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Query No. 18
Subject:
Treatment
of contingency relating to additional power tariff
demanded by a State
Government.1
A. Facts of the
Case
1. A company
has set up
a unit to
manufacture ferro alloys.
Its economics was based
on the policies
and assurances of
the State Government to provide
certain incentives. One of the incentives was to provide power at a tariff
which was about Re.0.50 per unit for a period of
5 years.
2. The State Government
later unilaterally withdrew
the notification on power tariff
and sought to levy tariff at the revised rates. The revision
of the notification of the
government was challenged in the High Court, which stayed the application of
the order pending full hearing.
3. According to
the querist, if the company accounts for the tariff
at the revised rates,
it would be
a sick industrial
company under section 3(1)(o) of the Sick Industrial Companies (Special
Provisions) Act, 1985, and if it does not account for the tariff at the revised
rates, it would result into payment of
income tax because
the electricity expense
due to concessional
tariff is lower as compared to the revised tariff.
B. Queries
4. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(a) Whether the
company is a sick company if it accounts for the tariff demanded on accrual
basis.
(b) If the
answer to (a) above is in the negative, whether provision for taxation is to be
made.
C. Points
considered by the Committee
5. The
Committee notes that the issues raised in the query primarily relate to the
accounting treatment to be accorded
to the revised
power tariff demanded by the State Government.
6. The Committee notes
that ‘contingency’ has
been defined in Accounting Standard (AS) 4, ‘Contingencies and Events
Occurring After the Balance Sheet Date’, issued by the
Institute of Chartered
Accountants of India, as below:
“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.”
7. The
Committee is of the view that the demand for the revised tariff by the
State Government, which
is subjudice, is
of the nature
of a contingency as the ultimate
decision in the matter will be known only on the settlement of the case.
8. The Committee
also notes that
AS 4 prescribes
the following accounting treatment
for contingent losses
vide paragraphs 10
and 11 reproduced below:
“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 future
events will confirm
that, after taking into account
any related probable recovery, an asset has been impaired or a liability has
been incurred as at the balance sheet 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.”
9. The
Committee further notes paragraph 4.4 of AS 4 which states as below:
“4.4 The estimates
of the outcome
and of the
financial effect of contingencies are determined by the judgement of the management of the
enterprise. This judgement is
based on consideration
of information available up to the date on which the financial
statements are approved and will include a review of events occurring after the
balance sheet date,
supplemented by experience
of similar transactions and, in
some cases, reports from independent experts.”
10. From the above,
the Committee is
of the view
that it would
be a matter of judgement based on considerations mentioned in paragraph
4.4
of
AS 4 reproduced
above, as to what
would be the probability of the outcome of the case pending in the High
Court. In case it is probable that the company will have to pay the revised
duty, a provision in this regard will have to be made; otherwise, it should be
disclosed in the financial statements as contingent liability.
11. The Committee
notes the facts
of the case
stated in paragraph
3 above, according to which, if provision is made at the revised rates,
the company will become
a sick company
within the meaning
of section
3(1)(o) of the Sick Industrial
Companies (Special Provisions) Act, 1985. The Committee is of the view that in
case a provision for revised tariff is required to be made in view of paragraph
10 above, it should be considered as a sick company.
12. With regard to
whether provision for taxation should be made, the Committee is of the view
that in case the provision for revised tariff is not required to be made in
view of paragraph 10 above, and this results into tax liability, provision for
taxation should be made.
D. Opinion
13. On the basis of
the above, the Committee is of the opinion that it would be a
matter of judgement based on
considerations mentioned in
paragraph 4.4 of
AS 4 reproduced
in paragraph 9
above, as to
what would be the probability of the outcome of the case pending in the
High Court. In case
it is probable
that the company
will have to
pay the revised duty, a provision
in this regard will have to be made; otherwise, it should be
disclosed in the
financial statements as
contingent liability. Whether
the company is a sick company or a provision
for taxation is required to be
made as contemplated in paragraph 4 above, would depend upon whether
or not the
provision for revised
tariff is required
to be made as aforesaid.
1Opinion finalised by the Committee on
26.5.2001.
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