Contingencies – FAQs and answers are given below
1. Is it appropriate to conclude that a contingency may invariably result in a loss?
A contingency may result in a loss or gain. Prudence dictates that it is not appropriate to recognise a gain if it is contingent upon an event that may or may not occur.
2. What are the likely contingencies that may possibly have an impact on the carrying amount of assets in the BS?
A reporting entity generally encounters the possibility of one or more items in asset-side being impaired. A few examples are:
- Dishonour of Bills of exchange receivable, which have been discounted with recourse resulting in likely cash outgo if that event were to happen
- A third party to whom loan has been given may fail to service the loan as per terms, and this may cause doubts on recoverability.
- Foreign currency balances held by an entity in an off-shore banking account may be adversely affected due to fluctuations in exchange rates, and rupee value may require to be adjusted
3. How does an entity assess and evaluate that there may be a contingent loss?
The entity first makes an estimate of the probable outcome of a contingent situation. This is a call of judgment, and, with due caution is based on information available up to the date on which Financial Statements are approved. There may be some additional evidence of a given set of conditions.
An asset may or may not be impaired. If the probability of an asset being impaired were to surface, then, the entity proceeds to evaluate if there is a monetary impact. If the impairment of an asset is perceived as a probability and monetary impact could also be assessed, then the contingent loss is deemed to exist. If either one of the two conditions is not met, then the entity makes a disclosure.
4. Is it necessary for an entity to evaluate “each individual asset” separately to make an assessment of contingent loss?
This is a preferred approach. However, similar items (receivables) can be grouped and an assessment can be made, as in the case of warranties for products sold.
5. When an entity encounters a situation where its foreign currency deposits with a foreign bank is rendered difficulty of repatriation, what it should do.
The entity should make an assessment of the amount likely to be recovered out of the FC deposit, make a provision, and this provision is to be presented as a deduction from the Bank Deposit (effectively, reducing the carrying amount).
6. In situations where an entity is likely to be make a gain, what should be the accounting treatment?
Such a gain termed is Contingent Gain, may not be realised and hence, is not recognized in financial statements. Should there be a certainty about it, such a gain is not a contingency and is recognised when realization is certain.
7. What should be the accounting policy of an entity in the area of contingencies?
An entity normally adopts a policy in this area, and discloses the same under Significant Accounting Policies. For example, Losses likely to arise from collection of trade receivables and for which amounts are determinable, are provided for in the accounts and cases where the amount is not determinable are disclosed at their estimated value.
Post Balance Sheet Events
8. What is the end-of-period, events occurring during which, should an entity evaluate? In other words, what is the post-balance sheet period?
The Standard provides that the period to be considered is between two dates – first is the balance sheet date (or reporting date) and the second is the date on which (if it is a company) the Board approves the financials, or (if it is any other body), the governing body approves the same.
9. In a situation where an entity’s reporting date is 31st March, the Board meeting recommending the financials for adoption by shareholders is held on 16th June, the Managing Director makes an announcement of results on 17th June, the financials are forwarded to shareholders on 18th June, the AGM adopts the financials on 21st July. What is the cutoff date that the entity should consider?
The entity takes 16th June as the cutoff date, since that is the date of issue.
10. If in the situation narrated in “b” above, other dates being the same — the CMD makes the public announcement of announcement of results on 12th June. What is the cutoff date that the entity should consider?
The entity should not consider the date of CMD’s announcement. But only takes Board approval date, namely, 16th June as the cut off date.
11. Under a management set up in an entity, there are two stages of clearances. First, the committee of Directors approves the Financials, (say 17th June) and thereafter the financials are presented to the full-fledged non-executive Supervisory Board, on 20th June. The financials are approved by both the bodies. Which date should the entity consider?
The financial statements are deemed to have been approved by the Board on 17th June, when the Committee of Directors approve the same for onward submission to the Supervisory Board.
12. The financials of an entity are first approved by the Board on 17th June. Within a period of 45 days, the financials are reissued to conform to regulations for issue of an IPO offer document, say, on 29th July. Of the two days, which one should be considered as end-period?
The scope of AS 4 is the accounting for and disclosure of events after the BS date and that the Standard prescribes when an entity should adjust its FS for events after the reporting date, and what disclosures are made in other cases.
