1.17     Query

Accounting treatment of time barred liabilities

related to purchase of fixed assets

1. A company purchased certain plant and machinery in the year 1979. Part payment was made to the suppliers of the said plant and machinery and the balance amount of about Rs. 2 lakhs has been lying in their account since then. In the year 1984, the company has written back these liabilities as they became time barred under the Limitation Act, 1963.

2.The company has incurred about Rs. 6 lakhs towards technical service charges in the year 1979 and 1980, which were payable in those years to the foreign collaborators. These were capitalised in the same years as part of the plant and machinery. The liability on account of these technical service charges has also been written back as the party is not claiming them any more.

            3.            The company has been incurring losses and has at present accumulated losses of several crores of rupees.

            4.            In this context, the querist has raised the following issues for the opinion of the Expert Advisory Committee:

(i)         Whether the said time barred liability on account of capital expenditure (as mentioned in para 1 above) can be written back in profit and loss account as it cannot be claimed having become time barred under the Limitation Act, 1963.

(ii)        If the answer to (i) above is in the affirmative, whether the said amount will be available for distribution as dividends.

(iii)       If the answer to (ii) above is in the negative, whether the said can be adjusted against accumulated losses.

(iv)       Whether the liabilities on account of technical service charges (mentioned in 2 above) can be written off to Profit and Loss Account and if so, whether they will be available for distribution as dividends or for writing off the accumulated losses.

                                               Opinion                                                                        May 19, 1986

 1.The Committee assumes that the liabilities in respect of plant and machinery and technical service charges have actually become time barred as per the Limitation Act, 1963. The Committee also assumes that the expenditure on technical service charges has been properly capitalised as a part of the cost of plant and machinery.

2.The Committee is of the view that the liabilities on account of purchase of plant and machinery and technical service charges cease to be liabilities in the period in which recourse is taken by the management to treat them as time barred in accordance with the provisions of the Limitation Act, 1963. The consequent gain is of capital nature. It fulfils the requirements of the definition of  “extraordinary items” given in Accounting Standard No. 5 on ‘Prior Period and Extraordinary Items and Charges in Accounting Policies’, issued by the Institute of Chartered Accountants of India, as “gains or losses which arise from events or transactions that are distinct from the ordinary activities of the business and which are both material and expected not to recur frequently or regularly. These would also include material adjustments necessitated by circumstances, which though related to previous periods are determined in the current period.”

3.The Committee notes that para 10 of the aforesaid Standard recommends as follows:

“10. Extraordinary items of enterprise during the period should be disclosed in the statement of profit and loss as part of net income. The nature and amount of each such item should be separately disclosed in a manner that their relative significance and effect on the current operating results of the period can be perceived.”

4.The Committee notes that there is no direct reference to the distribution of capital profits as distinguished from capital reserves in the Indian Companies Act, 1956. Therefore, a view on the matter can be taken on the basis of application of accounting principles and sound and prudent financial policies. The Committee notes that two foreign cases viz., Lubbock vs. the British Bank of South America Ltd., and Foster vs. the New Trinidad Lake Asphalte Co. Ltd., lay down wholesome principles in this regard which the Committee supports:

            (i)            The Articles of Association permits such a distribution.

            (ii)            The surplus is realised.

(iii)       Surplus remains after a proper valuation of the assets and liabilities and has been fairly taken.

5.On the basis of the above, the point-wise opinion of the Expert Advisory Committee, subject to the assumptions made in para 1 above, is as below:

(i)         The said time-barred liability related to purchase of plant and machinery i.e. on account of capital expenditure, can be credited to the profit and loss account as an extraordinary item. The nature and amount of the liability should be disclosed in a manner that its relative significance and effect on the current operating results of the period can be perceived.

(ii)        The said amount will be available for distribution in case the following three conditions are fulfilled:

            (a)        The articles of association permits such a distribution;

            (b)        The surplus is realised;

(c) Surplus remains after a proper valuation of the assets and liabilities and has been fairly taken.

(iii)       The said amount can be adjusted against accumulated losses provided the three conditions mentioned in (ii) above are fulfilled.

(iv)       The question is already replied in paragraphs (i), (ii) and (iii) above.

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