Query No. 22
Subject: Provision for NPAs in the quarterly results of a non-banking financial company.[1] A. Facts of the Case
1. A non banking financial company [hereinafter referred to as ‘the company’] which is listed on a stock exchange accepts deposits from public. The company is required to publish unaudited working results on a quarterly basis to comply with the listing requirements.
2. The querist has mentioned that the company is required to make a provision for Non Performing Assets (NPAs) as per the prudential norms prescribed by the Reserve Bank of India (RBI). The acceptance of public deposits by the company is linked to the credit rating assigned to it by the rating agencies.
3. According to the querist, when the company publishes its unaudited results for each quarter, provision for NPAs is stated at 1/4th of the provision required as on that date as per the prudential norms. It is contended that as the working results pertain to a three-month period, making the provision in full would distort the working results and also send wrong signals to the rating agencies. It is also contended that making the provision for every quarter in the manner stated above ensures that when the working results for the four quarters are consolidated, the provision for NPAs as required on the balance sheet date is correctly and fully stated and there is no distortion of the working results.
B. Queries
4. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
Whether the auditor is required to qualify the quarterly accounts due to the provision being made in the manner described in paragraph 3 above.
C. Points Considered by the Committee
5. Some costs incurred by an enterprise can be clearly identified with a period of time. Such costs are regarded as ‘period costs’ and, under the accrual basis of accounting, are expensed in the period in which they are incurred, e.g., salaries, depreciation, etc.
6. Period costs, by their very definition, vary directly with the length of the accounting period. This characteristic of period costs necessitates pro-rata application of rates or amounts of period costs where the length of the accounting period with reference to which such rates/amounts have been determined is different from the one for which financial statements are to be prepared. For example, if an yearly rate of depreciation of 20% on straight-line basis has been worked out in respect of an asset and the enterprise is preparing quarterly accounts, only 1/4th of the aforesaid depreciation rate (i.e., 5%) would be applied.
7. The above principle of pro-rating applies only to period costs and not to other costs. The other costs need to be recognised in the accounts in full as soon as they are incurred, irrespective of the length of the accounting period. Thus, the amount of the loss resulting from a fire needs to be recognised as a loss in the financial statements for the period in which the fire took place, irrespective of whether the accounting period is a quarter or a half year or a full year. There is no question of pro-rata recognition of the loss in the profit and loss account if the accounting period is a quarter or a half year.
8. The nature of provision for non-performing assets is not akin to that of period costs. Accordingly, once a provision for non-performing asset is required to be made, the entire amount of the provision should be recognised as expense immediately notwithstanding the length of the accounting period. Since such a provision is not in the nature of a period cost, there is no question of its being made on a pro-rata basis. Thus, where a provision of say, 20% (or any other percentage) is required to be made for non-performing assets, the provision should be made at this rate.
D. Opinion
9. Based on the above, the Committee is of the following opinion on the issues raised in paragraph 4 above:
[1] Opinion finalised by the Committee on 28.5.1999. |