1. CHEMBUR C.A.STUDY CIRCLE OF WESTERN INDIA REGIONAL COUNCIL OF THE INSTITUTE OF CHARTERED ACCOUNTANTS OF INDIA Sunday, 1 st April 2001 ASSET CLASSIFICATION, INCOME RECOGNITION & PROVISIONING by Vipul Choksi Chartered Accountant 1

2. INCOME RECOGNITION & ASSET CLASSIFICATION Back groundBack ground ConceptConcept Some important aspects relating to NPASome important aspects relating to NPA Provisioning NormsProvisioning Norms Some IssuesSome Issues2

3. BACK GROUND Earlier system lacked transparency & uniformity.Earlier system lacked transparency & uniformity. New Asset Classification & Provisioning norms applicable from year ended 31-3-1993.New Asset Classification & Provisioning norms applicable from year ended 31-3-1993. Uniform & consistent application of normsUniform & consistent application of norms Income is recognised on realisation basisIncome is recognised on realisation basis Financial statements more realistic & transparentFinancial statements more realistic & transparent Financial discipline & Accountability of Banks.Financial discipline & Accountability of Banks.3

4. CONCEPT STANDARD ASSET OR PERFORMING ASSET.STANDARD ASSET OR PERFORMING ASSET. i) Does not disclose any problem. ii) Generates income for the bank. iii) Does not carry more than normal risk attached to business.. NON PERFORMING ASSET (NPA)NON PERFORMING ASSET (NPA) i) Does not generate income. ii) Have credit weakness. Step 1 - Identification of the Account as NPA.  Step 1 - Identification of the Account as NPA.  Step 2 - Classify the account into substandard, doubtful or loss asset. or loss asset. 4

5. IDENTIFICATION OF ACCOUNT AS NPA a) Term Loans :- Interest and/or Instalment remains ‘overdue’ for a period of more than 180 days. i) Change in criteria from two quarters to more than 180 days. ii)Concept of ‘past due’ done away with (cir dt.10.10.2000) ii)Concept of ‘past due’ done away with (cir dt.10.10.2000) Exceptions / some issues.  Where moratorium is available ( Cir. dt. 17.12.1992)  Reschedulement of term loan before commencement of production.  Reschedulement after commencement of commercial production can be classified as Standard Asset(Cir.dt.10.5.1999) 5

6. b) Cash Credits and Overdrafts : The account remains out of order for a period of more than 180 days.(earlier for six months) The account remains out of order for a period of more than 180 days.(earlier for six months) Criteria : Outstanding balance is continuously in excess of sanctioned limit /drawing power. OR There are no credits continuously for six months as on the date of balance sheet. OR Credits not enough to cover the interest debited during the period. Exception : Account need not be classified as NPA merely due to existence of temporary deficiencies. (Cir. dt. 29.01.1997) 6 IDENTIFICATION OF ACCOUNT AS NPA (Cont’d)

7. c) Bills Purchased / Discounted : Remains over due for a period of more than 180 days from the due date of the bill(earlier 2 quarters) d) Other Accounts : If the amount to be received remains over due for a period of more than 180 days. e.g. Demand loan,, L.C. forced loan, invoked guarantees, o/s in Credit Card operation. (Cir. dt. 30.03.1999) Debit balance in S.B. A/c, Current A/c. e) Agricultural Advances :.(Cir dt. 04.03.1998) If interest and/or instalment of principal remains over due for two harvest season but not exceeding two half years Exception : (Cir. dt. 29.12.1998) Agricultural loan affected by natural calamities. 7 IDENTIFICATION OF ACCOUNT AS NPA (Cont’d)

8. f) Advance secured against term deposits, NSC, KVP, IVP, & LIP. :  Need not be treated as NPA.  Income recognised if sufficient margin available. g) Credit facilities backed by Govt. of India, State Govt. :  Though overdue should not be treated as NPA.(Cir dt. 17.12.1992)  Exemption only for asset classification not for recognition of income. (Cir dt. 24.11.1993) Amendment : (Cir dt. 31.10.1998) Amendment : (Cir dt. 31.10.1998) Provisioning norms have been introduced in respect of advances guaranteed by STATE GOVT., where guarantee has been invoked and has remained in default for two quarters. 8 IDENTIFICATION OF ACCOUNT AS NPA (Cont’d)

