1.33 Query: Writing-back of provision for a contingent loss.
1. A public limited company is engaged in manufacture of sponge iron. It procures iron ore from the private mine-owners. As per the purchase order of the company, during the currency of the purchase order, if any fresh/additional levy is imposed by the Government, such as, cess, royalty etc., the same shall be reimbursed by the company to the mine-owners.
2. The querist has stated that the State Government was hitherto collecting the cess on the minerals. The constitutional validly of the collection of cess was challenged and the Supreme Court had held that the collection of cess on minerals by the State Government is invalid and unconstitutional. However, regarding the refund of cess, the Supreme Court held that the decision will have prospective effect. To validate collection made prior to the Supreme Court’s order, an Ordinance was promulgated (7th of 1992) on the cess and other taxes on minerals. According to the Ordinance, beyond 4th April, 1991, the State Government is not empowered to levy the cess and other taxes on minerals including iron ore. As per the querist, the said State Government which had not been collecting the cess on iron ore, prior to the promulgation of the Ordinance, demanded the cess from the iron ore mine-owners who were supplying iron ore to the company up to 4.4.1991, taking shelter under the said Ordinance.
3. As per the querist, the company had provided during the year 1992-93, the additional cess payable to the mine-owners as per the purchase orders issued, in the books of account. After the book-closure for 1992-1993, the matter was examined in detail and the company had decided to challenge the levy in the High Court. It accordingly filed a writ petition in the High Court, challenging the demand of cess by the State Government. The amount involved is Rs. 10.80 lacs, for which the provision had been made in 1992-93.
4. The querist has sought the opinion of the Expert Advisory Committee as to whether the aforesaid provision for the liability relating to the payment of cess liability can be reserved by crediting the same to the profit and loss account?
Opinion February 8, 1994
1. The Committee notes from clause (ix) of Part II of Schedule VI to the Companies Act, 1956, that where any amount set aside to provisions made for meeting specific liabilities, contingencies or commitments, is no longer required, it can be written back by crediting the same to the profit and loss account of the relevant year.
2. The Committee further notes paras 3.1, 10 and 11 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 read 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.”
“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 the financial statements 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. The Committee notes from the above, that a contingent loss should be provided for if both of the conditions enumerated in para 10 of Accounting Satandard (AS) 4, as reproduced above, are satisfied. However, in the view of the Committee, in assessing the probability of the existence of a liability, as at the date of the financial statements, in respect of which a litigation is pending, all the relevant factors should be considered. Some of these factors could be the opinions/views of legal counsel and other experts, the experience of the enterprise in similar cases, and the experience of other enterprises, etc. If, after taking into account all the relevant factors and information available upto the date of the financial statements, both of the conditions set out in para 10 of Accounting Standard (AS) 4 are met a provision would be required in this regard. In case either of the conditions set out in the aforesaid para 10 is not met and the possibility of the loss is not remote, only a disclosure of the contingent loss would be required.
4. The Committee is further of the view that the assessment of a provision for an expense, or, as the case may be, disclosure of a contingent loss, should be reviewed at the date of every subsequent financial statements. This would require fresh assessment of the probability of occurrence of liability. In case it is found that there exist cogent and very strong reasons indicating significant reduction in the probability of occurrence of such liability, a provision earlier made might qualify to be disclosed as a contingent liability. To write back a provision it must be demonstrated that the same is “no longer required”. The Committee is, therefore, of the opinion that a mere filing of writ petition in a court of law, in itself, does not mean that there is a significant reduction in the probability of occurrence of liability in the relevant subsequent financial statements. The events which may justify the reduction may be availability of additional information, e.g., receipt of court orders that may reduce the probability of incurring of the liability, etc. _____________________________ |