BBA110 CU - Sem 2 -Bcom-BBA- Advance Accounting-converted-converted

b) Unsecured lease exposures, as defined in paragraph 5.4 above, which are identified as ‘substandard’ would attract additional provision of 10 per cent, i.e., a total of 20 per cent. ii) Doubtful assets 100 percent of the extent to which, the finance is not secured by the realisable value of the leased asset. Realisable value is to be estimated on a realistic basis. In addition to the above provision, provision at the following rates should be made on the sum of the net investment in the lease and the unrealised portion of finance income net of finance charge component of the secured portion, depending upon the period for which asset has been doubtful: Period for which the advance has Provision remained in ‘doubtful’ category requirement (%) Up to one year 20 One to three years 30 More than three years 100 iii) Loss assets The entire asset should be written off. If for any reason, an asset is allowed to remain in books, 100 percent of the sum of the net investment in the lease and the unrealised portion of finance income net of finance charge component should be provided for. Guidelines for Provisions under Special Circumstances 1 Advances granted under rehabilitation packages approved by BIFR/term lending institutions (i) In respect of advances under rehabilitation package approved by BIFR/term lending institutions, the provision should continue to be made in respect of dues to the bank on the existing credit facilities as per their classification as substandard or doubtful asset. (ii) As regards the additional facilities sanctioned as per package finalised by BIFR and/or term lending institutions, provision on additional facilities sanctioned need not be made for a period of one year from the date of disbursement. (iii) In respect of additional credit facilities granted to SSI units which are identified as sick [as defined in Section IV (Para 2.8) of RPCD circular RPCD.PLNFS.BC. No 83 /06.02.31/20042005 dated 1 March 2005] and where rehabilitation packages/nursing 150 CU IDOL SELF LEARNING MATERIAL (SLM)

programmes have been drawn by the banks themselves or under consortium arrangements, no provision need be made for a period of one year. 2 Advances against term deposits, NSCs eligible for surrender, IVPs, KVPs, gold ornaments, government & other securities and life insurance policies would attract provisioning requirements as applicable to their asset classification status. 3 Treatment of interest suspense account Amounts held in Interest Suspense Account should not be reckoned as part of provisions. Amounts lying in the Interest Suspense Account should be deducted from the relative advances and thereafter, provisioning as per the norms, should be made on the balances after such deduction. 4 Advances covered by ECGC guarantee In the case of advances classified as doubtful and guaranteed by ECGC, provision should be made only for the balance in excess of the amount guaranteed by the Corporation. Further, while arriving at the provision required to be made for doubtful assets, realisable value of the securities should first be deducted from the outstanding balance in respect of the amount guaranteed by the Corporation and then provision made as illustrated hereunder: Example Outstanding Balance Rs. 4 lakhs ECGC Cover 50 percent Period for which the advance has More than 3 years remained doubtful remained doubtful (as on March 31, 2004) Value of security held Rs. 1.50 lakhs (excludes worth of Rs.) Provision required to be made Outstanding balance Rs. 4.00 lakhs Rs. 1.50 lakhs Less: Value of security held Rs. 2.50 lakhs Cover Unrealised balance Rs. 1.25 lakhs Less: ECGC (50% of unrealisable balance) 151 CU IDOL SELF LEARNING MATERIAL (SLM)

Net unsecured balance Rs. 1.25 lakhs Provision for unsecured portion of Rs. 1.25 lakhs (@ 100 percent of advance unsecured portion) Provision for secured portion of advance Rs.0.90 lakhs (@ 60 per cent of the (as on March 31, 2005) secured portion) Total provision to be made Rs.2.15 lakhs (as on March 31, 2005) 5 Advance covered by CGTSI guarantee In case the advance covered by CGTSI guarantee becomes nonperforming, no provision need be made towards the guaranteed portion. The amount outstanding in excess of the guaranteed portion should be provided for as per the extant guidelines on provisioning for nonperforming advances. Two illustrative examples are given below: Example I Asset classification Doubtful – More than 3 years (as on March 31, 2004) status: CGTSI Cover 75% of the amount outstanding or 75% of the unsecured amount or Rs.18.75 lakh, whichever is the least Realisable value of Rs.1.50 lakh Security Balance outstanding Rs.10.00 lakh Less Realisable value of Rs. 1.50 lakh security Unsecured amount Rs. 8.50 lakh Less CGTSI cover (75%) Rs. 6.38 lakh Net unsecured and Rs. 2.12 lakh uncovered portion: Provision Required (as on March 31, 2005) Secured portion Rs.1.50 lakh Rs. 0.90 lakh (@ 60%) Unsecured & uncovered Rs.2.12 lakh Rs. 2.12 lakh (100%) portion 152 CU IDOL SELF LEARNING MATERIAL (SLM)

Total provision required Rs. 3.02 lakh Example II Asset classification Doubtful – More than 3 years (as on March 31, 2005) status CGTSI Cover 75% of the amount outstanding or 75% of the unsecured amount or Rs.18.75 lakh, whichever is the least Realisable value of Rs.10.00 lakh Security Balance outstanding Rs.40.00 lakh Less Realisable value of Rs. 10.00 lakh security Unsecured amount Rs. 30.00 lakh Less CGTSI cover (75%) Rs. 18.75 lakh Rs. 11.25 lakh Net unsecured and uncovered portion: Secured portion Rs.10.00 lakh Provision Required Unsecured & uncovered Rs.11.25 lakh (as on March 31, 2005) portion Rs. 10.00 lakh (@ 100%) Total provision required Rs.11.25 lakh (100%) Rs. 21.25 lakh 6 Takeout finance The lending institution should make provisions against a 'takeout finance' turning into NPA pending its takeover by the taking-over institution. As and when the asset is taken-over by the taking-over institution, the corresponding provisions could be reversed. 7 Reserves for Exchange Rate Fluctuations Account (RERFA) When exchange rate movements of Indian rupee turn adverse, the outstanding amount of foreign currency denominated loans (where actual disbursement was made in Indian Rupee) which becomes overdue, goes up correspondingly, with its attendant implications of provisioning 153 CU IDOL SELF LEARNING MATERIAL (SLM)

