Bill discounting — hazy picture in the books

Sellers/ exporters (the drawer) generally use bill discounting facilities, which is one of the modes of advances commercial banks use. It is a financial facility granted against realisable book debt. According to the Companies Act, the expression ‘temporary loans’ means “loans repayable on demand within six months from the date of the loan, such as short-term cash credit arrangements, the discounting of bills and issue of other short-term loans of a seasonal character…”

Although the term “bill purchased” seems to imply that the bank becomes the purchaser/ owner of such bills, in almost all cases it will be seen that the bank holds the bills (even if they are endorsed in its favour) only as security for the advance. In other words, the banker will have recourse over the drawer of the bill, should the drawee (buyer) not fulfil his commitment.

The question is how to account for bills discounted? Should the seller credit sundry debtors with the proceeds from discounting bills with banks, and show the outstanding amounts at the balance sheet date as a contingent liability? Or, should the seller reflect the debtors at the gross amount and the amount received from banks on bill discounting as “loans from banks”?

The Expert Advisory Committee has reflected on this in the past, but not recently. It had opined that sundry debtors should be credited with the proceeds from the bank, and the bill discounting fact should be reflected through a contingent liability note (primarily arising out of the requirement in the pre-revised schedule VI).

The committee felt it was not correct to reflect bill discounted as loan because it represented a contingent liability, as their dishonour by the drawee, though possible, is not considered probable due to an implied or written prior agreement by the buyer to pay through a bank.

The committee relied on the definition of ‘contingent liability’ in Eric Kohler’s dictionary for accountants: “an obligation, relating to a past transaction or other event or condition that may arise in consequence of a future event now deemed possible but not probable”. It also relied on the definition of contingency in AS-4 Contingencies and Events Occurring After the Balance Sheet Date: “a condition or situation, the ultimate outcome of which, gain or loss, will be known or determined only on the occurrence, or non-occurrence of one or more uncertain future events.”

It felt that bills discounted with a bank, even if covered by an irrevocable letter of credit or bank guarantee of the drawee’s bank, should be disclosed as a contingent liability, because the seller would be liable to the bank if the buyer who has accepted the bills fails to pay the bank. The fact that the seller would be able to recover the amount from the guarantors is of secondary significance.

The panel did not buy the argument that the financial statements will not reflect true and fair view if bills discounted were not presented as loans from banks. It felt that disclosure through a contingent liability note adequately brings to the notice of the users of financial statements the existence of the facility, thereby mitigating that risk.

Interestingly, it also accepted as an alternative view the practice of disclosing sundry debtors at the gross amount and the amounts received on discounting bills as loans received. Given this flip-flop, the practice followed by Indian companies is mixed.

AS30, Financial Instruments: Recognition and Measurement is clearer on this matter, but is, unfortunately, not yet mandatory. AS30 does not permit de-recognition when the entity has substantially all the risks and rewards of ownership. One such example provided in the standard is a sale of short-term receivables in which the entity guarantees to compensate the transferee for likely credit losses. In the case of bills discounted, where the banker has full recourse to the seller and can proceed against him if the buyer does not fulfil his commitment, the de-recognition requirements are not met and, consequently, sundry debtors will be reflected at gross amounts and monies received on bills discounted will be presented as loans from banks.

The standard setters should try and resolve this anomaly soon. One way is to make the standards on financial instruments mandatory. The requirement set out in AS30 will better reflect the true and fair view of the entity’s financial position.

Dolphy D’Souza is Partner and National Leader, IFRS Services in a member firm of Ernst & Young Global

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