; and (e) to tender these documents to the buyer, so that he can obtain delivery of goods on arrival or recover for their loss if they are lost on the voyage.

24. When to recognise the revenue in following cases? In a CIF contract, the question whether the property in the goods passes to the buyer depends on the question whether the seller has parted with the control over the disposal of the goods. It is not an unconditional contract because in commercial parlance, CIF presumes an undertaking by the seller to do something more, namely to put the goods on a ship and this postpones the passing of property until the goods are shipped by the seller. But the presumption that the property passes on shipment is a presumption as to the intention of the parties, and may be excluded either by the express terms of the contract or other circumstances.

25. When to recognise the revenue in following cases? • Accounting for Sales Return Fact : A company expects 2% sales return on an average in the month following the sales. Though the company is not legally obliged to accept the goods back (since they were accepted by the customer after proper inspection), it does so to maintain good business relations. At the year end how should the company account for the anticipated 2% sales return in respect of its last month sales? Response : AS 9 contains the following provision : Paragraph 9.3 - "When the uncertainty relating to collectability arises subsequent to the time of sales or rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded".

26. When to recognise the revenue in following cases? The appendix to AS-9 provides the following guidelines, When delivery is made giving the buyer an unlimited right of return, revenue recognition will depend on the substance of the agreement. In the case of retail sales offering a guarantee of "money back if not completely satisfied", it may be appropriate to recognize the sale but to make a suitable provision for returns based on previous experience. Hence, in the above case its more appropriate to make the provision for margin that is not going to be realized on account of sales return.

27. When to recognise the revenue in following cases? • Trade Discount and Volume Rebate given 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. Fact : T Ltd. Purchased the goods on credit for Rs. 5 Crores for export from ABC Ltd. Upon the export order being cancelled, T Ltd. Decided to sell the same in the domestic market at a discounted price. Accordingly, ABC Ltd was requested to offer a price discount of 25%. ABC Ltd. wants to adjust the sales figure to the extent of discount requested by T Ltd.

28. When to recognise the revenue in following cases? Response : ABC Ltd. Had sold goods on credit worth Rs. 5 Crores to T Ltd. And therefore the sales was complete in all respects. T Ltd's decision to sell the same in the domestic market at a discount does not affect the amount booked under sales by ABC Ltd. The price discount of 25% offered by ABC Ltd. at a request of T Ltd. was not in the nature of discount given during the ordinary course of trade because otherwise it would have been given at the time of sale itself. Now as far as ABC ltd. is concern, there appears to be uncertainty relating to collectability, which has arisen subsequent to the time of sale, it would be appropriate to make a separate provision to reflect the uncertainty relating to collectability rather than to adjust the amount of revenue originally recorded. Therefore, such discount should be written off to the profit and loss account and not shown as deduction from the sales figure.

29. B. RENDERING OF SERVICES Revenue from the rendering of services can be recognised based on the following two methods : • Proportionate Completion Method Performance consist of execution of more than one act. Revenue is recognised based on the performance of each act. The amount of revenue to be recognised is determined based on contract value, associated cost, number of acts or other suitable basis.

30. B. RENDERING OF SERVICES • Completed Service Contract Method Performance consist of execution of single act. Alternatively, services are performed in more than a single act and the services yet to be performed are so significant in relation to the transaction taken as a whole that a performance can not be deemed to have been completed until execution of those acts. Hence, the revenue is recognised when sole or final act takes place and service becomes chargeable.

31. When to recognise the revenue in following cases? • Freight and Handling Income Fact : The company is engaged in the business of handling and transportation of containerised cargo. Freight and Handling income/expenses are accounted for at the time of booking of containers. Ground rent and wharfrage are accounted for at the time of release of containers on completed service contract method. Claims and penalties are accounted at the time of settlement. Whether the accounting treatment is correct?

32. When to recognise the revenue in following cases? Response : The accounting policy being followed by the company for recognition of revenue arising from freight and handling income are not in accordance with AS 9 and section 209 of the companies act 1956. Freight and handling income/expenses should be accounted for as and when the service are rendered. Claims and penalties are accounted for on a product basis when the obligation arises, rather than at the time of settlement. The revenue from ground rent should be recognized on straight line over the period.

