1.6 Query
Accounting and tax aspects of interest payments/receipts under accrual system.
1.A public limited company is engaged in the manufacture and sale of resins. It has a net-work of distributors (consignment agents) throughout India. As per the agreement with the distributors, the company draws bill of exchange (Hundi) for the value of goods dispatched to them. The Hundi amount is drawn for the value of proforma invoice raised on distributors. This amount becomes payable after 90 days from the date of Hundi, alongwith interest @ 20% p.a. on the Hundi value. Thus, the amount realised on due dates by the company’s bankers consists of principal value of Hundi plus interest at stipulated rate. In other words, the company offers credit period of 90 days, but during the credit period, the customer has to bear the cost of interest right from the very first day.
2..As indicated above, the Hundi is drawn for the bare value of proforma invoice, but it contains an order on the drawee to pay interest at stipulated rate from the date of Hundi to the date of actual payment. As per the existing practice, the company does not raise any debit note or invoice, etc., either at the time of making the Hundi, or, at the time of its realization through bank. The company gets such Hundis discounted with its bankers on the date of its drawing. The bankers are collecting interest @ 16.5% p.a. for the usance period of Hundi (i.e., for 90 days) on the date of its discounting and the net amount (i.e., the value of Hundi minus interest so collected for the entire period of usance) is credited to the cash credit account of the company.
3. The company’s accounting year ends on 31st day of March every year.
4.From the facts stated above, it is clear that as on the date of closing of its accounting year, the company may be left with Hundis drawn on the customers and discounted with the banks, which will fall due for payments by the customers after 31st of March. The interest collected by the bankers at the time of discounting the Hundis for the period falling after 31st day of March till the due date, is ‘material and substantial’.
5.The querist has referred the following issues for the opinion of Expert Advisory Committee:
(a) Would it be necessary for the company to segregate the interest paid to banks which relates to the period falling after 31st March and debit the same to ‘prepaid expenses account’ and credit the ‘interest account’ by way of a journal entry? On the same principle, would it be obligatory for the company to account for the income accrued but not due on such Hundis from the dates of their making till 31st day of March @ 20% p.a.?
(b) If no adjustments of the nature referred in para (a) above are made in the accounts, would it be necessary to give effect of such adjustments while computing and filing the return of taxable income?
6.The querist has also informed that, till date, the company was accounting for such income and expense on cash basis but in view of compulsory maintenance of accounts on accrual basis, the above issue bears special significance.
Opinion January 23, 1990
1.The Committee notes that paragraphs 3.10 (i) and 4.4 of the ‘Guidance Note on Accrual Basis of Accounting’, issued by the Research Committee of the Institute of Chartered Accountants of India, recommend, inter alia:
“3.10 The revenues from the above sources are recognised on the following basis:
(i) Interest accrues, in most circumstances, on the time basis determined by the amount outstanding and the rate applicable. Usually, discount or premium on debt securities held is treated as though it were accruing over the period of maturity.
4.4 Expenses relating to a future period are accounted for as prepaid expenses even though they are paid for in the current accounting period. Similarly, expenses of the current year, for which payment has not yet been made (outstanding expenses) are charged to the profit and loss account for the current accounting period.”
2.It is apparent from the facts of the query that the company is following accrual system of accounting except for the transactions of interest paid to bank on Hundis and interest received from distributors, which are accounted for on cash basis. The Committee is of the view that proper books of account shall not be deemed to have been kept by the company as per the requirements of the Companies Act, 1956, and true and fair view of the profit (loss) and the state of affairs of the company as per the profit and loss account and the balance sheet, respectively, would be adversely affected if the company does not account for the abovesaid transactions of interest on accrual basis.
3.The Committee is of the view that an assessee cannot escape liability to tax by omitting to make an entry in the accounts and that the date of taxability of income is the date when the appropriate entries are made or should be made in the accounts in accordance with the method of accounting regularly employed by the assessee.
4.On the basis of the above, the Committee is of the following opinion in respect of the issues raised by the querist in para 5 of the query:
(a) (i) Interest paid to the bank by the company for the usance period of the Hundi, if the usance period extends beyond the accounting year end of the company, should be accounted for as prepaid expense to the extent it relates to the period falling after the accounting year end.
(ii) The company should account for the interest accrued but not due on Hundis from the date of their making till 31st March, where the due date of Hundis fall after the accounting year end, i.e., 31st March.
(b) The adjustments referred to in (a) above may be required to be made while computing the taxable income under the Income-tax Act.
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