Query No. 35

Subject:         Accounting treatment of unidentified receipts and unclaimed liability towards stale cheques to vendors and customers and de-recognition of income of the previous years on account of change in accounting policy in current financial year.[1]

A. Facts of the Case  

1.         A company is an unlisted, non-deposit accepting non-banking financial company registered with the Reserve Bank of India (RBI). The company is engaged in issuing credit cards to consumers in India.

2.         Upto financial year (F.Y.) 2012-13, the following accounting policy was consistently followed and disclosed by the company:

“Notes to Accounts 2C (iv)  - Stale cheques including credit balance refund (CBR) credits, unidentified credits and other trade liabilities outstanding for more than three years are taken into income.” (Emphasis supplied by the querist.)

Following are the details about these items:
Credit balance refund (CBR): Credit balance refunded to customer but cheque not presented by the customer.
Unidentified credits: Any payment received by the company wherein either wrong credit card number is mentioned or no card number is mentioned is considered as unidentified credit. The origination of these payments can be classified under the following two categories:

(a) Unidentified credit received from bank, i.e., Cash Management Partner (CMP):
These cheques are directly banked by CMP and money is received by the company. As these receipts cannot be credited into any customer account, hence, these are accounted for under ‘Unidentified Credits Account (current liability account)’ in general ledger. Remittances team follows a process for curing these payments by matching previous history, cheque series, partial match and various other means to identify the correct card number and subsequently, the payment is transferred from ‘Unidentified Credits Account (current liability account)’ to customers’ account. This curing process by remittances team helps the curing of approximately 90% of such receipts. The remaining 10% lies in ‘Unidentified Credits Account (current liability account)’ and can be cured only when customer approaches the company.

(b) Unidentified credit received from alternate payment modes (other than cheques):

Receipts from other sources like National Electronic Funds Transfer (NEFT), online payment options, over the counter (other than bank CMP as stated above) wherein customers’ correct card number cannot be identified falls under this category. Such credits are also accounted in ‘Unidentified Credits Account (current liability account)’. These kind of credits can also be cured only when customer approaches the company. 

Other trade liabilities: This comprises any cheque issued to vendors but not presented for payment.

3.         The querist has stated that upto F.Y. 2012-13, the above amounts were being kept in current liabilities for three years and then taken to income considering liability no more required. However, any claims afterwards by customers/vendors, which are very rare, are duly refunded by the company. Following were the key rationale to adopt the above policy upto F.Y. 2012-13:

(i) There is no specific Accounting Standard or law for the treatment of these types of transactions.

(ii) The company writes off all the recoverable from customers on 180 days past due and some of these payments may pertain to written off customers as well. The company does recovery follow ups through phone (if available) only for all the cases > Rs. 1,000 and physical visits for > Rs. 3,000.  Hence, for the payments less than these threshold amounts or where customer is not contactable, the company will not be able to resolve these cases. Further, as the payment by customer could not be credited to his/her account due to lack of information provided by him/her, the debit balance in customer account may have got written off from books at 180 days past due. This is evident from the following data table that in F.Y. 2013-14, of the total unidentified credit cases resolved (when the customer approaches company), 38% of these cases were identified and credited to the written off customers’ account.

(iii) It is very unlikely that a customer will pay and forget to contact the company for three years.

(iv) No action on these liabilities after 3 years will result into piling up of non-movable transactions and balances in balance sheet which will weaken the overall control on these and are prone to fraud/misappropriation/wrong adjustments.

(v) The policy does not deprive off the customer/vendor from their genuine claims even after three years though there are rarely such claims. In F.Y. 2013-14, only one such case came for and the company refunded the same.

(vi) The customers’ base is more than 25 lacs and approximately 3.3 lacs payments are received every month. Out of this, approximately 200 payments per month form part these liabilities,

However, the Reserve Bank of India (RBI) and Comptroller and Auditor General of India (C&AG) have questioned the above policies in past (prior to F.Y. 2013-14) and in their view, the liability should not be taken to the income even after three years. Considering the views of these authorities, the company has changed the above accounting policy in F.Y. 2013-14 and discontinued recognising these liabilities in income even after 3 years. The policy was implemented prospectively for F.Y. 2013-14 onwards.

