Reetu | Mar 9, 2021 |
ICAI Guidance note on accounting by E-Commerce entities
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
In recent times we have witnessed a rise in the number of online transactions involving buying and selling of products or online services over the internet. In the E-commerce process, the buyers and the sellers are a mere click-of-the-mouse away and business is transacted involving technologies such as internet banking, mobile commerce, electronic fund transfer, etc. In view of these unique features, varied accounting practices being followed across the companies. In the above scenario, a need was felt by the Research Committee of the Institute in bringing out guidance for the benefit of all stakeholders at large.
The Research Committee has revised ‘Guidance Note on Dot-Com companies’ as the ‘Guidance Note on Accounting by E-commerce Entities’. The old guidance note dealt with accounting treatment of various revenue and expense items peculiar to the dot-com business. However, the revised guidance note deals with accounting by e-commerce entities in respect of accounting issues relating to revenue and expense recognition.
Guidance Note on Accounting by E-commerce Entities
Introduction
1. This Guidance Note deals with accounting by e-commerce entities in respect of certain issues relating to revenue and expense recognition.
2. Some of the accounting issues in e-commerce entities have arisen due to the new business models being used in such entities. Some accounting issues, such as those relating to advertising partnerships, rebates, point and loyalty programmes, which are more common in business carried on by e-commerce entities.
E-commerce
3. E-commerce (electronic commerce) is the activity of electronically buying or selling of products or online services over the Internet. Electronic commerce draws on technologies such as mobile commerce, electronic funds transfer, supply chain management, internet marketing, online transaction processing, electronic data interchange (EDI), inventory management systems, and automated data collection systems. E-commerce is in turn driven by the technological advances of the semiconductor industry and is the largest sector of the electronics industry. E-commerce is a business model that lets the firms and individuals conduct business over electronic networks, such as internet.
4. E-commerce, which can be conducted over computers, tablets, or smartphones may be thought of like a digital version of mail-order catalogue shopping. Nearly every imaginable product and service is available through e-commerce transactions, including books, music, plane tickets, and financial services such as stock investing and online banking.
5. One form of e-commerce companies is that of on-line content companies focus on the content sites, i.e., the internet sites that provide news, information and knowledge as their main business. These include companies that provide Internet navigation services and reference guide information for World Wide Web and that publish, provide or present proprietary, advertising, and/or third-party content. Examples of content sites include Wikipedia, etc.
6. Another form of e-commerce is electronic retailing is the sale of goods and services through the Internet. E-tailing can include business-to-business (B2B) and business-to-consumer (B2C) sales of products and services. E-tailing requires companies to tailor their business models to capture Internet sales, which can include building out distribution channels such as warehouses, Internet webpages, and product shipping centers. Examples of e-tailing vendors are Flipkart, Amazon, Makemytrip, Yatra.com, Trivago and Grofers. Electronic retailing includes a broad range of companies and industries. Internet commerce companies sell products and services over the websites on the Internet and include on-line dealers. Mode of payments to e-commerce entities by customers may take various forms, such as, debit card, credit card, net banking, electronic wallet payment, cash against delivery or any other mode.
7. E-commerce entities may operate in various major market segments, for example:
B2B sites link different businesses or different parts of a business. Transactions on these sites take place between industrial manufacturers, wholesalers or retailers. Special features of these transactions are high volumes per customer, lesser number of customers, secured payment systems, privacy of information, etc. Examples of sites in this category are indiaconstruction.com, clickforsteel.com and seekandsource.com.
B2C sites sell products or services directly to consumers. A large number of e-commerce entities fall in this category. Transactions on these websites are characterised by low volumes per consumer and a large number of consumers. Examples of sites in this category are flipkart.com, amazon.com, urban clap, swiggy, zomato, uber eats, red bus, IRCTC, rediff.com, jaldi.com, indiatimes.com, zipahead.com, and fabmart.com.
C2C sites enable consumers to buy and sell from each other through auction or other similar sites. Examples of sites in this category are bazee.com, snapdeal.com, olx.com, quikr.com, jabong.com, ebay.com, myntra.com and bidorbuy.com.
C2B sites enable consumers to set prices and business entities bid to offer products and services. Examples of sites in this category are razorfinish.com and priceline.com.
