Non-Accrual of Interest on Borrowings by Companies in Violation of Indian Accounting Standards: NFRA Asks Auditors to Strictly Follow Norms [Read Order]

The National Financial Reporting Authority (NFRA) has advised all the Companies to follow Ind AS and their audit committees and advised not to discontinue recognition of the principal or interest merely because of the borrowings being declared NPA or the Management's expectation of a likely settlement with or without concessions from the banks.

A circular was issued after concluding the professional misconduct proceedings against a statutory auditor (CA Som Prakash Aggarwal) of a listed company (Vikas WSP Limited), that the company in the Financial Statements of 2019-20, had discontinued accrual/recognition of interest expense on its bank borrowings, which had been reportedly classified as Non-Performing Asset (NPA) by the lender banks and for which the company was negotiating One Time Settlement with the banks.

“This accounting treatment was in contravention of the provisions of applicable accounting standards, as these borrowings as well the interest payable thereon continued to be the financial liabilities of the company and were required to be accounted for as amortized cost in accordance with the requirements of Indian Accounting Standard (Ind AS) 109, Financial Instruments (Ind AS 109). Full details of the NFRA's Disciplinary Order in the above referred case of CA Som Prakash Aggarwal are available on NFRA website,” the NFRA said.

The company's discontinuation of the recognition of accrual of interest while calculating the amortized cost of the borrowings was in violation of Effective Interest Method (EIM) and Effective Interest Rate (EIR) principles and concepts underpinning the Amortised Cost measurement. In the above case, the Statutory auditor who was required to identify and question the company on this change in accounting treatment failed to do so and report this critical non-compliance to the shareholders.

Noting that the banks do discontinue, in their accounts, the recognition of interest income on the assets classified as NPAs based on prudential guidelines of RBI, the NFRA stated that “However, these guidelines also require the banks to maintain a Memorandum Record of Accrued Interest on the NPAs clearly reflecting the fact that the bank has not legally released the borrowers from their contractualliability to pay interest on their borrowings from the bank. This is the case even when the bank writes off loans for accounting purposes (called Technical Write-off) but continues to maintain memorandum records for pursuing its legal proceedings for recovery of its dues from the borrower.”

“In this connection it is pertinent to bear in mind the prudent and stringent principles of Ind AS 109 for the derecognition of any financial liability or part of it. Para 3.3.1 of Ind As 109 explicitly requires that financial liability shall be removed from the Balance Sheet when, and only when, it is extinguished. Para B3.3.1 further states that financial liability is extinguished only when the borrower is legally released from primary responsibility for the liability (or part of it) either by process of law or by the creditor. In the present case, the banks had not released the company from the liability of the borrowing as well as the interest,” the NFRA said.

“In view of the above reasons, discontinuation of interest expense recognition on financial liability solely based on the borrowing company's expectations of loan/interest waiver/concession without evidence of the legally enforceable contractual documents results in major non-compliance with the applicable accounting standards, compliance with which is mandated by the Act. In this regard, all concerned may also note the use of the word "shall" in the language of the hid AS, emphasizing their mandatory nature,” the NFRA circular added.

“Accordingly, all companies which are required to follow Ind AS and their audit committees are hereby advised not to discontinue recognition of the principal or interest merely because of the borrowings being declared NPA or the Management's expectation of a likely settlement with or without concessions from the banks. The auditors are required to ensure strict compliance with this circular while performing audits,” it said.

To Read the full text of the Order CLICK HERE

Support our journalism by subscribing to TaxscanPremium. Follow us on Telegram for quick updates.