Comments on Exposure Draft of Guidance Note on Revenue from Operations in case of Contractors issued by the Research Committee of The Institute of Chartered Accountants of India (ICAI)

Thank you so much for the opportunity to comment on the exposure draft of Guidance Note on Revenue from Operations in case of Contractors. Following are our comments:
1. Paragraph 1 of the Guidance Note states that it deals with the issue whether the revenue recognised in the financial statements of ‘contractors’ as per the requirements of Accounting Standard (AS) 7, Construction Contracts (Revised 2002) and Ind AS 115, Revenue from Contracts with Customers, can be considered as ‘Revenue from Operations’ for presentation in Schedule III to the Companies Act, 2013. However, it fails to define what it means by the term ‘contractors’. Ind AS 115 is titled as Revenue from Contracts with Customers. Therefore, as per Ind AS 115, any entity that has contracted with customer is a contractor. The guidance must make it clear whether it is proposing any meaning to ‘contractor’ other than the one stated above.

2. Reading the exposure draft, it appears that rather than explaining whether ‘Revenue’ under AS 7 or Ind AS 115 is ‘Revenue from Operations’ under Schedule III, the exposure draft attempts to establish revenue recognition principles apart from those stated in Ind AS 115. Paragraph 6 of the exposure draft states when should revenue be recognised over time. Paragraph 35 of Ind AS 115 provides the principles for recognition of revenue over time and the application of those principles are explained in further paragraphs of Ind AS 115 and in Appendix B of Ind AS 115. The exposure draft introduces new terms as ‘buyer’ in place of ‘customer’. Similarly, the exposure draft specifies conditions that are not present in paragraph 35 of Ind AS 115 such as buyer does not have discretion to terminate the contract. This is clearly deviation from the principles specified in Ind AS 115 which is notified under Companies (Indian Accounting Standards) Rules, 2015 under section 133 of the Companies Act, 2013. Such a change comes within the domain of Accounting Standards Board (ASB) of ICAI and must be issued by ASB adding a paragraph on carve out in Appendix 1 of Ind AS 115 rather than research committee. In our view, there is no need to discuss when revenue must be recognised over time by contractors as Ind AS 115 provides those principles. The exposure draft must stick to its objective of explaining whether ‘Revenue’ recognised as per notified standards can be regarded as ‘Revenue from Operations’ stated in Schedule III to the Companies Act, 2013.

3. One of the reasons for deviation from its objective could be that it is not clear as to what was the problem that created a need to issue such a guidance note. Any research is to address a problem. The research must define the problem in clear terms. Definition of the problem is core to the research activity. Inappropriate definition of the problem could result in inappropriate research process and results. From the objective paragraph, the hypothesis here seems to be that ‘Revenue’ recognised as per notified standards is ‘Revenue from Operations’ under Schedule III to the Companies Act, 2013. The research committee has tested this hypothesis which is documented in the exposure draft. However, reading the hypothesis, it seems obvious that ‘Revenue’ recognised as per notified standards has to be ‘Revenue from Operations’ under Schedule III to the Companies Act, 2013 and there is no requirement for research as there is no problem. In our view, the problem that needs to be addressed and therefore, the hypothesis that need to be tested is ‘Revenue from Operations’ in Schedule III is equivalent to ‘Income arising in the course of ordinary activities’ in Ind AS 115. Accordingly, the guidance note, apart from stating what it deals with, must state why it deals with. This will enable the guidance given to stick to the objective of addressing the problem and not deviate by introducing new revenue recognition principles.

4. Clause 8 of General Instructions for Preparation of Financial Statements of a Company required to comply with Ind AS of Division II of Schedule III to the Companies Act, 2013 states that for the purpose of this Schedule, the terms used shall have the same meanings assigned to them in Indian Accounting Standards. ‘Revenue’ is defined in Ind AS 115 as income arising in the course of ordinary activities. Therefore, ‘Revenue from Operations’ means ‘Income arising in the course of ordinary activities from Operations’.  Thus, it could be interpreted that Schedule III envisages that ‘Revenue’ can be from other than operations too and therefore, it requires revenue “from operations” to be presented separately. If such was not the intention, Schedule III should simply say “Revenue”. However, Schedule III requires income that are not ‘Revenue from Operations’ to be presented as ‘Other Income’. ‘Other Income’ could include income from other than ordinary activities too such as gain on sale of non-current assets, government grants as per Ind AS 20 etc. Thus, reading the requirements of Schedule III together, the words ‘from Operations’ used in Schedule III in addition to ‘Revenue’ have no relevance as it ultimately means ‘Income arising in the course of ordinary activities’. The Guidance Note must explain the significance of the words “from Operations” used in Schedule III though Ind AS 115 defines revenue as income arising in the course of ‘Ordinary Activities’.

5. Expert Advisory Committee of The ICAI in one of its opinions published in July 2020 edition of The Chartered Accountants Journal of The ICAI has opined that it is appropriate to present export incentives as Revenue from Operations though Ind AS 20 requires the same to be presented as ‘Other Income’. The Guidance Note on Division II-Ind AS Schedule III to the Companies Act, 2013 interprets the requirements of Schedule III to include any revenue arising from company’s operating activities. Thus, the Guidance Note introduces a new term ‘operating activities’ which could be understood differently from ‘ordinary activities’ used in Ind AS 115. Response to question 4 of the Educational Material on Ind AS 115 issued by ICAI explains that export incentive is not revenue. It is government grant. Thus, ICAI has issued plethora of guidance from different committees on presentation and composition of ‘revenue’ each interpreting the term ‘Revenue’ or ‘Revenue from Operations’ to suit its objectives and perspectives which ultimately makes the financial statements incomparable and inconsistent. This exposure draft is an addition to that plethora which now propose new revenue recognition principles thus adding to the inconsistent guidance.

6. There should be only one committee within ICAI that can issue guidance notes related to financial reporting matters. This would ensure consistent guidance and thereby consistent application of notified standards resulting in comparable and consistent financial statements.

Conclusion:
There is no need to issue Guidance Note to explain whether ‘Revenue’ under AS 7 or Ind AS 115 could be regarded as ‘Revenue from Operations’ in Schedule III to the Companies Act, 2013. The need is to issue Guidance Note on whether ‘income from operating activities’ is equivalent to ‘income arising in the course of ordinary activities’. This would clarify that ‘Revenue from Operations’ used in Schedule III is nothing but ‘income arising in the course of ordinary activities’ stated in Ind AS 115.

August 09, 2020