4.         The auditors from C&AG office audited the financial statements for F.Y. 2013-14. Following are their observations and the corresponding management response to the same:

However, C&AG office did not accept management’s response and verbally advised the company to reverse all the incomes recognised in previous years (prior to F.Y. 2013-14) as well amounting to Rs. 12.21 crore.

B.        Query

5.         In the above background, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) In the light of the key rationale highlighted under paragraph 3 above, whether the company can adopt an accounting policy to write the liability back in the statement of profit and loss after a certain period (e.g., after 3 years) which will help the company to avoid piling up of non-movable transactions and balances in balance sheet which will weaken the overall control on these items and are prone to fraud/misappropriation/wrong adjustments.

(ii) As this was a policy change in F.Y. 2013-14, whether it will be appropriate to reverse all the previously recognised incomes considering that these were not an error or omission rather these were as per the accounting policy applicable in those years?

C.        Points considered by the Committee

6.         The Committee notes that the basic issues relate to correctness of the accounting treatment of  writing back of the unclaimed liability towards credit balance refund, unidentified credits and other trade liabilities comprising cheques issued to vendors but not presented for payment, to the statement of profit and loss as ‘income’ after a period of 3 years, as mentioned in paragraph 2 above and since such treatment has been changed w.e.f. F.Y. 2013-14, whether such change should be considered as ‘prior period item’ or as ‘change in accounting policy’ as per the provisions of AS 5. The Committee has, therefore, considered only these issues and has not considered any other issue that may arise from the Facts of the Case, such as, propriety of writing off all the recoverables from customers on 180 days past due, etc. Further, the Committee has opined purely from accounting perspective and not from any legal perspective in view of Rule 2 of the Advisory Service Rules. The Committee has also presumed in the extant case that the transactions and amounts in respect of the afore-mentioned accounting treatment are material.

7.         At the outset, the Committee notes that the credit balances/liabilities being written off to the statement of profit and loss as income in the extant case can be broadly classified into two categories, first, unidentified credits from the customers for which adjustments against specific customers’ dues are pending and second, unclaimed liability towards credit balance refund and other trade liabilities comprising cheques issued to vendors/customers but not presented for payment.

8.         As far as the first issue relating to unidentified credits from customers for which adjustments against specific customers’ dues are pending is concerned, the Committee is of the view that in order to determine the correctness of the accounting treatment, it is necessary to know the nature of the item, i.e., whether the unidentified credits can at all be considered as liabilities of the company or not. Therefore, the Committee notes the definition of the term ‘liability’ as per paragraphs 49(b), 59 and 61 from the Framework for the Preparation and Presentation of Financial Statements, issued by the ICAI as follows:

“(b) A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”

“59. An essential characteristic of a liability is that the enterprise has a present obligation. An obligation is a duty or responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement. This is normally the case, for example, with amounts payable for goods and services received. Obligations also arise, however, from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner. If, for example, an enterprise decides as a matter of policy to rectify faults in its products even when these become apparent after the warranty period has expired, the amounts that are expected to be expended in respect of goods already sold are liabilities.”

“61.     The settlement of a present obligation usually involves the enterprise giving of resources embodying economic benefits in order to satisfy the claim of the other party. …”

The Committee notes from the above that a liability is a present obligation arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits for the satisfaction of the claim of the other party. The Committee notes that unidentified credit in the extant case represents the money received from the customers against their dues, which on account of certain problems, could not be identified with specific customers’ dues (receivables) account and therefore, the settlement against the respective customers’ accounts is pending. The Committee is of the view that such unidentified credits are merely recoveries against the receivable accounts that would not require any outflow of resources to satisfy the claims of any party and, therefore, cannot be considered as a liability of the company. The Committee further notes from the Facts of the Case that the company has a policy of writing off all the recoverables from customers that are 180 days past due. Therefore, it is possible that unidentified credits also relate to the written off recoverables as on the reporting date. Accordingly, the Committee is of the view that at the reporting date, the company should make an estimate as to whether the unidentified credits as on the reporting date relate to the recoverables written off during the reporting period, considering various factors, such as, outstanding date and period of the recoverables, date and amount of credit unidentified, etc.  Accordingly, the Committee is of the view that on the basis of such estimate of the management, unidentified credits relating to the recoverables written off should be recognised as ‘income’ in the statement of profit and loss. Further, the Committee is of the view that in case the total amount of unidentified credit exceeds written off recoverables, income should be recognised only to the extent of written off recoverables.