requirements. Such assets should not normally be revalued. In case such assets need to be revalued as per requirement of accounting practices or for any other requirement, the following procedure may be adopted: • The loss on revaluation of assets has to be booked in the bank’s Profit& Loss Account. • Besides the provisioning requirement as per Asset Classification, banks should treat the full amount of the Revaluation Gain relating to the corresponding assets, if any, on account of Foreign Exchange Fluctuation as provision against the particular assets. 8 Provisioning for country risk Banks shall make provisions, with effect from the year ending 31 March 2003, on the net funded country exposures on a graded scale ranging from 0.25 to 100 percent according to the risk categories mentioned below. To begin with, banks shall make provisions as per the following schedule: Risk ECGC Provisioning Requirement (per category Classification cent) Insignificant 0.25 Low A1 0.25 Moderate A2 5 High B1 20 Very high B2 25 Restricted C1 100 Off credit C2 100 D Banks are required to make provision for country risk in respect of a country where its net funded exposure is one per cent or more of its total assets. The provision for country risk shall be in addition to the provisions required to be held according to the asset classification status of the asset. In the case of ‘loss assets’ and ‘doubtful assets’, provision held, including provision held for country risk, may not exceed 100% of the outstanding. Banks may not make any provision for ‘home country’ exposures i.e. exposure to India. The exposures of foreign branches of Indian banks to the host country should be included. Foreign banks shall compute the country exposures of their Indian branches and shall hold appropriate provisions in their Indian books. However, their exposures to India will be excluded. 154 CU IDOL SELF LEARNING MATERIAL (SLM)

Banks may make a lower level of provisioning (say 25% of the requirement) in respect of short-term exposures (i.e. exposures with contractual maturity of less than 180 days). 9 Excess Provisions on sale of Standard Asset / NPAs (a) If the sale is in respect of Standard Asset and the sale consideration is higher than the book value, the excess provisions may be credited to Profit and Loss Account. (b) Excess provisions which arise on sale of NPAs can be admitted as Tier II capital subject to the overall ceiling of 1.25% of total Risk Weighted Assets. Accordingly, these excess provisions that arise on sale of NPAs would be eligible for Tier II status in terms of paragraph 4.3.2 of Master Circular DBOD.No.BP.BC.11/21.06.001/2008-09 dated July 1, 2008 on Prudential guidelines on Capital Adequacy and Market Discipline - Implementation of New Capital Adequacy Framework ( NCAF) and paragraph 2.1.1.2.C of Master Circular DBOD.No.BP.BC.2/21.01.002/2008-09 dated July 1, 2008 on Prudential Norms on Capital adequacy - Basel I Framework. 10 Provisions for Diminution of Fair Value Provisions for diminution of fair value of restructured advances, both in respect of Standard Assets as well as NPAs, made on account of reduction in rate of interest and / or reschedulement of principal amount are permitted to be netted from the relative asset. 11 Provisioning norms for Liquidity facility provided for Securitisation transactions The amount of liquidity facility drawn and outstanding for more than 90 days, in respect of securitisation transactions undertaken in terms of our guidelines on securitisation dated February 1, 2006, should be fully provided for. 12 Provisioning requirements for derivative exposures Credit exposures computed as per the current marked to market value of the contract, arising on account of the interest rate & foreign exchange derivative transactions, and gold, shall also attract provisioning requirement as applicable to the loan assets in the 'standard' category, of the concerned counterparties. All conditions applicable for treatment of the provisions for standard assets would also apply to the aforesaid provisions for derivative and gold exposures. 6. Guidelines on sale of financial assets to Securitisation Company (SC)/Reconstruction Company (RC) (created under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) and related issues Scope 155 CU IDOL SELF LEARNING MATERIAL (SLM)

These guidelines would be applicable to sale of financial assets enumerated in paragraph 6.3 below, by banks/ FIs, for asset reconstruction/ securitisation under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002. Structure The guidelines to be followed by banks/ FIs while selling their financial assets to SC/RC under the Act ibid and investing in bonds/ debentures/ security receipts offered by the SC/RC are given below. The prudential guidelines have been grouped under the following headings: i) Financial assets which can be sold. ii) Procedure for sale of banks’/ FIs’ financial assets to SC/ RC, including valuation and pricing aspects. iii) Prudential norms, in the following areas, for banks/ FIs for sale of their financial assets to SC/ RC and for investing in bonds/ debentures/ security receipts and any other securities offered by the SC/RC as compensation consequent upon sale of financial assets: a) Provisioning / Valuation norms b) Capital adequacy norms c) Exposure norms iv) Disclosure requirements Financial assets which can be sold A financial asset may be sold to the SC/RC by any bank/ FI where the asset is: i) A NPA, including a non-performing bond/ debenture, and ii) A Standard Asset where: (a) the asset is under consortium/ multiple banking arrangements, (b) at least 75% by value of the asset is classified as non-performing asset in the books of other banks/FIs, and 156 CU IDOL SELF LEARNING MATERIAL (SLM)

