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A. Facts of the Case
1. A company is a Government of India undertaking incorporated
in the year 1975 under the Companies Act, 1956. One of the
objectives of the company is to set up power plants at various
geographical locations in the country and to supply bulk power to
various State Electricity Boards.
2. The company, being an electricity generating company, is
governed by the provisions of the Electricity Act, 2003. As per the
querist, since the Government has not prescribed any format for
statement of accounts for the central undertakings engaged in
generation of electricity, the company is preparing its accounts in
the format prescribed as per Schedule VI to the Companies Act,
1956. The company is also listed with the Bombay Stock Exchange
and the National Stock Exchange.
3. The company has ambitious expansion and diversification plans
for the future and aims to be a 75,000 MW company by the year
2017. Further, it intends to diversify by way of backward and
forward integration. As a part of its diversification plans, it has
entered into the hydro sector, coal mining and oil and gas
exploration sectors. Before setting up the projects, the company
prepares the feasibility report comprising demand analysis and
justification, feasibility studies, layout systems, plant systems &
works, environmental aspects, technical data, cost estimate and
financial analysis, schedule of project implementation, manpower
training and placement and operation and maintenance philosophy,
etc.
4. The querist has stated that as per ‘Mega Power Projects
Policy’ of the Government of India, all mega power projects require
‘First Stage Site Clearance’ from the Ministry of Environment and
Forest (MOEF), Government of India. Further, no objection
certificate is to be obtained from the State Pollution Control Board as well as MOEF. Accordingly, for setting up thermal/gas power
projects, the company obtains environment clearance from the
Ministry of Environment & Forest of the Government of India and
from the State Pollution Control Board. To minimise the pollution
from power projects, various measures are undertaken by the
company. These include installation of various plants and machinery
in the various areas as indicated below. For execution of these
works, separate award letters/contracts are issued by the company
alongwith other contracts for the project. These works include
construction/ installation/setting up of plant and machinery etc. in
the power station, for example:
(i) Electrostatic precipitator for reducing ash emissions
through smoke in the environment;
(ii) Chimneys;
(iii) Cooling towers;
(iv) Ash handling plant;
(v) Effluent treatment plant;
(vi) Dust extraction and supercession system;
(vii) Fire protection and explosion hazards;
(viii) De-mineralised water treatment systems;
(ix) Sewerage collection, treatment and disposal systems;
(x) Environmental lab equipments; and
(xi) Afforestation and green belt development
5. The querist has further stated that during the review of
accounts for the year 2006-07, Government auditor observed that
“Provisions do not include an obligatory expenditure towards
environmental liabilities to be discharged by the company in respect
of its projects under construction/expansion. By not making above
provision, the company has violated the provisions of Accounting
Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent
Assets’.”
6. According to the querist, the related provisions with regard to
recognition of provision for a liability in AS 29 are as under:
Recognition of Provision:
“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.”
Contingent Liability:
“26. An enterprise should not recognise a contingent
liability.
27. A contingent liability is disclosed, as required by
paragraph 68, unless the possibility of an outflow of resources
embodying economic benefits is remote.
28. Where an enterprise is jointly and severally liable for an
obligation, the part of the obligation that is expected to be met
by other parties is treated as a contingent liability. The
enterprise recognises a provision for the part of the obligation
for which an outflow of resources embodying economic benefits
is probable, except in the extremely rare circumstances where
no reliable estimate can be made (see paragraph 14).”
7. The querist has explained the existing accounting treatment
being followed by the company as under:
(i) Pending award of contracts for such works, the company
is neither providing liability nor disclosing the same as
contingent liability even though these works are included in the Feasibility Report (FR) or Detailed Project Report
(DPR) of the company, since inclusion of the above
works in the FR or DPR does not create present
obligation for the company as a result of a past event or
meet the requirement for disclosure of contingent liability
in terms of provisions of AS 29 mentioned above.
(ii) On award of such works, the balance amounts of such
contacts remaining to be executed are disclosed as
‘Estimated amount of contracts remaining to be executed
on Capital Account’ in the ‘Notes to Accounts’ forming
part of annual accounts.
(iii) On execution of such works, the amount paid to the
contractors is debited to the ‘Capital work-in-progress –
Plant & Machinery’ and liabilities for works executed
and not paid as at the balance sheet date are provided
for.
B. Query
8. Considering the applicable provisions of AS 29 and the present
practice followed by the company, the querist has sought the
opinion of the Expert Advisory Committee on the following issues:
(i) Whether the existing practice followed by the company
indicated in paragraph 7(i) to 7(iii) is in order.
(ii) In case answer to (i) above is in the negative, whether
the company should provide liability in respect of
contracts mentioned above for which award letters will
be issued in future and also the works will be executed
only after award of such contracts.
(iii) In case no liability is to be provided in respect of the
above works, whether any disclosure of this fact is to
be made in the ‘Notes to Accounts’ forming part of
annual accounts.
C. Points considered by the Committee
9. The Committee notes from the Facts of the Case that the
basic issue raised in the query relates to timing of creation of provision / disclosure of contingent liability towards various
environmental measures undertaken by the company in the setting
up of thermal/gas power stations as enumerated in paragraph 4
above. The Committee has, therefore, considered only this issue
and has not touched upon any other issue arising from the Facts
of the Case.
