1.3 Query: Rectification of accounts of the previous financial year.
1. A public limited company whose accounting year ends on 31st March, sold a machine for Rs.50 lakhs and booked profit on sale of this machine of Rs.35 lakhs during financial year 1994-95.
2. During the financial year 1994-95, the company was not in receipt of sale proceeds of machine from the buyer and the machine was in possession of the company. During this year, the company earned net profit of Rs.25 lakhs inclusive of profit on sale of above machine of Rs.35 lakhs.
3. For the financial year 1994-95, the company declared and paid 10% dividend on its paid-up equity shares out of general reserves.
4. During current financial year, when the company approached the buyer of machine to pay the amount of Rs.50 lakhs, he refused to pay and did not take delivery of machine. Hence, the company had to cancel the agreement.
5.The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Can the company square-off of buyer’s account by debiting full amount of Rs.50 lakhs in machine account?
(ii) If the answer to (i) is in the affirmative, will the company be entitled to claim depreciation on Rs.50 lakhs both as per Income-tax Act and Companies Act?
(iii) If the answer to (i) above is in the negative, can the company revise the entries passed in financial year 1994-95, in current year 1995-96?
The querist has sought the opinion of the Expert Advisory Committee as to what will be the best course of treatment in the above case.
Opinion April 19, 1996
1. The opinion of the Committee given hereafter is purely from the accounting point of view. The Committee has not addressed itself to legal implications, if any, since the Committee is prohibited from giving opinion on matters involving interpretation of law in view of Rule 2 of the Advisory Service Rules. The Committee has also not addressed itself to the duty of the auditor in the case of this unusual transaction. The opinion of the Committee given hereafter is also based on the assumption that the querist is not a manufacturer or a dealer of the machine in question. The machine is, therefore, a fixed asset of the company.
2. The Committee is of the view that with regard to booking of the sale of machine last year, two situations were possible-
(a) the sale was properly booked, i.e., the property in the machine (or the significant risks and rewards of ownership thereof) has passed to the buyer and that at the time of the booking of the sale it was not unreasonable to expect ultimate collection.
(b) The sale was not as per (a) above.
3. The Committee is of the view that in case the sale was not booked as per the principles stated in para 2 (a) above, then it should be considered as an error and, therefore, should be treated as a ‘prior period item’ in view of the following definition of the said term 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.”
The Committee notes that as per the aforesaid Standard the disclosures with regard to the prior period items should be as follows:
“Prior period items should be separately disclosed in the current statement of profit and loss together with their nature and amount in a manner that their impact on current profit or loss can be perceived.”
The Committee wishes to add that apart from making the above disclosures the machine account should be debited by Rs.15 lakhs, the profit and loss account should be debited by Rs. 35 lakhs and the debtor should be credited with Rs.50 lakhs. The aforesaid amount of Rs.35 lakhs should be disclosed separately in the profit and loss account alongwith a sufficiently detailed note explaining the transaction. Also, depreciation on the machinery for the year 1994-95 should be charged (to the extent not provided) apart from the same for the year 1995-96. It is reiterated that the Committee is not expressing any opinion about the liability which may attach to directors, auditors and others for this error.
4. The Committee notes that if the situation was that the sale was booked properly as per the principles described in para 2 (a) above, the company would have a legal case for specific performance and damages against the buyer. No mention has, however, been made about this in the query. In this case also, the machine account should be debited by Rs.15 lakhs, the profit and loss account should be debited by Rs.35 lakhs as a write-off of the bad debt or a provision for bad debt, as the case may be, and disclosed separately as an exceptional item. In this case also, the question of depreciation not provided for the year 1994-95 should be considered. Further, appropriate disclosure should be made in the notes to the accounts, explaining with complete facts the nature of the reversal and the reasons therefor.
5. On the basis of the above, the Committee is of the following opinion in respect of the issues raised at para 5 of the query:
(i) See paras 3 and 4 above.
(ii) Since the answer to (i) above is not in the affirmative, the company cannot claim depreciation on Rs.50 lakhs.
(iii) The company should pass the relevant entries in the books of the current year, i.e., 1995-96. _______________________________
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