Unit 4: Income Recognition, Classification of Assets & Provisions: Notes | Advanced Accounting for CA Intermediate PDF Download

 Page 1


  
8.40 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 4: INCOME RECOGNITION, CLASSIFICATION  
OF ASSETS AND PROVISIONS 
 
 
In this unit, you will be able to:  
? Determine the profit/loss of a bank which is determined by 
the income recognition policy. Learn the technique of income 
recognition followed by a bank. 
? Classify advances of a Bank according to the riskiness i.e. 
standard assets, sub-standard assets, doubtful assets, and 
loss assets. Try to understand the definitions of various 
categories and also follow Illustration given in the chapter to 
learn. 
? Create adequate provision against sub-standard, doubtful 
and loss assets. This helps to find out the bank profit in a 
conservative manner. Reserve Bank (RBI) has issued 
guidelines stating the rates to be followed for making such 
provision.  
? Make provision for depreciation on their current investments. 
Learn how to classify investments into permanent and current 
and also follow the 
  
Page 2


  
8.40 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 4: INCOME RECOGNITION, CLASSIFICATION  
OF ASSETS AND PROVISIONS 
 
 
In this unit, you will be able to:  
? Determine the profit/loss of a bank which is determined by 
the income recognition policy. Learn the technique of income 
recognition followed by a bank. 
? Classify advances of a Bank according to the riskiness i.e. 
standard assets, sub-standard assets, doubtful assets, and 
loss assets. Try to understand the definitions of various 
categories and also follow Illustration given in the chapter to 
learn. 
? Create adequate provision against sub-standard, doubtful 
and loss assets. This helps to find out the bank profit in a 
conservative manner. Reserve Bank (RBI) has issued 
guidelines stating the rates to be followed for making such 
provision.  
? Make provision for depreciation on their current investments. 
Learn how to classify investments into permanent and current 
and also follow the 
  
 
 
 8.41 
 
BANKING COMPANIES 
 4.1 INCOME RECOGNITION 
Bulk of a banks’ income is from two sources:- 
1. Interest earned on Loans & Advances extended to its customers. 
2. Discount and commission earned handling Bills of Exchange and Non-Funded 
advances like Letter of Credit (LC), Letter of Guarantee (LG) etc. 
In this unit Income recognition from Loans & Advances will be dealt with and in the 
next unit Income from Bills/LCs’/LGs’ will be taken up. 
Income recognition for interest earned is a function of classification of the Bank 
loans & advances (i.e. its Assets into Performing & Non-Performing Assets (NPA’s)). 
For Performing assets income is recognised as it is earned i.e. accrued. It is an 
essential condition for accrual of income that it should not be unreasonable to 
expect its ultimate collection. For Non-Performing assets interest income is not 
considered on accrual basis and it is recognised only when it is actually received. 
Basically an NPA is a bad and doubtful debt. 
An asset becomes non-performing when the bank does not receive income from it 
for a certain period. In concept, any credit facility (assets) becomes non-performing 
“when it ceases to generate income for a bank.”   
Income from non-performing assets can only be accounted for as and when it is 
actually received.The Accounting Standard 9 (AS 9) on ‘Revenue Recognition' 
issued by the Institute of Chartered Accountants of India (ICAI) requires that the 
revenue that arises from the use, by others, of enterprise resources yielding interest 
should be recognized only when there is no significant uncertainty as to its 
measurability or collectability.   
Illustration 1 
Given below are the interests on advances of a commercial bank ( ` in lakhs) 
  Performing Assets NPA 
 Interest Interest Interest Interest 
 earned received earned received 
Term Loans 120 80 75 5 
Cash credits and overdrafts 750 620 150 12 
Bills purchased and discounted 150 150 100 20 
Find out the income to be recognized for the year ended 31st March, 20X1. 
Page 3


  
8.40 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 4: INCOME RECOGNITION, CLASSIFICATION  
OF ASSETS AND PROVISIONS 
 
 
In this unit, you will be able to:  
? Determine the profit/loss of a bank which is determined by 
the income recognition policy. Learn the technique of income 
recognition followed by a bank. 
? Classify advances of a Bank according to the riskiness i.e. 
standard assets, sub-standard assets, doubtful assets, and 
loss assets. Try to understand the definitions of various 
categories and also follow Illustration given in the chapter to 
learn. 
? Create adequate provision against sub-standard, doubtful 
and loss assets. This helps to find out the bank profit in a 
conservative manner. Reserve Bank (RBI) has issued 
guidelines stating the rates to be followed for making such 
provision.  
? Make provision for depreciation on their current investments. 
Learn how to classify investments into permanent and current 
and also follow the 
  
