Query No. 12

Subject:

Treatment of waiver of interest on loan and adjustment of purchase

tax and royalty against the sales tax liability by the State Government.¹

A. Facts of the Cases

1. A government company is engaged in the business of manufacture and sale of paper and sugar. A State Government is the principal shareholder holding 65% of the shares in the company. The company is incurring losses from the financial year 2002 onwards. As per the querist, in the absence of revenue concessions from the Government, the company’s operations would have become potentially sick as per the Sick Industrial Companies Act, 1985 (SICA). Therefore, with a view to improve the operations of the company, the State Government granted revenue concessions to the company. The grant of concessions helped the company to keep its operations as an on-going concern and also outside the purview of potential sickness as per SICA.

2. The government grants, inter-alia, included:

        (a) waiver of purchase tax on sugarcane,

        (b) waiver of royalty on purchase of pulpwood from governmental sources, and

        (c) waiver of interest on government loans.

3. The querist has subsequently informed as follows:

       (a) Purchase tax was levied by the State Government on purchase of cane from the farmers. The purchase tax was paid to the Government on monthly basis, i.e., calculated at the rate of Rs.60/MT for the number of tonnes of cane purchased during a particular month. Similarly, royalty is paid on purchase of pulp wood from the Government sources. But the royalty is paid along with every purchase made by the company.

       (b) Waiver of purchase tax/royalty is allowed by the Government at the end of the year so as to help the company to reduce its losses. As both the purchase tax and royalty were paid by the company during that financial year, the waiver by the Government is by way of adjustment against sales tax dues payable by the company subsequent to issue of Government Order, i.e., from April onwards in the subsequent financial year. This procedure has been followed consistently since many years and is accepted by both the statutory auditors and the Accountant General (AG). The Sales Tax Department also carries out the adjustment accordingly.

4. The querist has stated that the company is accounting for these grants as income under the head ‘other income’ as per Schedule 3.01 forming part of accounts of the company. This practice has been followed consistently and was accepted by both the statutory auditors and also by the Accountant General (AG) till the financial year 2004-05. However, during the course of audit of accounts for the financial year 2005-06, the AG has observed that the rebates and incentives (government grants) should be credited to the respective expenditure heads instead of treating these concessions as income, as the same have a direct impact on the valuation of closing stock. The observations of the AG were not accepted by the company and a detailed reply was furnished to the AG. The replies were not accepted by the AG and preliminary comments on the accounts were issued thereafter. Both the company and the statutory auditors reiterated the earlier replies and requested the AG to withdraw the preliminary comments issued on the treatment of rebates and incentives granted by the government.

5. The querist has further stated that the AG forwarded the audit observations/preliminary comments and replies of the company to the Comptroller & Auditor General of India (C&AG), New Delhi, for his opinion. The C&AG accepted the replies of the company. Accordingly, the AG withdrew his preliminary comments on the accounts on this subject for the financial year 2005-06. Further, the AG has requested the company to refer this issue to the Institute of Chartered Accountants of India (ICAI) for its expert opinion and take action in accordance with the Institute’s opinion in the accounts for the financial year 2006-07.

6. According to the querist, the following justifications were given to the AG by the company:

       (a) The concessions (revenue in nature) granted by the State Government to the company to revive its operations were accounted under the head ‘other income’ consistently and accepted by the AG. The income on account of these concessions was shown separately keeping in view the need for proper presentation in the quarterly results and to maintain the costing records. Normally, the concessions are granted at the end of the year and in the absence of specific sanction, this income cannot be credited/accrued in advance and cost statements prepared accordingly. There will be a total distortion in the costing records, if the entire amounts are deducted in reporting the related expenditure for the last quarter only as these are received at the end of the year and will not give a fair comparison when compared to earlier quarter results. So is the case with unaudited results being published by the company as part of the SEBI requirements under the listing agreement. The company, therefore, discloses the same as income and shows it by way of a note in the unaudited results published by the company in the last quarter so as to keep the SEBI and other investors informed accordingly.