(c) at least 75% (by value) of the banks / FIs who are under the consortium / multiple banking arrangements agree to the sale of the asset to SC/RC. Procedure for sale of banks’/ FIs’ financial assets to SC/ RC, including valuation and pricing aspects (a) The Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act) allows acquisition of financial assets by SC/RC from any bank/ FI on such terms and conditions as may be agreed upon between them. This provides for sale of the financial assets on ‘without recourse’ basis, i.e., with the entire credit risk associated with the financial assets being transferred to SC/ RC, as well as on ‘with recourse’ basis, i.e., subject to unrealized part of the asset reverting to the seller bank/ FI. Banks/ FIs are, however, directed to ensure that the effect of the sale of the financial assets should be such that the asset is taken off the books of the bank/ FI and after the sale there should not be any known liability devolving on the banks/ FIs. (b) Banks/ FIs, which propose to sell to SC/RC their financial assets should ensure that the sale is conducted in a prudent manner in accordance with a policy approved by the Board. The Board shall lay down policies and guidelines covering, inter alia, i. Financial assets to be sold; ii. Norms and procedure for sale of such financial assets; iii. Valuation procedure to be followed to ensure that the realisable value of financial assets is reasonably estimated; iv. Delegation of powers of various functionaries for taking decision on the sale of the financial assets; etc. (c) Banks/ FIs should ensure that subsequent to sale of the financial assets to SC/RC, they do not assume any operational, legal or any other type of risks relating to the financial assets sold. (d) (i) Each bank / FI will make its own assessment of the value offered by the SC / RC for the financial asset and decide whether to accept or reject the offer. (ii) In the case of consortium / multiple banking arrangements, if 75% (by value) of the banks / FIs decide to accept the offer, the remaining banks / FIs will be obligated to accept the offer. 157 CU IDOL SELF LEARNING MATERIAL (SLM)

(iii) Under no circumstances can a transfer to the SC/ RC be made at a contingent price whereby in the event of shortfall in the realization by the SC/RC, the banks/ FIs would have to bear a part of the shortfall. (e) Banks/ FIs may receive cash or bonds or debentures as sale consideration for the financial assets sold to SC/RC. (f) Bonds/ debentures received by banks/ FIs as sale consideration towards sale of financial assets to SC/RC will be classified as investments in the books of banks/ FIs. (g) Banks may also invest in security receipts, Pass-through certificates (PTC), or other bonds/ debentures issued by SC/RC. These securities will also be classified as investments in the books of banks/ FIs. (h) In cases of specific financial assets, where it is considered necessary, banks/ FIs may enter into agreement with SC/RC to share, in an agreed proportion, any surplus realised by SC/RC on the eventual realisation of the concerned asset. In such cases the terms of sale should provide for a report from the SC/RC to the bank/ FI on the value realised from the asset. No credit for the expected profit will be taken by banks/ FIs until the profit materializes on actual sale. Prudential norms for banks/ FIs for the sale transactions (A) Provisioning/ valuation norms (a)(i) When a bank / FI sells its financial assets to SC/ RC, on transfer the same will be removed from its books. (ii) If the sale to SC/ RC is at a price below the net book value (NBV)(i.e., book value less provisions held), the shortfall should be debited to the profit and loss account of that year. (iii) If the sale is for a value higher than the NBV, the excess provision will not be reversed but will be utilized to meet the shortfall/ loss on account of sale of other financial assets to SC/RC. (iv) When banks/ FIs invest in the security receipts/ pass-through certificates issued by SC/RC in respect of the financial assets sold by them to the SC/RC, the sale shall be recognised in books of the banks / FIs at the lower of: ◘ the redemption value of the security receipts/ pass-through certificates, and ◘ the NBV of the financial asset. 158 CU IDOL SELF LEARNING MATERIAL (SLM)

The above investment should be carried in the books of the bank / FI at the price as determined above until its sale or realization, and on such sale or realization, the loss or gain must be dealt with in the same manner as at (ii) and (iii) above. (b) The securities (bonds and debentures) offered by SC / RC should satisfy the followingconditions: (i) The securities must not have a term in excess of six years. (ii) The securities must carry a rate of interest which is not lower than 1.5% above the Bank Rate in force at the time of issue. (iii) The securities must be secured by an appropriate charge on the assets transferred. (iv) The securities must provide for part or full prepayment in the event the SC / RC sells the asset securing the security before the maturity date of the security. (v) The commitment of the SC / RC to redeem the securities must be unconditional and not linked to the realization of the assets. (vi) Whenever the security is transferred to any other party, notice of transfer should be issued to the SC/ RC. (c) Investment in debentures/ bonds/ security receipts/ Pass-through certificates issued by SC/ RC All instruments received by banks/FIs from SC/RC as sale consideration for financial assets sold to them and also other instruments issued by SC/ RC in which banks/ FIs invest will be in the nature of non SLR securities. Accordingly, the valuation, classification and other norms applicable to investment in non-SLR instruments prescribed by RBI from time to time would be applicable to bank’s/ FI’s investment in debentures/ bonds/ security receipts/PTCs issued by SC/ RC. However, if any of the above instruments issued by SC/RC is limited to the actual realisation of the financial assets assigned to the instruments in the concerned scheme the bank/ FI shall reckon the Net Asset Value (NAV), obtained from SC/RC from time to time, for valuation of such investments. (B) Capital Adequacy For the purpose of capital adequacy, banks/ FIs should assign risk weights as under to the investments in debentures/ bonds/ security receipts/ PTCs issued by SC/ RC and held by banks/ FIs as investment: i) Risk weight for credit risk: 100%. 159 CU IDOL SELF LEARNING MATERIAL (SLM)

