1.16  Query:  

Treatment of export obligations under advance licenses.

1. A company imports components against advance licenses, for use in the manufacture of export vehicles. An obligation is cast on the company by the licensing authorities to export specified number of vehicles against each advance license, within a specified time period, failing which the company will have to pay customs duty. For obtaining these advance licenses, the company has to execute a legal undertaking stating that the company shall pay customs duty on the shortfall in case it fails to export the specified number of vehicles.

2. At the year end, in respect of some advance licenses, the company has yet to fulfill its export obligation and the time limit specified for fulfilling that obligation has not yet expired. In the annual accounts, the company does not disclose the value of outstanding export performance obligation against the legal undertakings in the notes to the accounts as it feels that it is not a contingent liability and that there is no other requirement of Schedule VI to the Companies Act, 1956, to disclose this. A contingent liability in respect of legal undertaking arises when a company issues guarantees to another person on behalf of a third party. When a company undertakes to perform its own obligations, it does not represent a contingent liability. As per the querist, the above is supported by reply to Query No. 1.9, reported on page 10 of Compendium of Opinions- Volume I.

3. The Government auditors have commented on the accounts of the company and have stated that the value of outstanding export performance obligations have not been indicated in the notes forming part of accounts.

4. The querist seeks the opinion of the Committee on the following issues:

(i)         Does the value of outstanding export performance obligations against the legal undertakings executed by the company amounts to contingent liability and needs disclosure as such?

(ii)        If not, is it necessary to disclose the value of such outstanding export performance obligations in the notes forming part of accounts?

                                                                          Opinion                               October 7, 1992

1. The Committee notes paragraph 3.1 of the Accounting Standard (AS) 4 on Contingencies and Events Occurring After Balance Sheet Date, issued by the Institute of Chartered Accountants of India, which states as follows:

“3.1      A contingency is a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or non-occurrence, of one or more uncertain future events.”

The Committee is of the view that the obligation in question gives rise to a contingency as whether the company will have to pay customs duty will be determined only on the occurrence or non-occurrence of fulfillment of export obligation in future.

2. The Committee further notes that paras 10 and 11 of AS 4 state as follows:

“10.      The amount of a contingent loss should be provided for by a charge in the statement of profit and loss if:

(a)        it is probable that at the date of financial statement events subsequent thereto will confirm that (after taking into account any related probable recovery) an asset has been impaired or a liability has been incurred as at that date, and

(b)        a reasonable estimate of the amount of the resulting loss can be made.

11.       The existence of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph 10 is not met, unless the possibility of a loss is remote.”

3. On the basis of the above, the Committee is of the following opinion in respect of the issues raised by the querist in para 4 of the query:

(i)         The Committee feels that in the present case a reasonable estimate of the amount of customs duty to be paid to the authorities can be made. Thus, the Committee is of the opinion that if it is probable that the outstanding obligation will not be fulfilled, then the amount should be provided for in the accounts. Otherwise, the fact of the obligation/commitment should be appropriately disclosed in the accounts. Such a disclosure is not necessary where the possibility of a loss is remote, e.g., at the time of the signing of the accounts the export obligation under advance license is being fulfilled.

                        (ii)        Please see (i) above.

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