      (b) Further, under Schedule 1.00 – Statement of Accounting Policies, at paragraph 1.10, forming part of accounts of the company, it is indicated in detail under the head ‘accounting for government grants’ as to how the revenue grants are treated in the books of account. The accounting policy with regard to revenue grants is that the revenue grants are shown under rebates and incentives as income.

      (c) Accounting Standard (AS) 12, ‘Accounting for Government Grants’, issued by the Institute of Chartered Accountants of India, deals with accounting for government grants. As per AS 12, the revenue grants can be shown either on gross approach basis or on net approach basis. AS 12 does not prescribe any specific approach, hence, the company has discretion to follow any of the two approaches. In the case of gross approach, the amount of grant should be shown as a separate item of revenue or as an item of other income. In the case of net approach, the grants have to be deducted from the relevant expenditure. The AG has suggested the net approach while the company has followed the gross approach. The procedure of following either of the approaches is in order. While the company has followed the gross approach, it has declared an accounting policy as well. If the net approach as suggested by the AG is followed, the accounting policy of the company will be contravened to that extent. The gross approach gives a wider analysis than the net approach proposed by the AG.

      (d) In view of the above, the company took a stand that the procedure followed by it is in order and wants to continue the same policy and practice in future.

B. Query

7. The querist has sought the opinion of the Expert Advisory Committee as to whether the policy followed and the treatment given by the company in accounting for the rebates and incentives granted by the government as income is in order or not.

C. Points considered by the Committee

8. The Committee notes from the Facts of the Case that the querist has used various expressions, such as, ‘waiver’, ‘concessions’, ‘rebates’, ‘grants’, etc., to describe the waiver of interest on loan and the adjustment of purchase tax and royalty against the sales tax paid/payable by the company. The Committee hereinafter uses the expressions ‘waiver of interest on loans’ and the ‘adjustment of purchase tax and royalty against sales tax liability’. The Committee also wishes to point out at the outset that it has considered only the question of the treatment of waiver of interest and the adjustment of purchase tax and royalty against the sales tax liability of the company as ‘other income’ or adjustment from the relevant items in the financial statements. The Committee has, accordingly, not considered any other issue which may arise from the Facts of the Case, such as, timing of the recognition of the waiver and the said adjustments, as such issues have not been raised by the querist.

9. The Committee notes the definition of the term ‘government grants’ as contained in paragraph 3.2 of Accounting Standard (AS) 12, ‘Accounting for Government Grants’, which provides as follows:

       “3.2 Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the enterprise.”

10. The Committee also notes paragraphs 6.4 and 9.1 of AS 12, which are reproduced below:

       “6.4 In certain circumstances, a government grant is awarded for the purpose of giving immediate financial support to an enterprise rather than as an incentive to undertake specific expenditure. Such grants may be confined to an individual enterprise and may not be available to a whole class of enterprises. These circumstances may warrant taking the grant to income in the period in which the enterprise qualifies to receive it, as an extraordinary item if appropriate (see Accounting Standard (AS) 5, Prior Period and Extraordinary Items and Changes in Accounting Policies²).”

       “9.1 Grants related to revenue are sometimes presented as a credit in the profit and loss statement, either separately or under a general heading such as ‘Other Income’. Alternatively, they are deducted in reporting the related expense.”

11. The Committee is of the view that waiver of interest on loans and the adjustment of purchase tax and royalty against the sales tax liability fall within the definition of the term ‘government grants’ as these are provided to the company for the purpose of giving immediate financial support to it. The Committee is, therefore, of the view that as provided in paragraph 9.1 of AS 12, the company can follow the alternative of presenting the aforesaid grants, which are related to revenue items as ‘Other Income’.

D. Opinion

12. On the basis of the above, the Committee is of the opinion that the policy of treating the waiver of interest on loans and the adjustment of purchase tax and royalty against sales tax liability of the company as ‘other income’ is appropriate subject to the considerations stated in paragraph 8 above.

¹ Opinion finalised by the Committee on 30.5.2008