8. An entity can earn revenue in many ways such as :
1. Sale of the product directly to consumer.
2. B2C and B2B can also earn by subscription mode.
3. Online advertising.
Elements of e-commerce transaction
9. In an e-commerce transaction, all the traditional elements of commerce exist though with some differences. The following elements are ordinarily present in an e-commerce transaction:
10. Further, the entities may use more traditional techniques either on-line or through the mail;
11. Apart from the above elements of e-commerce transactions, certain facilities are also provided on the website, for example, information of the exact status of an order may be provided to the customer.
Scope
12. This Guidance Note aims at providing a perspective on the various accounting issues which are unique to the e-commerce. In case of entities normally carrying on businesses other than e-commerce, the recommendations contained in this Guidance Note should be applied for recording e-commerce transactions undertaken by them.
This Guidance Note applies to companies preparing financial statements under Companies (Accounting Standards) Rules, 2006, as amended, under Section 133 of Companies Act, 2013.
This Guidance Note also applies to entities such as Limited Liabilities Partnership firms and Partnership firms that prepare financial statements under the Accounting Standards issued by the ICAI.
This Guidance Note deals with specific accounting aspects and does not deal with other generic accounting issues commonly faced across industries. This Guidance Note deals with the key issues of e-commerce companies.
Revenue Recognition
13. The main sources of revenue of e-commerce companies presently include:
14. E-commerce companies are often valued based on revenue multiples and, therefore, it is one of the most important performance parameters. Most e-commerce companies either accept payments online through credit cards, internet banking, debit cards or cash on delivery. Further, in most cases, the delivery is the responsibility of the entity and, hence, it is important to determine when does the ‘risk and rewards’ under Companies (Accounting Standards) Rules, 2006, as amended, under Section 133 of Companies Act, 2013. This is an important issue for business-to-customer as well as business-to-business models.
15. The basic principles of revenue recognition as set out in Accounting Standard (AS) 9, ‘Revenue Recognition’, notified under Companies (Accounting Standards) Rules, 2006, as amended, under Section 133 of Companies Act, 2013 and that issued by the ICAI apply to recognition of revenue from the above sources. The relevant extracts from AS 9 that are relevant in this context are reproduced below:
“4.1 Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an entity from the sale of goods, from the rendering of services, and from the use by others of entity resources yielding interest, royalties and dividends. 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, receivables or other consideration.”
“10. Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.”
“11. In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled:
(i) the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership; and
(ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.”
“12. In a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method.
Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service.”
Under AS 9 principles, apart from the general criteria, revenue is recognised either on the transfer of property in the goods or transfer of significant risk and rewards of ownership. In evaluating the point at which the risks and rewards of ownership transfer from the seller to the buyer, one of the key considerations is the shipment terms.
Membership and subscription
16. Many a times, entities receive upfront payments from customers before they provide the contracted service or deliver a good. Such upfront fees generally relate to the activation or set-up of a good to be used or a service to be provided in the future. In many cases, the upfront amounts paid by the customer are non-refundable. In order to avail of the services provided by e-commerce entities, consumers are usually required to pay an amount as membership fees or subscription. Such membership fee or subscription may also be collected in the form of registration fee. While some services are available to members free of cost after registration, other services may be made available only on payment of an additional fee.
17. The membership/registration fees received by an e-commerce entity may fall in the following categories:
18. E-commerce companies often offer membership services to customers, wherein customers pay non-refundable upfront fees to the e-commerce entity. In return, the members (customers) get, for example, discounts and other benefits in partner restaurants.
19. AS 9 contains guidance on the recognition of non-refundable fees as revenue.
20. Revenue earning process is completed by performance of specified actions as per the terms of the arrangements, not simply by originating a revenue generating arrangement.
21. Supply of products or rendering of services by e-commerce companies may involve charge of a non-refundable upfront fee/initial (membership/ registration) fee with or without subsequent payments for products or services to be provided in future. Under AS 9, revenue recognition from these sources will depend on the nature of the services being provided. AS 9 states that entrance fee received is generally capitalised. If the membership fee permits only membership and all other services or products are paid for separately, or if there is a separate annual subscription, the fee should be recognised when received. If the membership fee entitles the member to services or publications to be provided during the year, it should be recognised on a systematic and rational basis having regard to the timing and nature of all. The capitalised/ deferred membership fee may be presented in a separate line item such as, “deferred membership fees”, under liabilities in the balance sheet.
