Query No. 18 Subject: Accounting policy in respect of insurance claims.1
A. Facts of the Case
1. A company was incorporated in the year 1988 as a joint venture of the Government of India and a state government with the objective of catering to the needs for power generation, irrigation and drinking water. The whole project is in the construction stage and hence ‘incidental expenditure during construction period account’ is being prepared instead of the profit and loss account.
2. From the year 1991-92 to the year 1995-96, the accounting policy of the company in respect of insurance claims was as under: “Insurance claims are brought to account on their acceptance by insurance company.”
3. As per the querist, the statutory auditors, in the course of audit of accounts for the year 1995-96, commented that the above policy of the company of accounting for insurance claims on their acceptance by the insurance company was not correct as the company was not disclosing or accounting for claims lodged.
4. According to the querist, in view of the above comments, the accounting policy was changed during the year 1996-97. The new policy states as below:
“Claims on insurance companies and railways for damages/losses are accounted for on lodging of claims.”
5. The following accounting entry is being passed at the time of lodging of claim:
Claims Recoverable from Insurance Company A/c Dr .
To Claims Suspense A/c
6. As per the querist, the government auditors, in their report on the accounts of the company for the year 1998-99, commented as under:
“The accounting policy is not complete inasmuch as it does not indicate the fact that the aggregate claims lodged with insurance companies and railways are also shown as a liability in the balance sheet.”
In view of the above comments of the government auditors, the company has decided to review the above-mentioned policy and carry out the necessary amendments, if any.
7. The querist has referred to an earlier opinion (Query No. 1.2 contained in Compendium of Opinions, Vol. VII) issued by the Expert Advisory Committee on a similar issue which states as below:
“With regard to claims recoverable from an outside insurance company relating to shortages/damages at ports, the recoverability of which is uncertain, the Committee notes that paragraphs 9.1 and 9.2 of Accounting Standard (AS) 9 ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, provide as below:
‘9.1 Recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service, it would not be unreasonable to expect ultimate collection’.
‘9.2 Where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest, etc., revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made’.
On the basis of the above principles of revenue recognition, the Committee is of the view that revenue recognition, in respect of the claims recoverable from an outside insurance company, should be postponed where the management considers their recoverability or collection uncertain .....”
8. The querist has also referred to the Appendix to the ‘Guidance Note on Accrual Basis of Accounting’, issued by the Institute of Chartered Accountants of India, which states as below:
“3. Uncertainty of collection
In respect of the following items of revenue, if the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, revenue recognition is postponed to the extent of uncertainty involved:
(v) Insurance claim in respect of loss of goods or loss of profits, when the amount receivable is not certain or capable of being determined.”
B. Queries
9. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the current accounting policy of the company is correct or it requires modification.
(b) If it requires modification, what would be the correct accounting policy?
(c) In case the Committee considers the existing accounting policy of the company to be correct, whether the accounting entry passed by the company as stated in paragraph 5 above is in order.
(d) How should the company disclose the ‘Claims Recoverable A/c', and the ‘Claims Suspense A/c' in the balance sheet?
(e) If the answer to (c) above is in the negative, what would be the correct accounting entry and its correct disclosure in the annual accounts?
(f) Whether the company should revert to its old accounting policy (as followed by the company from the year 1991-92 to the year 1995-96) as stated in paragraph 2 above with the disclosure in notes to accounts as below:
“As on 31st March, the company has lodged the claims with insurance company for Rs........... which will be accounted for at the time of acceptance of the claims.”
C. Points Considered by the Committee
10. Paragraph 4.1 of Accounting Standard (AS) 9, ‘Revenue Recognition’, defines the term ‘revenue’ as follows:
“Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.”
11. According to paragraph 9.1 of AS 9, “recognition of revenue requires that revenue is measurable and that at the time of sale or the rendering of the service it would not be unreasonable to expect ultimate collection”. Paragraph 9.2 of AS 9 provides that “where the ability to assess the ultimate collection with reasonable certainty is lacking at the time of raising any claim, e.g., for escalation of price, export incentives, interest etc., revenue recognition is postponed to the extent of uncertainty involved. In such cases, it may be appropriate to recognise revenue only when it is reasonably certain that the ultimate collection will be made. Where there is no uncertainty as to ultimate collection, revenue is recognised at the time of sale or rendering of service even though payments are made by installments.”
12. The Committee notes that insurance claims do not fall within the definition of ‘revenue’ as given in AS 9. However, the Committee is of the view that as in the case of sale of goods or rendering of services, the recognition of insurance claims also requires that the amount realisable is measurable and it is not unreasonable to expect ultimate collection.
13. The Committee is of the view that the company should determine the timing of recognition of insurance claims based on the above principles. If the amount realisable is measurable and it is not unreasonable to expect ultimate collection at the time of lodging of claims, the insurance claims should be recognised at that time. On the other hand, if at the time of lodging of a claim, the amount recoverable under the claim or its ultimate collection cannot be assessed with reasonable certainty, recognition of the claim should be postponed until the time the amount thereof can be measured reliably and ultimate collection is reasonably certain.
14. The Committee notes that the statutory auditors of the company had objected to the accounting policy being followed by the company earlier (viz., recognition of insurance claims at the time of acceptance) on the ground that the claims pending settlement were not accounted for or disclosed in the financial statements. The Committee is of the view that if, based on the principles set forth in paragraph 13, the company does not recognise insurance claims at the time of lodgement but the disclosure of claims lodged but not yet settled is considered necessary, this can be done by way of a note. The note should be so worded that it clearly brings out the uncertainties involved and does not give any misleading impression as to the recoverability of the relevant claims. Alternatively, such claims can be credited to a suspense account.
15. As regards the manner of disclosure of the 'Insurance Claims Suspense account' in the balance sheet, the same can be either deducted from insurance claims recoverable or shown on the liabilities side as a separate item. In the latter case, the nature of 'Insurance Claims Suspense account' should be described by way of a note to the accounts. The Committee is of the view that considering the nature of insurance claims suspense account, the former manner of presentation would be more appropriate.
D. Opinion
16. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9:
(a) Accounting for insurance claims at the time of lodgement without taking into account the uncertainty regarding measurability and collectability is not appropriate.
(b) Insurance claims should be recognised when the amount thereof can be measured reliably and ultimate collection is reasonably certain.
(c) This question is not applicable in view of what has been stated at (a) above.
(d) The balance in the insurance claims suspense account referred to in paragraph 14 above may be netted off against insurance claims recoverable.
(e) See (b) above.
(f) See (b) above.
1 Opinion finalised by the Committee on 22.4.2000. |