1.61     Query

Disclosure of the amount payable to a bank in

performance of a guarantee, in the final accounts.

During the course of inspection under Section 209-A it was noticed that a company had given guarantee to a bank in respect of a loan taken by an individual from the bank.  The individual failed to repay the loan to the bank.  Consequently the company was to repay to the bank the amount due from the individual on this account.  As per the Contract Act there was a liability on the part of the company to pay the amount to the bank and the company had the right to recover the amount from the individual.  In the books of the company, the amount payable to the bank was shown under’ Sundry Creditors’ and amount recoverable from the individual was shown under ‘Sundry Debtors’. The basis of this classification was that the company did not borrow money from the bank, therefore, the amount due to the bank could not be shown under ‘Loans’.  There is another view that these transactions are to be classified as ‘Loans’.  Kindly advise.

                                                         Opinion                                                                     April 10, 1980

 The Committee is of the opinion that the amount payable to the Bank in performance of guarantee should not be classified as a loan and the same should be shown under the head ‘Current Liabilities’.

 The company has not taken any loan from the bank and there is no relationship of a lender and a borrower.  The relationship and the liability arose on account of a guarantee to the bank on behalf of a third party and as such it is a liability and should be shown as such under the head “Current Liabilities and Provisions” either as a separate item or under the head “Sundry Creditors”, preferably the former.

 The original transaction is that of a loan from the bank to the individual which was guaranteed by the company.  On failure of the individual to repay, the company is called upon to discharge its obligations undertaken through the execution of the guarantee.  In such a case, the liability of the guarantor is co-extensive with that of the principal debtor by virtue of the provisions of Indian Contract Act.  While the provisions of Contract Act determine the extent of the rights and obligations arising on account of enforcement of guarantee, the same does not determine the character of the liability and rights.  Just because the transaction is of a bank loan from the point of view of the individual who had borrowed money from the bank, it does not become a loan from the bank from the point of view of guarantor who discharges the liability.  The categorisation and presentation in the books of the company cannot be determined by the nature of transaction from the point of view of the third party or by the methodology and effect given by a third party in its accounts for the same transaction.  The company is liable to pay the bank on account of the guarantee and not because of loan given by the bank to the company.

 As regards the amount due from the person on whose behalf the liability to the bank is to be discharged, the same should be shown on the assets side under the head “Loans and Advances” and not “Sundry Debtors” as the debit has not arisen as a result of the business activities of the company.

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