Facts
A Company is engaged in the manufacturing of Defense Sector. Some of products manufactured by Company are on Special Order.
The querist has stated that as the some products are made only against specific orders, the company receives advances from various customers on agreed percentages of sale value of an order for supply of goods and services. While raising the sale invoice on supply of ordered goods or services, advances to the extent of proportionate value of invoice to the total sales value of the order is adjusted. The balance amount of the invoice is disclosed under trade receivable account. Also, in case of failure on part of Company, the advance amount shall be returned to the customer as per the terms of the contract.
On reporting date for a single contract there can be both trade receivable as well as advance amount. Company has classified the above trade receivables as financial asset and advance amount as financial liability in compliance of the provisions stated in the Indian Accounting Standards (Ind AS): 32 Financial Instruments: Presentation and disclosed only net amount as trade receivable or advance (as the case may be) in its books.
Whether the accounting treatment adopted by Company is right as per the provisions stated in the Indian Accounting standard?
Answer
No, Company is not correct in disclosing only net amount as trade receivable/ advance amount (as the case may be) in its books of accounts.
Ind AS 32 Financial Instruments: Presentation states that a contractual right to receive cash or a financial asset from another entity is termed as financial asset. Whereas, a contractual obligation to deliver cash or any other financial asset to another entity is termed as financial liability. Further, para 42 of the standard states that a financial asset and a financial liability can be offset only when an entity currently has a legally enforceable right to set-off and intends to either settle on a net basis, or to realize the asset and settle the liability simultaneously.
Thus, there should be a legal right to offset both the items and mere intention by one or both the parties on net basis is not an adequate base to offset the items because the rights and obligations of both the parties remain unaltered. Further, para 47 of the standard states that an entity’s intention of settlement of assets and liabilities can be influenced with many factors like financial market position, business practices followed, etc.
Therefore, on combined reading of para 42, 46 and 47 of the standard it can be stated that in the instant case the set- off cannot be made.
References
EAC opinion Query 1, Volume 38, Refer https://resource.cdn.icai.org/63189eac-compendium-of-opinions-vol38.pdf