 
 
 8.41 
 
BANKING COMPANIES 
 4.1 INCOME RECOGNITION 
Bulk of a banks’ income is from two sources:- 
1. Interest earned on Loans & Advances extended to its customers. 
2. Discount and commission earned handling Bills of Exchange and Non-Funded 
advances like Letter of Credit (LC), Letter of Guarantee (LG) etc. 
In this unit Income recognition from Loans & Advances will be dealt with and in the 
next unit Income from Bills/LCs’/LGs’ will be taken up. 
Income recognition for interest earned is a function of classification of the Bank 
loans & advances (i.e. its Assets into Performing & Non-Performing Assets (NPA’s)). 
For Performing assets income is recognised as it is earned i.e. accrued. It is an 
essential condition for accrual of income that it should not be unreasonable to 
expect its ultimate collection. For Non-Performing assets interest income is not 
considered on accrual basis and it is recognised only when it is actually received. 
Basically an NPA is a bad and doubtful debt. 
An asset becomes non-performing when the bank does not receive income from it 
for a certain period. In concept, any credit facility (assets) becomes non-performing 
“when it ceases to generate income for a bank.”   
Income from non-performing assets can only be accounted for as and when it is 
actually received.The Accounting Standard 9 (AS 9) on ‘Revenue Recognition' 
issued by the Institute of Chartered Accountants of India (ICAI) requires that the 
revenue that arises from the use, by others, of enterprise resources yielding interest 
should be recognized only when there is no significant uncertainty as to its 
measurability or collectability.   
Illustration 1 
Given below are the interests on advances of a commercial bank ( ` in lakhs) 
  Performing Assets NPA 
 Interest Interest Interest Interest 
 earned received earned received 
Term Loans 120 80 75 5 
Cash credits and overdrafts 750 620 150 12 
Bills purchased and discounted 150 150 100 20 
Find out the income to be recognized for the year ended 31st March, 20X1. 
  
 
8.42 ADVANCED ACCOUNTING 
Solution  
Interest on performing assets should be recognised on accrual basis, but interest 
on NPA should be recognised on cash basis. 
    ` in lakhs 
Interest on Term Loan : (120 + 5)  =  125 
Interest on cash credits and overdraft : (750 + 12) =  762 
Income from bills purchased and discounted : (150 + 20) =  170 
    1,057 
Illustration 2 
Find out the income to be recognized in the case of SS Bank for the year ended  
31st March, 20X1: 
   
      (` in lakhs) 
 Performing Assets  Non-performing Assets 
 Interest 
accrued 
Interest 
received 
Interest 
accrued 
Interest 
received 
Term loans  240  160  150  10 
Cash credits and overdrafts 1,500  1,240  300  24 
Solution 
Calculation of interest income of SS Bank to be recognized for the year ended 
31.3.20X1 
 (` in lacs) 
Term Loan   
Interest accrued on Performing Assets  240  
Interest received on Non - Performing Assets 10  250 
Cash credit and overdraft   
Interest accrued on Performing Assets  1,500  
Interest received on Non - Performing Assets  24  1,524 
Total interest to be recognized  1,774 
Identification of NPA 
The Reserve Bank of India has issued detailed guidelines to banks regarding the 
Page 4


  
8.40 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 4: INCOME RECOGNITION, CLASSIFICATION  
OF ASSETS AND PROVISIONS 
 
 
In this unit, you will be able to:  
? Determine the profit/loss of a bank which is determined by 
the income recognition policy. Learn the technique of income 
recognition followed by a bank. 
? Classify advances of a Bank according to the riskiness i.e. 
standard assets, sub-standard assets, doubtful assets, and 
loss assets. Try to understand the definitions of various 
categories and also follow Illustration given in the chapter to 
learn. 
? Create adequate provision against sub-standard, doubtful 
and loss assets. This helps to find out the bank profit in a 
conservative manner. Reserve Bank (RBI) has issued 
guidelines stating the rates to be followed for making such 
provision.  
? Make provision for depreciation on their current investments. 
Learn how to classify investments into permanent and current 
and also follow the 
  
