1.14 Query:            Accounting of excess provision for bad and doubtful debts.

1.The querist is a government company engaged in buying and selling of cotton, both in local as well as international market. The company also deals in cotton seeds, lint etc. The query relates to the accounting of provision for bad and doubtful debts made in the earlier years, but no longer required in the subsequent year. The company is making provision for doubtful debts after scrutiny of each account and the debts and advances considered doubtful on the basis of actual balances are fully provided for every year, as stated in the ‘Significant Accounting Policies’ annexed to the annual accounts. Once the provision is made, the same is reviewed at the time of finalisation of accounts every year with reference to actual balance in the party’s account. In some cases, subsequent recoveries are made as a result of persuasion and protracted correspondence etc. In such cases, the excess provision on account of such recoveries is written back in the profit and loss account under the head “Provision for doubtful debts-previous year written back”. In respect of some other accounts, if it is observed that the provision made is lesser than the balance provided for, the same is shown as expenditure under the head “Provision for Doubtful Debts and Advances”.

2.In Schedule VI, Part I, to the Companies Act, 1956, it is stated that in respect of debts, “the provision to be shown under this head should not exceed the amounts of debts stated to be considered doubtful or bad” and any surplus of such provision, if already created, should be shown at every closing under “Reserves and Surplus” in the liability side under the separate sub-head “Reserve for doubtful or bad debts”.

3.While conducting the audit of accounts for the year 1989-90, the government auditors have observed that the procedure stated in the preceding para should be followed by the company in respect of the accounting provision no longer required for bad and doubtful debts, after obtaining opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India, if necessary.

4.In the balance sheet, net provision at the year end after adjusting excess provision written back and additional provision made during the year is shown by way of deduction from “Sundry Debtors-considered doubtful” and “Advances-considered doubtful”.

5.The querist has also sated that the Schedule VI does not prescribe procedure to be adopted for utilising the amount credited to reserve for doubtful or bad debts. The company is having carried forward losses of around Rs. 90 crores as on 31^st March, 1990, and as such, there is no possibility of declaration of any dividend in near future.

6.The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether the system being followed by the company as stated above is in order.

 

(b) If the answer to (a) above is in the negative, then what is the correct system that should be adopted, while preparing the annual accounts?

Opinion                                                                                                                 April 26, 1991

1. The Committee notes the relevant portion of Part I of Schedule VI which is reproduced at para 2 of the query and also para 7(2) of Part III of Schedule VI to the Companies Act, 1956, which is reproduced below:

“Where-

(a) Any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act; or

 

(b) Any amount retained by way of providing for any known liability; is in excess of the amount which in the opinion of the directors is reasonably necessary for the purpose, the excess shall be treated for the purposes of this schedule as a reserve and not as a provision.”

2.The Committee is of the view that the relevant requirement of Part I of Schedule VI, read with para 7(2) of Part III of Schedule VI should not be taken to mean that provision for doubtful or bad debts created in the previous years which is no longer required and which is reversed in the accounts is to be treated as ‘Reserve for doubtful or bad debts’.

3.The Committee is of the view that if a company makes a provision for bad or doubtful debts in any year and in that very year such provision is in excess of the amount considered to be reasonably necessary for the purpose, the excess shall be treated as reserve. On the contrary, if a company makes a provision which is considered reasonably necessary in that year but subsequently in any year the provision becomes excessive, the excess may be written bank to the profit and loss account of the subsequent year and if it is not written back and the excess provision is allowed to be carried forward in the accounts, the excess amount should be treated as ‘Reserve’ in the balance sheet in terms of requirements of para 7(2) of Part III of Schedule VI as set out in para 1 above.

4.The Committee is accordingly of the view that where a company creates a provision for doubtful or bad debts in a year which is considered to be reasonably necessary but in a subsequent year/years such provision is considered to be short/excessive due to changed circumstances, then:

(i) If such provision is considered to be short, the shortfall should be provided in the subsequent year by debiting the profit and loss account and crediting the provision for doubtful or bad debts; and

 

(ii) If such provision is considered to be excessive, the excess should be written back to the profit and loss account of such subsequent year. In case, it is not written back, such excess shall be considered as a ‘Reserve’.

5.The Committee is accordingly of the opinion that the accounting policy followed by the company is correct in facts and circumstances of the case.