Interest of overdue outstanding amounts- Expert Advisory Committee

A. Facts of the Case

A public sector undertaking was engaged in the mining of manganese ore. The Company usually supplied ore against advance payments, however majority of its supplies to large manufacturers was on credit and followed a 14-day credit policy, and beyond that interest was charged at a rate of 1% above the rate of bank borrowing.
The interest was accounted as income accrued. However, it was observed by the Government auditors while analysis the debtors that the interest accrued had very poor rate of acceptance and recovery.
The auditors noticed that realization of the principal amount itself was challenging and the chances of realization of interest on the outstanding were very remote. Therefore, the auditors were concerned that provision of interest on accrual basis resulted in overstatement of profit and overstatement of debtor’s balances.

B. Query

The Company had sought the opinion as to:

Whether the Company should move to cash basis only for accounting the interest on outstanding amounts, since the amounts are not realized easily.
Whether any disclosures are required for such changes in accounting method?

C. Opinion

As per Companies Act, accrual basis and double entry system of accounting are fundamental requirement of accounting.
Accordingly, the interest on overdue outstanding should be accounted for on accrual basis. However, at the time of accrual of interest income, there is a significant uncertainty as to the ultimate collectability of the interest accrued thereon or any part thereof, recognition of such interest income should be postponed. The interest income should be accrued as revenue only in the period in which it is reasonably certain that the ultimate collection will be made.
Postponement of the recognition of such revenue is in accordance with the accrual basis of accounting and as such does not amount to adoption of cash basis of accounting.
However, if the uncertainty relating to collectability thereof arises subsequent to the recognition of interest income, it would be appropriate to make a provision to reflect the uncertainty.
Therefore, the Company has to assess the recoverability of the interest before accruing for the same, and it would not amount to “cash basis” of accounting.

The above opinion was affirmed by the ICAI-Expert Advisory Committee.

Articles