ii) Risk weight for market risk: 2.5 % Applicable risk weight = (i) + (ii) (C) Exposure Norms Banks’/ FIs’ investments in debentures/ bonds/ security receipts/PTCs issued by a SC/RC will constitute exposure on the SC/RC. As only a few SC/RC are being set up now, banks’/ FIs’ exposure on SC/RC through their investments in debentures/ bonds/security receipts/PTCs issued by the SC/ RC may go beyond their prudential exposure ceiling. In view of the extra ordinary nature of event, banks/ FIs will be allowed, in the initial years, to exceed prudential exposure ceiling on a case-to- case basis. Disclosure Requirements Banks/ FIs, which sell their financial assets to an SC/ RC, shall be required to make the following disclosures in the Notes on Accounts to their Balance sheets: Details of financial assets sold during the year to SC/RC for Asset Reconstruction a) No. of accounts b) Aggregate value (net of provisions) of accounts sold to SC / RC c) Aggregate consideration d) Additional consideration realized in respect of accounts transferred in earlier years e) Aggregate gain / loss over net book value. Related Issues (a) SC/ RC will also take over financial assets which cannot be revived and which, therefore, will have to be disposed of on a realisation basis. Normally the SC/ RC will not take over these assets but act as an agent for recovery for which it will charge a fee. (b) Where the assets fall in the above category, the assets will not be removed from the books of the bank/ FI but realisations as and when received will be credited to the asset account. Provisioning for the asset will continue to be made by the bank / FI in the normal course. Guidelines on purchase/ sale of Non - Performing Financial Assets 160 CU IDOL SELF LEARNING MATERIAL (SLM)

In order to increase the options available to banks for resolving their non-performing assets and to develop a healthy secondary market for nonperforming assets, where securitisation companies and reconstruction companies are not involved, guidelines have been issued to banks on purchase / sale of Nonperforming Assets. Since the sale/purchase of nonperforming financial assets under this option would be conducted within the financial system the whole process of resolving the non-performing assets and matters related thereto has to be initiated with due diligence and care warranting the existence of a set of clear guidelines which shall be complied with by all entities so that the process of resolving nonperforming assets by sale and purchase of NPAs proceeds on smooth and sound lines. Accordingly guidelines on sale/purchase of nonperforming assets have been formulated and furnished below. The guidelines may be placed before the bank's /FI's /NBFC's Board and appropriate steps may be taken for their implementation. Scope 1 These guidelines would be applicable to banks, FIs and NBFCs purchasing/ selling non performing financial assets, from/ to other banks/FIs/NBFCs (excluding securitisation companies/ reconstruction companies). 2 A financial asset, including assets under multiple/consortium banking arrangements, would be eligible for purchase/sale in terms of these guidelines if it is a nonperforming asset/non performing investment in the books of the selling bank. 3 The reference to ‘bank’ in the guidelines on purchase/sale of nonperforming financial assets would include financial institutions and NBFCs. Structure 4 The guidelines to be followed by banks purchasing/ selling nonperforming financial assets from / to other banks are given below. The guidelines have been grouped under the following headings: i) Procedure for purchase/ sale of non-performing financial assets by banks, including valuation and pricing aspects. ii) Prudential norms, in the following areas, for banks for purchase/ sale of non-performing financial assets: a) Asset classification norms b) Provisioning norms c) Accounting of recoveries 161 CU IDOL SELF LEARNING MATERIAL (SLM)

d) Capital adequacy norms e) Exposure norms iii) Disclosure requirements Procedure for purchase/ sale of non-performing financial assets, including valuation and pricing aspects i) A bank which is purchasing/ selling nonperforming financial assets should ensure that the purchase/ sale is conducted in accordance with a policy approved by the Board. The Board shall lay down policies and guidelines covering, inter alia, a) Non performing financial assets that may be purchased/ sold; b) Norms and procedure for purchase/ sale of such financial assets; c) Valuation procedure to be followed to ensure that the economic value of financial assets is reasonably estimated based on the estimated cash flows arising out of repayments and recovery prospects; d) Delegation of powers of various functionaries for taking decision on the purchase/ sale of the financial assets; etc. e) Accounting policy ii) While laying down the policy, the Board shall satisfy itself that the bank has adequate skills to purchase non performing financial assets and deal with them in an efficient manner which will result in value addition to the bank. The Board should also ensure that appropriate systems and procedures are in place to effectively address the risks that a purchasing bank would assume while engaging in this activity. iii) Banks should, while selling NPAs, work out the net present value of the estimated cash flows associated with the realisable value of the available securities net of the cost of realisation. The sale price should generally not be lower than the net present value arrived at in the manner described above. (Same principle should be used in compromise settlements. As the payment of the compromise amount may be in instalments, the net present value of the settlement amount should be calculated and this amount should generally not be less than the net present value of the realisable value of securities.) 162 CU IDOL SELF LEARNING MATERIAL (SLM)

iv) The estimated cash flows are normally expected to be realised within a period of three years and at least 10% of the estimated cash flows should be realized in the first year and at least 5% in each half year thereafter, subject to full recovery within three years. v) A bank may purchase/sell nonperforming financial assets from/to other banks only on ‘without recourse’ basis, i.e., the entire credit risk associated with the nonperforming financial assets should be transferred to the purchasing bank. Selling bank shall ensure that the effect of the sale of the financial assets should be such that the asset is taken off the books of the bank and after the sale there should not be any known liability devolving on the selling bank. vi) Banks should ensure that subsequent to sale of the non-performing financial assets to other banks, they do not have any involvement with reference to assets sold and do not assume operational, legal or any other type of risks relating to the financial assets sold. Consequently, the specific financial asset should not enjoy the support of credit enhancements / liquidity facilities in any form or manner. vii) Each bank will make its own assessment of the value offered by the purchasing bank for the financial asset and decide whether to accept or reject the offer. viii) Under no circumstances can a sale to other banks be made at a contingent price whereby in the event of shortfall in the realization by the purchasing banks, the selling banks would have to bear a part of the shortfall. ix) A nonperforming asset in the books of a bank shall be eligible for sale to other banks only if it has remained a nonperforming asset for at least two years in the books of the selling bank. x) Banks shall sell nonperforming financial assets to other banks only on cash basis. The entire sale consideration should be received upfront and the asset can be taken out of the books of the selling bank only on receipt of the entire sale consideration. xi) A non-performing financial asset should be held by the purchasing bank in its books at least for a period of 15 months before it is sold to other banks. Banks should not sell such assets back to the bank, which had sold the NPFA. (xii) Banks are also permitted to sell/buy homogeneous pool within retail nonperforming financial assets, on a portfolio basis provided each of the nonperforming financial assets of the pool has remained as nonperforming financial asset for at least 2 years in the books of the selling bank. The pool of assets would be treated as a single asset in the books of the purchasing bank. (xii) The selling bank shall pursue the staff accountability aspects as per the existing instructions in respect of the nonperforming assets sold to other banks. 163 CU IDOL SELF LEARNING MATERIAL (SLM)

