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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 providing
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.
4. The querist has stated that before setting up the projects, the company prepares the feasibility report comprising demand
analysis and justification, feasibility studies, layout systems, plant
systems and works, environmental aspects, technical data, cost
estimate and financial analysis, schedule of project implementation,
manpower training and placement, and operation and maintenance
philosophy, etc.
5. The querist has also informed 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 the MOEF. Accordingly, for setting up Hydel Power
Projects, the company obtains environment clearance from the
Ministry of Environment and Forest of the Government of India/
concerned State and also clearance from the State Pollution Control
Board. To minimise the pollution from hydel power projects, various
measures are undertaken by the company. These include:
(a) Compensatory afforestation;
(b) Greenbelt development around the perimeters of the
project;
(c) Catchment area treatment;
(d) Installation of following plant and machinery to reduce
noise and water pollution:
(i) Effluent treatment plant;
(ii) Fire protection and explosion hazards;
(iii) De-mineralised water treatment systems;
(iv) Sewerage collection, treatment and disposal
systems; and
(v) Environmental lab equipments.
6. According to the querist, in respect of compensatory
afforestation, greenbelt development around the perimeters of the
project and the catchment area treatment, amounts are paid to the concerned State Governments for carrying out the works. For
execution of the works mentioned at paragraph 5(d) above, 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.
7. During review of accounts for the financial year 2006-07, the
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’.”
8. According to the querist, the related requirements with regard
to recognition of provision for a liability in AS 29, issued by the
Institute of Chartered Accountants of India, 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).”
9. The querist has stated that the existing accounting treatment
being followed by the company is as follows:
(i) The company is neither providing liability nor disclosing
the same as contingent liability in respect of works
mentioned at paragraph 5 above which are only included
in the approved Feasibility Report (FR) or Detailed
Project Report (DPR) of the company, since mere
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 AS 29 mentioned above.
(ii) The amounts agreed to be paid by the company to the
State Government towards compensatory afforestation,
greenbelt development around the perimeters of the
project and the catchment area treatment 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) The amounts paid by the company to the State
Government on receipt of demand for carrying out
compensatory afforestation, greenbelt development and
the catchment area treatment are accounted as ‘Capital
work-in-progress – incidental expenditure towards
diversion of forest land’.
(iv) On award of contracts indicated at paragraph 5(d) above,
the amounts of such contracts 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.
(v) 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
10. 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 accounting treatment followed by
the company indicated at paragraph 9(i) to (v) above is
in order.
(ii) In case the answer to (i) above is in the negative, whether
the company should provide liability in respect of
contracts mentioned at paragraph 5 above for which
agreements/award letters will be signed/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 for in respect of the
above works, whether any disclosure is required to be
made in the ‘Notes to Accounts’ forming part of annual
accounts.
C. Points considered by the Committee
11. The Committee notes that the basic issue raised in the query
primarily relates to timing of creation of provision and disclosure of
contingent liability in relation to various environmental measures
undertaken by the company for setting up of power plant projects.
The Committee has, therefore, considered only this issue and has
not touched upon any other issue that may arise from the Facts of
the Case, such as, accounting for the expenditure involved in
preparation of feasibility and detailed project reports, etc.
12. 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 8 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.”
13. 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 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 does not create an obligation on the
company for undertaking these measures unless an obligating
event has occurred.
14. On the basis of the above, the Committee is of the view that
the obligating event in respect of compensatory afforestation,
greenbelt development and catchment area treatment (mentioned
in paragraphs 5(a) to (c) 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 State Governments for these works,
keeping in view the requirements of relevant law/terms of contract
rather than inclusion of these items in the Feasibility Report or
Detailed Project Report. As far as the obligating event in respect
of works to be executed under paragraph 5(d) 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 contract, rather than merely the
award of the contract. With regard to disclosure as contingent
liability also, the Committee is of the view that a possible obligation
does not arise merely on inclusion of various works in the Feasibility
Report or Detailed Project Report. The disclosure of estimated
amount of contracts remaining to be executed on capital account
made by the company 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 Schedule VI .
D. Opinion
15. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 10 above:
(i) It is not appropriate to create a provision or to make a
disclosure as contingent liability in respect of works
mentioned at paragraph 5 above merely on inclusion
thereof in the approved Feasibility Report or Detailed
Project Report. A provision is required to be made in
case the agreement on the part of the company to pay
amounts to the State Government creates an obligation
for the company. The treatment mentioned in subparagraphs
(iii), (iv) and (v) of paragraph 9 above
appears to be correct in respect of the stages mentioned
in the sub-paragraphs. However, creation of provision
or disclosure of contingent liability needs to be made in
respect of the relevant expenditures at the time the
obligating event takes place as discussed in paragraphs
13 and 14 above.
(ii) & (iii) Please see (i) above.
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