Expert Advisory Committee

1.29 Query:

Accrual basis of accounting

1. AFC is a wholly owned subsidiary of a nationalised bank. The company is engaged in the business of financial services. The company was perforce obliged to stop the fresh business after the scam broke out. The company is undregoing tight liquidity position, since most of the assets of the company are blocked in various claims/petitions in the Special Court.

2. The company has accepted Inter-Corporate Deposits (ICDs) from various Public Sector Undertakings. Inspite of not carrying on any fresh business for the past 2 years, the company is interested to settle the dues and, accordingly, it is making its best efforts to settle the dues. The company has settled (repaid) almost 40% of ICDs alongwith the interest upto the contract date. In few cases only, ICDs were settled alongwith the token interest till the date of repayment. In the cases where it was agreed upon, the company has created provision for interest till the date of repayment. The company has not renewed any of these contracts. But, there were claims at varied rates of interest from lenders from the due date of ICDs to the date of repayment.

3. The company has provided interest, as per the terms of the contract, till the due date and a note for non-provision of interest from the due date to the date of repayment was effected in the financial statements as follows in the year 1993-94:

“Notes to Schedule 14 – No. 3. Finance cost. Provision is made towards interest on the Inter Corporate Deposits (ICDs) accepted by the Company at the contracted rates only upto due dates of the deposits and no provision of interest on Inter Corporate Deposits is made after the due date upto 31.3.94 save otherwise in cases where the Company signed specific agreements for settlement. If the interest at the contracted rates is calculated from the due date to 31.3.1994, it worked out to Rs. 58.99 Crores (Previous year Rs. 21.78 Crores)”.

4. On account of uncertainties existing regarding the determination of the amount and in the absence of any specific legal obligation at present, as per the terms of contracts, the company considers that these claims are in the nature of “claims against the company not acknowledged as debt”, and the same has been disclosed by way of a note in the accounts instead of making a provision in the profit and loss account, which tantamounts to acceptance of the liability. As per the querist, this is in accordance with Accounting Standard (AS) 9, on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, which states that “The amount of revenue arising on a transaction is usually determined by agreement between the parties involved in the transaction. When uncertainties exist regarding the determination of the amount or its associated costs, those uncertainties may influence the timing of revenue recognition.”

5. According to the querist, a contingent liability is an obligation relating to a past transaction or other event or condition, that may arise in consequence of a future event now deemed possible but not probable. Statement on Auditing Practices, issued by the Institute of Chartered Accountants of India, defines ‘Contingent Liabilities’ as “possible liabilities arising from past circumstances or actions which may or may not crystallise into actual liabilities and which, if they do become actual liabilities, give rise to a loss or an expense or an asset of doubtful value. The uncertainty as to whether there will be any legal obligation differentiates a contingent liability from an actual liability.”

6. Based on the above contentions, the relevant note in the ‘Notes to Accounts’ for year 1994-95 is stated as follows:

“Schedule 15 – Notes to Accounts

No. 2 The Company has provided interest on Inter Corporate Deposits (ICDs), accepted by it at the contracted rate upto the due dates of the deposits only. The Company has initiated the process of settlements with the parties. Interest due, if any, on account of such settlements is provided in the accounts. Pending settlements of certain ICDs on which interest after the due date upto 31.3.95 amounting to Rs. 102.93 Crores at contract rates (Previous year Rs. 58.99 Crores) has not been provided in the books.”

7. The auditors of the company, to this extent, have qualified their report and have stated that the balance sheet and profit and loss account read together with the notes give a true and fair view of the affairs of the company. However, C&AG is of the opinion that the loss of the company is understated to the extent of Rs. 102.93 Crores and that the financial statements of the company do not reflect a true and fair view of the affairs of the company. It was observed that C&AG has agreed with the contents of the Annual Report of another public sector financial company (Say ABC Ltd.) and stated that they have no comments to make or supplement the Auditor’s Report, whereas in respect of the company in question, AFC Ltd., similar treatment was given and C & AG held that the final accounts of AFC Ltd. do not reflect a true and fair view of the affairs of the company. The querist has given below the C & AG’s comments in the two cases:

Auditor’s Comments (As published in the Annual Report of ABC Ltd for the year 1994-95):

Refer Auditor’s Report point No. 13.

“No provision for interest has been made for the year in respect of Rs. 115 Crores shown under unsecured loans pending settlement of terms and conditions governing the said loans (Refer Note 3.2 in Schedule ‘Q’)”.

Auditor’s Comments (As published in the final accounts of AFC for the year 1994-95).

Refer Auditor’s Report point No. B.

“The Company has not provided the interest payable on Inter Corporate Deposits at contracted rates from the due dates to the Balance Sheet date (Refer Note No. 2 of Notes to Accounts). The amount thus, not provided for works out to Rs. 102.93 Crores upto 31.3.1995 (Rs. 58.99 Crores upto 31.3.1994).”

8.It may be observed that the above transactions, i.e., acceptance of ICDs and payment of interest, are similar in nature in both the companies. In both the cases interest after the due date of the respective deposits has not been accounted for. However, it has been quantified in respect of AFC in their notes to the accounts forming part of the balance sheet. While C & AG did not make any comments in respect of ABC, they commented that the loss is understated by Rs. 102.93 Crores due to non-provision of interest on ICDs in case of AFC.

9. Under the stated circumstances, the querist has sought the opinion of the Expert Advisory Committee as to:

(a) Whether claims raised by the various lenders, for the amount of interest from the due date to the date of repayment, amounts to “Claims not acknowledged as debts”.

(b) If the answer to the above is in the affirmative, then is it sufficient if it is disclosed by way of a note?

(c) If the answer to the above is in the affirmative, then, how the amounts of interest to be provided should be determined?

(d) Whether non-provision of the interest liability due to uncertainties involved amounts to violation of accrual basis of accounting.

Opinion January 15, 1997

1. The Committee notes that the basic question is whether interest on overdue inter-corporate deposits which have been claimed by the depositors at varying rates is an actual liability or a contingent liability.

2. The Committee notes that Accounting Standard (AS) 1 on ‘Disclosure of Accounting Policies’, issued by the Institute of Chartered Accountants of India, recognises ‘prudence’ as one of the major considerations governing the selection and application of accounting polices, as explained below:

“In view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information”.

3. The Committee also notes that accrual is one of the fundamental accounting assumptions as per AS 1, according to which, “revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate.”

4. The Committee notes that interest liability accrues on the basis of the time for which the money borrowed from an other entity is used. The Committee also notes from the facts of the query that the arguments given by the querist are primarily on the ground of uncertainties in the determination of the amount of interest payments, rather than on the question of the existence of the liability in this regard. (In this context, it is mentioned that drawing support from AS 9, as has been done by the querist, is not appropriate since that standard deals with accounting for recognition of only revenue items). The Committee is of the view that irrespective of the terms of the contract, so long as the principal amount of a loan is not repaid, the lender cannot be placed in a disadvantageous position by non-payment of interest in respect of the overdue amount. From the aforesaid, it is apparent that the company has an obligation on account of the overdue interest. The Committee is, therefore, of the view that in this situation, the company should provide for the liability at an amount estimated on reasonable basis based on facts and circumstances of each case. The Committee is, however, of the view that in respect of the overdue interest amounts which are settled, the liability therefor should be accrued to the extent of amounts settled.

5. On the basis of the above, the Committee is of the following opinion in respect of the issues raised in para 9 of the query:

(a) No.

(b) Since the answer to (a) above is in the negative, this question does not arise.

(d) Non-provision of the overdue interest liability amounts to violation of accrual basis of accounting.

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