10. As far as recognition of provisions and disclosure of contingent
liabilities are concerned, the Committee notes paragraph 14 and
paragraphs 26 to 28 of AS 29 (as reproduced in paragraph 6
above), and the following definitions and paragraphs from AS 29,
which provide 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.
An obligating event is an event that creates an obligation
that results in an enterprise having no realistic alternative
to settling that obligation.
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.
Possible obligation – an obligation is a possible obligation
if, based on the evidence available, its existence at the
balance sheet date is considered not probable.”
“11. An obligation is a duty or responsibility to act or perform
in a certain way. Obligations may be legally enforceable as a
consequence of a binding contract or statutory requirement.
Obligations also arise from normal business practice, custom
and a desire to maintain good business relations or act in an
equitable manner.”
“16. A past event that leads to a present obligation is called
an obligating event. For an event to be an obligating event, it
is necessary that the enterprise has no realistic alternative to
settling the obligation created by the event.
17. Financial statements deal with the financial position of
an enterprise at the end of its reporting period and not its
possible position in the future. Therefore, no provision is
recognised for costs that need to be incurred to operate in the
future. The only liabilities recognised in an enterprise’s balance
sheet are those that exist at the balance sheet date.
18. It is only those obligations arising from past events
existing independently of an enterprise’s future actions (i.e.
the future conduct of its business) that are recognised as
provisions. Examples of such obligations are penalties or cleanup
costs for unlawful environmental damage, both of which
would lead to an outflow of resources embodying economic
benefits in settlement regardless of the future actions of the
enterprise. Similarly, an enterprise recognises a provision for
the decommissioning costs of an oil installation to the extent
that the enterprise is obliged to rectify damage already caused.
In contrast, because of commercial pressures or legal
requirements, an enterprise may intend or need to carry out
expenditure to operate in a particular way in the future (for example, by fitting smoke filters in a certain type of factory).
Because the enterprise can avoid the future expenditure by
its future actions, for example by changing its method of
operation, it has no present obligation for that future
expenditure and no provision is recognised.
19. An obligation always involves another party to whom
the obligation is owed. It is not necessary, however, to know
the identity of the party to whom the obligation is owed —–
indeed the obligation may be to the public at large.”
11. The Committee notes from the above that a provision cannot
be recognised simply because there is an approved cost or there
is a legal or contractual obligation until an event takes place which
triggers creation of an obligation for an entity that leaves no realistic
alternative to an enterprise apart from settling that obligation, and
other conditions as mentioned in the above-reproduced paragraph
14 of AS 29 are also met. Thus, a provision should not be
recognised before the obligating event arises under the provisions
of law or the terms of the contract. A contingent liability should be
disclosed when either there is a possible obligation arising from
the past events, the existence of which will be confirmed by the
occurrence or non-occurrence of one or more uncertain future
events not wholly within the control of the enterprise or there is a
present obligation but is not recognised because the outflow of
resources embodying economic benefits required to settle the
obligation is not probable or a reliable estimate cannot be made of
the amount of the obligation. The Committee is of the view that
simply existence of legal requirements to undertake various
environmental measures or mere inclusion of various works in the
Feasibility Report or Detailed Project Report does not create an
obligation on the company, for undertaking these measures unless
an obligating event has occurred.
12. As far as obligating events in respect of various measures
enumerated in paragraph 4 above are concerned, the Committee
is of the view that the obligating event in respect of afforestation
and greenbelt development (mentioned in paragraph 4(xi) above)
could arise either on the acquisition of land or at the start of the
site preparation for setting up the power plants by way of cutting trees, deforestation etc. or when the demand is raised by the
concerned authorities for these works keeping in view the
requirements of relevant law/terms of cotnract. As far as the
obligating event in respect of construction/installation/setting up of
various plant and machinery etc. as mentioned in paragraph 4(i) to
4(x) above is concerned, the Committee is of the view that the
obligating event in this case should also be determined keeping in
view the relevant legal/contractual requirements, for instance, the
obligating event could be the performance of work by the concerned
contractors, wholly or in part, as per the terms of the contract,
rather than merely the award of the contract. Further, on
commencement of execution of such works, the capital work-inprogress
of the related asset should be debited to the extent of
work executed. As far as disclosure of estimated amount of
contracts remaining to be executed on capital account made by
the company is concerned, the same is in accordance with the
requirements of Schedule VI to the Companies Act, 1956 relating
to the matters to be shown separately as a footnote to the balance
sheet, as provided under the head ‘Current Liabilities and Provisions’
of Part I ‘Form of Balance Sheet’ of the Schedule VI.
D. Opinion
13. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 8 above:
(i) Subject to paragraphs 11 and 12 above, the accounting
treatment followed by the company as indicated in
paragraph 7 above appears to be correct with respect
to items of plant and machinery mentioned in paragraph
4(i) to 4(x) above. For afforestation and greenbelt
development mentioned in paragraph 4(xi) above, please
refer to paragraphs 11 & 12 above.
(ii) and (iii) With respect to the construction/installation/setting
up of various items of plant and machinery mentioned
in paragraph 4(i) to 4(x) above, no provision or contingent
liability needs to be created or disclosed respectively in
respect of contracts for which the award letters will be
issued in future unless an obligating event in respect
thereof has arisen as discussed in paragraphs 11 and 12 above. For afforestation and green belt development
mentioned in paragraph 4(xi) above, please refer to
paragraphs 11 & 12 above.
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