1.5       Query

Disclosure of bills discounted in financial statements.

1.The query relates to the treatment of usance bills discounted with a bank before these are accepted by the drawee and the discounted demand bills. In this context, the following points have been raised:

                    (i) Is the present practice of crediting sundry debtors with the proceeds realised on the discounting of such bills with banks,                     and showing the outstanding amounts at the date of the balance sheet as a contingent liability, correct?

                    (ii) Is it not more appropriate and correct to show such outstanding amounts on the liabilities side of the balance sheet as                     ‘Loans from banks’ (secured or unsecured depending on whether the bills are documentary or clean), and the gross amount                     of book debts on the assets side (without reducing it by the amount of such outstanding bills) to give a true and fair view of                     the state of affairs of the company in its balance sheet?

2. The arguments advances by the querist against the present accepted accounting practice of treating such bills as a “contingent liability” are as follows:

(1)Discounting of bills is on of the modes of advances adopted by the commercial banks. Therefore, it is a financial facility granted against realisable book debts. This view has been supported as below:

                    (i)  Explanation II to Section 293 (1) of tlhe Companies Act, 1956, provides—

“The expression temporary loans in Clause (d) means loans repayable on demand or within six months from the date of the loan, such as Short Term Cash Credit arrangements, the Discounting of Bills and issue of other Short Term Loans of a seasonal character but does not include loans raised for the purpose of financing expenditure of a capital nature”.

                    (ii) It is stated in Chapter XI of ‘Practical Banking Advances’ by H.L. Bedi and V.K. Haridikar (6^th Edition) at page 102/106                     that

                    “ADVANCES by commercial banks are made in different forms such as loans, cash credits, overdrafts, bills purchased, bills                     discounted, etc. These are generally short-term advances.”

                    “Bills purchasedAlthough the term “Bills Purchased” seems to imply that the bank becomes the purchaser/owner of such                     bills, it will be observed that in almost all cases, the bank holds the bills (even if they are endorsed in its favour) only as                     security for the advance.”

                    (iii) Para 6.9 of ‘Audit of Banks’ (3^rd Edition, 1973) of the Institute of Chartered Accountants of India, reads as below:

                    “Advances given by a bank are in the following two forms: --

                    (a) Loans, Cash Credits, Overdrafts, ect.

                    (b) Bills discounted and purchased.”

(2) The contingency, if any, is only in respect of the repayment (in case the buyer (drawee) fails to pay the amount on presentation of the documents) but this has nothing to do with the nature of liability as such which arises and accrues at the very moment the bills are discounted and the money is paid by the bank. Therefore, this is not a payment by the bank on behalf of the drawee, hence crediting this account to the drawee tantamounts to understating total of book debts and not disclosing a very important and real liability of loan/borrowing.

(3) The discounting of a usance bill after it has been accepted by the buyer (drawee) can be treated as a contingent liability, because, the drawer’s liability against the bank will be deemed to have been discharged by the drawee on his acceptance of the bill of exchange. However, this is not true in the case of discounting of demand bills and in the case of discounting of usance bills which have not been accepted at the time of discounting. Thus, in the last two cases, the liability is real and must be so disclosed in the balance sheet.

3. The querist therefore opines that the demand bills discounted and the usance bills discounted before acceptance should be shown under secured and unsecured loans for documentary and clean bills respectively and the gross amount of book debts should be exhibited without reducing book debts by the amount of the bills discounted and remaining outstanding on that date.

                                                              Opinion                                                       March 15, 1982

1. The Committee considered the above arguments in the light of the prevailing accounting practices and is of opinion as below: --

                    (i)  The various authorities quoted by the querist have described that discounting of bills as a loan purely from the point of                     view of the prevailing banking practice. This is clear from the reason advanced while amending Section 293 of the                     Companies Act, 1956, in 1960 (Ramaiya, A Guide to Companies Act, 1980, p. 636). It is not necessary that a good banking                     practice is also a sound accounting practice.

                    (ii) The argument that as soon as a demand bill or a usance bill before acceptance is discounted, the drawer becomes liable                     to the banker for the amount, is not correct. The legal position regarding bills of exchange is that the liability of the drawee                     arises only when he accepts the bill. However, in the above mentioned case, it is implied that the drawee will accept the bill                     and honour it. Therefore, on the consideration of substance over form, the bills discounted with a bank—whether accepted                     or not—can not be treated as loans.

According to Eric. L. Kohler (A Dictionary for Accountants, Fourth Edition, p. 107) a contingent liability is “an obligation, relating to a past transaction or other event or condition, that may arise in consequence of a future event now deemed possible but not probable.” The bills discounted with a bank represent a contingent liability since their dishonour by the drawee, though possible is not considered probable, because in such cases there is an implied or written prior agreement under which the buyer (the drawee) agrees to make the payment through a bank.

                    (iii)  The argument that if bills (including usance bills before acceptance) discounted are not treated as a liability, the balance                     sheet will fail to give a true and fair view of the state of affairs is also not correct because they are shown as contingent                     liabilities by way of footnote to the balance sheet. Thus the nature of the liability is clearly brought to the notice of the user                     of the financial   statements.

2.  In view of the above, the Committee is of the opinion that a bill not accepted by the drawee and discounted with a bank should be shown as a contingent liability because the liability of the drawer of the bill has not been determined on the date of the balance sheet unless the bill has been dishonoured by that date.

3. The Committee recognises that the practice of disclosing the gross amount of sundry debtors on the assets side and the amount of monies received from the banks against bills on the liabilities side is also prevalent. This practice is also permissible if proper disclosure of the nature of the transaction has been made.