1.28 Query: Change in method of accounting from accrual to cash basis in respect of interest income.
1. A public sector understanding set up to provide financial assistance for rural electrification programmes in the country, is registered as a company under the Companies Act, 1956. The company functions under the administrative control of the Department of Power in the Ministry of Power, Government of India. The main objectives of the company are as follows:
(i) To finance rural electrification schemes in the country.
(ii) To subscribe to special rural electrification bonds that may be issued by the State Electricity Boards (SEBs) on conditions to be stipulated from time to time.
(iii) To promote and finance rural electric cooperatives in the country.
(iv) To administer the money received, from Government of India and other sources, from time to time, as grants or otherwise for the purpose of financing rural electrification in general.
2. The main source of income for the company is interest on loans advanced to the State Electricity Board/State Governments and Rural Electric Cooperative Societies. Since beginning, the company has been following the accrual system of accounting as per the provisions of the Companies Act, 1956.
3. The querist has stated that for the last 4-5 years the company is facing acute resource crunch due to default by borrowers in repayment of principal and interest. The quantum of outstanding interest dues receivable from the borrowers account for 60% to 70% or even more of the yearly interest income accounted for on accrual basis. Based on the profit arrived at on accrual basis, the company has been paying income-tax. However, in reality as per the cash accruals, there will not be cash inflow even for payment of income-tax for which funds are being arranged from other sources. In view of the overdue problem there is a proposal under consideration to change the method of accounting of interest income from accrual basis to cash basis so as to account for only the interest income received from the borrowers. For this purpose, the company has already taken up the matter with the Department of Company Affairs is through its administrative ministry for permitting the company to account for its interest income on cash basis.
4. The querist has further stated that the Institute of Chartered Accountants of India has issued accounting standards in respect of (i) disclosure of accounting policies (ii) accounting for research and development (iii) revenue recognition etc., and the same have been made mandatory in respect of accounts for period commencing on or after 1.4.91. As per Accounting Standard (AS) 9 on ‘Revenue Recognition’, “Revenue from sales or service transactions should be recognised when the requirements as to performance set out in paragraphs 11 and 12 (of the standard) are satisfied, provided that at the time of performance it is not unreasonable to expect ultimate collection. If at the time of raising of any claim it is unreasonable to expect ultimate collection, revenue recognition should be postponed.”
5. In the above context, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Since Accounting Standard (AS) 9 on ‘Revenue Recognition’ has been made mandatory by the Institute of Chartered Accountants of India, w.e.f. 1.4.91, whether the company can change the method of accounting for interest income from accrual basis to cash basis.
(ii) If the company changes the method of accounting as per the accounting standard, will there be any consequential effect on any of the provisions of the Companies Act?
(iii) Whether the Income-tax Department will accept the accounts prepared by taking interest income on cash basis, based on the accounting standard issued by the Institute of Chartered Accountants of India. Whether any permission is required from Income-tax Department for this.
Opinion July 15, 1993
1. The Committee notes that section 209(3) of the Companies Act, 1956, inter alia, provides that a company shall not be deemed to have kept proper books of account “if such books are not kept on accrual basis and according to the double entry system of accounting”.
2. The Committee notes that para 13 of Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, inter ala, states that “Revenue arising from the use by others of enterprise resources yielding interest, royalties and dividends should only be recognised when no significant uncertainty as to measurability and collectability exists.”
3. The Committee also notes paras 3.5 and 8.1 of ‘Guidance Notes on Accrual Basis of Accounting’, issued by the Research Committee of the Institute of Chartered Accountants of India, which read as follows:
“3.5 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. It is possible that the uncertainty of collection may be either in respect of the entire transaction or a part thereof. For that part in respect of which there is no uncertainty of collection, the revenue is immediately recognised and for the remaining part, recognition of revenue is postponed. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. It is necessary to disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties. 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. 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 rather than to adjust the amount of revenue originally recorded”.
“8.1 The Council of ICAI and its various Committees have issued various Guidance Notes, Statements and Accounting Standards. The accounting treatments contained in these documents are primarily based on accrual accounting. Thus, adoption of accounting treatments recommended in these documents would ensure that a company has followed accrual basis of accounting….”
4. As per Rule 2 of Advisory Service Rules of the Expert Advisory Committee, the Committee does not answer the queries relating to taxation matters involving only interpretation of law.
5. The Committee is of the view that in case of any particular loan or advance made by the company, if, at the time of accrual of interest income, there is a significant uncertainty as to the ultimate collectability of the interest accrued thereon or any part thereof, recognition of such interest income should be postponed. However, the fact that interest has not been received for a number of years does not necessarily mean that there exists an uncertainty as to its ultimate collection. The interest income, the recognition of which has been postponed as suggested heretofore, should be taken as revenue only in the period in which it is reasonably certain that the ultimate collection will be made. Postponement of the recognition of such revenue, as per the above stated pronouncement of the Institute of Chartered Accountants of India, is in accordance with the accrual basis of accounting and as such does not amount to adoption of cash basis of accounting. However, if the uncertainty relating to collectability thereof arises subsequent to the recognition of interest income, it would be appropriate to make a provision to reflect the uncertainty.
6. On the basis of the above, the Committee is of the following opinion in respect of the issues raised at para 4 of the query:
(i) Change in the method of accounting in respect of interest income from accrual basis to cash basis is not permissible. Recognition of revenue, as per AS 9 and the Guidance Note on Accrual Basis of Accounting, as per para 5 above, is in accordance with accrual basis of accounting.
(ii) Postponement of the recognition of revenue in accordance with Accounting Standard (AS) 9 and ‘Guidance Note on Accrual Basis of Accounting’, as per para 5 above, does not contravene the relevant provision of the Companies Act, 1956.
(iii) No opinion in view of para 4 above. ______________________________ |