1.27 Query
Accounting of interest for defaulted period under hire purchase scheme.
1.A corporation, which is a Government of India undertaking, is supplying machinery and equipment to the small industrial units on hire purchase basis under its hire purchase scheme.
2. As per the terms and conditions of the scheme, the hirer is liable to pay penal interest @ 2% per annum over and above the normal rate on the defaulted amount from the date of default to the date of actual payment in case the payment of instalment is not made, within one month of its due date.
3.The penal interest and normal interest for the defaulted period which is charged as above is reflected in the books of account as under: -
Hirer’s Account Dr. To Penal Interest Suspense Account
When actual payment is received, the following entries are passed: -
(i) Bank Account Dr. To Hirer’s Account
(ii) Penal Interest Suspense Account Dr. To Penal Interest Earned Account
Penal interest and normal interest for the defaulted period are being credited to the profit and loss account to the extent of the actual amount received in accordance with the relevant accounting policy followed by the corporation, i.e., they are treated as income when they are actually realised.
4.In cases where the hirers’ accounts are frozen on account of legal action taken or for any other reason, no interest is charged from the date of issuing of the freezing order and the income, if any, is accounted for only on the settlement of cases, i.e., on cash basis only.
5.There have been a number of cases where penal interest is not being recovered. In view of the uncertainty attached to the recovery of the penal interest, the credit balance lying in ‘Penal Interest Suspense Account’ is shown as a contra item to the sundry debtors to avoid unnecessary inflation of sundry debtors and is reflected in the balance sheet in the schedule of ‘Current Assets’ as under: - SUNDRY DEBTORS:
Sundry Debtors – accrued instalments ___________________
Less: Penal Interest Suspense ___________________
Less: Provision for doubtful debts ___________________
The above presentation is being made in view of the opinion received from the Office of Member Audit Board and Ex-officio, Director of Commercial Audit during 1972-73.
6.The statutory auditors are now of the opinion that “Penal Interest Suspense Account” is a liability and should not have been deducted from the sundry debtors. It is argued by them that once the corporation has charged to sundry debtors individually, it should not reduce the accumulated balance from the sundry debtors as a whole as such sundry debtors are understated.
7.The amounts lying to the credit in this account, viz., “Penal Interest Suspense Account” are Rs. 6.61 crores and Rs. 8.19 crores as on 31st March, 1988, and 31st March, 1989, respectively, which are about 21.42% and 21.88% respectively of the sundry debtors.
8. In order to improve upon the realisation position, the management has waived the penal interest in several cases. It is adjusted in corporation’s books of account by making the following accounting entry: -
Losses written off on account of Penal Interest Suspense Account. Dr.
To Penal Interest Suspense Account. (as per contra)
The above adjustments is reflected in the profit and loss account in Schedule No. 15, ‘Interest’, as a contra adjustment.
9.The querist has sought the opinion of the Expert Advisory Committee as to whether ‘Penal Interest Suspense Account’ which is doubtful in nature should be shown as a ‘Current Liability’ under liability side or should it be continued to be deducted from the sundry debtors.
Opinion August 10, 1990
1.The Committee notes para 9 of the Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, which states:
“Effect of Uncertainties on Revenue Recognition
9.1 Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection.
9.2 Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest, etc., revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. Where there is no uncertainty as to ultimate collection, revenue is recognised at the time of sale or rendering of service even though payments are made by instalments.
9.3 When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rater than to adjust the amount of revenue originally recorded.
9.4 An essential criterion for the recognition of revenue is that the consideration receivable for the sale of goods, the rendering of services or from the use by others of enterprise resources is reasonably determinable. When such consideration is not determinable within reasonable limits, the recognition of revenue is postponed.
9.5 When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognised.”
2.The Committee is of the view that the penal interest and the normal interest for the defaulted period should be accounted for only when it is reasonably certain that the ultimate collection will be made. Only then the hirer’s account should be debited with the amount of interest so accounted for and the profit and loss account should be credited with the same. In view of this, the need for opening ‘Interest Suspense Account’ will not arise.
3.The Committee is further of the view that where the ability to assess the ultimate collection of the abovesaid interest with reasonable certainty is lacking, the recognition of the same in the accounts should be postponed. In such a case, the amount not so recognised in the accounts should be disclosed in the notes to the financial statements.
4.The Committee is, therefore, of the opinion that the accounting treatment followed by the company is not correct. The company should account for the abovesaid interest in the manner suggested in paras 2 and 3 above.
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