 
 
 8.41 
 
BANKING COMPANIES 
 4.1 INCOME RECOGNITION 
Bulk of a banks’ income is from two sources:- 
1. Interest earned on Loans & Advances extended to its customers. 
2. Discount and commission earned handling Bills of Exchange and Non-Funded 
advances like Letter of Credit (LC), Letter of Guarantee (LG) etc. 
In this unit Income recognition from Loans & Advances will be dealt with and in the 
next unit Income from Bills/LCs’/LGs’ will be taken up. 
Income recognition for interest earned is a function of classification of the Bank 
loans & advances (i.e. its Assets into Performing & Non-Performing Assets (NPA’s)). 
For Performing assets income is recognised as it is earned i.e. accrued. It is an 
essential condition for accrual of income that it should not be unreasonable to 
expect its ultimate collection. For Non-Performing assets interest income is not 
considered on accrual basis and it is recognised only when it is actually received. 
Basically an NPA is a bad and doubtful debt. 
An asset becomes non-performing when the bank does not receive income from it 
for a certain period. In concept, any credit facility (assets) becomes non-performing 
“when it ceases to generate income for a bank.”   
Income from non-performing assets can only be accounted for as and when it is 
actually received.The Accounting Standard 9 (AS 9) on ‘Revenue Recognition' 
issued by the Institute of Chartered Accountants of India (ICAI) requires that the 
revenue that arises from the use, by others, of enterprise resources yielding interest 
should be recognized only when there is no significant uncertainty as to its 
measurability or collectability.   
Illustration 1 
Given below are the interests on advances of a commercial bank ( ` in lakhs) 
  Performing Assets NPA 
 Interest Interest Interest Interest 
 earned received earned received 
Term Loans 120 80 75 5 
Cash credits and overdrafts 750 620 150 12 
Bills purchased and discounted 150 150 100 20 
Find out the income to be recognized for the year ended 31st March, 20X1. 
  
 
8.42 ADVANCED ACCOUNTING 
Solution  
Interest on performing assets should be recognised on accrual basis, but interest 
on NPA should be recognised on cash basis. 
    ` in lakhs 
Interest on Term Loan : (120 + 5)  =  125 
Interest on cash credits and overdraft : (750 + 12) =  762 
Income from bills purchased and discounted : (150 + 20) =  170 
    1,057 
Illustration 2 
Find out the income to be recognized in the case of SS Bank for the year ended  
31st March, 20X1: 
   
      (` in lakhs) 
 Performing Assets  Non-performing Assets 
 Interest 
accrued 
Interest 
received 
Interest 
accrued 
Interest 
received 
Term loans  240  160  150  10 
Cash credits and overdrafts 1,500  1,240  300  24 
Solution 
Calculation of interest income of SS Bank to be recognized for the year ended 
31.3.20X1 
 (` in lacs) 
Term Loan   
Interest accrued on Performing Assets  240  
Interest received on Non - Performing Assets 10  250 
Cash credit and overdraft   
Interest accrued on Performing Assets  1,500  
Interest received on Non - Performing Assets  24  1,524 
Total interest to be recognized  1,774 
Identification of NPA 
The Reserve Bank of India has issued detailed guidelines to banks regarding the 
 
 
 8.43 
 
BANKING COMPANIES 
classification of advances between performing and non-performing assets which 
are revised from time to time. The latest guidelines for identifying an NPA’s are: 
1. Bills purchased and discounted become NPA if interest and / or instalment 
of principal remain overdue for a period exceeding 90 days. 
2. Term Loans: become NPA if their amount (interest or principal) remain 
overdue wholly or partly for a period exceeding 90 days. 
3. A cash credit / overdraft account is treated as NPA if it becomes out of 
order. An account is deemed to be out of order if the outstanding balance remains 
continuously in excess of the sanctioned borrowing power or though the 
outstanding balance remains below the sanctioned borrowing power, there have 
been no credits in the account for a continuous period of more than 90 days prior 
to the Balance Sheet date or where the credits have not been enough to cover the 
interest debited during the same period. Therefore, an account is treated as 'out 
of order' if any of the following conditions are satisfied: 
(a) The outstanding balance remains continuously in excess of the sanctioned 
limit/drawing power for a continuous period of 90 days prior to the Balance 
Sheet date.  
(b) Though the outstanding balance is less than the sanctioned limit/drawing 
power – 
(i) there have been no credits for a continuous period of more than 90 
days prior to the date of balance sheet; or 
(ii) credits during the aforesaid period are not enough to cover the interest 
debited during the same period. 
c)  Further any amount due to the bank under any credit facility is ‘overdue’ if it 
is not paid on the due date fixed by the bank. 
Example of OUT OF ORDER 
Sanctioned limit  ` 60,00,000 
Drawing power ` 55,00,000 
Amount outstanding continuously from 1.01.20X1 to 31.03.20X1 ` 47,00,000 
Total interest debited  ` 3,42,000 
Total credits            ` 1,25,000 
 
