1.22 Query:    

Evidence pertaining to assessment of certainty of a claim for export incentive.

1. A public sector company manufacturing and supplying process control equipments closes its accounts on 31.3.90. The company lodges claims with the Chief Controller of Import & Export, New Delhi, for supplementary cash assistance in lieu of duty drawback for supplies made to buyers against deemed export projects.

2. The company was accounting for the claims on cash basis upto the year 1987-88. In view of the amendment in the Companies Act in 1988, the company changed its accounting policy in respect of the claims from cash basis to accrual basis, w.e.f., 1988-89.

3. A claim lodged during the year 1988-89 was rejected due to non-filing of the application in time during the year 1988-89. The company did not account for the above mentioned claim during the year 1988-89 due to uncertainties of realisation of claim.

4. During 1989-90, the company filed an appeal to the Chief Controller of Imports & Exports, New Delhi, against the order of the lower authority with the request to reconsider and fix the rate of supplementary cash assistance in lieu of duty drawback. After discussion at various levels, the company’s view point was accepted by the authorities concerned and in the opinion of the company, the realisation on these claims was certain and, therefore, it was accounted for as revenue in the year 1989-90 in view of para 3.4 of “Guidance Note on Accrual Basis of Accounting” issued by the Institute of Chartered Accountants of India. The office of the Chief Controller of Imports and Exports also confirmed its stand in the month of June, 1990.

5. The auditors of the company have not agreed with the above views and commented upon accounts of the year 1989-90 stating that the profits of the company were over-stated to the extent of the amount of the above claims.

6. The querist has sought the opinion of the Expert Advisory Committee as to whether the responsibility of ascertaining the certainty of realisation rests with the management of the company. If so, is it necessary that documentary evidence must be available in order to prove certainty of realisation or can the management rely on its own assessment of the case based on discussion and decision arrived at such discussion? If documentary evidence is a necessity, whether that document should bear a date prior to the balance sheet date. Whether a document dated after the balance sheet date but prior to date of approval of financial statements by the approving authority can be considered as evidence for this purpose.

                                                                                           Opinion                       May 29, 1991

1. The Committee notes paragraph 13 of Accounting Standard (AS) 4 on Contingencies and Events Occurring After the Balance Sheet Date, issued by the Institute of Chartered Accountants of India, which states as under:

                        “Assets and liabilities should be adjusted for events occurring after the balance sheet that provide additional evidence to assist the estimation of amounts relating to conditions existing at the balance sheet date.”

2.The Committee notes para 4 and 8(b) of Statement of Standard Auditing Practices: Objective and Scope of the Audit of Financial Statements (SAP 2), issued by the Institute of Chartered Accountants of India, state as under:

“4 While the auditor is responsible for forming and expressing his opinion on the financial statements, the responsibility for their preparation is that of the management of the enterprise. Management’s responsibilities include the maintenance of adequate accounting records and internal controls, the selection and application of accounting policies and the safeguarding of the assets of the enterprise. The audit of the financial statements does not relieve management of its responsibilities.

8. The Auditor determines whether the relevant information is properly disclosed in the financial statements by:

(a) …………

(b) Considering the judgment that management has made in preparing the financial statements; accordingly, the auditor assesses the selection and consistent application of accounting policies, the manner in which the information has been classified, and the adequacy of disclosure.”

3. The Committee further notes that Statement on Standard Auditing Practices: Audit Evidence (SAP-5), issued by the Institute of Chartered Accountants of India, states in para 7 as below:

“The reliability of audit evidence depends on its source- internal or external, and on its nature- visual, documentary or oral. While the reliability of audit evidence is dependent on the circumstances under which it is obtained, the following generalisations may be useful in assessing the reliability of audit evidence:

* External evidence (e.g. confirmation received from a third party) is usually more reliable than internal evidence.

* Internal evidence is more reliable when related internal control is satisfactory.

* Evidence in the form of documents and written representations is usually more reliable than oral representations.

* Evidence obtained by the auditor himself is more reliable than that obtained through the entity.”

4.  On the basis of the above, the Committee is of the opinion that the responsibility of ascertaining the certainty of realisation of a claim rests with the management of the company and the management may rely on its own assessment of the case based on discussions and the decisions arrived at such discussion meeting. However, the auditor is entitled to examine the reasonableness of the assessment of certainty by the management and the relevant documentary evidence. The relevant document bearing a date falling after the balance sheet date but prior to the date of approval of financial statements by the approving authority can be considered as evidence for the purpose.

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