Query No. 20
Subject: Defamation case pending against a bank: whether a contingent liability.[1] A. Facts of the Case
1. The balance sheet of a nationalised bank showed the following amounts as ‘claims against the bank not acknowledged as debt’:
Financial year ended 31.3.1998: Rs. 199.92 crore.
Financial year ended 31.3.1997: Rs. 228.39 crore.
2. The above amounts included an amount of Rs. 42.5 crore in respect of a defamation case filed by a borrower. The borrower was allowed various credit facilities in consortium on 50:50 basis along with another bank. The borrower diverted the funds and the consortium members enforced the terms of hypothecation agreement and filed a suit for injunction against the borrowing company. This news was published in a local newspaper. Aggrieved that the news item had hurt its reputation in the eyes of the general public, the borrower filed a case for defamation with High Court in 1994 on the ground that the authorities of the consortium had given directions for publication of such a news item. The bank, being a part of the consortium, was made a party to the suit. The damages claimed for the alleged defamation by the borrower were to the tune of Rs. 85 crore.
3. In the opinion of the statutory auditors of the bank, 50% of the amount claimed, i.e. Rs. 42.5 crore comprised a contingent liability for the bank and was disclosed in the balance sheet accordingly.
4. The matter was referred to the solicitors of the bank who after perusal of the claim stated that as far as the bank was concerned, no cause of action appeared to have arisen within the jurisdiction of the High Court with which the suit had been filed. In their view, the case was likely to be dismissed and the allegation made appeared to be untenable.
5. Paragraphs 10 and 11 of Accounting Standard (AS) 4, ‘Contingencies and Events Occurring after the Balance Sheet Date’, state the following:
“10. The amount of a contingent loss should be provided for by a charge in the statement of profit and loss if:
“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.”
6. According to the querist, based on the opinion of the solicitors, the bank is of the view that the possibility of incurring any loss with regard to the alleged defamation is remote and, therefore, no contingent liability on this account needs to be disclosed.
B. Query
7. The querist has sought the opinion of the Expert Advisory Committee as to whether or not a contingent liability as aforesaid should be disclosed in the financial statements of the bank.
C. Points Considered by the Committee
8. Paragraphs 10 and 11 of AS 4 (reproduced above) lay down the accounting and disclosure requirements relating to contingent losses. It can be seen that the treatment of a contingency (i.e., whether to make a provision or a disclosure or neither) depends upon the estimate about the outcome of the contingency.
9. Paragraphs 7.1 and 7.2 of AS 4 deal with the manner in which the financial effects of contingencies are determined. These paragraphs are reproduced below.
“7.1 The amount at which a contingency is stated in the financial statements is based on the information which is available at the date on which the financial statements are approved. Events occurring after the balance sheet date that indicate that an asset may have been impaired, or that a liability may have existed, at the balance sheet date are, therefore, taken into account in identifying contingencies and in determining the amounts at which such contingencies are included in financial statements.”
“7.2 In some cases, each contingency can be separately identified, and the special circumstances of each situation considered in the determination of the amount of the contingency. A substantial legal claim against the enterprise may represent such a contingency. Among the factors taken into account by management in evaluating such a contingency are the progress of the claim at the date on which the financial statements are approved, the opinions, wherever necessary, of legal experts or other advisers, the experience of the enterprise in similar cases and the experience of other enterprises in similar situations.”
From the above, it can be seen that the estimate of the outcome of a contingency is based on a consideration of the facts and circumstances of a particular case.
10. In the instant case, there is a difference of opinion between the management and the statutory auditors as to the outcome of the defamation case pending against the bank. The bank, on the basis of the opinion received from its solicitors, is of the view that the possibility of devolvement of any loss (on account of the defamation case) on the bank is remote and, therefore, no contingent liability on this account needs to be disclosed. The statutory auditors, on the other hand, are of the view that a contingent liability on this account should be disclosed in the financial statements, implying thereby that in their view, the possibility of the loss is not remote.
11. It is well-accepted that the responsibility for preparation of the financial statements is that of the management of the enterprise and includes making various estimates and judgements. The responsibility of the auditor, on the other hand, is to form and express his opinion on the financial statements. This involves assessing the reasonableness of the judgements and estimates made by the management in preparing the financial statements.
12. Statement on Standard Auditing Practices (SAP) 9, ‘Using the Work of An Expert’, discusses the auditor’s responsibility in relation to, and the procedures the auditor should consider in, using the work of an expert as audit evidence. The term ‘expert’ has been defined as a person, firm or other association of persons, possessing special skill, knowledge and experience in a particular field other than accounting and auditing. A solicitor (or a firm of solicitors) is thus an expert for the purposes of SAP 9. Accordingly, the auditor needs to apply the audit procedures as per SAP 9 to evaluate the opinion of the solicitors. If, after performing these procedures, the auditor has a disagreement with the management about the disclosure of the relevant information in the financial statements, the auditor should, as required by SAP 9, express a qualified opinion or an adverse opinion, as may be appropriate, depending on the materiality of the amount involved.
D. Opinion
13. As stated in paragraph 8 above, the estimate of the outcome of a contingency depends on a consideration of the facts and circumstances of a particular case. Therefore, the Committee is not in a position to assess the likelihood of devolvement of the loss (on account of the defamation case) on the bank and, accordingly, does not express any opinion as to whether a provision or disclosure in respect of the same should be made in the financial statements or not. However, the Committee is of the opinion that if, after applying the procedures laid down in SAP 9, the auditor has a disagreement with the management in the matter, he should express a qualified opinion or an adverse opinion, as appropriate, depending on the materiality of the amount involved.
________ [1] Opinion finalised by the Committee on 28.5.1999. |