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Thread: Accounting Standard (AS) 04 - Contingencies and Events Occurring After the Balance Sheet Date

  1. #1
    Accounting Standards
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    Thumbs up Accounting Standard (AS) 04 - Contingencies and Events Occurring After the Balance Sheet Date

    Accounting Standard 4
    Contingencies and Events Occurring After the Balance Sheet Date
    The following is the text of the revised Accounting Standard (AS) 4,‘Contingencies and Events Occurring After the Balance Sheet Date’, issuedby the Council of the Institute of Chartered Accountants of India.This revised standard comes into effect in respect of accounting periodscommencing on or after 1.4.1995 and is mandatory in nature.3 It is clarifiedthat in respect of accounting periods commencing on a date prior to 1.4.1995,Accounting Standard 4 as originally issued in November 1982 (andsubsequently made mandatory) applies
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  2. #2
    Accounting Standards
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    Thumbs up Announcement Applicability of AS 4 to impairment of assets not covered by present Indian Accounting Standards

    Announcement
    Applicability of AS 4 to impairment of assets not covered by present Indian Accounting Standards

    1. Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, issued by the Institute in November 2003, comes into effect in respect of accounting periods commencing on or after 1-4-2004. As per AS 29, from the date of this
    Accounting Standard becoming mandatory, all paragraphs of Accounting Standard (AS) 4, Contingencies and Events Occurring After the Balance Sheet Date, that deal with contingencies (viz., paragraphs 1 (a), 2, 3.1, 4 (4.1 to 4.4), 5 (5.1 to 5.6), 6, 7 (7.1 to 7.3),
    9.1 (relevant portion), 9.2, 10, 11, 12 and 16), stand withdrawn.
    2. Paragraph 7 of AS 29 provides that this Statement defines provisions as liabilities which can be measured only by using a substantial degree of estimation. It further provides that the term 'provision' is also used in the context of items such as depreciation, impairment of assets and doubtful debts: these are adjustments to the carrying amounts of assets and are not addressed in this Statement. In view of this, impairment of assets and doubtful debts are not covered by AS 29.
    3. It may be noted that the paragraphs of AS 4 dealing with contingencies also cover provision for contingent loss in case of impairment of assets, not covered by other Accounting Standards, such as, AS 2, Valuation of Inventories, AS 10, Accounting for
    Fixed Assets, AS 13, Accounting for Investments and AS 28, Impairment of Assets (coming into effect from 1-4-2004). Accordingly, AS 4 deals with impairment of certain assets, for example, the impairment of financial assets like receivables (commonly referred to as the provision for bad and doubtful debts).
    4. As may be noted from paragraph 1 above, pursuant to AS 29 coming into effect, the paragraphs of AS 4 that deal with contingencies stand withdrawn. It may further be noted that while impairment of certain assets is covered by some existing Accounting Standards referred to in paragraph 3 above, impairment of financial assets such as receivables, which are not covered by AS 29, is expected to be covered in an Accounting Standard on Financial Instruments: Recognition and Measurement, which is under preparation.
    5. In view of the above, it is brought to the notice of the members and others that till the issuance of the proposed Accounting Standard on financial instruments, the paragraphs of AS 4 which deal with contingencies would remain operational to the extent
    they cover the impairment of assets not covered by other Indian Accounting Standards. Thus, for instance, impairment of receivables (commonly referred to as the provision for bad and doubtful debts) would continue to be covered by AS 4.

  3. #3
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    Thumbs up Whether creation of provision for contingencies not known at the balance sheet date is appropriate

    A. Facts of the Case

    1. A company has been incorporated under section 25 of the Companies Act, 1956. The main objective of the company is to promote India’s trade. One of the medium of promoting the trade is organising trade fairs and exhibitions in various parts of the country. The fairs/exhibitions organised by the company and also by outside agencies attract large crowds besides the exhibitors.

    2. The querist has informed that from the year 2000-01, it was decided to charge 5 per cent contingency charges from the participants/outside agencies on the income received from them by the company. While in the case of fairs organised by outside agencies, the 5 per cent contingency charges are levied separately in the invoice, the contingency charges in respect of fairs organised by the company itself are inbuilt in the space rent charged from the participants. Both are credited to the Income and Expenditure Account of the company. The intention of levying these charges is to meet any unforeseen liability which may arise in future. The instances of such unforeseen liabilities could be on account of injury/loss of life of visitors/exhibitors etc., due to fire, terrorist attack, stampede, electrocution, natural calamites and other public/third party liability, statutory liabilities, etc. The chances of occurrence of these events are high because large crowds visit the fairs/exhibitions. Besides, the likelihood of damage to the participant’s exhibits due to any of the reasons indicated also exists.

    3. The querist has mentioned that, as a prudent policy, a matching provision for the same is also being made in the accounts to reflect a true and fair view of the state of affairs of the company. A suitable disclosure to this effect is also made in the notes forming part of accounts. The decision to levy 5 per cent contingency charges was based on an assessment only, as the actual liability on this account cannot be estimated.

    4. During the audit of the accounts for the year 2002-03, the statutory auditors of the company felt that provision against unknown liabilities and the expenses of contingent nature, which are contingent/unkown, is violative of the provisions of the Companies Act, 1956. In other words, the statutory auditors were of the view that no liability can be provided in the books of account unless the quantum of the liability and the details of the payee are known.

