Query No. 17

Subject:           Accounting for interest on delayed payment by power generation companies against coal supplied under Fuel Supply Agreement. [1]

A. Facts of the Case

1.         A company (hereinafter referred to as the ‘company’) is wholly owned subsidiary of a government company, engaged in extraction of coal. The company is located in the eastern part of India and its fields of operations are in the states of West Bengal and Jharkhand.  The company supplies coal to:

For the year 2012-13, the company has produced 33.91 metric ton (MT) of coal and has achieved a net turnover of Rs. 9,191.91 crore.

2.         The company supplies coal to power houses under fuel supply agreement (FSA) (copy of the said agreement has been furnished by the querist for the perusal of the Committee), the salient features of which are enumerated below:

Modalities for billing claims and payments

3.         The querist has stated that although the power houses are generally irregular in releasing payment, the company has not resorted to stop the supply of coal under the terms of FSA having regards to the national interest. The company is claiming interest on the delayed payment by the power houses in terms of the provisions of FSA. However, such claim towards interest on delayed payment  by the company is not recognised as revenue in view of the uncertainty of ultimate collection having regard to  the provision of Accounting Standard (AS) 9, ‘Revenue Recognition’, notified under the Companies (Accounting Standards) Rules, 2006, (hereinafter referred to as the ‘Rules’) which is quoted as under:

“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. 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 instalments.”

4.         The company is following a constant practice of making provision towards debts doubtful of recovery, which is stated in the clause no. 4.1 of the additional notes on accounts of the company (Note 34) quoted as under:

“Provision of sundry debtors is generally made on case to case basis. Normally, no provision of sundry debtors is made on unsettled amount of debtors at the initial years. In the 2nd year provision is made up to 50% amount of unsettled amount of debtors, and the rest is provided in 3rd year if remains unsettled. Further, no provision is made on vendible stock except deterioration of old stock due to fire, theft, etc.”

B. Query

5.         Considering the above facts, the querist has sought the opinion of the Expert Advisory Committee as to whether the accounting treatment followed by the company with respect to claim of interest on delayed payments under the terms of agreement with its customers and its postponement of the recognition of revenue till the claim is admitted, is consistent with the provisions of AS 9 relating to recognition of revenue.

C.Points considered by the Committee

6.         The Committee notes that the basic issue raised by the querist relates to whether accounting treatment followed by the company with respect to claim of interest on delayed payments under the terms of the agreement with its customers and its postponement of recognition as revenue till the claim is admitted is in consistence with the principles of AS 9. The Committee has, therefore, considered only this issue and has not examined any other issue that may arise from the Facts of the Case such as, revenue recognition with respect to coal supply, accounting policy of the company for making provision for doubtful debts, legal interpretation of the Fuel Supply Agreement, etc.

7.         The Committee notes the following paragraphs of AS 9, notified under the Rules:

“4.1     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. ...”

“8.1     The use by others of such enterprise resources gives rise to:

(i) interest—charges for the use of cash resources or amounts due to the enterprise;

            …”

“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. 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 instalments.

9.3 When the uncertainty relating to collectability arises subsequent to the time of sale or the rendering of the service, it is more appropriate to make a separate provision to reflect the uncertainty rather than to adjust the amount of revenue originally recorded.”

“9.5 When recognition of revenue is postponed due to the effect of uncertainties, it is considered as revenue of the period in which it is properly recognised.”

“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.

...”

From the above, the Committee notes that interest represents charge for the use of cash resources or amounts due to the enterprise. Interest on delayed payments is thus in the nature of interest and should, therefore, be accounted for in accordance with the principles laid down for recognition of revenue. The Committee also notes that revenue arising from the use by others of enterprise resources yielding interest should only be recognised when no significant uncertainty as to measurability or collectability exists. It should be recognised on a time proportion basis taking into account the amount outstanding and the rate applicable.

8.         The Committee also notes the following paragraphs of the Fuel Supply Agreement, as supplied by the querist for the perusal of the Committee:

“12.0  Interest on delayed payment
In the event of delay in payment/adjustment of any amount payable/recoverable pursuant to the provisions of this Agreement, the Seller/the Purchaser shall be entitled to charge interest on such sum remaining outstanding for the period after the due date till such time the payment is made. The interest charged by the Seller/Purchaser pursuant to this Clause shall be at the Interest Rate, as per Clause 1.1 (dd).”

“1.1    DEFINITIONS:
…
(dd)  “Interest Rate” shall mean the repo rate of Reserve Bank of India (RBI) as applicable on the due date of payment of the Purchaser plus 3% (three).”

The Committee further notes that the payment mechanisms by the purchaser have also been specified in the Agreement.

9          From the above, the Committee notes that the amount of claim of interest for delayed payment from the customers is reasonably determinable as it is contractually agreed between the parties and it is clearly stated in the Agreement how the same would be calculated. Further, the Committee notes from the Facts of the Case that it has been explicitly stated by the querist in paragraph 3 above that although the company is claiming interest on the delayed payment by the power houses in terms of the provisions of FSA, such claim towards interest on delayed payment by the company is not recognised as revenue in view of the uncertainty of ultimate collection. The Committee is of the view that to assess the certainty or uncertainty of ultimate collection is a matter of judgement, which should be exercised considering various factors, such as, on the basis of past experience, etc. Accordingly, the Committee is of the view that to the extent and till the time such uncertainty of collection exists, revenue recognition should be postponed. The revenue needs to be recongised when it is reasonably certain that the ultimate collection will be made. The Committee is further of the view that in such cases, where the revenue recognition is postponed, disclosures should be made as per paragraph 14 of AS 9 which is reproduced below:

“14. In addition to the disclosures required by Accounting Standard 1 on ‘Disclosure of Accounting Policies’ (AS 1), an enterprise should also disclose the circumstances in which revenue recognition has been postponed pending the resolution of significant uncertainties.”

D.Opinion

10.       On the basis of above, the Committee is of the opinion that to assess the certainty or uncertainty of ultimate collection is a matter of judgement, which should be exercised considering various factors, such as, on the basis of past experience, etc. Accordingly, to the extent and till the time such uncertainty of collection exists, revenue recognition should be postponed. The revenue needs to be recognised when it is reasonably certain that the ultimate collection will be made. The Committee is further of the view that in such cases, where the revenue recognition is postponed, disclosures should be made as per paragraph 14 of AS 9, as discussed in paragraph 9 above.

__________________________

[1]Opinion finalised by the Committee on 6.6.2014.