Revenue recognition (shipment of goods)

[okosling]

At what point should revenue be recognized?

Scenario Goods are invoiced to customers on CIF/CPT/DDU basis (Carriage Paid To Named Place, or Delivered Duty Unpaid at Named Place). Under these terms, goods are at the seller’s risk until they arrive. The seller is responsible for the freight (and insurance, if desired) and title passes to the buyer only on arrival. Up to now, we have always recognized revenue at the point of invoicing & despatch. However, our US masters have told me that US GAAP requires revenue recognition at the point where the risk & title passes to the buyer (which means when the goods arrive).

I checked on internet for guidance on this point, and to my surprise, I found that IFRS and IAS 18 (para.14) also require this, at least in theory!

I would like to hear from other accountants about whether other companies actually do this in practice, i.e. back out invoiced sales, deferring revenue recognition until arrival of goods, for cases where risk & title does not pass from seller to buyer until arrival of goods.

In case anybody raises the question of materiality, I will mention that more than half of our sales are exports (= longer shipment times), and a significant part of our business is machines, of which we sell about 10 per year, so sometimes, the whole month’s machine revenue would be pushed into the next month!

[kamranACA]

Dear,

You have emphasized a very important matter to which normally people do not give much importance. We are a nation who follows the developements of others because we are still in the process of developement even after the elapse of almost 60 years. This slow progress has caused the decrease in creativity and initiatives. Therefore, in so many matters, we believe on what we have ever heard or which we have seen being done by the others. Besides this, if any of us takes some initiative, he is badly discouraged. There are so many examples which I dont want to quote in detail.

Anyways, your querry is very good and requires detailed discussions.

As per IAS-18, revenue arising from the sale of goods should be recognised when all of the following criteria have been satisfied [IAS 18.14]

-the seller has transferred to the buyer the significant risks and rewards of ownership;

-the seller retains neither continuing managerial involvement to the degree usually associated with ownership nor effective control over the goods sold;

-the amount of revenue can be measured reliably;

-it is probable that the economic benefits associated with the transaction will flow to the seller; and

-the costs incurred or to be incurred in respect of the transaction can be measured reliably.

If we simply base our analysis on the words, the last 4 criterias allow an entity to account for its export sales on delivery of goods to customers that is normally the Bill of Lading (B/L) Date. The seller retains no managerial involvement or effective control over the exported goods after the Mate Receipt. The amount of revenue can be determined as the invoice has been issued with B/L. The receipt of proceeds against such shipment is anticipated/probable as the sales contract has entered into. The costs incurred against such shipment can be reliably measured. These costs are the cost of goods sold, selling expenses, insurance, land and steamer freight, carriage or whatever that has been either paid or accrued.

The only one criteria remains questionable i.e. the seller has transferred to the buyer the significant risks and rewards of ownership. There could be a long debate on this component of criteria. Things are not concluded isolatedly.

When the entity has sent out its products from all of its manufacturing, storing and controlled premises with the intent of sales and when all the necessary documentation (contracts, outward gate passes, sales tax invoices, B/L, shipping bills, Goods declaration Challans, E-Forms, Customs verifications and mate receipts etc) has been made in the name of the buyer leaving no management involvement or control on the products being sold/dispatched, the situation suggests that the revenue can be recognized.

Normally, as per law, the entities have to declare such contracted sales beforehand to central bank of the country. The central bank never allows the cancellation of such information filed after shipments, because it has to monitor the foreign currency movements. So many economics data has to base on such informations. Further, if due to any reason the shipped products have to be received back in Pakistan, the entity will have to pay all import duties on it, as if it were the imports instead of sales return.

These factors also substantiate recognizing of revenue on delivery of goods i.e. B/L date.

Moreover, as per framework of IFRSs, revenues have to match their costs. If we see principles for recognising the expenses, they cause us to account for all the expenditures related to exports when they are paid or accrued. Resultantly, if an entity accures or books the expenses related to a shipment and do not account for the related revenue it would be against the principles of IFRSs laid down in its framework. Further, if the entity accounts for the revenue as a liability i.e. as deferred revenue then it will also have to defer its related expenditure. Here one thing is very important. There is no concept of deferring the revenue, if related costs and expenses have been incurred/accrued. Because there is no sense of deferring it if related costs have ben recognized. LIKEWISE, no international accounting standard allows deferring of any cost or expenditure. Therefor, both items can also not be deferred.

Booking all of the costs and expenses in the books of account and ignoring the recognition of related revenue will also not be prudent and will create imbalance in the financial results.

Due to above reasons, the matter gets extreme level of complexity.

In my humble opinion, in such situation, the criteria for recognizing the revenue is substantially met and it would be prudent to account for the revenue against export sales on B/L date or Mate Receipt date.

However, since the issue can attract further arguments and deliberations, any concerned can get a technical opinion from the Institute of Chartered Accountants for making a reasonable base of accounting practice in vouge.

I do not know the US accounting standards and framework thereof, therefore, I cannot comment on what criteria has been laid down there-under.

Hope you will find above points beneficial in deciding your accounting practice.

Best regards,

KAMRAN.