1.31 Query: Write-back of self-insurance reserve no longer required.
1.A Government company, established under the Companies Act, 1956, is under the administrative control of the Ministry of Civil Aviation. The corporation was incorporated on 15th October, 1985 and commenced its commercial operations on 6th October, 1986. The corporation is engaged in operating a fleet of helicopters mainly to provide necessary logistic support to another public sector corporation for transporting their men and materials.
2. The corporation purchased 21 Westland helicopters from M/s. Westland Helicopters Limited, U.K., and 27 Dauphin Helicopters from M/s. Aerospatiale, France, along with related inventories, ground support equipments, etc. About 45% of the fleet and related equipment was delivered to the corporation during 1986-87 and the balance fleet was received during the year 1987-88.
3. During the first year of its operations, the corporation had insured the fleet through GIC. The Board of Directors, at the time of its annual renewal, felt that the premium rate for helicopters was very high. Accordingly, a proposal of self-insurance for helicopters was mooted. As per this scheme, a reserve was to be created at a notional premium rate equivalent to the then prevailing market premium rate. This scheme was duly approved by the Board of Directors and the Government of India. This way the corporation saved the amount which would have been otherwise paid out to the insurance company. The amount of premium so saved was suitably invested. As per the scheme, in case of any loss to the helicopters on account of accidents, the written down value at the time of the loss was to be charged-off against the reserve fund so created. This scheme continued from September’87 to November’89. Thereafter, with the approval of the Government, this scheme was discontinued since the actual premium rates in the worldwide market fell drastically and it was found more economical to go for an outside insurance. During the period of the scheme, the corporation lost three helicopters, the written down value of which was charged off to the reserve account. At the time of termination of this scheme, there was a surplus balance of Rs. 7.25 crores which is proposed to be written back to the profit and loss account as a prior year adjustment during 1989-90.
4. The querist has further informed that the corporation had heavy taxable losses during the last two years. The creation of this reserve in the profit and loss account was disallowed for the purposes of income-tax.
5. The opinion of the Expert Advisory Committee has been sought as to whether the treatment of writing back the self-insurance reserve no longer required, as stated above, is correct. If not, an alternative suggestion has been requested.
Opinion December 6, 1990
1. The opinion of the Committee given hereinafter is from accounting point of view only.
2. The Committee notes from the facts of the query that the company had been writing off the written down value of the helicopters at the time of loss due to accident against the reserve fund created. The Committee is of the view that the correct accounting treatment in respect of such a transaction would be to account for the loss arising on accident through profit and loss account with a corresponding transfer from the reserve fund so created to the profit and loss account.
3. The Committee is of the opinion that since the self-insurance reserve is no longer required, it can be written-back in the profit and loss account of the relevant year and disclosed as suggested in the following paragraphs.
4. The Committee notes that the terms ‘Prior Period Items’ and ‘Extraordinary Items’ have been defined as follows in Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India:
“Prior period items” are material charges or credits which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.”
“Extraordinary items” are gains or losses which arise from events or transactions that are distinct from the ordinary activities of the business and which are both* materia and expected not to recur frequently or regularly. These would also include material adjustments necessitated by circumstances, which though related to previous periods are determined in the current period.”
5. The Committee is of the opinion that write-back of self-insurance reserve no longer required now is not due to an error in the previous years. Therefore, it cannot be considered as a prior-period item, but should be disclosed as an Extraordinary Item as per para 10 of AS-5, which is reproduced below:
“Extraordinary items of the enterprise during the period should be disclosed in the statement of profit and loss as part of net income. The nature and amount of each such item should be separately disclosed in a manner that their relative significance and effect on the current operating results of the period can be perceived.” ________________________
*Material items have been defined in the Accounting Standard on “Disclosure of Accounting Policies” (AS-1) as items the knowledge of which might influence the decisions of the users of the financial statements.
|