NFRA warns auditors against non-accrual of interest on NPA borrowings

Mere classification of a firm's loans as NPAs by lender banks does not relieve the borrower from its liability towards payment of interest or the principal, the authority says

The National Financial Reporting Authority has cautioned companies and auditors against non-accrual of interest on borrowings declared NPA by banks or for which the company is negotiating a one-time settlement.

“Mere classification of the company’s loans as NPAs by the lender banks does not relieve the borrowing firm from its liability towards payment of interest or the principal,” NFRA said.

The issue had come to NFRA’s attention during the proceedings of professional misconduct by the statutory auditor of Vikas WSP Ltd. The authority has observed similar violations in respect of many other companies too.

“The company’s discontinuation of recognition of accrual of interest while calculating the authorised cost of borrowing was in violation of effective interest rate method and effective interest rate principles and concepts underpinning the amortised cost measurement,” a circular issued by NFRA said.

The financial reporting authority said that banks do discontinue the recognition of interest income on the assets classified as NPA in their accounts. However, it said that RBI guidelines still require the banks to maintain a memorandum record of accrued interest on the NPAs. This, NFRA said, reflects that the bank has not legally released the borrowers from their contractual liability to pay interest on their borrowings.

Such discontinuation of interest expense recognition solely based on the company's expectation of a loan waiver or concession without legally enforceable contractual documents is a major non compliance with accounting standards, NFRA said. This practice results in incorrect and erroneous presentation of financial performance and financial position of the borrowing company to its shareholders, investors, creditors and lenders.  

“The auditors are required to ensure strict compliance with this circular while performing audits,” NFRA said. 

THE ISSUE

• The directive comes against the backdrop of instances of firms discontinuing accrual/recognition of interest expense on bank borrowings
• Says such an accounting treatment is in contravention of the provisions of applicable Indian Accounting Standard
• Violations with respect to recognising interest expenses on borrowing has been observed by the regulator with respect to several companies
• NFRA issues circular to draw the attention of all companies, audit committees, and statutory auditors