Page 5


  
8.40 ADVANCED ACCOUNTING 
 
LEARNING OUTCOMES 
UNIT 4: INCOME RECOGNITION, CLASSIFICATION  
OF ASSETS AND PROVISIONS 
 
 
In this unit, you will be able to:  
? Determine the profit/loss of a bank which is determined by 
the income recognition policy. Learn the technique of income 
recognition followed by a bank. 
? Classify advances of a Bank according to the riskiness i.e. 
standard assets, sub-standard assets, doubtful assets, and 
loss assets. Try to understand the definitions of various 
categories and also follow Illustration given in the chapter to 
learn. 
? Create adequate provision against sub-standard, doubtful 
and loss assets. This helps to find out the bank profit in a 
conservative manner. Reserve Bank (RBI) has issued 
guidelines stating the rates to be followed for making such 
provision.  
? Make provision for depreciation on their current investments. 
Learn how to classify investments into permanent and current 
and also follow the 
  
 
 
 8.41 
 
BANKING COMPANIES 
 4.1 INCOME RECOGNITION 
Bulk of a banks’ income is from two sources:- 
1. Interest earned on Loans & Advances extended to its customers. 
2. Discount and commission earned handling Bills of Exchange and Non-Funded 
advances like Letter of Credit (LC), Letter of Guarantee (LG) etc. 
In this unit Income recognition from Loans & Advances will be dealt with and in the 
next unit Income from Bills/LCs’/LGs’ will be taken up. 
Income recognition for interest earned is a function of classification of the Bank 
loans & advances (i.e. its Assets into Performing & Non-Performing Assets (NPA’s)). 
For Performing assets income is recognised as it is earned i.e. accrued. It is an 
essential condition for accrual of income that it should not be unreasonable to 
expect its ultimate collection. For Non-Performing assets interest income is not 
considered on accrual basis and it is recognised only when it is actually received. 
Basically an NPA is a bad and doubtful debt. 
An asset becomes non-performing when the bank does not receive income from it 
for a certain period. In concept, any credit facility (assets) becomes non-performing 
“when it ceases to generate income for a bank.”   
Income from non-performing assets can only be accounted for as and when it is 
actually received.The Accounting Standard 9 (AS 9) on ‘Revenue Recognition' 
issued by the Institute of Chartered Accountants of India (ICAI) requires that the 
revenue that arises from the use, by others, of enterprise resources yielding interest 
should be recognized only when there is no significant uncertainty as to its 
measurability or collectability.   
Illustration 1 
Given below are the interests on advances of a commercial bank ( ` in lakhs) 
  Performing Assets NPA 
 Interest Interest Interest Interest 
 earned received earned received 
Term Loans 120 80 75 5 
Cash credits and overdrafts 750 620 150 12 
Bills purchased and discounted 150 150 100 20 
Find out the income to be recognized for the year ended 31st March, 20X1. 
  
 
8.42 ADVANCED ACCOUNTING 
Solution  
Interest on performing assets should be recognised on accrual basis, but interest 
on NPA should be recognised on cash basis. 
    ` in lakhs 
Interest on Term Loan : (120 + 5)  =  125 
Interest on cash credits and overdraft : (750 + 12) =  762 
Income from bills purchased and discounted : (150 + 20) =  170 
    1,057 
Illustration 2 
Find out the income to be recognized in the case of SS Bank for the year ended  
31st March, 20X1: 
   
