1.28 Query:

Treatment of amount due from a customer in a

winding-up petition before the High Court.

1. A public sector company has fabricated energy saving equipment, viz., Windmill Towers, during 1996, as per the design and drawings supplied by the customer. A part of the consignment is delivered as per the schedule and the company has received part payment. However, due to liquidity crunch, the customer has requested the company for postponement in delivery schedule and requested the company to withhold the delivery of finished products and suspend the production of remaining items.

2. As a result of the above, the amount due from the customer for the goods already supplied was shown under ‘Sundry Debtors’ and the goods held by the company as work-in-progress and finished goods. The brief details of outstanding dues as on 31.03.97 from the customer is given below:

            (i)         20 nos. of Windmill Towers delivered                     Rs. 165 lakhs

                        Less: Amount received from the customer                           Rs. 90 lakhs

                                                                                                                 ___________

            Amount shown as Sundry Debtors as on 31.03.97              Rs. 75 lakhs

            (ii)        Add: 15 nos. of Windmill Towers stored in

           the company shown as finished goods at

           the request of the customer.                                                Rs. 120 lakhs

           (iii)       Add: Work- in- progress

                       Work abandoned due to liquidity problem

           faced by the customer                                                          Rs. 97 lakhs

                                                                                                       ___________

           Total outstanding as on 31.03.1997.                                    Rs. 292 lakhs

Meanwhile, the company has disclosed the position in the notes to the accounts.           

3. Having failed in collecting the dues from the customer inspite of visits by senior officers and a Director of the company, it has filed a winding-up petition against the customer in March, 1997. The petition has not come up for hearing till the date of sending of the query.

4. The company’s auditors have qualified the accounts stating “non-provision of Rs. 292 lakhs included in Sundry Debtors, finished goods and work-in-progress”.

5. The company has taken a stand with the auditors that the transaction with the customer is only 2 years old and the customer had a good track record as a dividend paying company during 1994-95 and 1995-96 and was facing liquidity problem during 1996-97 onwards. However, the auditors have taken a stand that in view of the fact that the winding-up petition was filed by the company, the amount due from customer has become doubtful and, hence, provision is required to be made in the accounts.

6. The querist has sought the opinion of the Expert Advisory Committee as to whether a provision for doubtful amount is required to be made in case where a winding-up petition is pending in a High Court without going to the merit of the position of the case.

                                                                           Opinion                                December 2, 1997

1. The Committee notes that with regard to valuation of current assets, the generally accepted accounting principle is that these should be valued at the net realisable value if it is lower than historical cost/ carrying value. Thus, a provision should be created in case a debt is considered doubtful and the inventories of finished goods/work-in-progress in case the net realisable value is below cost.

2. In the present query, the Committee notes that the total amount outstanding towards the customers is in respect of inventories of finished goods and work-in-progress and sundry debtors. With regard to inventories of finished products and work-in-progress, the Committee is of the view that in case it is expected that the net realisable value will be lower than the historical cost of the inventories, the shortfall should be written off. In case the inventories are customised, i.e., manufactured as per the customer’s specification and it is expected that these cannot be used by any other customer, the computation of net realisable value will have to be with reference to the ability of the specific customer to lift and pay for the inventories. in such a case the entire amount of inventories may have to be written-off.

3. With regard to sundry debtors, the Committee is of the view that whether a particular debt is doubtful or bad depends upon the assessment by the management and the auditor based on the relevant facts and circumstances of the case. In this regard, The Committee notes para 11 of the Guidance Note on Audit of Debtors, Loans and Advances, issued by the Institute of Chartered Accountants of India, which is reproduced below:

“11.      The following are some of the indications of doubtful and uncollectible debts, loans and advances:

           (a)        The terms of credit have been repeatedly ignored.

           (b)        There is stagnation, or lack of healthy turnover, in the account.

           (c)        Payments are being received but the balance is continuously increasing.

(d)        Payments, though being received regularly, are quite small in relation to the total outstanding balance.

(e)        An old bill has been partly paid (or not paid), while later bills have been fully settled.

           (f)         The cheques received from the debtor have been repeatedly dishonoured.

           (g)        The debt is under litigation, arbitration, or dispute.

(h)        The auditor becomes aware of unwillingness or inability of the debtor to pay the dues e.g., a debtor has either become insolvent, or has closed down his business, or is not traceable.

(i)         Amounts due from employees, which have not been repaid on termination of employment.

           (j)         Collection is barred by statute of limitation.”

4. The Committee notes from the facts of the query as stated in para 3 of the query that having failed in collecting the dues from the customer inspite of visits by senior officers and a Director of the company, it has filed a winding-up petition against the customer. The Committee is, therefore, of the view that there is a strong indication that the debt in question is doubtful (even though the company was a dividend paying company in the past) unless there is some other strong evidence to indicate the contrary, e.g., realisation after the balance sheet date. Accordingly, an adequate provision in this regard should be made. Similarly, if the customer is not able to pay for the goods delivered to him, the likelihood of his lifting and paying for the finished goods in stock is also doubtful. As far as work-in-progress is concerned, the fact that the work has already been abandoned is a strong indicator of its negligible net realisable value.

5. The Committee is of the opinion that provision/write-off in respect of inventories of finished products and work-in-progress and sundry debtors should be made as suggested in paras 2 and 4 above.

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