How long a provision for expense is allowed

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Sandeep Shriyan (Querist)
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15 March 2013 Dear All,

During the audit i came through some freight bills which were booked for payment in the month of July 2012 and all such bills were pertaining to September - December 2011.Client has made the provision for it and it has been reversed as and when the actual bills are booked.

My question is that how long a Company can maintain these provisions and does it differs from case to case ????

Looking forward for your opinion on this issue.

Thanks in Advance

Vivek Hebbar

Vivek Hebbar (Expert)
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16 March 2013 Dear Sandeep

The first step for making a provision for expenses is to list down those expenses which have been incurred and for which the bills are pending to be received. Then the amounts (estimated) have to be noted against each item. This is useful for tracking the payments in subsequent years. As regards the clearance of the balance in the provision for expenses account, if the company feels that there is invoice which is still pending to be received, the balance can go on for a resonable number of years. Generally, such provisions should not go beyond one year, but there can be exceptions. In one of the companies which I have seen, a huge amount is outstanding for more than 3 years, but the company does not want to reverse it due the following implications:

1. If it is reversed in the current year, it will be taxed.
2. The company is not following up with the vendor for the invoice (it is natural nobody wants to pay unless asked for even though it is due). Now if after reversing the same, the vendor raises the invoice is the subsequent year, it will be treated as prior period expense and the same will be disallowed in the subsequent year.

So there will be double disadvantage. In the second implication, the company can debate about not treating the expense as prior period, but it would involve lot of efforts in convincing the auditors as well as the tax authorities. Hence we can include the same in the MRL for audit documentation.