Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.4       Query

 

Treatment of liabilities the payments in respect of which are subject to performance of some activities

1. A public sector company has entered into a contract with M/s XYZ, Hungry, for the design, engineering, manufacture, supply of equipments as also supervision of erection, testing and commissioning of steam generators with auxiliaries. Paras 7.9 and 7.10 of the agreement, as reproduced below, set out the terms of payment in respect of supplies.

 

 

Nature of payment

% total price

% FOB price

Condition to be fulfilled

i)
Initial advance

10%+10%

-------

As laid down in terms of payment.

ii)

Despatch of equipment FOB on pro-rata tonnage (weight basis)

------

55%

Production of invoices and satisfactory evidence of shipment.

iii)

Receipt of equipment on pro-rata tonnage (weight basis)

------

15%

Verification and certification by the purchaser of the equipment received and stored-at-site. Payment to be made within six weeks from the date of receipt of materials at site.

iv)

Successful completion of performance tests for equipment

------

10% of each unit

Certification of results by the purchaser. If the performance tests are delayed beyond six months from the date of provisional take over of each unit, the final 10% shall be released against production of bank guarantee for an equivalent amount which will be valid till the expiry of the guarantee period of each unit.

 

2. The contractor has supplied the equipment and 90% payment has been made on receipt of materials and certification thereof. The final 10% is however linked to successful completion of the performance test on the equipments and as at the end of the accounting year the performance test has not been completed.

 

3. At the time of finalisation of accounts the balance 10% liability in respect of supply of equipment has been created by the company since materials have been received in good condition and in respect of supervision of erection and commissioning charges no liability has been created as the work of erection has not been completed. However, a view has been held that as the final 10% has been linked with the performance tests, the liability provided by the company was not correct and therefore should be withdrawn.

 

4. In this connection the opinion of the Expert Advisory Committee has been sought in respect of the following:

 

(i) As the contract has been performed (by supplying the materials) whether liability to pay the final 10% arises and has to be created as at the end of the year.

 

(ii) Is the creation of liability to be linked to payment terms towards supply of materials, since contractually and legally the actual payment would arise only after completion of performance test? In other words should the liability be created in accounts for supply of materials only after completion of performance tests?

 

(iii) If (ii) above is correct, clarification is required regarding the treatment in accounts of advance payment made to the contractor to the extent of 90% towards supplies, i.e., whether advance could be transferred to capital work-in-progress or to be retained as such till successful completion of performance tests of the equipments.

   

                                                                Opinion                                               January 13,1987

 

On the consideration of the facts of the query, the Committee is of the opinion that both the treatments described in the query are possible, i.e., (i) the company may treat advance payments made to the contractor to the extent of 90% towards supplies as capital work-in-progress and the remaining 10% as commitments on capital account to be disclosed as a footnote to the balance sheet; or (ii) the company may create a liability in respect of the 10% payable to suppliers if it is considered that materials are in good condition and they will, in all likelihood, pass the performance test in the usual course; in this case the entire 100% should be shown as capital work-in-progress.

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