MMTC Limited was established in the year 1963. It is a leading international trading company in India. It was awarded the status of ‘five star export house’ by the government of India for its contribution to exports.

For the year 2004–05, the auditors of the company issued a qualified report raising questions about the accounting policy regarding purchase and sale. The audit qualification in this regards is stated below:

‘In terms of Accounting Policy No. 1(b) regarding accounting of certain transactions as sales/purchases where letters of credit in the name of the company are assigned in favour of Business Associates and Accounting Policy No. 1(f) where purchases of some commodities are booked based on sales value less service charges, the company has treated sales of ₹27,896,466 thousand and purchases of ₹27,246,587 thousand (to the extent details made available and including canalized items) during the year as its own, as per past practice. On examination of the facts, circumstances and the manner of effecting these transactions, we are of the opinion that the sales and purchases booked by the company are not its own and as such, the above, accounting policy is not in conformity with Accounting Standard 9 “Revenue Recognition” issued by the Institute of Chartered Accountants of India and the guidelines issued by the Department of Public Enterprises. As a result of this policy, sales and purchases have been overstated by ₹27,896,466 thousand and ₹27,246,587 thousand, respectively. However, this policy has no effect on the profit of the company for the year. (Refer Note No.7.1 & 7.2)’.

The accounting policies and notes to account referred to by the auditors as aforesaid are reproduced as follows: 

Accounting Policies: 

1. Purchase and sales 

1. b) Purchase/Sales include transactions/shipments where L/C (Letter of Credit) in the name of MMTC, are assigned in favour of the business associates. 

2. f) In respect of some commodities, purchases are booked based on sale value less service charges.

Notes to Accounts 

7.1 Purchases and sales include ₹2,924,538 thousand (P.Y. ₹945,000 thousand) and ₹2,932,176 thousand (P.Y. ₹952,730 thousand), respectively, transactions/shipments where LCs in the name of MMTC has been assigned in favour of associates. The above includes canalized sales amounting to ₹1629,115 thousand (P.Y. ₹583,500 thousand and corresponding purchase of ₹622,824 thousand (P.Y. ₹576,300 thousand).

7.2 Sales amounting to ₹24,964,290 thousand (P.Y. ₹13,848,820 thousand) and corresponding purchases of ₹24,322,049 thousand (P.Y. ₹13,463,360 thousand) have been booked on the basis of invoice value reduced by the amount of service charges. The above includes canalized sales amounting to ₹15,894,621 thousand (P.Y. ₹6,203,680 thousand) and corresponding purchase of ₹5,488,915 thousand (P.Y. ₹6,048,070 thousand). 

The company reported a total sale of ₹151,237,206 thousand for the year 2004–05 (P.Y. ₹90,991,892 thousand).

Questions for Discussion 

1. Critically evaluate the accounting policy of MMTC Limited regarding booking of purchases and sales?

2. What is the impact of the above accounting policy on the financial performance of the company? 

3. How will you justify the accounting policy of MMTC Limited to the auditors in view of the qualification made by them?