Prudential norms for banks for the purchase/ sale transactions (A) Asset classification norms (i) The nonperforming financial asset purchased, may be classified as ‘standard’ in the books of the purchasing bank for a period of 90 days from the date of purchase. Thereafter, the asset classification status of the financial asset purchased, shall be determined by the record of recovery in the books of the purchasing bank with reference to cash flows estimated while purchasing the asset which should be in compliance with requirements in Para 7.5 (iv). (ii) The asset classification status of an existing exposure (other than purchased financial asset) to the same obligor in the books of the purchasing bank will continue to be governed by the record of recovery of that exposure and hence may be different. (iii) Where the purchase/sale does not satisfy any of the prudential requirements prescribed in these guidelines the asset classification status of the financial asset in the books of the purchasing bank at the time of purchase shall be the same as in the books of the selling bank. Thereafter, the asset classification status will continue to be determined with reference to the date of NPA in the selling bank. (iv) Any restructure/reschedule/rephrase of the repayment schedule or the estimated cash flow of the nonperforming financial asset by the purchasing bank shall render the account as a nonperforming asset. (B) Provisioning norms Books of selling bank i) When a bank sells its nonperforming financial assets to other banks, the same will be removed from its books on transfer. ii) If the sale is at a price below the net book value (NBV) (i.e., book value less provisions held), the shortfall should be debited to the profit and loss account of that year. iii) If the sale is for a value higher than the NBV, the excess provision shall not be reversed but will be utilised to meet the shortfall/ loss on account of sale of other nonperforming financial assets. Books of purchasing bank The asset shall attract provisioning requirement appropriate to its asset classification status in the books of the purchasing bank. 164 CU IDOL SELF LEARNING MATERIAL (SLM)

(C) Accounting of recoveries Any recovery in respect of a nonperforming asset purchased from other banks should first be adjusted against its acquisition cost. Recoveries in excess of the acquisition cost can be recognised as profit. (D) Capital Adequacy For the purpose of capital adequacy, banks should assign 100% risk weights to the nonperforming financial assets purchased from other banks. In case the nonperforming asset purchased is an investment, then it would attract capital charge for market risks also. For NBFCs the relevant instructions on capital adequacy would be applicable. (E) Exposure Norms The purchasing bank will reckon exposure on the obligor of the specific financial asset. Hence these banks should ensure compliance with the prudential credit exposure ceilings (both single and group) after reckoning the exposures to the obligors arising on account of the purchase. For NBFCs the relevant instructions on exposure norms would be applicable. Disclosure Requirements Banks which purchase non-performing financial assets from other banks shall be required to make the following disclosures in the Notes on Accounts to their Balance sheets: A. Details of non-performing financial assets purchased: (Amounts in Rupees crore) 1. (a) No. of accounts purchased during the year (b) Aggregate outstanding 2. (a) Of these, number of accounts restructured during the year (b) Aggregate outstanding B. Details of non-performing financial assets sold: (Amounts in Rupees crore) 1. No. of accounts sold 2. Aggregate outstanding 3. Aggregate consideration received 165 CU IDOL SELF LEARNING MATERIAL (SLM)

C. The purchasing bank shall furnish all relevant reports to RBI, CIBIL etc. in respect of thenon- performing financial assets purchased by it. Writing off of NPAs 1 In terms of Section 43(D) of the Income Tax Act 1961, income by way of interest in relation to such categories of bad and doubtful debts as may be prescribed having regard to the guidelines issued by the RBI in relation to such debts, shall be chargeable to tax in the previous year in which it is credited to the bank’s profit and loss account or received, whichever is earlier. 2 This stipulation is not applicable to provisioning required to be made as indicated above. In other words, amounts set aside for making provision for NPAs as above are not eligible for tax deductions. 3 Therefore, the banks should either make full provision as per the guidelines or write-off such advances and claim such tax benefits as are applicable, by evolving appropriate methodology in consultation with their auditors / tax consultants. Recoveries made in such accounts should be offered for tax purposes as per the rules. 4 Write-offs at Head Office Level Banks may write-off advances at Head Office level, even though the relative advances are still outstanding in the branch books. However, it is necessary that provision is made as per the classification accorded to the respective accounts. In other words, if an advance is a loss asset, 100 percent provision will have to be made therefor. SUMMARY Banks are urged to ensure that while granting loans and advances, realistic repayment schedules may be fixed on the basis of cash flows with borrowers. It is expected to ensure prompt repayment of loans and thus improve the recovery in advances. With the introduction of prudential norms, the ‘Health Code-based System’ for classification of advances has ceased to be a subject of supervisory interest. As such, all related reporting requirements under the Health Code System also cease to be a supervisory requirement. Banks may, however, continue the system at their discretion as a management information tool. A non-performing asset (NPA) is a classification used by financial institutions for loans and advances on which the principal is past due and on which no interest payments. It represents the 166 CU IDOL SELF LEARNING MATERIAL (SLM)