22. With regard to non-refundable fees that entitle a member to use the services of the website indefinitely without making any further payment for use of services, the initial fee, in substance, represents wholly or partly an advance payment for products or services to be provided in future. This implies that it is expected that the services would be provided on a continuous basis after payment of up-front fee. The non-refundable up-front fee and the continuing performance obligation related to the services to be provided or products to be delivered form an integrated package.
23. Accordingly, up-front membership fees, even if non-refundable, are actually earned as the products and/or services are delivered and/or rendered over the term of the arrangement or the expected period of performance.
24. Consequently, recognition of such non-refundable fees should be generally deferred and the same should be recognised systematically over the period during which fees are earned. However, keeping in view the uncertain nature of business of an e-commerce entity, non-refundable fees that entitle a member to use the services of the website indefinitely should be recognised as revenue over a reasonable period on a systematic and rational basis, i.e., on time proportion basis or any other basis, e.g., usage basis, whichever is more representative of the services rendered. In case the entity also provides services for periodic subscription, the revenue in respect of non-refundable fees to be recognised on the aforesaid basis should not exceed the corresponding periodic subscription.
25. Non-refundable fees that entitle a member to use the services of the website for a specified period of time in excess of the reasonable period of time should be recognised as revenue over a longer period of time based on the members’ entitlements. However, in case the specified period is less than the reasonable period, the fees should be recognised as revenue on a systematic and rational basis usually on a time proportion basis over the specified period unless another systematic and rational basis is more representative of the services rendered, e.g., the usage basis.
26. In respect of membership fees that are refundable to members subject to fulfilment of certain conditions (for example, a stipulated volume of usage within a specified period, etc.), it is not appropriate to recognise such fees as revenue on receipt thereof since it is expected that a member would ordinarily fulfil the conditions. Accordingly, the revenue from such transactions should be recognised when it becomes reasonably certain that conditions would not be fulfilled. Pending the recognition of revenue as aforesaid, the amounts received from customers should be credited and retained in a liability account such as ‘Customers Refundable Fees Account’. The entity should periodically review the status of this account to ascertain the extent of fulfilment or otherwise of the conditions.
27. Periodic membership subscriptions paid by members to avail of the services offered by the website should be recognised as revenue over the period of the subscription, in accordance with the principles of AS 9.
Merchandising activities
28. In case of e-commerce entities, generally multiple parties are involved in providing good and services. When there are multiple parties involved in providing goods or services to a customer, an entity evaluates the nature of its promise to the customer.
29. One of the significant issues in accounting by e-commerce companies is whether to recognise gross amount of revenues and the related cost of sales or to recognise the revenue on net basis, similar to commission. The significance of this issue is enhanced due to the importance often placed on the revenue being used as the basis for valuation of e-commerce companies.
30. The question of gross versus net revenue and cost recognition ordinarily arises in connection with e-commerce companies that distribute or resell third party products or services. This issue typically arises in the B2C sites. Often, there may be regulatory restrictions on whether an entity can sell its products directly to end-customers. This can also have an impact on the presentation of revenue is the books of the B2B and B2C companies on a gross or net basis.
31. In assessing whether revenue should be reported on gross basis with separate recognition of cost of sales or on net basis, under AS 9, it should be considered whether the e-commerce entity:
32. Where an e-commerce entity acts as a principal in the transaction, i.e., significant risks and rewards of ownership are first acquired by it and then transferred on sale, it is appropriate to recognise revenues and the related costs on a gross basis. If the e-commerce entity does not do so, i.e., it merely acts as an agent, it would be appropriate to recognise only the service charges as revenue, similar to commission.
33. The Technical Guide on Accounting Issues in the Retail Sector is issued by the Institute of Chartered Accountants of India, provides guidance on presentation of revenues. As per the Technical Guide, some of the factors that indicate that an entity is acting as a principal in transactions could include (indicative list only):
34. Determining whether an entity is acting as an agent or principal is based on an evaluation of the risks and responsibilities taken by the entity, including factors as mentioned above such an inventory risk and responsibility for the delivery of goods or services.
