Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.12   Query:  

Clubbing of expenses.

 

1. A medium size engineering company meets its borrowing requirements from various sources. During the course of its audit there were certain differences of opinion between the auditor and the company, regarding classification of certain financial costs.

 

2.  The company had excluded bill discounting charges from ‘Interest’, and had classified these as bank charges. Bank charges being lower than 1% of total revenue were not shown separately. These charges were clubbed under the head miscellaneous expenses. The company had similarly classified cheque discounting charges as bank charges. As per the querist, the auditor of the company is agreeable to classify cheque discounting charges as other than interest charges. However, he feels, that the bill discounting charges are in the nature of interest. The argument given by the auditor in this regard are as follows:

 

(i)         The company resorts to discounting of outstation cheques to realise cash more quickly than would be possible, if the cheques are sent for collection. The cheques do not have any usance period. Usual delay in realisation of such cheques is because of banking procedures in the country. However, there is nothing inherent in the instrument to prevent the cheques from being realised on the same day, although there may arise some practical difficulties. Hence, it can be said that the company does not incur any additional borrowing in discounting of cheques.

 

(ii)        Usance bills (hundies) are drawn/accepted to give/avail of credit. The company discounts two types of bills- (i) bills receivable, and (ii) bills payable. In case of bills receivable, it normally extends 45 days credit. To improve its cash position, it discounts these with a bank, to whom it pays bill discounting charges. In case of bills payable, it accepts bills drawn by the suppliers for 90 days usance. The bill is then discounted with a bank by the supplier and the company (not the supplier) pays the charges.

 

3. The querist has stated that the auditor is of the view that the bill discounting operation is a method of borrowing. Also, on the basis of the dictionary meaning of ‘Interest’ –“a charge for borrowed money; generally a percentage of the amount borrowed”-he feels that bill discounting charges should be classified as interest. However, the company contends that there is a distinction between bill discounting charges and interest. The commercial laws of the land also recognise the difference inasmuch as there is no tax deduction at source on bill discounting while usually tax is deducted at source in case of interest. The auditor is of the view that this aspect is not conclusive because at the same time ‘interest tax’ is levied on bill discounting charges.

 

4. The querist has further stated that the total bank charges constitute 0.9% of total revenue (including bill discounting charges which are 0.4% of total revenue) of the company. In addition to this there are certain other charges, as given hereunder:

 

(Percentage of total revenue)

Lease rentals                                                                                        (0.6%)

Provision for premium on redemption of debentures                               (0.1%)

Management fees paid on loans/leases                                       (0.1%)

 

5. The auditor of the company, as per the querist, is of the opinion that the above referred charges be clubbed with bank charges and shown separately in the profit and loss account under the head “ Financial and bank charges”, as together they constitute more than 1% of total revenue of the company. The company, however, is of the view that it is not appropriate to club these items, as they are of different nature. Lease rentals include repayment of principal also. Further, leasing is an investment as much as a financial decision. To classify this and other items as financial charges would give an adverse impression about financing costs incurred by the company. Similarly, the management fees are for processing of loans and are administrative in nature. According to the company, there can be differences of opinion on classification of expenses as long as these are not specifically prohibited by Schedule VI to the Companies Act, 1956.

 

6. As per the querist, the auditor fells that exclusion of bill discounting charges from interest by the company, is to show a better ‘Interest cover ratio’ for the financial institutions and banks, and its reluctance to club financial expenses is to avoid showing the high financing costs incurred by the company, which would be looked upon unfavorably by its lenders. However, according to the company, there can be differences of opinion on classification as long as these are not specifically prohibited by Schedule VI to the Companies Act, 1956.

 

7. The querist has sought opinion of the Expert Advisory Committee with regard to the following issues:

 

(a)        Whether the company is correct in excluding bill discounting charges from ‘Interest’.

 

(b)        Whether the auditor is correct in insisting that financial charges, mentioned at para 4 above, should be clubbed and not shown separately in the profit and loss account.

 

                                                       Opinion                           February 3, 1994

 

1. The Committee notes from the prevailing practice that discounting charges in respect of bills receivables can arise in two ways. First, where the bank purchases the bills from the company at a discount. Secondly, when the bank advances money against the bills as a part of the regular credit arrangements with the company. The Committee is accordingly of the view that in the first case, the amount charged by the bank for discounting the bill is in the nature of loss on transfer, whereas in the latter case, the amount charged by the bank is in the nature of interest. Further, in the view of the Committee, the bill discounting charges relating to the suppliers’ bills accepted by the company, payable by the company as per the terms and conditions of the agreement, are paid for the credit allowed by such suppliers. Therefore, these are also in the nature of interest.

 

2. The Committee further notes that the Institute of Chartered Accountants of India has issued ‘Guidance Note on Accounting for Leases’. Para 25 of this Guidance Note inter alia recommends as follows, regarding disclosure of lease rentals on finance leases:

 

“25.      Lease rentals should be accounted for on accrual basis over the lease term so as to recognise an appropriate charge in this respect in the profit and loss account, with a separate disclosure thereof…”

 

The Committee is, therefore, of the view that lease rentals should be shown separately and not clubbed with ‘financial and bank charges’.

 

3. The Committee also notes that clause 7(1)(a) of Part III of Schedule VI to the Companies Act, 1956, defines the term ‘provision’, as below:

 

“The expression “provision” shall, subject to sub-clause (2) of this clause, mean any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.”

 

4. The Committee further notes that clause 3(ix)(a) of Part II of Schedule VI to the Companies Act, 1956, requires for disclosure of provision, as follows:

 

“The aggregate, if material, of the amount set aside to provision made for meeting specific liabilities, contingencies or commitments”.

 

Accordingly, the Committee is of the view that the provision for premium on redemption of debentures should be shown separately in the profit and loss account.

 

5. The Committee notes that management fees paid on loans/leases are for processing of loans. Thus, it is of the nature of a financial expense. This item may, therefore, be clubbed with ‘financial and bank charges’.

 

6. On the basis of the above, the opinion of the Committee on the issues raised by the querist in para 7 of the query, is follows:

 

(a)        Bill discounting charges paid in respect of the bills purchased by the bank are in the nature of loss to the company, and, therefore, should not be clubbed with the ‘Interest’ item in the profit and loss account. Charges paid in respect of bills financed by the bank, under the regular financing arrangement made with such bank, are in the nature of interest and should be clubbed with the ‘interest’ item in the profit and loss account. Discounting charges in respect of the suppliers’ bills, paid by the company as per the terms of the agreement with such suppliers, are in the nature of interest and should be clubbed with the interest item.

 

(b)        No.

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