A. Facts of the Case
1. A public sector undertaking registered under the Companies
Act, 1956 is engaged in refining and marketing of petroleum
products and is having its refineries at various locations. The
company has entered into lump sum turn key (LSTK) agreement
with a foreign contractor for installation of process plant.
2. The querist has stated that the job was awarded to the foreign
contractor based on total lump sum price which was inclusive of
customs duty. Total lump sum price was bifurcated into three main
heads, viz., engineering, supply and construction. The supply part
of lump sum price consists of imported and indigenous supply.
The contractor furnished further break-up of lump sum prices
including structure of taxes and duties, which was used for release
of progressive payments.
3. The querist has further stated that the contractor paid customs
duty on the price at which he had procured the materials. The
procurement price of the material was less than the price indicated
by the contractor in the break-up of lump sum prices. However, he
claimed customs duty based on the CIF value as per the price
break-up (which corresponded to their quoted CIF amounts). Thus,
the total amount of customs duty as shown in the lump sum price
break-up was in excess of the amount of actual customs duty paid
by the contractor. However, as per the querist, notwithstanding the
amounts shown in the price break-up under various heads, the
total payments to the contractor for performance of this contract
shall be limited to lump sum price mentioned in the contract. The
balance of customs duty, as indicated in the relevant price schedule,
after accounting for progressive payments, was to be released on
submission of the proof of payment of customs duty.
4. Keeping in view the above contractual provisions and the fact
that the actual CIF value of the supplies made by the contractor
was much less as compared to the CIF values indicated in the
contract, the customs duty element was reimbursed to the contractor
based on the documents submitted for proof of payments and for
the balance amount of customs duty, i.e., against which the
documents were not submitted by the contractor, a liability has
been provided but the amount was withheld for payment.
5. The contractor has refuted the stand of the company and
contended that in a lump sum contract price, the stage-wise
payment particulars are only indicative items for effecting
progressive payments and that he is entitled to get the total price
irrespective of variations against the indicated CIF prices as given
in the contract and he is not required to submit any documents in
support of their final claim. The contractor has invoked the
arbitration proceedings over the withholding of the amount and the
final outcome of the arbitration is still awaited. However, the amount
withheld has been provided as liability and accordingly capitalised
in the books as, in the view of the company, the amount is payable
to the contractor and the dispute is only on the procedure, i.e.,
furnishing of documents before releasing the payment.
6. The accounting policy followed by the company in respect of
contingent liabilities and claims is given below:
“Contingent Liabilities –
Show Cause Notices issued by various Government Authorities
are not considered as obligation.
When the demand notices are raised against such show cause
notices and are disputed by the Corporation, these are
classified as disputed obligations.
The treatment in respect of disputed obligations, in each case
above Rs. 5 lakh, is as under:
(i) A provision is recognised in respect of present
obligations where the outflow of resources is
probable;
(ii) All other cases are disclosed as contingent liabilities
unless the possibility of outflow of resources is
remote.
Claims:
Claims are accounted for:
(i) When there is certainty that the claims are realisable
(ii) Generally at cost”.
7. The accounting treatment followed by the company is as
follows:
The total lump sum amount payable to the foreign contractor
including full amount of taxes and duties has been capitalised
and the amount withheld for want of custom duty documents
from the contractor is shown as liability in the books of account
against which the contractor has invoked arbitration
proceedings which are still pending.
B. Query
8. The opinion of the Expert Advisory Committee has been sought
in relation to accounting treatment of the withheld amount payable
to foreign contractor, pending final outcome of the arbitration
proceedings, on the following issues:
(a) Whether the accounting treatment of capitalising plant at
the total lump sum price (including taxes and duties)
payable to the foreign contractor for lump sum turn key
contract is in order by providing for liability for the amount
withheld towards balance customs duty on account of
non-submission of customs documents against which the
contractor has invoked arbitration proceedings.
(b) In case the answer to the above query is in the negative,
whether the amount withheld from the LSTK contractor,
which is under arbitration, is to be treated as contingent
liability.
(c) In case the same is to be treated as contingent liability,
whether provision can be made and capitalised since in
the view of management, the outflow of resources in this
case is probable.
C. Points considered by the Committee
9. The Committee, while expressing its opinion, has considered
only the issues raised in paragraph 8 above and has not touched
upon any other issue arising from the Facts of the Case, such as,
accounting policy of the company in respect of show cause notices
issued by the Government authorities.
10. The Committee notes that Accounting Standard (AS) 29,
‘Provisions, Contingent Liabilities and Contingent Assets’, issued
by the Institute of Chartered Accountants of India, defines the
terms ‘provision’, ‘liability’, ‘contingent liability’ and ‘present
obligation’ as follows:
“A provision is a liability which can be measured only by
using a substantial degree of estimation.”
