Accounting treatment of Commission to service agents and cash discount?

A. Facts of the Case

A public sector company is basically engaged in the manufacture and supply of life saving drugs for meeting the requirements of Central/State Government hospitals. As per the industry practice, the company is marketing its products through the channels of distribution which involve either a stockist or a distributing service agent.

In this case, the most critical parameter of the performance of the service agent is collection of payments on time. As per the agreement with service agent, as the percentage of commission payable depends upon the number of days taken for realisation of sale proceeds and beyond certain stipulated period it will decrease. Similarly, Company allows cash discount to other customers who purchased the goods and made payment within the specified period.

The company, follow a policy since inception, that it will recognise the accrual of the expenditure towards commission/cash discount at the point of realisation of the sale proceeds as the obligation to pay commission/cash discount accrues only on realisation of the sale proceeds within a stipulated period.

As per Statutory auditor, based on matching concept, commission should be recognised as expenditure in the year of sale. As the company is also has opinion that issue is involved in accounting.

B. Issue

The company has sought the opinion on the following issues arising from the above:

• At what point of time does a ‘present obligation’ arise in respect of commission and cash discount?
• Accordingly, whether the practice presently followed by the company of recognising liability towards commission/cash discount only on realisation is correct. If not, then at what time should company make provision?

C. Opinion

On the basis of the above, the opinion in respect of the issues raised by the company:

• According to AS 1, accrual states that expenses should be recognised as they are incurred. Similarly, a liability or a provision should be recognised when it accrues. As in this case, the present obligation of the company in respect of commission and cash discount to service agents arises only on collection of the sale proceeds.
• Therefore, the practice presently followed by the company of recognising liability towards commission/cash discount only on realisation is correct.

The above opinion was affirmed by the ICAI-Expert Advisory Committee.

Kriti Mehta, Audit Associate, SW India