1.34 Query
Withdrawal of future interest payable on deferred payments capitalised during the previous years.
1. During the years 1981 and 1982-83, a company purchased certain machinery from abroad under 10 years Deferred Payment Instalment Scheme, approved by the Government of India and Reserve Bank of India. In addition to the cost of machinery, sums of Rs. 12.27 lacs and Rs. 38.14 lacs, being the interest payable on future instalments, were also capitalised in the books of account for these years.
2. According to the querist, the fact that the company was following the policy of capitalising interest payable on future instalments of deferred payments was disclosed in the company’s accounting policy in the published accounts. However, consequent to the insertion of explanation to Section 43 of the Income-tax Act, 1961, in the Finance Bill, 1986, the company included the following note in the published accounts for the years 1985-86 and 1986-87:
“Consequent to the amendment to Section 43 of the I.T. Act, 1961, vide Finance Act, 1986, an estimated additional liability of Rs. 10 lacs for payment of arrears of income-tax for the accounting years 1981 to 1984-85 and of Rs. 0.89 lacs of sur-tax for the year 1981 have arisen. However, no provision is considered necessary in view of the other admissible reliefs.”
3. The querist has stated that the company did not make any reversal of the original entries in the books of account to withdraw the interest capitalised and depreciation thereon.
4. The accounts of the company are subject to Supplementary Audit by the Comptroller and Auditor General of India under Section 619B of the Companies Act, 1956. During the course of audit of accounts for the accounting year 1986-87, the C & A.G.’s Auditors have observed that the company should have:
(1) reversed the original entries of deferred payment interest capitalised since the Income-tax amendment had been introduced with retrospective effect from 1.4.1987;
(2) charged the interest actually incurred for the respective accounting year; and
(3) withdrawn the depreciation already charged in the accounts up to 1984-85.
The C & A.G.’s Auditors have advised the company to give effect to their observations in the next accounting year.
5. The querist has requested the Expert Advisory Committee to advise on the following:
(i) whether the reversal of the original entries passed in the year 1981 and 1982-83 is called for in the books of account of the company as per the provisions of the Companies Act since the amendment is effected only in the Income-tax Act, and
(ii) whether it would be sufficient to disclose the correct state of affairs of the company if, without reversing the original entries in the books of account, it is explained by way of an additional note to the statement of accounts indicating only the net effect of non-reversal for the deferred payment interest capitalised and the provision of depreciation made thereon on the profit or loss of the relevant accounting year.
Opinion November 15, 1988
1. The Committee notes that para 22 of the Statement on Treatment of Interest on Deferred Payments3 issued by the Institute of Chartered Accountants of India, provides as follows:
“Interest payable during the period of construction or installation of fixed assets can be capitalised. However, interest payable on fixed assets purchased on a deferred credit basis or on monies borrowed for acquisition of assets should not be capitalised after such assets are put to use.”
2. The Committee also notes that the Council of the Institute, through an item published in March, 1984 issue of ‘The Chartered Accountant’ reiterated its stand as stated in Para 6 and added that:
“In cases where interest has been so capitalised and the amount involved is material, it will be necessary for the auditor to qualify his report accordingly.”
3. From the above, the Committee notes that capitalization of future interest payable on deferred payments has not been considered a sound accounting practice by the Institute of Chartered Accountants of India, even before amendment to Section 43 of the Income-tax Act, 1961, vide Finance Act, 1986. Thus from the accounting point of view, the Committee feels that aforesaid amendment does not have much significance.
4. The Committee is, therefore, of the view that the accounting policy regarding capitalization of interest, followed by the company since 1981-82, is not in accordance with the one stated by the Institute. The said accounting policy should be changed from that year by the company to comply with the aforesaid Statement issued by the Institute. In this regard, the Committee notes that the Institute of Chartered Accountants of India, has issued Accounting Slandered 5 (AS- 5) on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’. Para 12 of AS-5, states as below:
“Any change in an accounting policy which has material effect should be disclosed. The impact of, and the adjustments resulting from such change, if material, should be shown in the financial statements of the period in which of such change is made to reflect the effect of such change. Where the effect of such change is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for the current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”
5. On the basis of the above, the opinion of the Committee, on the issues raised by the Querist in para 5 of the query, is as follows:
(i) Since the company has been following an inappropriate accounting policy since the purchase of the machines, it should reverse the original entries of deferred payment interest capitalised relating to the period after the concerned assets were put to use. The depreciation provided on the concerned assets, to the extent relevant, should also be adjusted accordingly. The adjustments and the disclosures should be made as required by para 12 of AS-5 (reproduced in para 4 above).
(ii) An explanation by way of a note, as suggested by the querist in para 5 (ii) of the query, will not be a proper accounting treatment.
3 Originally issued as a Guidance Note in 1979; changed to Statement in 1988. |