1.11 - Query

Accounting Treatment of Liability for Deferred
Payments.

A.B.C. Ltd. entered into an Agreement with Messrs X.Y.Z., a foreign company, by which Messrs X.Y.Z. agreed to supply machinery of a value of Rs. 230 lakhs. Out of this sum of Rs. 230 lakhs, a sum of Rs. 30 lakhs was paid by Messrs L.M.N., another foreign company, to Messrs X.Y.Z. for which A.B.C. Ltd. have issued equity shares of a value of Rs.30,00,000/- to Messrs L.M.N. The balance of Rs. 200 lakhs is to be paid on deferred payment basis in ten half-yearly installments of Rs. 20 lakhs each, the first of which is to commence nine months from the last date of shipment. On these installments interest is payable every half-yearly @ 6% per annum. A financial company guaranteed the installments of the deferred payments as well as interest thereon totalling Rs. 236 lakhs.

In accordance with the above, the company opened documentary letters of credit in favour of the manufacturers of machineries with whom orders were placed by Messrs X.Y.Z. The Company lodged with the Bank promissory notes in favour of the various manufacturers mentioning the dates on which monies are payable and the amounts payable on the various dates.

Messrs X.Y.Z. completed their shipment of machineries; the last shipment was made on 26-9-1963. The Promissory notes with the dates of payment duly mentioned on them and countersigned by the financial company have been transmitted to the foreign country. A statement giving dates of payment of the installments and interest is attached.

The Company is following the calendar years; and as on 31.12.1963, the entire sum of Rs.200 lakhs as also the interest totaling Rs. 36 lakhs would be outstanding as neither the first installment of principal nor interest is due for payment on the date. In the books of the Company, the asset account has been debited with the sum of Rs. 200 lakhs and an account styled “Liabilities on account of deferred payments” has been credited with this sum.

Part I Schedule VI of the Companies Act, 1956, does not provide a separate heading for showing these deferred payments. The following questions are therefore submitted for the opinion of the Committee:

(a) What is the proper major heading under the Liabilities side of the Balance Sheet under which the deferred payments are to be shown?

(b) Is the total interest of Rs. 36 lakhs to be capitalized and shown as outstanding on 31.12.1963 or should it be capitalized as and when installments of interest fall due for payment? In case the entire interest of Rs. 36 lakhs is to be shown as outstanding on 31-12-1963, what is the proper heading under which it should be shown in the Balance Sheet as on 31-12-1963?



A.B.C. LIMITED

Statement giving dates of payments of installments of deferred amount of Rs. 200 lakhs and interest thereon to the various manufacturers nominated by Messrs X.Y.Z.


A M O U N T
Date of Payment
Principal
Interest
26.3.1964
--
45,000
26.6.1964
1,50,000
--
26.9.1964
--
42,750
26.12.1964
1,50,000
--
26.3.1965
--
38,250
26.6.1965
1,50,000
--
26.9.1965
--
33,750
26.12.1965
1,50,000
--
26.3.1966
--
29,250
26.6.1966
1,50,000
--
26.9.1966
--
24,750
26.12.1966
1,50,000
--
26.3.1967
--
20,250
26.6.1967
1,50,000
--
26.9.1967
--
15,750
26.12.1967
1,50,000
--
26.3.1968
--
11,250
26.6.1968
1,50,000
--
26.9.1968
--
6,750
26.12.1968
1,50,000
2,250
Total £
________
15,00,000
_______
2,70,000

(All figures in Pound Sterling)




Opinion

April 18,1964

(a) In the view of the Committee, since the liability for deferred payments for the machinery purchased is not due for payment within one year from the date of the Balance Sheet, it should not be shown under the main head “CURRENT LIABILITIES AND PROVISIONS” on the Liabilities side of the Balance Sheet. Such amounts could be shown under the head “UNSECURED LOANS”, under the sub-heading “Other Loans and Advances : (b) From others,” (numbered as item 4(b) in the prescribed Form set out in Part I of Schedule VI of the Companies Act, 1956). Alternatively, if the amount is sufficiently material, as apparently it is in the present case, there should be no objection to it being shown under a separate main heading “LIABILITY FOR DEFERRED PAYMENTS FOR MACHINERY PURCHASED”, which could be inserted in the Balance Sheet between the main headings “UNSECURED LOANS” and “CURRENT LIABILITIES AND PROVISIONS”.

(b) The second question raised is whether the total interest of Rs. 36 lakhs should be capitalized and shown as outstanding on 31st December, 1963 or whether it should be capitalized as and when installments of interest fall due for payment.

The answer to this question, in the Committee’s opinion, is that only that part of the Interest which accrued from 26th September, 1963, (the date of the last shipment) to 31st December, 1963, (the Balance Sheet date) need be provided in the Accounts for 1963 under debit to Interest Account, the corresponding credit appearing in the Balance Sheet under the sub-heading “Interest accrued but not due on Loans” under the main head “CURRENT LIABILITIES AND PROVISIONS”. The Committee is of the opinion that capitalization of interest for periods falling after the machinery is installed and ready for use would not be justifiable on accounting principles.