1.19 Query: Whether margin money on account of Letters of Credit/guarantees given to a bank is a ‘current asset’ or a ‘non-current asset’.
1. In terms of RBI Circular IECD NO. 29/08.12.01/9596 dated 24.6.98, banks were advised to exclude ‘margin money’ on account of Letters of Credit (LC)/guarantees from the projected build up current assets while assessing working capital needs of a borrower. From this circular, the querist has drawn the following inferences:
(i) The margin money on account of Letters of Credit/guarantees is to be excluded from the build-up of current assets for the limited purpose of determining Maximum Permissible Bank Finance (MPBF).
(ii) As tenure of LCs/guarantees are generally short term in nature, in the view of the querist, obviously, margin on such LCs/guarantees would also be of short–term nature and hence is to be included under current assets for the purpose of determining current ratio. Therefore, as per the querist, such margin money should not be reckoned for the purpose of determining Net Working Capital (NWC).
(iii) In RBI’s Circular IECD No. 15/08.12.01/9394 dt.11.10.93, on treatment of term loan instalments payable within the next 12 months, a similar analogy was drawn. Accordingly, the term loan instalments payable within the next 12 months are reckoned for the purpose of determining current ratio, whereas kept outside for computing Net Working Capital (NWC) requirements.
(iv) An illustration has been furnished by the querist, in the annexure, explaining the concept and the inference drawn by him.
2. The querist has stated that his understanding of the concept and the inference drawn by him, have been prima facie confirmed by the RBI. However, as regards margin money on LCs/guarantees, to be classified as the ‘current’ or ‘non-current’ assets, RBI has directed the querist to seek guidance from the Institute of Chartered Accountants of India.
3. The querist has, accordingly, sought the opinion of the Expert Advisory Committee as to whether margin money paid on LCs/guarantees by the borrower should be treated as a current asset or a non-current asset.
Opinion October 23, 1997
1. The Committee restricts its opinion only on the classification of margin money on LCs/guarantees. It has not gone into the computation of Maximum Permissible Bank Finance, as the querist has not raised this issue.
2. The Committee notes paragraph 3.34 of the Guidance Note on Terms Used in Financial Statements, issued by the Institute of Chartered Accountants of India, which defines the term ‘current assets’ as below:
“Cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.”
3. The Committee notes that the margin money against LCs/guarantees is available to the borrower on the expiry of LC/guarantee period, generally, three or six months. In those situations where a borrower has taken an LC/guarantee limit and made a margin money deposit with a bank for a longer period, it is open to him to get the limit cancelled at any time, except to the extent of LCs/guarantees which are open at the time of cancellation, the money in respect thereof could be made available on the expiry of the LC/guarantee period.
4. On the basis of the above, the Committee is of the opinion that margin money against LCs/ guarantees paid to a bank by a borrower should be considered as a current asset for the purpose of computation of current ratio.
Annexure
In the above example: 400
300
MPBF in the above illustration based on RBI Circular dated 24.6.1996 would work out;
MBBF=WCG- (a) or (b) whichever is higher
MPBF= 210-100=110 ___________________________
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