35. Revenue represents the amount received by an entity for its own account. Therefore, for a principal, revenue should be presented at its gross amount and is measured before deducting related costs such as cost of materials and salaries. On the other hand, in an agency relationship, the amounts collected on behalf of and passed on to the principal is not revenue of the agent. The revenue of the agent is the amount of net margin, plus any other amount charged by the agent to the principal or other parties. The revenue collected from the ultimate customer (net of taxes) is recorded as revenue by the principal. The principal recognises the consideration retained by the agent as a cost.
36. Common example is that of an e-commerce entity purchasing traded goods from a wholesaler. E-commerce entity generally would sell these goods to the end customer and may or may not carry the associated inventory risk as it purchases goods from the wholesaler only when it receives orders from the end customer. However, it may bear the risk of those inventory items that have been returned by the customer. In such cases, the e-commerce entity does not seem to bear significant inventory risk, however, it may bear the following:
In such a case, the e-commerce entity may assess the above criteria to be significant and reflect the gross billing to its customers as its revenue.
Auctions
37. Some companies host auction sites as part of their on-line activities where users can purchase or sell goods or services. The entity ordinarily earns auction revenues through two sources – up-front (listing) fees and transaction-based fees.
38. Under AS 9, listing fees are the up-front fees that the e-commerce entity receives at the time a seller registers for a listing to be maintained over a specified period of time. The purchaser is paying for a service that is delivered over time. It is appropriate that listing fees are recognised over the period of the contract or arrangement, provided there are no significant outstanding vendor obligations to be fulfilled and collection of the related receivable is reasonably certain. Transaction fees are for facilitating the transaction and are usually based on a percentage of the revenue earned by the seller from the sale. Such fees should be recognised as revenue by the entity upon completion of the transaction or at the time when no further vendor obligations remain to be performed as per the terms with the vendor.
Shipping and handling activities
39. E-commerce companies selling products on-line often charge customers for shipping and handling activities. Such charges may or may not be a direct reimbursement of the costs incurred by e-commerce companies. Some companies display the charges separately whereas some do not.
40. In determining accounting treatment under AS 9, one of the considerations would be whether the products sold on-line are invoiced to the customers at a composite rate including shipping and handling charges or whether shipping and handling charges are recovered separately as an absolute amount or as a percentage of the sale value. In the former case, it may be appropriate to include such charges as a component of sales revenue provided a clear distinction cannot be made between the product value and the shipping and handling charge component. Where such charges are recovered as an absolute amount or as a percentage of sale value separately, these should not be included in sales revenue but should be recorded separately. Thus, such charges should not be included in computing the value of turnover to be disclosed in the statement of profit and loss. Shipping and handling charges should be recognised separately as an income and the actual cost incurred in respect thereof should be recognised as an expense. However, where these charges are clearly a reimbursement by the buyer of the actual cost incurred by the seller, these should be shown as a deduction from the shipping and handling cost in the statement of profit and loss, if the amount involved is material.
Multiple element arrangements
41. A multiple element arrangement generally exists where an e-commerce entity agrees to deliver more than one product/ service concurrently and deliver certain additional products/services in future. These additional products/services may include upgrades, enhancements or maintenance services. It is sometimes customary to bundle such products and services for a consolidated price.
42. AS 9 does not provide any specific guidance on multiple-element sale arrangements. However, various past pronouncements of the ICAI have stated that it is appropriate to ‘unbundle’ the separate elements of the arrangement or contract. For this purpose, entity-specific fair values in respect of which objective evidence is available should be used, i.e., what the entity would have received had it sold each item/ service separately. Entity-specific objective evidence of fair value is determined in respect of transactions with unrelated parties. For example, an e-commerce entity may agree to host another entity’s website and also provide web maintenance service for a fixed fee of ` 15 lakh for a term of one year and six months, respectively. If the e-commerce entity has evidence that in its recent transactions, it has charged separate fees for web hosting and web maintenance of ` 12 lakh for one year and ` 6 lakh for six months, respectively, then revenue in respect of the composite service now being provided should be recognised in the ratio of 2:1, i.e., ` 10 lakh from web hosting over one year and ` 5 lakh as revenue from web maintenance services over a period of six months.