      (` in lakhs) 
 Performing Assets  Non-performing Assets 
 Interest 
accrued 
Interest 
received 
Interest 
accrued 
Interest 
received 
Term loans  240  160  150  10 
Cash credits and overdrafts 1,500  1,240  300  24 
Solution 
Calculation of interest income of SS Bank to be recognized for the year ended 
31.3.20X1 
 (` in lacs) 
Term Loan   
Interest accrued on Performing Assets  240  
Interest received on Non - Performing Assets 10  250 
Cash credit and overdraft   
Interest accrued on Performing Assets  1,500  
Interest received on Non - Performing Assets  24  1,524 
Total interest to be recognized  1,774 
Identification of NPA 
The Reserve Bank of India has issued detailed guidelines to banks regarding the 
 
 
 8.43 
 
BANKING COMPANIES 
classification of advances between performing and non-performing assets which 
are revised from time to time. The latest guidelines for identifying an NPA’s are: 
1. Bills purchased and discounted become NPA if interest and / or instalment 
of principal remain overdue for a period exceeding 90 days. 
2. Term Loans: become NPA if their amount (interest or principal) remain 
overdue wholly or partly for a period exceeding 90 days. 
3. A cash credit / overdraft account is treated as NPA if it becomes out of 
order. An account is deemed to be out of order if the outstanding balance remains 
continuously in excess of the sanctioned borrowing power or though the 
outstanding balance remains below the sanctioned borrowing power, there have 
been no credits in the account for a continuous period of more than 90 days prior 
to the Balance Sheet date or where the credits have not been enough to cover the 
interest debited during the same period. Therefore, an account is treated as 'out 
of order' if any of the following conditions are satisfied: 
(a) The outstanding balance remains continuously in excess of the sanctioned 
limit/drawing power for a continuous period of 90 days prior to the Balance 
Sheet date.  
(b) Though the outstanding balance is less than the sanctioned limit/drawing 
power – 
(i) there have been no credits for a continuous period of more than 90 
days prior to the date of balance sheet; or 
(ii) credits during the aforesaid period are not enough to cover the interest 
debited during the same period. 
c)  Further any amount due to the bank under any credit facility is ‘overdue’ if it 
is not paid on the due date fixed by the bank. 
Example of OUT OF ORDER 
Sanctioned limit  ` 60,00,000 
Drawing power ` 55,00,000 
Amount outstanding continuously from 1.01.20X1 to 31.03.20X1 ` 47,00,000 
Total interest debited  ` 3,42,000 
Total credits            ` 1,25,000 
 
  
 
8.44 ADVANCED ACCOUNTING 
Since the credit in the account is not sufficient to cover the interest debited during 
the period account will be said as NPA. 
4. Agricultural Advances: Advances granted for agriculture purposes becomes 
NPA if interest and/or installment of principal remains overdue for two crop 
seasons in case of short duration crops and a loan granted for long duration 
crops will be treated as NPA, if the installment of principal or interest thereon 
remains overdue for one crop season. Crops having crop season of more than one 
year i.e. upto the period of harvesting the crops raised will be termed as ‘long 
duration” crops and other crops will be treated as “short duration” crops. 
5. Securitisation transactions: Such transactions become NPA when the 
amount of liquidity facility remains overdue for more than 90 days. 
6. Derivative transactions: Such transactions become NPA when the overdue 
receivables representing positive mark to market value of a derivative contract 
remain unpaid for a period of 90 days from the specified due date for payment. 
7. Government guaranteed advances: The credit facilities backed 
by guarantee of the Central Government though overdue may be treated as NPA 
only when the Government repudiates its guarantee when invoked. This exemption 
from classification of Government guaranteed advances as NPA is not for the 
purpose of recognition of income. The requirement of invocation of guarantee 
has been delinked for deciding the asset classification and provisioning 
requirements in respect of State Government guaranteed exposures. With effect 
from the year ending 31 March 2006 State Government guaranteed advances and 
investments in State Government guaranteed securities would attract asset 
classification and provisioning norms if interest and/or principal or any other 
amount due to the bank remains overdue for more than 90 days. 
8. Advances to Staff: As in the case of project finance, in respect of housing 
loans or similar advances granted to staff members where interest is payable after 
recovery of principal, the overdue status (in respect of payment of interest) should 
be reckoned from the date when there is default in payment of interest or 
repayment of installment of principal on due date of payment. 
9. Take-out Finance: In the case of take-out finance arrangement, the lending 
bank should apply the prudential norms in the usual manner so long as the account 
remains on its banks.