Dibyendu Majumder, partner, Price Waterhouse & Co evaluates why food retail companies need to take a closer look into Indian Accounting Standards
The topic of Ind AS has been playing on the minds of C-suite members for a while now. Being well into the year when Ind AS is applicable for large companies with shareholders’ equity in excess of Rs 500 crore, what is it that we’ve learnt around how it can impact companies in the food retail business? Let’s take a quick look.
Top areas of impact
As with all types of change, one does observe that certain parts of the financial statements change more than other parts. For food retailers, this change is most prominent in the way a company treats sales and incentives, contractual arrangements with a hidden lease component and shrinkage.
Sales and incentives: When a company sells to customers, the key issues involve, among other things, combined sale of goods and services, sales of gift vouchers and ‘buy one get one free’ sales.
There are two main types of incentives provided: trade discounts and incentive payments.
The food retailer, in an effort to increase the volume of products it sells to the customer, reduces the selling price. Such incentives might include volume rebates and pallet allowances. The incentives are treated by the food retailer as a reduction of sales.
These types of incentives can be attributed to the individual units of products supplied. These discounts reduce the cost of inventories, which will subsequently result in reduced cost of sales.
Payments to a customer are an attempt to increase sales of the supplier’s products to consumers. This includes payments for prime locations in the store, bundling of food and boarding charges where the sum of parts is less than buying individual product offerings and other incentives to dealers, distributors and customers which are seemingly related to achieving volumes.
These payments enable the company to secure a competitive advantage and drive sales. In most cases, the services provided by the retailers for that purpose cannot be distinguished from other selling activities performed by the retailer. Unless the service paid for by the company can be clearly distinguished (for example – the supplier can purchase the same service from a third party), these payments are sale incentives, that should be treated by the company as a reduction of sales. The retailer will correspondingly treat these extra incentives it receives as a discount in the cost of purchases.
Leases: Thinking of simply ‘outsourcing’ part of your supply chain? Thinking about it carefully is the learning from implementing Ind AS so far. Arrangements in the nature of leases are commonly observed in situations such as contract manufacturing, where a company may take up a significant portion of the manufacturer’s capacity under contract. Depending on contractual terms, this may result in the contract manufacturing agreement becoming a finance or operating lease.
Food retailers normally enter into lease agreements for restaurants, shops and facilities with specific clauses, such as rent-free periods, payment of key money, contingent rental payments and mandatory renovations. Rent-free periods should be taken into account in the calculation of the monthly expense over the whole lease term. The payment of key money may give rise to an asset in some circumstances.
Where there is a clause that a building or premises that has been leased out is to be returned as given to the tenant, the cost of restoring the property to its original condition should also be provided for upfront.
Shrinkage: Shrinkage is accounted for as a cost of sale. Inventory quantities are reduced to reflect an estimate of the shrinkage that will have occurred since the last stock take.
With very few items remaining ‘off balance sheet items’ in the Ind AS world, valuation and fair values are quickly becoming buzzwords that are giving leaders of companies a lot of food for thought. From a net profit perspective, what is reported is unlikely to significantly change unless a company has investments that are fair valued with huge unrealised gains/ losses attached to them. However, the level of transparency in the accounts has certainly gone up by leaps and bounds.
(With inputs from Niranjan Raman, Director and Anand Balasubramanian, Associate Director, Price Waterhouse & Co.)