Query No. 9

Subject: Accounting treatment of waiver of loan and interest thereon.^[1]

A. Facts of the Case

1. A closely held public limited company, incorporated in May, 1984, has the main object of undertaking the business of deep sea fishing. The authorised capital of the company is Rs. 36 lakh divided into 36,000 equity shares of Rs. 100 each. The paid-up capital as on 31st March, 1997 was Rs. 15.70 lakh consisting of 15,700 equity shares of Rs. 100 each.

2.  The company had imported a deep sea fishing trawler during 1985 at a cost of US Dollars 8,00,000. The company had availed of rupee term loan amounting to Rs. 90,28,800 from Shipping Development Fund Committee (SDFC) for acquiring the trawler. The total cost of the trawler was Rs. 112,64,899 as detailed below:

The company commenced commercial operations during December, 1986.

3. The term loan availed from SDFC carried interest at the rate of 8% p.a., to be paid over a period of 16 years.

4. SDFC was abolished by the Central Government under Shipping Development Fund Committee (Abolition) Act, 1986 and the activities of SDFC were taken over by the Shipping Credit & Investment Company of India Ltd. (SCICI). Consequent to the merger of SCICI with the Industrial Credit and Investment Corporation of India Limited (ICICI), ICICI was appointed as the designated person of the Central Government under Shipping Development Fund Committee (Abolition) Act, 1986.

5. The querist has stated that due to various problems faced by the deep sea fishing industry, the company could not achieve the projected turnover and profitability and incurred losses and could not pay the interest and instalments of the term loan.

6. The Government of India appointed a Technical Committee (known as ‘Murari Committee’) to study the problems faced by the deep sea fishing industry and to suggest measures for rehabilitation of the industry. Based on the recommendations of the Murari Committee, the government decided to provide rehabilitation reliefs and offered two options (option ‘A’ and option ‘B’) to the companies assisted by the erstwhile SDFC. For the purposes of the rehabilitation scheme, the cut-off date was fixed as 5.5.1997.

7. According to the querist, the company availed of option ‘B’ (one-time settlement). The relevant extracts of the scheme as supplied by the querist are as under:

(i)      All penal interest and normal interest (including capitalised pre-delivery interest) and 70% of the outstanding principal as on the cut-off date would be written off; and

(ii)     the balance 30% of the outstanding principal as on the cut-off date would be reckoned as outstanding principal and would be paid, upfront, as one single payment on or before November 3, 1997 but not later than three months from the date the option was exercised.

8. Accordingly, the company was extended the following reliefs:

(i)      Waiver of all penal interest and normal interest (including capitalised pre-delivery interest) outstanding as on the cut-off date.

(ii)     Waiver of 70% of the principal outstanding as on the cut-off date.

9.  The details of the amount due to SCICI/ICICI towards principal and interest as on 31st March, 1997 have been stated by the querist to be as under:

‘Other dues’ represent insurance premium paid by SCICI on behalf of the company, out of which the company has paid Rs. 40,291 on 9.12.1997 and the claim for the balance, i.e., Rs. 22,592 has been withdrawn by ICICI as the same was not payable by the company.

10. As per the querist, out of the total dues (other than ‘other dues’) of Rs. 174,12,513 in terms of option ‘B’ exercised by the company, the company has paid Rs. 27,08,640 in full and final settlement of all dues as per the following details:

11. The summarised balance sheet of the company as on 31st March, 1997 (as furnished by the querist) is as under:

12. According to the querist, the company had charged in the audited accounts, depreciation on WDV method at the rate of 10% p.a. upto 31.3.1993 and at the rate of 14.6% p.a. from 1.4.1993 to 31.3.1997. The book value of the trawler as on 31.3.1997 was as under:

13. As per the querist, the interest including penal interest had been provided in the books of account of the company upto the accounting year 31.3.1996. The rehabilitation reliefs offered by government of India were communicated to the company by ICICI vide letter dated 7.5.1997 and the company exercised its option vide letter dated 31.7.1997. Hence, interest for the year ended 31.3.1997 had not been provided for in the accounts.

14. The company has accounted for the amounts waived as follows:

(a)     The outstanding principal amount waived by ICICI (i.e. Rs.63,20,160) has been credited to Capital Reserve Account by debit to Term Loan Account.

(b)     The capitalised pre-delivery interest, other normal interest, and penal interest waived, amounting to Rs. 83,83,713 have been offset against the debit balance of profit and loss account as on 1.4.1997 without crediting the same to the current year’s profit and loss account.

B.  Queries

15. The querist has sought the opinion of the Expert Advisory Committee on the accounting treatment of:

(a)     part of the outstanding principal waived by the term lending institution; and

(b)     capitalised pre-delivery interest, other normal interest, and penal interest waived by the term lending institution.

C.  Points Considered by the Committee

16. The Committee notes that waiver of a part of the outstanding principal and of the outstanding interest represents extinguishment of an existing obligation.

17. The Committee also notes that two possible treatments of the amount waived are:

(a)     reduction from the carrying amount of the related fixed asset, namely, deep-sea fishing trawler;

(b)     transfer to profit and loss account as an item of income.

18. Adjustment to carrying amount of an asset is appropriate only where the extinguishment of the obligation can be clearly attributed to the acquisition of the asset concerned. This principle is followed, for example, in accounting for government grants related to fixed assets. In the instant case, however, such attribution does not appear proper in view of the fact that the waiver is an outcome of the inability of the company to make the payments (owing to financial difficulties) rather than due to its having acquired the trawler. It can be inferred from the facts of the case that the waiver would not have taken place had the company been in a position to meet its obligation. Thus, the waiver cannot be said to be attributable to the acquisition of the trawler. As such, adjustment of the amount waived against the cost of the related fixed asset would not be proper under the facts and circumstances of the case.

19. The treatment of the amount waived as an item of income and accordingly its transfer to the profit and loss account would be appropriate only if the conditions subject to which the waiver takes place do not stipulate compliance with certain obligations in future. In case there are such stipulations, the principle of matching would warrant that the amount waived should be recognised as income in the same periods and in the same proportions as the cost of meeting those obligations. In the instant case, from the facts of the query, it is clear that no such stipulations have been prescribed while waiving the amount. Accordingly, under the facts and circumstances of the case, it would be appropriate to treat the amount waived as an item of income which should be credited to the profit and loss account of the year in which the amount waived is recognised in the financial statements.

20. The Committee further notes the following definitions of the terms ‘ordinary activities’ and ‘extraordinary items’ as given in paragraph 4 of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’:

“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.”

21. The Committee also notes paragraph 12 of AS 5 which states as under:

“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.”

22. The Committee notes that the gain arising as a result of waiver falls under the definition of ‘ordinary activities’ as it accrues to the company as part of its business. In view of the significance of the amount waived, the disclosures set out in paragraph 12 of AS 5, as reproduced above, would be required.

D.  Opinion

23. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 15:

(a)     The part of the outstanding principal waived by the term lending institution should be treated as income in the profit and loss account of the company. Also, a separate disclosure of the nature and amount of the same should be made in accordance with paragraph 12 of AS 5.

(b)     The accounting treatment would be the same as in (a) above.

[1]Opinion finalised by the Committee on 24.12.1998.