amount of interest currently owed to lenders and is typically a current liability have been made for a period of time. Simply put, asset classification is a system for identifying and recording good or performing assets and bad or non-performing assets of a lender based on several identified characteristics. Banks are required to classify loan accounts in accordance with the Prudential Norms on Income Recognition, Asset Classification and Provisioning, pertaining to Advances dated July 1, 2015 (“IRAC Norms”) issued by the RBI. A ‘non-performing asset’ as per the IRAC Norms is a loan or an advance where interest and/ or instalment of principal remains overdue for a period of more than 90 days with respect to a term loan. The non-performing asset (“NPA”) is further classified into: (a) sub-standard, (b) doubtful and (c) loss asset, depending on the time period for which such an account has remained non-performing. KEY WORDS • Trade credit: Credit granted to customers by wholesalers or retailers • Tangible assets: Long-term assets that have physical substance. • Simple interest: The interest cost for one or more periods when the amount on which the interest is computed stays the same from period to period. • Revenues: Increases in stockholders' equity that result from operating a business • Record date The date on which ownership of stock, and thus the right to receive a dividend, is determined LEARNING ACTIVITY 1. Explain income recognition policy 2. How to upgrade loan accounts classified as NPA’s? UNIT END QUESTIONS 167 A. Descriptive Type Questions Short Questions CU IDOL SELF LEARNING MATERIAL (SLM)

1. What is income recognition? 2. Outline asset classification. 3. What are the categories of NPA? 4. Explain doubtful assets? 5. What are loan assets? Long Questions 1. Discuss Advances to PACS/FSS ceded to Commercial Banks 2. Explain Advances under consortium arrangements 3. State Asset Classification to be borrower-wise and not facility-wise B. Multiple Choice Questions 1. In income measurement &recognition of assets & liabilities which of the following concepts goes together? (a) Periodicity, Accrual, Matching (b) Cost, Accrual, matching (c) Going concern, cost, Realization (d) Going concern, Periodicity, Reliability 2. A substandard asset is one, which has remained NPA for a period less than or equal to . a) 6 months b) 12 months c) 18 months d) 24 months 3. is one where the bank, for economic or legal reasons relating to the borrower’s financial difficulty, grants to the borrower concessions that the bank would not otherwise consider. a) Renovated account b) Reprimed account c) Advance account d) Restructured account 168 CU IDOL SELF LEARNING MATERIAL (SLM)

4. A is one where loss has been identified by the bank or internal or external auditors or the RBI inspection but the amount has not been written off wholly. a) Standard Asset b) Loss Asset c) By-stand Asset d) Loan Asset 5. An account should be treated as if the outstanding balance remains continuously in excess of the sanctioned limit/drawing power. a) out of limit b) out of order c) out of drawing d) out of line 6.The Indian banking sector is facing the problem of heavy NPAs. Which among the following industries has contributed least to the level of NPAs? a) Real estate sector b) Iron and steel c) Software and BPO d) Infrastructural development 7.Which of the following is not part of criteria laid down by RBI for NPA? a) Interest on loan remains overdue for a period of 90 days. b) Interest on loan taken for a long-duration agricultural crop remains unpaid for one crop season. c) Interest on loan taken for a short duration agricultural crop remains unpaid for two crop seasons. d) Interest on loan taken to purchase personal asset remains overdue for 60 days. 169 CU IDOL SELF LEARNING MATERIAL (SLM)

8. Which of the following statements is correct regarding Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act,2002? a) The act enables banks to recover NPAs through easy disposal of secured assets. b) The act enables banks to do multiple lending on deposits received by the public. c) The act requires courts to give priority to cases involving NPAs of banks. d) None of these 9. Economic Survey 2017 has recommended establishment of Public Asset RehabilitationAgency. What will be the function of this agency? a) The agency will sell assets of loss making PSUs. b) The agency will collect the payments due towards electricity boards. c) The agency will guide and chart out the path for loss-making PSUs. d) The agency will take over the non-performing assets of banks. 10.Anchor Banks refer to a) Public-sector banks that will drive the consolidation process among the state-owned banks. b) Public-sector banks that are providing most of the infrastructural financing. c) Public-sector banks that will coordinate banking activities in a district. d) Public-sector banks that have been classified as Domestic Systemically Important Banks (D-SIBs). Answers 1. a 2. b 3. b 4. b 5. b 6. c 7. d 8. a 9. d 10. a REFERENCES • Monga, J.R. (2005). Financial Accounting: Concepts and Applications. New Delhi: Mayor Paper Backs • Lal, Jawahar. & Srivastava, Seema. (2009). Financial Accounting Text &Problems.Mumbai: Himalaya Publishing House • Tulsian, P.C. (2014). Corporate Accounting. New Delhi: Tata McGraw-Hill Education • Ross, S. M. (2014). Mathematical Finance, Cambridge University Press, Chapters 1-8. • Financial accounting and reporting: by BarryElliot 170 CU IDOL SELF LEARNING MATERIAL (SLM)

• Accounting best practices: by Steven Bragg • Accounting in a nutshell: accounting for non-specialist: by Janet walker 171 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-6 BANKING ACCOUNTS III Structure Learning Objective Introduction Capital Adequacy norms. Summary Key words Learning Activity Unit -End Questions References LEARNING OBJECTIVES After studying this unit, you will be able to: • State capital adequacy norms • Describe Basel I, II, III • Explain Tier I, II capital INTRODUCTION Under Basel III, the minimum capital adequacy ratio that banks must maintain is 8%. The capital adequacy ratio measures a bank's capital in relation to its risk-weighted assets. The capital-to-risk- weighted-assets ratio promotes financial stability and efficiency in economic systems throughout the world. CAPITAL ADEQUACY NORMS Along with profitability and safety, banks also give importance to Solvency. Solvency refers to the situation where assets are equal to or more than liabilities. A bank should select its assets in such a way that the shareholders and depositors' interest are protected. 1. Prudential Norms The norms which are to be followed while investing funds are called \"Prudential Norms.\" They are formulated to protect the interests of the shareholders and depositors. Prudential Norms are generally prescribed and implemented by the central bank of the country. Commercial Banks have to follow these norms to protect the interests of the customers. 172 CU IDOL SELF LEARNING MATERIAL (SLM)

