Expert Advisory Committee

Query No. 2

Subject:

Accounting treatment of surcharge in the nature of interest on overdue outstandings.^[1]

A. Facts of the Case

1. A central public sector company is engaged in construction and operation of hydroelectric power projects. The power generated by the company is supplied to various state electricity boards (beneficiaries), the rates for which are notified by the Government of India separately for each generating station.

2. According to the querist, on the recommendations of the Public Accounts Committee, the Government of India had decided to charge surcharge in the nature of interest @ 2% p.m. in case of payments for sale of power getting delayed beyond one month of issue of the respective bill. This decision formed part of the notification issued by the Government of India notifying rates for sale of power for generating stations.

3. The sales during 1996-97, 1997-98 and 1998-99 were Rs. 534 crore, Rs. 1,118 crore (estimated) and Rs. 1,277 crore (estimated) respectively. The profit for the respective years was Rs. 86 crore, Rs. 234 crore (provisional) and Rs. 198 crore (provisional).

4. The company had been raising bills on account of surcharge but payments were not being received uptil financial year 1996-97. Such bills were not being accounted for in the books of account. The company was, however, disclosing the following accounting policy consistently:

“Revenues and expenses are generally accounted for on accrual basis except in the case of surcharge recoverable from debtors, sale of scrap, income from consultancy charges and the expenditure on account of LTC encashment.”

5. The querist has stated that realisations from the debtors, viz., the state governments/state electricity boards on account of sale of power are not good. No debtor paid interest, which has accumulated for the last 10/12 years. The average debt collection period at present is around one and a half years. The company was financing its operational expenses till 1996-97 from the receipts from debtors. In 1997-98 it had to raise temporary loans to meet the shortfall in this regard. The interest payable on these loans will not be reimbursed out of tariff.

6. As per the querist, the government decides from time to time to recover the outstandings from state governments through appropriation of Central Plan Assistance in various instalments during the next four years. Earlier, only principal was stipulated to be recovered, but in 1997-98 the government decided to also recover the interest accrued and billed upto 30.12.96/31.3.97. This recovery is to be made in suitable instalments as may be decided by the government and is likely to be spread over a period of about 4 years.

7. As per the querist, in view of the uncertainty involved, the company had not accounted for surcharge. However, since the company has now received substantial amount of surcharge and is likely to get the balance amount of surcharge, review of the policy and its depiction in the balance sheet need consideration. The issues involved, as per the querist, are:

(i) What will be the amount to be shown as income on account of surcharge, i.e.,

(a) the actual surcharge recovered during the year, i.e., Rs. 63 crore; or

(b) the amount of surcharge included for recovery in central appropriation, i.e., Rs. 301.19 crore; or

(ii) The manner of disclosure of the amount so determined.

(iii) Depending on (i) and (ii) above, the tax implications.

8. The querist has stated that the company has examined these issues in the light of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, Accounting Standard (AS) 9, ‘Revenue Recognition’, Guidance Note on ‘Disclosure of Items of Income and Expenditure of Previous Year’, section 209(3)(b) of the Companies Act, 1956, Part II of Schedule VI to the Companies Act, 1956, opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India published in Vol. XV (Query No. 1.2), and instructions issued by the Company Law Board from time to time.

9. As per the querist, if the company is to account for the amounts as listed in paragraph 7(i)(b) or (c) above as revenue for the year, then other income as well as profit for the year will shoot up manifold and will drop substantially in the next year. The figure of the net profit will not be comparable and profit on account of surcharge may be more than the profit from operations. Similarly, the company in future may have to account for surcharge on accrual basis in terms of section 209(3)(b) along with Accounting Standard (AS) 9.

10. Paragraph 4.1 of AS 9 defines revenue as the gross inflow of cash, receivables, or other consideration arising in the course of the ordinary activities and is measured by the charges made to the customers or clients for the goods supplied, the services rendered to them and by the charges and rewards arising from the use of resources by them.

11. Further, paragraph 9.4 of AS 9 states as below:

“An essential criterion for the recognition of revenue is that the consideration receivable for the sale of goods, the rendering of services or from the use by others of enterprise resources is reasonably determinable. When such consideration is not determinable within reasonable limits, the recognition of revenue is postponed.”

12. According to the querist, in the case of the company, part recovery of surcharge has been made, the amount yet to be recovered can be reasonably determined as it is chargeable at a fixed rate of 2% per month on outstandings, part of the bills have been raised, and levy of surcharge is part of agreement/notification. However, the recovery of the full amount indicated earlier is quite difficult and uncertain particularly when full recovery of even the principal amount through normal channel is extremely difficult. Moreover, if the company notionally accounts for surcharge recoverable in the books of account, the company may have to pay income tax on the amount which is unlikely to be received in near future.