33. When to recognise the revenue in following cases? • Installation Fees In cases where installation fees are other than incidental to the sale of a product, they should be recognized as revenue only when the equipment is installed and accepted by the customers. • Freight on incomplete Voyage Some shipping companies recognise freight income only when the voyage is complete. Other companies recognise freight on pro-rata basis for voyages in progress at the balance sheet date. The practice in India is mixed . In any case, whichever method is followed, cost should be matched to the revenue recognised. Thus, if on incomplete voyage, revenue is not recognised, cost on such voyage should be carried forward as WIP. If on the other hand revenue is recognised on pro-rata, the corresponding pro-rata cost should also be recognised in the profit and loss account.

34. When to recognise the revenue in following cases? • Internet Service Internet service providers provide internet access to customers at a given price for a specified number of hours to be used within a specified period. Most internet service providers recognize revenue based on the usage by the customers. At the end of the specified period, the remaining unutilized hours, if any are recognized as revenue. Revenue from banner advertisement and sponsorship contracts hosted on the website of the service provider is recognized ratably over the period in which the advertisement are displayed. Revenue from electronic commerce transactions are recognized when the transaction is complete.

35. When to recognise the revenue in following cases? • Advertising and insurance agency commission Revenue should be recognized when the service is completed. For advertising agencies, media commissions will normally be recognized when the related advertisement or commercial appears before the public and the necessary intimation is received by the agency, as opposed to production commission, which will be recognized when the project is completed. Insurance agency commissions should be recognized on the effective commencement or renewal dates of the related policies.

36. When to recognise the revenue in following cases? • Financial Service commission A financial service may be rendered as a single act or may be provided over a period of time. Similarly, charges for such services may be made as a single amount or in stages over the period of the service or the life of the transaction to which it relates. Such charges may be settled in full when made or added to a loan or other account and settled in stages. The recognition of such revenue should therefore have regard to: (a) Whether the service has been provided “once and for all” or is on a “continuous basis”. (b) the incidence of the costs relating to the service;

37. When to recognise the revenue in following cases? (c) When the payment for the service will be received. In general, commission charged for arranging or granting loan or other facilities should be recognised when a binding obligation has been entered into. Commitment, facility or loan management fees which relate to continuing obligations or services should normally be recognized over the life of the loan or facility having regard to the amount of the obligation outstanding, the nature of the services provided and the timing of the costs relating thereto.

38. When to recognise the revenue in following cases? • Front end fees/ Processing fees Front end fees or processing fees are received under various situations, for example, a housing finance company receives it on sanction of the loan or a lessor receives lease management fees on a grant of lease, etc. Theoretically, there are essentially, three ways in which such income can be recognized. (a) Recognize the entire fees upfront i.e. on sanction of the loan or lease contract. (b) Recognize the fees equally over the period of the loan or lease agreement.

39. When to recognise the revenue in following cases? (c) Recognize fees upfront to the extent of the cost incurred for processing the loan or lease arrangement, which will then be followed by an equal distribution of the remainder of the fees over the life of the loan or lease contract. • Admission fees Revenue from artistic performances, banquets and other special events should be recognized when the event takes place. When a subscription to a number of events is sold, the fee should be allocated to each event on a systematic and rational basis.

40. When to recognise the revenue in following cases? • Franchisee fees of Training Institute Fact : A well known computer training institute appointed some franchisee to conduct training. The institute earns franchisee fees in exchange of its brand and technical assistance. The franchisee fees is payable in lumpsum or in installments and is non-refundable. The institute wants to recognize the franchisee fees in the profit and loss account upfront, is that acceptable? Response : The franchisee fees are in the nature of royalty in exchange of a right to use an asset (brand) over a defined period of time and therefore revenue on franchisee fees should be recognised on a time proportion basis over the period of agreement unless

41. When to recognise the revenue in following cases? having regard to substance of the transaction, if some other systematic or rational basis is more appropriate in which case that basis may be adopted. However, recognizing the entire franchisee fee upfront would be unreasonable.

42. When to recognise the revenue in following cases? • Training Fees and Registration Fees received in Advance Training fees should be recognized on accrual basis proportionately over the period of instructions. Fact : A company grants license for certain number of years to the franchisee for using the company’s brand name and full assistance of technical know-how in the field of providing education and training in IT and to use intellectual property for which the company takes registration fees. How are the registration fees accounted for? Response : The registration fees should be recognized on a time proportion basis over the period of agreement.

