Query No. 25

Subject:     

Accounting treatment of interest waived in the books of the borrower.^[1]

A. Facts of the Case

1. A company was declared sick by the Board for Industrial and Financial Reconstruction (BIFR).  A rehabilitation scheme was sanctioned in the year 1993 under which the banks and financial institutions restructured their outstanding dues after waiver of compound interest and liquidated damages.  The effect to the above waiver was given in the financial statements of the company for the year 1992-93.

2. Later on, a modified scheme was approved by Appellate Authority for Industrial and Financial Reconstruction (AAIFR) in August 1998.  As per the modified scheme, the institutions agreed to accept payment of 100% principal and 20% of the outstanding simple interest accrued and due up to the date of the modified scheme.  The payment was to be made as under:

(a) Principal to be paid within 180 days in three instalments as follows:

               (i) 25% within 30 days from the date of sanction of the modified scheme.

               (ii) Another 25% within next 60 days.

               (iii) Balance 50% within next 90 days.

 

(b) Interest to be paid as follows:

                (i) 50% to be repaid in four quarterly instalments commencing 3 months after full payment of the principal amount.

               (ii) Balance 50% to be converted within 180 days of sanction of the modified scheme into cumulative optionally convertible preference shares (COCPS) with a coupon rate equivalent to IFCI’s Prime Lending Rate (PLR) applicable at the time of allotment of COCPS.  The COCPS are redeemable after 3 years, with an option with the institutions to convert the same into equity.

3. Apart from above, it is a condition of the settlement with the institutions that in case of a default persisting for a period longer than one month, the institutions shall have the right to charge interest and liquidated damages and also have the right to revoke the settlement by restoring the liability as per the covenants of the loan agreement.

4. As per the above restructuring, the company has made the part payment of principal amount.  However, part of the principal amount and 50% of the interest amount is to be paid in the year 1999-2000 and the balance 50% would be converted into COCPS which would be redeemable after 3 years, with an option that the same may be converted into equity.

5. According to the querist, the amount of interest waived under the settlement is substantial.

B. Query

6. The opinion of the Expert Advisory Committee has been sought on the issue as to whether the effect to the above waiver should be given in the books of account of the company in the year 1998-99, or after full payment to the institutions (the full payment to the institutions would be made by the year 2002).

C. Points Considered by the Committee

7. The query involves two accounting aspects:

 

(a) Whether, from the stand point of the company, the nature of the waiver is that of income.

 

(b) At what point of time should the company give effect to the waiver in its books of account.

8. As regards the nature of the waiver, the Committee notes that the waiver results in the extinguishment of an existing obligation without a corresponding extinguishment of an asset or replacement of the obligation by another obligation.  As such, its nature is that of income.

9. As regards the timing of recognition of the waiver, the Committee notes that Accounting Standard (AS) 9, ‘Revenue Recognition’, lays down the following three conditions for recognition of revenue :

 

(a) Performance of the act giving rise to revenue.  For example, in a transaction involving the sale of goods, performance is regarded as being achieved when the seller of goods has transferred to the buyer the property in the goods for a price, or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of those goods to a degree usually associated with ownership.

 

(b) Measurability of the revenue.  For example, in a transaction involving the sale of goods, revenue is not recognised if there is any significant uncertainty regarding the amount of consideration that will be derived from the sale of the goods.

 

(c) Collectability of the revenue.  If, at the time of the performance of the act giving rise to revenue, there is significant uncertainty as to collectability, revenue recognition is postponed.

10. The Committee further notes that Accounting Standard (AS) 12, ‘Accounting for Government Grants’, requires (paragraph 13) that “government grants should not be recognised until there is reasonable assurance that (i) the enterprise will comply with the conditions attached to them, and (ii) the grants will be received.”

11. The Committee is of the view that while neither AS 9 nor AS 12 is directly applicable under the facts of the case, the principles laid down in the aforesaid standards (as discussed in paragraphs 9 and 10 above) provide the framework for deciding the issue raised by the querist.

12. In the instant case, the amount waived under the settlement is clearly known and, as such, there is no uncertainty about the measurability of the amount of income.  The condition regarding collectability does not apply as no collection is involved.  However, the agreement executed by the company with the institutions which has given rise to the income envisages compliance with certain conditions as to repayment of principal and payment of interest as per an agreed time schedule. If these conditions are not complied with, the institutions shall have a right to revoke the settlement by restoring the liability.  In these circumstances, keeping in view the principles enunciated in AS 12, the amount waived by the institutions should not be recognised as income until there is reasonable assurance that the company will comply with the conditions as to repayment of principal and payment of interest as per the terms of the settlement.  If such assurance is available by the time of finalisation of the accounts for the year 1998-99, the income should be recognised in the financial statements for the year 1998-99.  If not, recognition of the income should be postponed till such time that compliance with the said conditions is reasonably assured.

D. Opinion

13. Based on the above, the Committee is of the following opinion on the issues raised in paragraph 6 above :

(a) The amount waived should not be recognised as income until there is reasonable assurance that the company will comply with the conditions regarding repayment of principal and payment of interest as laid down in the settlement.  If such reasonable assurance is available by the time of finalisation of the accounts for the year 1998-99, the income should be recognised in the financial statements for the said period.

 

(b) If reasonable assurance as to compliance with the conditions of the settlement is available only when full payment to the institutions has been made, the income should be recognised in the period in which the full payment is made to the institutions.

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^[1] Opinion finalised by the Committee on 28.5.1999.