B. Queries

13. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) (i) Whether the company will be complying with the requirements of section 209(3)(b) of the Companies Act, 1956 read with Accounting Standard (AS) 9, ‘Revenue Recognition’ if it recognises actual receipt on account of surcharge during the year as revenue, while continuing to disclose the accounting policy as given in paragraph 4 above with the additional words “which are accounted for on actual receipt basis”.

(ii) Whether the amount to be recognised would be shown as a ‘prior period item’ or would it be recognised as an ordinary activity for the year.

(b) If answer to (a)(i) is in the negative, which of the amounts, i.e., amount as per paragraph 7(i)(b) or as per paragraph 7(i)(c), is to be considered as revenue for the year.

C. Points Considered by the Committee

14. Paragraph 4.1 of Accounting Standard (AS) 9, ‘Revenue Recognition’, states as under:

“Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them......”

15. Paragraph 8.1 of AS 9 provides inter alia that interest represents charge for the use of cash resources or amounts due to the enterprise. Surcharge on outstanding dues is thus in the nature of interest and should, therefore, be accounted for in accordance with the principles laid down for recognition of revenue.

16. As per paragraph 13 of AS 9, revenue arising from the use by others of enterprise resources yielding interest should only be recognised when no significant uncertainty as to measurability or collectability exists. It should be recognised on a time proportion basis taking into account the amount outstanding and the rate applicable.

17. Paragraph 9 of AS 9 relating to the ‘Effect of Uncertainties on Revenue Recognition’ reads as follows:

“9.1 Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection.

9.2 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. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. 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.

9.3 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.

9.4 An essential criterion for the recognition of revenue is that the consideration receivable for the sale of goods, the rendering of services or from the use by others of enterprise resources is reasonably determinable. When such consideration is not determinable within reasonable limits, the recognition of revenue is postponed.

9.5 When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognised.”

18. The amount of surcharge in question is reasonably determinable as it is stated to be levied as a fixed percentage of amount outstanding. As per the facts of the query, the reasonable certainty of collection of surcharge needs to be assessed particularly because only a certain portion of the surcharge (upto a particular date) has been identified by the government for recovery through appropriation of Central Plan Assistance.

19. On the basis of the above, surcharge should be accrued in the books of account to the extent there is no significant uncertainty as to its collectability. The revenue recognition in respect of the amount for which there is significant uncertainty of collection should be postponed; in such a case, disclosures should be made as per paragraph 14 of AS 9 which is reproduced below:

“14. In addition to the disclosures required by Accounting Standard 1 on ‘Disclosure of Accounting Policies’, (AS 1), an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.”

20. Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’ defines ‘ordinary activities’, ‘extraordinary items’ and ‘prior-period items’ as below:

“Ordinary activities are any activities which are undertaken by an enterprise as part of its business and such related activities in which the enterprise engages in furtherance of, incidental to, or arising from, these activities.”

“Extraordinary items are income or expenses that arise from events or transactions that are clearly distinct from the ordinary activities of the enterprise and, therefore, are not expected to recur frequently or regularly.”

“Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.”

21. As stated by the querist, the non-recognition of surcharge in the year in which claim was raised was due to significant uncertainty of its collection, and not because of any error or omission. Therefore, in the current year, on the surcharge having become reasonably certain of recovery, it cannot be termed as a ‘prior-period item’ also, the surcharge has arisen from the ordinary activities of the company. It cannot, therefore, be termed as an ‘extraordinary item’. Thus, the recognition of surcharge in the year in which it becomes reasonably certain of recovery should be considered as an item of income from ‘ordinary activities’. However, in view of the nature of the item and the amount involved, it would require a disclosure in accordance with paragraph 12 of AS 5, which states as below:

“12. When items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.”

D. Opinion

22. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 13:

(a) (i) According to the facts of the query, there does not seem to be any significant uncertainty regarding the recovery of the amount of surcharge included for recovery in central appropriation, i.e., the amount as given in paragraph 7(i)(b) above. Accordingly, recognition of surcharge on actual receipt basis will not be in accordance with the requirements of the Accounting Standard (AS) 9 on ‘Revenue Recognition’ and section 209(3)(b) of the Companies Act, 1956, even with the extended note as suggested by the querist.

(ii) The amount of surcharge recognised should not be shown as a prior period item. It should be recognised as an item of income from ordinary activities of the company. However, disclosure in accordance with paragraph 12 of AS 5 reproduced above, would be required to be made.

(b) In view of (a)(i) above, the amount given in paragraph 7(i)(b) above, should be recognised in the year 1997-98 when the government included it in central appropriation. As regards the remaining amount of surcharge accrued as at the end of the year, an assessment needs to be made as to whether there is any significant uncertainty as to its collectability. If there is no such significant uncertainty, it should be recognised. In case of significant uncertainty, the revenue recognition should be postponed and disclosures should be made in accordance with paragraph 14 of AS 9 reproduced above.

[1]Opinion finalised by the Committee on 23.6.1998.