    5. The querist has drawn the attention of the Committee to Accounting Standard (AS) 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, issued by the Institute of Chartered Accountants of India, wherein the term ‘Contingency’ has been defined as "a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or non-occurrence, of one or more uncertain future events." In the view of the querist, some events may occur in future which may affect the profitability of the company and, as a safeguard, a provision to meet unforeseen liability can be made in the books of account. The company’s contention that the matching provision is being made against the amounts being recovered to discharge any future liability, which may or may not occur, was however not accepted by the auditors and the accounts of the organisation were qualified by the statutory auditors on this aspect.

    B . Query

    6. The querist has sought the opinion of the Expert Advisory Committee as to whether the creation of provision for contingencies under the facts and circumstances of the case is in conformity with AS 4.

    C. Points considered by the Committee


    7. The Committee notes that in respect of accounting for ‘contingencies’, Accounting Standard (AS) 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, issued by the Institute of Chartered Accountants of India, is mandatory in respect of accounting periods commencing before 1-4-2004 and Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’ is mandatory in respect of accounting periods commencing on or after 1-4-2004. In the present case, AS 4 is applicable to this company as query relates to accounting period commencing before 1-4-2004.

    8. The Committee notes that the term ‘Contingency’ has been defined in AS 4 as reproduced in paragraph 5 above. The Committee further notes paragraphs 4.1, 5.6 and 10 of AS 4, which are reproduced below:

    "4.1 The term "contingencies" used in this Statement is restricted to conditions or situations at the balance sheet date, the financial effect of which is to be determined by future events which may or may not occur."

    "5.6 Provisions for contingencies are not made in respect of general or unspecified business risks since they do not relate to conditions or situations existing at the balance sheet date."

    "10. The amount of a contingent loss should be provided for by a charge in the statement of profit and loss if:

    (a) it is probable that future events will confirm that, after taking into account any related probable recovery, an asset has been impaired or a liability has been incurred as at the balance sheet date, and

    (b) a reasonable estimate of the amount of the resulting loss can be made."

    9. On the basis of the above paragraph, the Committee is of the view that in respect of contingencies against which provision is being created by the company, no condition or situation exists on the balance sheet date. Accordingly, it cannot be considered probable that future events will confirm that a liability has been incurred as at the balance sheet date. In view of this, the Committee is of the view that the provision for contingencies cannot be created irrespective of the fact that a charge in this regard is made from its customers.

    10. The Committee also notes paragraph 14 of Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’, which is reproduced below:

    "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."

    11. From the above paragraph, the Committee notes that in respect of the contingencies considered by the company, neither a present obligation exists as a result of past event, nor a reliable estimate can be made of the amount of the obligation. Accordingly, a provision cannot be recognised for contingencies under the facts and circumstances stated by the querist.

    12. The Committee notes that Part III of Schedule VI to the Companies Act, 1956, inter alia, provides the following:

    "7. (1) For the purposes of Parts I and II of this Schedule, unless the context otherwise requires, –

    (a) the expression "provision" shall, subject to sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, or retained by way of providing for any known liability, of which the amount cannot be determined with substantial accuracy;

    ……..

    (2) Where –

    (a) any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets, not being an amount written off in relation to fixed assets before the commencement of this Act; or

    (b) any amount retained by way of providing for any known liability, is in excess of the amount which in the opinion of the directors is reasonably necessary for the purpose, the excess shall be treated for the purposes of this Schedule as a reserve and not as a provision."

    13. On the basis of the above paragraph, the Committee is of the view that since the contingencies stipulated by the company are not known at the balance sheet date, the provision in this regard cannot be created. Accordingly, the provision for contingencies created by the company is of the nature of a reserve.

    D. Opinion
    14. On the basis of the conclusions drawn in paragraphs 9, 11 and 13 above, the Committee is of the opinion that, under the facts and circumstances of the case, creation of the provision for contingencies is not in conformity with AS 4 and AS 29 issued by the Institute of Chartered Accountants of India and Schedule VI to the Companies Act, 1956.

    Opinion finalised by the Committee on 5.8.2004

  4. #4
    Accounting Standards
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    Thumbs up Treatment of contingency relating to additional power tariff demanded by a State Government

    A. Facts of the Case
    1. A company has set up a unit to manufacture ferro alloys. Its economics was based on the policies and assurances of the State Government to provide certain incentives. One of the incentives was to provide power at a tariff which was about Re.0.50 per unit for a period of 5 years.

    2. The State Government later unilaterally withdrew the notification on power tariff and sought to levy tariff at the revised rates. The revision of the notification of the government was challenged in the High Court, which stayed the application of the order pending full hearing.

    3. According to the querist, if the company accounts for the tariff at the revised rates, it would be a sick industrial company under section 3(1)(o) of the Sick Industrial Companies (Special Provisions) Act, 1985, and if it does not account for the tariff at the revised rates, it would result into payment of income tax because the electricity expense due to concessional tariff is lower as compared to the revised tariff.


    B. Queries


    4. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
    (a) Whether the company is a sick company if it accounts for the tariff demanded on accrual basis.
    (b) If the answer to (a) above is in the negative, whether provision for taxation is to be made.

    D. Opinion

    On the basis of the above, the Committee is of the opinion that it would be a matter of judgement based on considerations mentioned in paragraph 4.4 of AS 4 reproduced in paragraph 9 above, as to what would be the probability of the outcome of the case pending in the High Court. In case it is probable that the company will have to pay the revised duty, a provision in this regard will have to be made; otherwise, it should be disclosed in the financial statements as contingent liability. Whether the company is a sick company or a provision for taxation is required to be made as contemplated in paragraph 4 above, would depend upon whether or not the provision for revised tariff is required to be made as aforesaid.


    Opinion finalised by the Committee on 26.5.2001.

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