Provision for Debtors Transferred to Franchisee

Fact of the case

An electricity distribution company entered into a Distribution Franchisee Agreement (DFA) with a bidder. As per the agreement terms, sundry debtors as on the effective date, excluding amounts collected within three months of the last billing cycle, were handed over to Franchisee, and on the DFA expiry date, all sundry debtors, excluding amounts collected within three months of last billing cycle, would be handed over by Franchisee to the company.

Accordingly, the company transferred the sundry debtors as on effective date to Franchisee and created a provision for doubtful debts by debiting profit and loss account on remaining amount of sundry debtors, since, as per the DFA, the right to recover the amount was transferred to Franchisee.

Issue:

The auditor objected this treatment stating there is no loss of sundry debtors, it is only transfer of sundry debtors to the Franchisee, like any other assets transferred to Franchisee for operation, and on expiry of the franchise period, the company will receive all the sundry debtors. Thus provision will result in overstatement of other expenses, and understatement of sundry debtors only.

The Company responded to the auditors, explaining that the debtors cannot be recognised as an asset, since the resource was not controlled by the company and will be recovered by the Franchisee. Also, at the end of the franchise period, the company will receive the outstanding debtors of the Franchisee, which are two different transactions, and cannot be correlated, since the franchisee agreement is for 15 years.

EAC Opinion:

• The EAC presumed that before transfer, no portion of the debtors was doubtful, & hence, no need for any provision for doubtful debts before transfer. Also, no separate consideration was received by the company from the Franchisee.
• Thus Debtors have been transferred in the extant case, the same should be de-recognised & should be transferred to an appropriate account (alternate asset). Subsequent clearance from this account should be made in an appropriate manner by taking account of expected increase in net revenue during the Franchise period.
• The EAC concurs with the Company that the possible return of the uncollectible transferred debtors to the company at the end of Franchise period is a contingency, and as per AS 29 provisions, contingent assets are not recognized.
• The EAC disagrees with the Company that derecognition and provision for doubtful debts, which are offset against carrying amount of debtors, have the same effect on the presentation in balance sheet.
• De-recognition means removal of item from balance sheet, whereas offset does not result in such removal. For ex- Derecognition of an asset, which is not accompanied by concurrent recognition of another asset for equal amount, results in a gain or loss, whereas offset of a liability or an allowance for impairment loss against an asset does not result in any gain or loss, though provision for doubtful debts has an impact on profit, which, however, is not correct in the extant case.
• Therefore, the EAC concludes that the booking of loss upon transfer of debtors is incorrect

Manav Rajgaria, Audit Associate, SW India