1.29 Query: Accounting for provisions made in earlier years no longer required.
1. The querist audited the accounts of a company belonging to the Government of Maharashtra. Subsequently, in a supplementary audit carried out under section 619(4) of the Companies Act, 1956, the Comptroller and Auditors General of India (C&AG) made the following comment on the accounts of the company:
“Comment
OTHER INCOME Rs. 1.86 Crores
This includes provision no longer required, written back as follows:
(i) Head Office Rs. 17.59 Lakhs
(ii) Telematics Division (JV No. 653) Rs.28. 42 Lakhs
(iii) Radio Communication division Rs. 25. 06 Lakhs _____________ Total Rs. 71.07 Lakhs
The facts leading to above comment are as under:
As the written back provision is in respect of provision made related to earlier years, this should have been shown below the line. The profit for the year is, therefore, overstated by Rs. 71.07 Lakhs.”
2. The company had made provision in the accounts of the earlier years for doubtful debts and also provided for the inventories which were not found physically with the company on verification or the whereabouts of which were not known or the confirmation of the physical possession of which was not available with the company at the relevant point of time and certain slow moving and obsolete stocks.
3. In the current year, the company recovered amounts from the debtors, which were considered doubtful in the earlier years. Also, on the basis of confirmations and physical recovery of stocks, and on account of recovery/confirmation of debtors, some of these provisions were found to be no longer required. These provisions were written back in the books of account for the year ended 31st March, 1990, amounting to Rs. 71.07 lakhs.
4. The querist has stated that while replying to the draft comment raised by C&AG, the company drew their attention to the mandatory Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items’, issued by the Institute of Chartered Accountants of India. In the said standard, the term ‘Prior period item’ has been assigned the following meaning:
“3.1 ‘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.”
Also para 5 of the said standard further explains prior period items as:
“5.1 Prior period items are generally infrequent in nature. They should not be confused with accounting estimates which are, by their nature, approximations that may need correction as additional information becomes known in subsequent periods. The charge or credit arising on the outcome of a contingency, which at the time of occurrence could not be estimated accurately, does not constitute the correction of an error but a change in estimate. Such an item is not treated as a prior period item.
5.2 Prior period items are included in the statement of profit and loss for the current period but a separate disclosure of all such items is made so that their impact on the current profit or loss can be perceived. Such disclosure complies with the requirements of statutes, wherever applicable.”
5. In the light of the above, the querist is of the view that prior period items are only those items which arise as a result of errors or omissions in the preparation of the accounts of the earlier periods. Events like receipt of money from debtors, receipt of goods from the parties or receipt of confirmations from the parties in the current year, leading to writing back of provisions, cannot be construed as errors or omissions committed in 1988-89. Therefore, the querist has stated that in their reply to the C&AG the company has explained that the treatment given by the company to these items is correct in terms of the generally followed accounting principles and Accounting Standard (AS) 5 issued by the Institute of Chartered Accountants of India as referred to above.
6. The querist has informed that C&AG had raised a similar draft comment on the accounts for the year ended as on 31st March, 1989 and his reply to that was also on the same lines as discussed above. After examining the reply, the C&AG had dropped the said comment.
7. The querist has sought the opinion of the Expert Advisory Committee whether the company has correctly shown the amount of provisions written back as part of other income in its profit and loss account for the year ended as on March 31, 1990.
Opinion December 8, 1992
1. The Committee notes clause 3(ix)(b) of Part II of Schedule VI to the Companies Act, 1956, which provides that “the profit and loss account shall disclose, in respect of the period covered by the account, the aggregate, if material, of the amounts withdrawn from such provisions, as no longer required.”
2. The Committee also notes para 8.1 of Accounting Standard (AS) 5, issued by the Institute of Chartered Accountants of India, which states as follows:
“8.1 The preparation of financial statements involves making estimates which are based on the circumstances existing at the time when the financial statements are prepared. For example, estimates are required of uncollectable receivables, inventory obsolescence, and the useful lives of depreciable assets. It may be necessary to revise an estimate in the subsequent period if there is a change in the circumstances on which the estimate was based. Revision of an estimate does not bring the resulting amount within the definition either of a prior period item or of an extraordinary item. Revision of an estimate that relates to an item that was treated as an extraordinary item is itself treated as extraordinary. A change in an accounting estimate sometimes has so material an effect on the income trend of the enterprise that there is a need to disclose the effects of the change.”
3. The Committee also notes para 5 of Accounting Standard (AS) 5, issued by the Institute of Chartered Accountants of India, reproduced at para 4 of the query.
4. The Committee is of the view that writing back of provisions made in previous accounting periods in respect of doubtful debts and loss/obsolescence etc., of inventory is a change in accounting estimate. The effect of a change in an accounting estimate should be accounted for as part of income of the enterprise in the profit and loss account. If the effect of the change is material it should be appropriately disclosed.
5. On the basis of the above, the Committee is of the opinion that the company has rightly written-back the amount of provisions made in earlier year(s) no longer required, in the profit and loss account of the current year. However, a separate disclosure of the same should have been made instead of showing it as a part of ‘Other Income’. __________________________ |