1.7 Query Treatment of a provision raised in an earlier year which is no longer required. 1. A State Government Company is involved mainly in raising gypsum and raw phosphate ore from mines. The selling price, the ratio of ore raised to overburden removed and the other terms and conditions are fixed by the State Government from time to time. For the year 1974-75 the ore to overburden ratio was 1:4. In that year it was stipulated that the company would raise 3 lakh tonnes of ore and remove 12 lakh tonnes of overburden; but in fact the company raised 4 lakh tonnes of ore and only 6 lakh tonnes of overburden. Applying the ratio of 1:4, for 4 lakh tonnes, 16 lakh tonnes of overburden should have been removed. The shortfall of 10 lakh tonnes in the year 1974-75 was valued at the estimated future cost of removal of overburden at Rs. 8.20 per tonne and a “Provision for Non-removal of Overburden” for Rs. 82 lakhs was raised in the accounts. The amount was included in the “cost of removal of overburden” and was written off in the profit and loss account for the year ending 31st March, 1975. The provision was disclosed as a current liability in the balance sheet for the year. The provision for non-removal of overburden for Rs. 82 lakhs was carried through till the current year i.e. 1979-80. In the intervening years, the amount of the provision was not enhanced because of the redetermined ratio of ore to overburden and because the matter was referred to a Committee of the Government for the final determination of the ratio of ore to overburden. 2. While determining 5% of profit as the Managing Director’s remuneration u/s 349 of the Companies Act, 1956, the sum of Rs. 82 lakhs was not added back to the ‘profit as per the profit and loss account’ for the year ending 31st March, 1975. 3. The company also claimed deduction from income-tax on account of non-removal of overburden. In this context a note to the accounts for the year ended 31st March, 1980 appeared as under: “Estimated expenditure on non-removal of overburden Rs. 657.59 lakhs (previous year 564.93 lakhs) though claimed/to be claimed as deduction in income-tax returns since 1975-76 as the Company is negotiating with the Government (State) for fixation of remuneration in this regard. The amount already provided should be dealt appropriately on finalisation of negotiations.” 4.In view of the remuneration fixed in November 1980, the company felt that “the provision for non-removal of overburden” made in 1974-75 was no longer required. 5.The querist sought the opinion of the Committee on the following:
(i)Whether the provision can remain in the books of accounts. (ii) In view of changed circumstances whether fresh returns have to be submitted as the company claimed deductions in earlier years for non-removal of overburden. (iii) In 1974-75, before computing profit of the company, the Managing Director was entitled to remuneration @5% of profit. If the amount of Rs. 82 lakhs is added back whether the necessary provision should be made for managerial remuneration in accordance with Section 349 of the Companies Act.
Opinion April 5, 1982
The point-wise opinion of the Committee on the queries is given below:
(i) The Committee expresses no opinion on whether in actual fact the liability against which the provision was made exists or not, either fully or partly. This is dependent on interpretation of the agreement and the actual facts of the case. If it is absolutely clear from the terms of the agreement that the liability against which the provision was made has not crystallized, it is appropriate that the provision should be written back to the profit and loss account of the current year with appropriate disclosure.
(ii)If in any year a liability ceases and/or is waived, the corresponding credit is to be treated as the income of that year. Accordingly the sum of Rs. 82 lakhs may be treated as the income of the year in which the liability is waived.
(iii)The calculation of the amount of the Managing Director’s remuneration for the current year should be made after including Rs. 82 lakhs in the profits. _________________________
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