43. When to recognise the revenue in following cases? • Income from consultancy fees As 7 would apply to revenue Recognition from consultancy fees received only for design engineering and project management directly related to construction of an asset whereas, revenue from consultancy fees received for design engineering and project management not directly related to construction of an asset would be recognized as per AS 9. recognition of revenue from design engineering on turnkey projects directly related to construction of an asset on a pre-determined fixed percentage basis would be appropriate provided it represents the stage of the completion achieved on the relevant project at the end of each year. The stage of completion on the contract should be determined by considering all relevant factors as stated in AS 7 and no special weightage should be given to a single factor.

44. When to recognise the revenue in following cases? With regard to recognition of revenue from consultancy fees received from design engineering on other than turnkey projects and for project management directly related to construction contract, the recognition of revenue on the basis of bills raised may not be appropriate since there may be cases where the work has been completed up to the relevant stage but the bill has not been raised. Accordingly, the raising of bills should not be the criteria for recognition of revenue. The profit arising from recognition of revenue in respect of the projects covered by above paras should be recognized only where the work has progressed to a reasonable extent on the project. However, provision for all the foreseeable losses on the project should be made irrespective of the stage of completion achieved on the contract.

45. When to recognise the revenue in following cases? With regard to recognition of revenue from consultancy fees received from design engineering on other than turnkey projects and for project management directly related to construction contract, the recognition of revenue on the basis of bills raised may not be appropriate since there may be cases where the work has been completed up to the relevant stage but the bill has not been raised. Accordingly, the raising of bills should not be the criteria for recognition of revenue. The profit arising from recognition of revenue in respect of the projects covered by above paras should be recognized only where the work has progressed to a reasonable extent on the project. However, provision for all the foreseeable losses on the project should be made irrespective of the stage of completion achieved on the contract.

46. When to recognise the revenue in following cases? Revenue from consultancy fees received in respect of procurement projects and for design engineering and project management not directly related to construction of an asset should be recognized as per AS 9. The revenue should be recognized on a suitable basis at a particular stage of rendering of service that would relate the revenue to the services rendered provided no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service at the time of recognition. The stage of service rendered should be determined on the basis of consideration receivable, associated costs and performance made up to the end of the year. The revenue arising from revision in the cost of the projects could be recognized in the accounting year in which the fact is known to the extent to which it relates to the stage of completion provided no significant uncertainty exists regarding the amount of consideration receivable.

47. B. REVENUE FROM USE BY OTHERS OF ENTERPRISE RESOURCES YIELDING INTEREST, DIVIDEND AND ROYALTY • INTEREST Charges for the use of Cash resources or amounts due to the enterprise. Recognized on accrual basis based on the outstanding amount and rate applicable. (Para 8.2) • ROYALTY Charges for the use of such assets as know-how, patents, trade marks and copy rights. Recognized based on the relevant agreement or unless having regard to the substance of the transactions, it is more appropriate to recognize revenue on some other systematic basis. (Para 8.3)

48. B. REVENUE FROM USE BY OTHERS OF ENTERPRISE RESOURCES YIELDING INTEREST, DIVIDEND AND ROYALTY • DIVIDEND Rewards from the holding of investment in shares. Recognized in the profit and loss account only on the right to receive payment is established. (Para 8.4) • INTEREST, ROYALTY AND DIVIDEND FROM FOREIGN COUNTRIES (PARA 8.5) If the above income is earned from foreign countries and requires exchange permission and uncertainty in remittance is anticipated, revenue recognition may need to be postponed.

49. When to recognise the revenue in following cases? • Interest on Overdue Debtors Fact : The invoice, if not paid within the stipulated period, attracts interest at a rate of 1% above the rate of bank borrowings. An analysis of the debtors recently revealed that the interest accrued and accounted in earlier years had very poor rate of acceptance and recovery. In many cases the amounts of interest had been protested and in some cases contested and sought to be adjusted after necessary rectification in the original invoices for low-grade supplies. There is also an apprehension about recovery of the face value of mounting invoice on which interest is provided on accrual basis. Under these circumstances, how should such interest be recognized?

50. When to recognise the revenue in following cases? Response : Interest on overdue outstanding should be accounted for on accrual basis. However, in case of any particular overdue outstanding of the company, if, at the time of accrual interest income, there is a significant uncertainty as to the ultimate collectability of the interest accrued thereon or any part thereof, recognition of such interest income should be postponed. The interest income, the recognition of which has been postponed, should be taken as revenue only in the period in which it is reasonably certain that the ultimate collection will be made. However, if the uncertainty relating to collectability thereof arises subsequent to the recognition of interest income, it would be appropriate to make a provision to reflect the uncertainty.