Query No. 8

  Accounting treatment of dues recoverable from subsidiary company under liquidation.1

Subject:  

A.   Facts  of  the  Case

1.  A company ‘X’ was incorporated on 18th   July, 1964 in the State of West Bengal with the object of manufacturing cast iron pipes. The company is presently a wholly owned subsidiary of company ‘Y’.   Company ‘X’ became a government company under section 617 of the Companies Act, 1956 on 17th July, 1976 when the holding company ‘Y’ became a government company in terms of Indian Iron & Steel Company (Acquisition of Shares) Act, 1976.  Company ‘X’ became a subsidiary of another company ‘Z’ on 1.5.1978, when its holding company ‘Y’ became a subsidiary company of company ‘Z’.

2. The manufacturing unit of company ‘X’ has an installed capacity to manufacture cast iron/spun pipes of 60,000 tonnes per annum. The operations of  the  company were  profitable upto  the year  1985-86, but  deteriorated thereafter, except for marginal operating profits during the year 1990-91. The accumulated losses as on 10.7.1997 amounted to Rs. 1,705 lakh as against the paid-up share capital  of Rs. 300 lakh.   The  company has manpower strength of 189.

3.  On 25.3.1994, company ‘X’ was referred to the Board for Industrial and Financial Reconstruction (BIFR) under section 15(1) of the Sick Industrial Companies (Special Provisions) Act, 1985.   On 21.6.1996, BIFR decided that the company was not likely to make up its accumulated losses within a reasonable period of time while meeting all its obligations and that, it was just and equitable to wind it up. Consequently, the Hon’ble High Court, Calcutta, on 10.7.1997 directed that company ‘X’ be wound up and directed the official liquidator to take possession of the assets of the company.   On 5.5.1999, upon hearing the submissions made on behalf on various parties, the Hon’ble High Court withdrew the order directing winding up of the company. However, on an application filed by company ‘Y’, the restoration of winding up order was made on 14.12.2000. The liquidator is in the process of disposing off the assets.

4. The financial position of company ‘X’ as on 10.7.1997 was as under:

                                                                                                                    Rs. lakh

Assets:

Net fixed assets (including Capital WIP)                                                            282

Current assets:                                         

Inventory                                                                                                         340

Receivables                                                                                                       90

Other current assets                                                                                          76

Total                                                                                                                788

Liabilities:        

Share capital (30 lakh equity shares of Rs. 10 eachheld by company ‘Y’)          300

Current liabilities:         

-Sundry creditors          1916   

-National renewal fund  41       

-Other liabilities            83                                                                                2040

Provisions                                                                                                             82

Loans: from Government of India                                                                          31

from company ‘Y’                                                                                                40

Profit and loss account (debit balance)                                                              (1705)

Total                                                                                                                    788

5. The total land area of the plant of company ‘X’ is about 177 acres, of which 103 acres is freehold and the rest is leasehold.  On the freehold land apart from the factory, the company has residential township for employees with reasonable amenities.  The land is well connected by government and private means of transport. The leasehold land measures about 43,407 square metres and hosts the non-executive residential quarters, constructed during the years 1982 and 1983.

6.  According to the querist, a consultancy company has assessed in March 2000 the fair market value of the property of company ‘X’, consisting of land and the construction thereon, to be Rs. 25.09 crore (freehold Rs. 21.60 crore, leasehold Rs. 3.49 crore).

7. Company ‘Z’ has dues of Rs. 16.51 crore from company ‘X’ towards materials supplied to it and the same is included under the head ‘Current Liabilities’ – Sub-head ‘Sundry creditors’ in the books of company ‘X’.  As per the querist, the dues of company ‘Z’ will be discharged by the liquidator out of the proceeds of the sale of assets of company ‘X’.  According to the querist, the value of the assets of company ‘X’ is assessed to be adequate to repay the liabilities including the dues of company ‘Z’.

8.   According to the querist, book value of assets is used to ascertain the value of business on a going concern basis.  If the business is not a going concern, the fair market value of assets is considered to measure the value of business.  As per the querist, since company ‘X’ is not a going concern and is under liquidation, fair market value of the assets is to be considered for the purpose of measuring the capacity of the company to repay its debts.

9.  In respect of dues receivable from company ‘X’, company ‘Z’ made the following disclosure in its annual accounts for the year 2000-01:

“Sundry debtors, loans & advances include Rs. 16.51 crore (including Government of India loan and interest thereon amounting to Rs. 0.55 crore) due from company ‘X’, a subsidiary company of company ‘Y’, for which the official liquidator has been appointed and who, after taking over the possession of the assets, has since invited offers for their sale. The company has got the land and buildings of company ‘X’ as on 31st March, 2000, re-valued by an independent agency and the re-valued amount of the above assets, along with the value of other assets like plant & machinery, etc., is quite adequate to cover the above loans and advances made by the company which are, therefore, considered to be recoverable.”

10. The Comptroller & Auditor General (C&AG) issued a comment on the annual accounts of company ‘Z’ for the year 2000-01 that the dues of Rs. 16.51 crore should have been provided for, as company ‘X’ is under liquidation. The C&AG made the following observation on non-provision of dues from company ‘X’:

“This includes Rs. 16.51 crore (including Government of India loan and interest thereon of Rs. 0.55 crore) due from company ‘X’, a sick company, which was under BIFR and was declared by the High Court, Calcutta, on 10.7.1997 for being wound up.

As the company is under the process of liquidation and no money could be recovered as yet, the amount of Rs. 16.51 crore being shown by company ‘Z’ as recoverable as on 31st  March, 2001, should have been categorised as ‘doubtful’ and necessary provision created.

Non-provision has, therefore, resulted in overstatement of Current Assets and Loans & Advances, and understatement of loss by Rs. 16.51 crore.”

11. The company replied to the observation made by C&AG as follows:

“An official liquidator has been appointed for company ‘X’ who has initiated the liquidation process.  The value of land and building of company ‘X’ assessed by an independent agency adequately covers the loans and advances given by the company. Therefore, no provision is required.”

B .   Query

12. The querist has sought the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India as to whether the accounting practice followed  by company ‘Z’ with  regard to  non-provision of  dues receivable from company ‘X’ is proper.

C.   Points  considered  by  the  Committee

13. The Committee notes that as per the generally accepted accounting principles, current assets are valued at the lower of the cost/carrying value and net realisable value.  Thus, a provision should be created to the extent it is estimated that the company will not be able to recover its dues.

14.The Committee is of the view that whether a provision should be created against  a  particular  debt  or  not,  depends  upon  the  assessment  of  the management and the auditor based on the relevant facts and circumstances of the case.   The basic consideration for assessing whether a provision is required or not depends on the capacity and willingness of the debtor to repay the debt.   Capacity of the debtor to repay the debt depends on the ability of the business of the debtor to generate adequate cash flows from business operations and/or from sale of his assets.  In the case of liquidation of the business of the debtor the latter factor, i.e., the ability of the business of the debtor to generate cash flows from sale of his assets, is of importance. Thus, if it is assessed that the realisable value of the assets of the business of the debtor, after meeting the liabilities having preferential rights as per the law, is adequate to repay the debt, it may not be necessary to make a provision against that debt.  In making such an assessment, events occurring after the balance sheet date may be taken into consideration.

D.    Opinion

15.  On the basis of the above, the Committee is of the opinion that whether a provision is required or not, would depend upon the assessment of the reliability of the debt on the bases explained in paragraph 14 above.

  1 Opinion finalized by the Committee on 26.4.2002.