Right of Returns
43. E-commerce companies, particularly e-tailers, often provide option of returning the goods for exchange either in cash or goods or services or by way of store credit coupons which can be used by the customer for subsequent purchases, either with or without a time limit. In such cases, the entity would need to evaluate the appropriate timing of recognising revenue as there is certain level of uncertainty attached as to when and whether the customer would exchange the goods or services and further whether the customer would utilise the coupons, if any, obtained in exchange of returning the goods or services. While most retailers are able to discern past trends with respect to returns, others may have a varied and disparate experience of ‘sales returns’ and would need to make the best estimates with the available information.
44. Paragraph 10 of AS 9 states the following:
Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.
Further, with regard to sale of goods, the criteria set out for revenue recognition in paragraph 11 of AS 9, “Revenue Recognition”, are:
In a transaction involving the sale of goods, performance should be regarded as being achieved when the following conditions have been fulfilled:
(i) the seller of goods has transferred to the buyer the property in the goods for a price or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of the goods transferred to a degree usually associated with ownership; and
(ii) no significant uncertainty exists regarding the amount of the consideration that will be derived from the sale of the goods.
45. With regard to revenue recognition for service contracts, the criteria is set out in Paragraph 12 of AS 9 states that: –
In a transaction involving the rendering of services, performance should be measured either under the completed service contract method or under the proportionate completion method, whichever relates the revenue to the work accomplished. Such performance should be regarded as being achieved when no significant uncertainty exists regarding the amount of the consideration that will be derived from rendering the service.
Following Illustration in AS 9 explains the application of AS 9 to commercial situations.
“A. Sale of Goods
2. Delivered subject to conditions
(c) guaranteed sales i.e. delivery is made giving the buyer an unlimited right of return
Recognition of revenue in such circumstances 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 recognise the sale but to make a suitable provision for returns based on previous experience.
(d) consignment sales i.e. a delivery is made whereby the recipient undertakes to sell the goods on behalf of the consignor. Revenue should not be recognised until the goods are sold to a third party.”
Therefore, in case of sales with customers’ right to return in exchange for cash, AS 9 requires recognition of revenue 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 recognise the sale but to make a suitable provision for returns based on previous experience. In other cases, the substance of the agreement may amount to a sale on a consignment basis.
Right of Return in exchange for cash
46. In cases where such right of return is provided in exchange for cash, under AS 9, it is appropriate to proceed on the basis that the sales, to the extent of estimate of likely returns, have not been made. Accordingly, sales recognised during the period should be reduced by the estimate of the returns, at the gross amount of sales and a corresponding current asset should be recognised representing the inventory that may be returned.
Example: Right of return in exchange of cash under AS
Arc, an online retailer, sells shirts with a right to the customers to return the shirts within 60 days of purchase through its website and mobile application. Returns are accepted with proof of purchase and if the shirts are unused and in good condition such that Arc can sell it as new. Historically, 10% of the Arc’s sales are returned by customers and this rate is expected to continue. History has shown that all such returned shirts are resold at full price. The gross margin on sale of shirts is 5%. Customers have option to return shirts by communicating through Arc’s mobile application or website subsequent to which Arc refunds money to the customer against returns, if return is in an acceptable condition.
Arc has sold shirts of sale value of ` 1000 and the period of return is not expired till the end of the financial year in which sales are made. No returns have been received till the end of the financial year.
There are returns of ` 80 in the following financial year before the expiry of return period. The accounting entries in this regard are as under.
At the time of initial sale:
| Cash/bank | Dr. | 1000 | Cash received at the time of sale |
| Sales | Cr. | 1000 | Revenue recognised to the full extent |
At the time of Year end
| Sales | Dr. | 100 | 10% of sales based in the past trend of expected returns |
| Provision for Expected right to return (Current Liability) | Cr. | 100 | |
| Expected returns from customers (Current asset) | Dr. | 95 | Cost of sales – 95% of sale price – gross margin being 5 % |
| Cost of Sales | Cr | 95 |
In the following financial year
| Provision for expected right of return (Current Liability) | Dr. | 100 | |
| Cash/Bank | Cr | 80 | Cash paid on right of return exercised by the customer |
| Sales | Cr | 20 | Balance sales (` 100- ` 80) for which the period of right to return has expired |
| Inventory | Dr | 76 | Inventory recognised to the extent of goods returned [(` 80*` 95)/` 100] |
| Cost of sales | Dr. | 19 | Cost of sales recognised to the extent of sales revenue of ` 20 |
| Expected returns from customers (Current asset) | Cr | 95 | Adjustment relating to costs reversed |
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