“A liability is a present obligation of the enterprise arising
from past events, the settlement of which is expected to
result in an outflow from the enterprise of resources
embodying economic benefits.”
“A contingent liability is:
(a) a possible obligation that arises from past events
and the existence of which will be confirmed
only by the occurrence or non-occurrence of
one or more uncertain future events not wholly
within the control of the enterprise; or
(b) a present obligation that arises from past events
but is not recognised because:
(i) it is not probable that an outflow of
resources embodying economic benefits will
be required to settle the obligation; or
(ii) a reliable estimate of the amount of the
obligation cannot be made.”
“Present obligation - an obligation is a present obligation
if, based on the evidence available, its existence at the
balance sheet date is considered probable, i.e., more likely
than not.”
11. The Committee further notes paragraphs 14, 15 and 22 of AS
29, which state as follows:
“14. A provision should be recognised when:
(a) an enterprise has a present obligation as a result
of a past event;
(b) it is probable that an outflow of resources
embodying economic benefits will be required
to settle the obligation; and
(c) a reliable estimate can be made of the amount
of the obligation.
If these conditions are not met, no provision should be
recognised.
15. In almost all cases it will be clear whether a past event
has given rise to a present obligation. In rare cases, for
example in a lawsuit, it may be disputed either whether certain
events have occurred or whether those events result in a
present obligation. In such a case, an enterprise determines
whether a present obligation exists at the balance sheet date
by taking account of all available evidence, including, for
example, the opinion of experts. The evidence considered
includes any additional evidence provided by events after the
balance sheet date. On the basis of such evidence:
(a) where it is more likely than not that a present
obligation exists at the balance sheet date, the
enterprise recognises a provision (if the recognition
criteria are met); and
(b) where it is more likely that no present obligation
exists at the balance sheet date, the enterprise
discloses a contingent liability, unless the possibility
of an outflow of resources embodying economic
benefits is remote (see paragraph 68).”
“22. For a liability to qualify for recognition there must be not
only a present obligation but also the probability of an outflow
of resources embodying economic benefits to settle that
obligation. For the purpose of this Statement, an outflow of
resources or other event is regarded as probable if the event
is more likely than not to occur, i.e., the probability that the
event will occur is greater than the probability that it will not.
Where it is not probable that a present obligation exists, an
enterprise discloses a contingent liability, unless the possibility
of an outflow of resources embodying economic benefits is
remote (see paragraph 68).”
12. The Committee notes from paragraph 5 of the Facts of the
Case that as far as the company is concerned, the amount of
customs duty claimed by the supplier has been recognised as a
liability as the amount is payable to the contractor and the dispute
is only on the procedure, i.e., furnishing of documents evidencing
payment of customs duty before releasing the payment. The
Committee also notes from the Facts of the Case that the supplier
cannot present such documents, as evidence of payment of
customs duty, since the duty has not been paid at all. In the view
of the Committee, since such documents cannot be presented, it
cannot be considered as a procedural matter. If the argument of
the company is to be accepted that the company has to release
only the actual customs duty paid, there is no liability of the company
in this regard. The Committee, however, also notes that the supplier
has contended that irrespective of the actual payment of customs
duty, it is the total amount of contracted price which is payable by
the company under the terms of the lump sum turn key contract.
Keeping in view the fact that the matter is pending before arbitration,
the Committee is of the view that the company will have to make
an assessment about the probability of the outcome of the
arbitration proceedings. In case the company is of the view that it
is probable that the arbitration award will require the company to
pay the full contracted amount irrespective of the actual payment
of customs duty, the company should make a provision. Otherwise,
the same should be disclosed as a contingent liability as per the
requirements of AS 29. In case the company considers that based
on its assessment it is necessary to create a provision, it is
appropriate to capitalise the amount of the provision for customs
duty as a part of the cost of the plant.
D. Opinion
13. On the basis of the above, the opinion of the Committee on
the issues raised in paragraph 8 above is as follows:
(a) The accounting treatment of capitalising plant at total
lump sum price (including taxes and duties) payable to
the foreign contractor for lump sum turn key contract is
in order if provision for liability for the amount withheld
towards balance customs duty, which is pending before
arbitration, is made in accordance with the requirements
of AS 29.
(b) In case the company does not consider appropriate to
create a provision under the requirements of AS 29, the
amount of balance customs duty in dispute should be
disclosed as a contingent liability.
(c) In case the amount of disputed balance of customs duty
is to be disclosed as contingent liability as required under
AS 29, a provision cannot be made and capitalised. If
the management considers that the outflow of resources
is probable and other recognition criteria as specified in
paragraph 14 of AS 29 are met, it would not be
appropriate to disclose the amount as a contingent liability.
1Opinion finalised by the Committee on 9.8.2007.
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