For international banks, prudential norms were prescribed by the Bank for International Settlements popularly known as BIS. The BIS appointed a Basle Committee on Banking Supervision in 1988. 2. Basel Committee The Basel Accords are three series of banking regulations (Basel I, II, and III) set by the Basel Committee on Bank Supervision (BCBS). The committee provides recommendations on banking regulations, specifically, concerning capital risk, market risk, and operational risk. The accords ensure that financial institutions have enough capital on account to absorb unexpected losses. Basel I The first Basel Accord, known as Basel I, was issued in 1988 and focused on the capital adequacy of financial institutions. The capital adequacy risk (the risk that an unexpected loss with hurt a financial institution), categorizes the assets of financial institutions into five risk categories (0%, 10%, 20%, 50% and 100%). Under Basel I, banks that operate internationally are required to have a risk weight of 8% or less. Basel II The second Basel Accord, called the Revised Capital Framework but better known as Basel II, served as an update of the original accord. It focused on three main areas: minimum capital requirements, supervisory review of an institution's capital adequacy and internal assessment process, and the effective use of disclosure as a lever to strengthen market discipline and encourage sound banking practices including supervisory review. Together, these areas of focus are known as the three pillars. Basel III In the wake of the Lehman Brothers collapse of 2008 and the ensuing financial crisis, the BCBS decided to update and strengthen the Accords. The BCBS considered poor governance and risk management, inappropriate incentive structures, and an overleveraged banking industry as reasons for the collapse. In November 2010, an agreement was reached regarding the overall design of the capital and liquidity reform package. This agreement is now known as Basel III. Basel III is a continuation of the three pillars along with additional requirements and safeguards. For example, Basel III requires banks to have a minimum amount of common equity and a minimum liquidity ratio. Basel III also includes additional requirements for what the Accord calls \"systemically important banks\" or those financial institutions that are considered \"too big to fail.\" The Basel Committee on Banking Supervision agreed on the terms of Basel III in November 2010, and it was scheduled to be introduced from 2013 until 2015. Basel III implementation has been extended repeatedly, and the latest completion date is expected to be January 2022. 173 CU IDOL SELF LEARNING MATERIAL (SLM)

Basel committee appointed by BIS formulated rules and regulation for effective supervision of the central banks. For this it, also prescribed international norms to be followed by the central banks. This committee prescribed Capital Adequacy Norms in order to protect the interests of thecustomers. 3. Definition of Capital Adequacy Ratio Tier 1 capital is a bank's core capital, which consists of shareholders' equity and retained earnings; it is of the highest quality and can be liquidated quickly. This is the real test of a bank's solvency. Tier 2 capital includes revaluation reserves, hybrid capital instruments, and subordinated debt. In addition, tier 2 capital incorporates general loan-loss reserves and undisclosed reserves. Tier 1 capital is intended to measure a bank's financial health; a bank uses tier 1 capital to absorb losses without ceasing business operations. Tier 2 capital is supplementary, i.e., less reliable than tier 1 capital. A bank's total capital is calculated as a sum of its tier 1 and tier 2 capital. Regulators use the capital ratio to determine and rank a bank's capital adequacy. Tier 3 capital consists of subordinated debt to cover market risk from trading activities. Capital Adequacy Ratio (CAR) is defined as the ratio of bank's capital to its risk assets. Capital Adequacy Ratio (CAR) is also known as Capital to Risk (Weighted) Assets Ratio (CRAR). SquareIndia and Capital Adequacy Norms The Government of India (GOI) appointed the Narasimhan Committee in 1991 to suggest reforms in the financial sector. In the year 1992-93 the Narasimhan Committee submitted its first report and recommended that all the banks are required to have a minimum capital of 8% to the risk weighted assets of the banks. The ratio is known as Capital to Risk Assets Ratio (CRAR). All the 27 Public Sector Banks in India (except UCO and Indian Bank) had achieved the Capital Adequacy Norm of 8% by March 1997. The Second Report of Narasimhan Committee was submitted in the year 1998-99. It recommended that the CRAR to be raised to 10% in a phased manner. It recommended an intermediate minimum target of 9% to be achieved by the year 2000 and 10% by 2002. SquareConcepts of Capital Adequacy Norms Capital Adequacy Norms included different Concepts, explained as follows: - Concepts of Capital Adequacy Norms 174 CU IDOL SELF LEARNING MATERIAL (SLM)

1. Tier-I Capital Capital which is first readily available to protect the unexpected losses is called as Tier-I Capital. It is also termed as Core Capital. Tier-I Capital consists of: - Paid-Up Capital. Statutory Reserves. Other Disclosed Free Reserves: Reserves which are not kept side for meeting any specific liability. Capital Reserves: Surplus generated from sale of Capital Assets. 2. Tier-II Capital Capital which is second readily available to protect the unexpected losses is called as Tier-II Capital. The term tier 2 capitals refers to one of the components of a bank's required reserves. Tier 2 is designated as the second or supplementary layer of a bank's capital and is composed of items such as revaluation reserves, hybrid instruments, and subordinated term debt. It is considered less secure than Tier 1 capital—the other form of a bank's capital—because it's more difficult to liquidate. In the United States, the overall capital requirement is partially based on the weighted risk of a bank's assets. Bank capital requirements were designated as part of the international Basel Accords. This set of recommendations was developed by the Basel Committee on Bank Supervision over a number of years dating back to the 1980s. According to the regulations, banks must maintain a certain amount of cash and/or other forms of liquid assets on hand in order to meet their obligations. No more than 25% of a bank's capital requirements can be comprised of Tier 2 capital. Bank capital is divided into two layers—Tier 1 or core capital and Tier 2 or supplementary capital. A bank's capital ratio is calculated by dividing its capital by its total risk-based assets. The minimum capital ratio reserve requirement for a bank is set at 8%—6% of which must be provided by Tier 1 capital. The remaining must be Tier 2 capital. Along with Tier 1 capital, it provides a bank with a financial cushion in case it needs to liquidate its assets. There are four components of Tier 2 capital. These include: • Revaluation Reserves: These are reserves created by the revaluation of an asset. A typical revaluation reserve is a building owned by a bank. Over time, the value of the real estate asset tends to increase and can thus be revalued. 175 CU IDOL SELF LEARNING MATERIAL (SLM)