Financials prepared in accordance with AS 4 should reflect all adjusting and non-adjusting events, occurring till the date of approval. AS 4 does not address the question of re-issue of financial statements. The moot question to be resolved is when the financials are reissued, have the originals been withdrawn? If yes, then the reissued date becomes relevant. If not, the original date is maintained.
13. A customer is rendered bankrupt after BS date, but before it is approved by the Governing Body. How does an entity tackle the effect of this event?
Quite often, a situation of bankruptcy is the result of a series of events (including court cases) that would have begun before the reporting date. In these general cases, the likely loss on recoverability of receivables is recognised. In some rare (and at least theoretical cases), the bankruptcy could also be triggered by mismanagement, such as, taking positions in large derivate contracts without any hedge. Such cases are more an exception rather than a rule.
14. An entity disposes a part of its inventory (items of similar nature) a few days after reporting date, and encounters that the realization is much less than cost. What action the entity should take?
Fall in realization of inventory items may be the consequence of a variety of reasons, including but not limited to (i) competitive factors, (ii) Government action in reducing cess, levies or duties, or (iii) other reasons, that were not possible to be envisaged. In such cases, a determination is made whether the fall in realization can be attributed to conditions that existed on reporting date, or did not exist on that date. Depending on this careful assessment, the decision is taken whether an adjustment is to be made or not.
Nevertheless, in most cases, a fall realization of inventory after reporting date, but approval is considered as adjusting event.
15. An entity disposes of some assets before reporting date, but a determination of the sale proceeds is made after reporting date. What should be the approach?
The loss or gain is an adjusting event.
16. An entity carries a legal obligation to make profit sharing bonus payments, and this is invariably decided after reporting date. What should be the approach?
This is an adjusting event.
17. An entity faces a situation where there is a decline in the fair value of investments between reporting date, and approval date. What should be the approach?
Such a situation does not normally indicate a condition that existed on reporting date, but arises only because of certain situations that arose later than reporting date (that is, conditions were not present on BS date). The entity does not therefore adjust the amounts, without carefully analyzing all the evidences available in such cases.
18. How will an entity treat a situation, where the lender “agrees” to waive off a loan granted (or to modify the terms and conditions of a loan agreement) after the reporting date.
This is treated as non-adjusting event.
19. Specify a few examples of non-adjusting events.
Non-adjusting events include: (i) disposal of a subsidiary, (ii) an amalgamation or (iii) decision to discontinue some operations. Other examples are:
- Destruction of a major part of operating plant by fire,
- Abnormal volatility and changes in exchange rates,
- Changes in tax laws that may impact profit
- Commencement of litigation activities against one or more customers,
- Proposal of payment of dividends after reporting period
- Sale of a bond or capital stock issue.
- Settlement of litigation when the event giving rise to the claim took place subsequent to the balance-sheet date.
20. Is it not necessary to make adjustments in assets and liabilities proposed?
Earlier, the Companies Act had a specific provision that proposed dividends should be a part of the current liability. However, on deeper examination, it is conceded that dividends proposed as at balance sheet date is neither a provision nor a liability.
Accordingly, paragraph 8.5 of AS 4 has been modified and it is adequate if this proposal to declare dividends – subject to approval of appropriate authorities – is disclosed in notes. (if dividends are declared after the balance sheet date but before the financial statements are approved for issue, the dividends are not recognised as a liability at the balance sheet date because no obligation exists at that time unless a statute requires otherwise. Such dividends are disclosed in the notes)
21. An entity is faced with a situation to rescind the dividends paid in the interim period, arising from detection of error. What should be the accounting entry?
This is an adjusting event. A receivable is created for the amount to be received on cancellation of dividends paid, by a corresponding debit to either reserve or P&L as applicable.
However, if the entity were to specifically seek the help of shareholders for return of a part of dividend due to cash-flow shortage, then, that event is not treated as an adjusting event.
22. How should an entity treat the effect of changes in tax-rates after reporting period in determining current and deferred taxes?
These are rare but possible situations. There can be circumstances, when changes in tax rates or tax laws announced after reporting period, may carry the effect of such changes having taken place with a substantive effect at the reporting date. To the extent that they are not substantively enacted at the end of the reporting period, there is no need to make adjustment.
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