1.2 Query:           

Accounting for interest on overdue outstandings.

1.  A public sector undertaking is engaged in the mining of manganese ore and products processed from basic raw material viz., manganese. Though the company supplies ore against payment either in advance or against delivery, the bulk of the ore is supplied on credit to the manufacturers of steel, ferro-manganese etc. As per the company policy, normally 14 days credit is allowed. The invoice, if not paid within the stipulated period, attracts interest at a rate of 1% above the rate of bank borrowing.

2. The querist has informed that the accounting policy of the company in respect of interest on overdue outstanding states that the interest at the stipulated rate is payable by the purchasers from the date when the invoice falls due for payment and is accounted as income on accrual basis during the relevant year. According to the querist, the accounting policy was consistently followed since its inception in the financial year 1980-81.

3. The querist has further informed that an analysis of the debtors recently revealed that the interest accrued and accounted for during 1990-91 to 1993-94 had very poor rate of acceptance and recovery. In many cases the amounts of interest had been protested and in some cases contested and sought to be adjusted after necessary rectification in the original invoices for low-grade supplies. According to the querist, there is also an apprehension about recovery of the face value of mounting invoices on which interest is provided on accrual basis.

4.  The querist has further informed that government audit party from the commercial audit wing has observed that as the company is facing a great difficulty even in realisation of principal amount, the chances of realisation of interest on outstandings are very remote. Further, the parties have also not acknowledged/confirmed the interest amount billed by the company. The government audit party was of the view that, on the basis of cannons of financial prudence and propriety, the interest on outstandings should not have been accounted for as income.  The audit observation stated that the provision of interest on accrual basis has resulted in overstatement of profit and overstatement of debtors of even amount.  The querist also informed that the matter was reviewed in the office of Comptroller & Auditor General where it was noticed that the accounts were correctly drawn and prepared as per the accounting policies. Hence, the observation was dropped. However, it was felt that in view of the uncertainty in recovery of full amount of interest it would be prudent to review the accounting policy in respect of interest on overdue outstandings for the financial year 1994-95 onwards.

5.  In the above context, the querist has sought the opinion of the Expert Advisory Committee in respect of the following matters:

(i) Whether the company can follow cash basis for accounting interest on overdue outstandings as against the accrual basis presently followed and change its accounting policy accordingly.

 

(ii) What mandatory disclosures are required in the annual accounts of the company if the change in accounting method is permitted?

 

(iii) Whether, in the given circumstances and in view of the facts stated, the change in accounting policy is acceptable under the direct tax laws.

 

                                                                         Opinion                                          April 3, 1995

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 alia, 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 Note 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 interest on overdue outstandings should be accounted for on accrual basis. However, in case of any particular overdue outstanding of 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. The interest income, the recognition of which has been postponed as suggested heretobefore, 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 5 of the query:

(i) The accounting treatment in respect of interest on overdue outstandings should be as given in para 5 above.

(ii) This question does not arise as the change in accounting policy is not permitted.

(iii) No opinion in view of para 4 above.

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