9. SOME IMPORATANT ASPECTS RELATING TO NPA  Account need not be treated as NPA if regularised before the balance sheet date through genuine sources. (Cir dt. 29.01.1997)  If one facility is classified as NPA all the facilities should be classified as such. (Cir dt. 17.12.1992) Exception : Exception : Credit facility to Primary Agricultural Credit Societies (PACS) and Farmers Service Societies (FSS). (Cir dt. 21.10.1999)  In case of Consortium advances facility should be classified as NPA on the basis of record of recovery of the branch. (Cir dt. 29.01.1997)  In case of sub-limits classification of facility as per classification by the main branch. 9

10.  Provision need not be made for a period of one year from the date of disbursement in respect of of additional facilities granted under rehabilitation package approved by : (i) BIFR / Term Lending Institutions (Cir dt. 03.04.1995) (ii)Bank/Consortium to SSI units (Cir dt.24-4-2000)  Delay in payment due to political risk in respect of export project finance,relaxation in application of NPA norms.(Cir.dt.7.2.2000)  If an account is classified as NPA for year ended 31.03.2001 then reverse unrealised interest of earlier year. (Cir dt. 03.04.1995)  Partial recovery in NPA could be taken to income if credits are not out of fresh / additional credit facilities. (Cir dt. 03.04.1995) 10 SOME IMPORATANT ASPECTS RELATING TO NPA (Cont’d)

11. CLASSIFICATION OF ASSET 1. Substandard Asset :  Classified as NPA for a period not exceeding 18 months.  Classification of renegotiated or rescheduled accounts should not be upgraded for one year [Earlier two years] (Cir dt. 27.04.1992 / 24.04.1999) Exception: Potential threat of recovery. (Cir dt. 29.01.1997) 2. Doubtful Asset : Account remains as NPA for a period exceeding 18 months. 3. Loss Asset :  Account where loss has been identified by the bank, external or internal auditors or RBI inspectors as wholly irrecoverable. 11

12. PROVISIONING NORMS STANDARD ASSETS : General provision of 0.25% of balance outstanding. (Cir dt. 31.10.1998) SUB-STANDARD ASSETS : General provision of 10% of balance outstandings. DOUBTFUL ASSETS : 100% of unsecured portion after considering the realisable value of security which should be realistic..100% of unsecured portion after considering the realisable value of security which should be realistic.. In addition to above on secured portion on the following basis: In addition to above on secured portion on the following basis: - Upto 1 year 20% - 1 to 3 years 30% - more than 3 years 50% Provision on account which has become doubtful due to reduction in period of sub-standard asset to be distributed over two years Provision on account which has become doubtful due to reduction in period of sub-standard asset to be distributed over two years LOSS ASSETS: 100% of balance outstanding. 12

13. SOME ISSUES Verify Control ReturnsVerify Control Returns Verify the date of NPA from earlier year statement carefully.Verify the date of NPA from earlier year statement carefully. Borrower has not submitted stock / book debts statement for past six months whether last stock statement available on record should be considered while valuing the security.Borrower has not submitted stock / book debts statement for past six months whether last stock statement available on record should be considered while valuing the security. Loan granted for purchase of premises which in turn is let out to bank. Rent is credited to the account of the borrower every month which is enough to service interest only.Loan granted for purchase of premises which in turn is let out to bank. Rent is credited to the account of the borrower every month which is enough to service interest only.13

14. (i)How to classify an account where payment is stipulated by way of EMI(i)How to classify an account where payment is stipulated by way of EMI (ii)Appropriation of recovered amount where payment is stipulated by way of EMI. (ii)Appropriation of recovered amount where payment is stipulated by way of EMI. Valuation report in respect of immovable and movable property not available.Valuation report in respect of immovable and movable property not available. Documents in respect of assets hypothecated / mortgaged incomplete.Documents in respect of assets hypothecated / mortgaged incomplete. Evergreening.Evergreening.14 SOME ISSUES (Cont’d)

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