Query No. 28
Subject: Money market instruments – treatment and presentation by an insurance company.[1] A. Facts of the Case
1. An insurance company invests its funds in the following two types of
short term instruments on a regular basis.
(i) Front-ended instruments like commercial paper (CP), certificate of deposit (CD) and bills under rediscounting scheme (BRD).
(ii) Rear-ended instruments like fixed deposits with banks and call money on notice.
2. The interest on rear-ended instruments is accounted for by the company on
receipt basis. In the case of front-ended instruments such as CP, CD and BRD, the rate of
interest which the instrument should fetch is agreed upon at the time of the
contract and the purchase price of the instrument is determined by discounting
the face value of the instrument (the realisable value on maturity) at a rate
that will fetch the buyer the interest at the agreed rate.
3. The querist has illustrated the accounting treatment of front-ended
instruments as follows:
Suppose, on 1.3.1999, the company invests in commercial paper @ 10.50% for 51 days. The commercial paper matures on 21.04.1999. In order to fetch Rs. 5 crore @ 10.50% on maturity, the amount required to be paid for the CP comes to Rs. 4,92,77,045. As per the accounting practice of the company, the CP would be recorded as an asset at Rs. 5 crore though the consideration paid is Rs. 4,92,77,045. The balance of Rs. 7,22,955 would be accounted for as revenue under the account head ‘interest earned’. On the date of the balance sheet, i.e., on 31.03.1999, the company would provide for the ‘unearned portion of interest’ on a pro-rata basis by crediting Rs. 2,83,511.76 to the account head ‘interest received in advance’ with appropriate adjustment against the revenue.
4. As per the querist, the government auditors have made the following
observation with regard to the treatment of interest on front-ended instruments:
“Loans under Certificate of Deposit and Commercial Papers include Rs. 5,82,09,029 being the interest accrued but not due (Rs. 3,21,92,527) and interest receivable for the year 1998-99 (Rs. 2,60,16,502) on the ‘Certificate of Deposit’ and ‘Commercial Papers’ made during the year, resulting in aggregate overstatement in the above heads to that extent. This has also resulted in overstatement of sundry creditors by Rs. 2,60,16,502.”
5. The directors’ reply to the observation made by government auditors is
as below:
“Short term money market instruments such as CP, CD and BRD are discounted at the time of contract at the agreed rates on the face value of such instruments and hence are accounted for at their face value, which represents their cost. This is the standard practice of accounting for such instruments in the industry.”
6. According to the querist, the company discloses the unearned component of
discount under the account head ‘Interest received in advance’ and if the
asset value were to be read in conjunction with the aforesaid disclosure, the
value of the asset cannot be said to have been overstated. The querist has
contended that the transactions involving the acquisition of assets of the
nature discussed above have two dimensions.
The first is the price of the instrument which is its face value and the
other is the revenue component of the transaction.
As per the querist, the accounting method followed by the company gives
due consideration to both these elements and accordingly records the face value
of the asset as the acquisition cost while simultaneously recording the revenue
component.
B. Queries
7. The querist has sought the opinion of the Expert Advisory Committee on
the following issues:
C. Points Considered by the Committee
8. The Committee notes that the querist has sought its opinion only in
respect of the front-ended instruments. Therefore,
it restricts itself to the queries raised and does not express opinion on other
aspects covered by the query.
9. Accounting Standard (AS) 13, ‘Accounting for Investments’, issued by
the Institute of Chartered Accountants of India, requires an enterprise to
classify its investments into two categories: current investments and long term
investments. The Standard defines a
current investment as “an investment that is by its nature readily realisable
and is intended to be held for not more than one year from the date on which
such investment is made”. The
Committee notes that the investment in CP, CD and BRD is made by the company for
short term. Considering the nature of the aforesaid instruments and the intended
period of holding them, the Committee is of the view that these instruments are
in the nature of current investments.
10. The Committee notes paragraph 31 of AS 13 which states as below:
“31. Investments classified as current investments should be carried in the financial statements at the lower of cost and fair value determined either on an individual basis or by category of investment, but not on an overall (or global) basis.”
11. The Committee is of the view that the cost of the front-ended instruments
like CP, CD and BRD is the amount paid by the company to acquire them. Accordingly, the Committee is of the view that such
instruments should be presented in the balance sheet at the amount paid to
acquire them or their maturity value, whichever is lower.
The comparison of the amount paid to acquire such instruments and their
maturity value should be made either on individual investment basis or by
category of investment.
12. The Committee is of the view that the discount at which certificates of
deposit and commercial paper have been acquired (i.e., the difference between
the amount paid by the company to acquire the aforesaid instruments and their
maturity value) represents interest on funds invested in those instruments.
In this regard, the Committee notes paragraph 13 of Accounting Standard
(AS) 9, ‘Revenue Recognition’ issued by the Institute of Chartered
Accountants of India, which states as below:
“13. Revenue arising from the use by others of enterprise resources yielding interest, royalties and dividends should only be recognised when no significant uncertainty as to measurability or collectability exists. These revenues are recognised on the following bases:
(i) Interest: On a time proportion basis taking into account the amount outstanding and the rate applicable.....”
13. As regards the manner of disclosure of short term instruments and
interest thereon, the Committee notes that the First Schedule to the Insurance
Act, 1938 requires ‘Investments’ to be shown separately in the balance
sheet, further classified in the manner given in the said Schedule.
The classification given in Form A does not cover short term instruments
of the nature of CP, CD and BRD. The
Committee is of the view that these short terms instruments should be shown
separately with an appropriate description of their nature.
The Committee also notes that ‘interest, dividends and rents accruing
but not due’ are required to be shown separately in the balance sheet.
Accordingly, the Committee is of the view that interest on short term
instruments accruing up to the date of the balance sheet should be shown under
the aforesaid head.
14. The Committee further notes that AS 13 requires the disclosure, in the
financial statements, of “the accounting policies for determination of
carrying amount of investments” (paragraph 35).
Accordingly, the accounting policy followed for valuation of short term
instruments like CP, CD and BRD should be disclosed in the financial statements.
D. Opinion
15. Based on the above, the Committee is of the following opinion on the
issues raised in paragraph 7:
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[1]Opinion finalised by the Committee on 23.7.1999. |