9.         With respect to unclaimed liability towards credit balance refund and other trade liabilities comprising cheques issued to vendors/customers but not presented for payment, the Committee is of view that these represent obligations of the company towards the vendors/customers involving outflow of resources embodying economic benefits and are therefore, these are to be treated as a liability. In this connection, with regard to the issue relating to accounting treatment to write back the unclaimed liability to the statement of profit and loss as ‘income’ after a period of 3 years, the Committee notes paragraphs 91-92 of the ‘Framework for the Preparation and Presentation of Financial Statements’, issued by the Institute of Chartered Accountants of India, as reproduced below:

“Recognition of Income

91. Income is recognised in the statement of profit and loss when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. This means, in effect, that recognition of income occurs simultaneously with the recognition of increases in assets or decreases in liabilities (for example, the net increase in assets arising on a sale of goods or services or the decrease in liabilities arising from the waiver of a debt payable).

92. The procedures normally adopted in practice for recognising income, for example, the requirement that revenue should be earned, are applications of the recognition criteria in this Framework. Such procedures are generally directed at restricting the recognition as income to those items that can be measured reliably and have a sufficient degree of certainty.”

From the above, the Committee notes that an income can be recognised due to decrease in liability, i.e., when a liability is no longer payable, for example, decrease in liability arising from the waiver of a debt payable or from the extinguishment/settlement of liability.  The Committee also notes from paragraph 92 above that income can be recognised only in respect of those items that can be measured reliably and have a sufficient degree of certainty. The Committee is of the view that in case of an item of income resulting from decrease in liability, sufficient degree of certainty would normally arise only on extinguishment/settlement of liability. The Committee notes that in the extant case, the extinguishment/settlement through actual discharge or cancellation by the parties does not take place even after three years. Therefore, the Committee is of the view that assessment of liability as no longer payable should be made keeping in mind the relevant legal provisions, past experience, management estimates, etc. In this context, the Committee wishes to point out that if the requirements of the law are such that a debt does not expire/become time barred if the debtor continues to recognize the liability in respect of such debt in its books of account, then, the liability in such a situation can be written-off when the liability is considered to be no longer payable. Accordingly, the Committee is of the view that the accounting treatment of the company to write back a liability to the statement of profit and loss as its income automatically after three years would be correct only if it is done keeping in mind various factors, as explained above.

10.       On the basis of the above, the Committee is of the view that the company should have followed the accounting treatment in respect of unidentified claims/unclaimed liability, as suggested above and if the company has not followed the same, it would be an incorrect accounting treatment followed by the company and the company should rectify the same treating it as ‘Prior Period Item’ in accordance with the following provisions of AS 5, notified under the ‘Rules’:

“4.3     Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.”
“15.  The nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived.”    

11.       With regard to the argument of treating the change in the accounting treatment for the unidentified credit/ unclaimed liability as change in accounting policy, the Committee notes the definition of ‘accounting policies’ as per AS 5 as follows:

4.4 Accounting policies are the specific accounting principles and the methods of applying those principles adopted by an enterprise in the preparation and presentation of financial statements.”

The Committee is of the view that in the extant case, it is a matter of accounting treatment in respect of the timing of derecognition of unidentified credit and extinguishment of unclaimed liability which is application of an accounting principle and not in itself a principle or method of application of principle, Therefore, there is no change in accounting policy.      

D.        Opinion

12.       On the basis of the above, the Committee is of the following opinion on the issues raised by the querist in paragraph 5 above:

(i) The company should follow the accounting policy in respect of unidentified credit, as suggested in paragraph 8 above and in respect of unclaimed liability, as suggested in paragraph 9 above.

(ii) If the company has not followed the accounting treatment in respect of unidentified credit/unclaimed liability, as suggested in paragraphs 8 and 9 above, it would be an incorrect accounting treatment followed by the company. Accordingly, the company should rectify the same treating it as ‘Prior Period Item’ in accordance with the provisions of AS 5, notified under the ‘Rules’, as discussed in paragraph 10 above and not as a change in accounting policy, as discussed in paragraph 11 above.

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[1]Opinion finalised by the Committee on 11.12.2014.