• General Provisions: This category consists of losses that a bank may have of an as yet undetermined amount including from loans. The total general provision amount allowed is 1.25% of the bank's risk-weighted assets (RWA). • Hybrid Capital Instruments: This type of capital is a mixture of both debt and equity instruments. Preferred stock is an example of a hybrid instrument. A bank may include hybrid instruments in its Tier 2 capital as long as the assets are sufficiently similar to equity so losses can be taken on the face value of the instrument without triggering the liquidation of the bank. • Subordinated Debt: Debt is subordinated in regard to ordinary bank depositors and other loans and securities that constitute higher-ranking senior debt. The minimum original termof this debt is five years or more. Tier 2 capital is split into upper and lower levels. Upper-level Tier 2 capital consists of securities that are perpetual—meaning they have no maturity date—revaluation reserves, and fixed asset investments. Lower-level Tier 2 capital consists of subordinated debt and is generally inexpensive for a bank to issue. Tier-II Capital consists of:- Undisclosed Reserves and Paid-Up Capital Perpetual Preference Shares. Revaluation Reserves (at discount of 55%). Hybrid (Debt / Equity) Capital. Subordinated Debt. General Provisions and Loss Reserves. There is an important condition that Tier II Capital cannot exceed 50% of Tier-I Capital for arriving at the prescribed Capital Adequacy Ratio. 3. Risk Weighted Assets Capital Adequacy Ratio is calculated based on the assets of the bank. The values of bank's assets are not taken according to the book value but according to the risk factor involved. The value of each asset is assigned with a risk factor in percentage terms. Risk Weighted Assets Suppose CRAR at 10% on Rs. 150 crores is to be maintained. This means the bank is expected to have a minimum capital of Rs. 15 crores which consists of Tier I and Tier II Capital items subject to a condition that Tier II value does not exceed 50% of Tier I Capital. Suppose the total value of items 176 CU IDOL SELF LEARNING MATERIAL (SLM)

under Tier I Capital is Rs. 5 crores and total value of items under Tier II capital is Rs. 10 crores, the bank will not have requisite CRAR of Rs. 15 Crores. This is because a maximum of only Rs. 2.5 Crores under Tier II will be eligible for computation. 4. Subordinated Debt These are bonds issued by banks for raising Tier II Capital. They are as follows:- They should be fully paid up instruments. They should be unsecured debt. They should be subordinated to the claims of other creditors. This means that the bank's holder's claims for their money will be paid at last in order of preference as compared with the claims of other creditors of the bank. The bonds should not be redeemable at the option of the holders. This means the repayment of bond value will be decided only by the issuing bank. SUMMARY Capital Adequacy Ratio is additionally known as Capital to Chance Resources Proportion, is the proportion of a bank's capital to its chance. National controllers track a bank's CAR to guarantee that it can retain a sensible sum of misfortune and complies with statutory Capital requirements. It may be a degree of a bank's capital. KEY WORDS • Tier I Capital:A term used to refer to one of the components of regulatory capital. It consists mainly of share capital and disclosed reserves (minus goodwill, if any). Tier I items are deemed to be of the highest quality because they are fully available to cover losses Hence it is also termed as core capital. • Tier II Capital:Refers to one of the components of regulatory capital. Also known as supplementary capital, it consists of certain reserves and certain types of subordinated debt. Tier II items qualify as regulatory capital to the extent that they can be used to absorb losses arising from a bank's activities. Tier II's capital loss absorption capacity is lower than that of Tier I capital. • Capital Reserves:That portion of a company's profits not paid out as dividends to shareholders. They are also known as distributable reserves and are ploughed back into the business. 177 CU IDOL SELF LEARNING MATERIAL (SLM)

• CRAR (Capital to Risk Weighted Assets Ratio):Capital to risk weighted assets ratio is arrived at by dividing the capital of the bank with aggregated risk weighted assets for credit risk, market risk and operational risk. The higher the CRAR of a bank the better capitalized it is. • Cash Reserve Ratio (CRR)M:Cash Reserve Ratio is the amount of mandatory funds that commercial banks have to keep with RBI. It is always fixed as a percentage of total demand and time liabilities. LEARNING ACTIVITY 1. Why is Capital Adequacy Ratio important? 2. What is the current Capital Adequacy Ratio in India? UNIT END QUESTIONS A. Descriptive Type Questions Short Questions 1. What is the Capital Adequacy Ratio (CAR)? 2. What is the capital adequacy ratio formula? 3. What does tier II capital consist of? 4. Write a note on Basel II Long Questions 1. Calculating capital adequacy according to Basel II, should \"unaudited profits\" beconsidered in Tier 2 Capital? 2. What are the possible reasons why capital adequacy may not be significant in determining bank efficiency? 3. Is the capital adequacy ratio risk-adjusted under Basel 1, 11 or 111? B. Multiple Choice Questions 1. The minimum total capital ratio under Basel -III is ...................................% of RWA. That is: a) 2.5% 178 CU IDOL SELF LEARNING MATERIAL (SLM)

b) 3.5% c) 9% d) 10.5% 2. To calculate capital adequacy ratio, the banks are required to take into account which of the following risks? a) Credit risk and operational risk b) Credit risk and market risk c) Market risk and operational risk d) Credit risk, market risk, operational risk 3. To calculate capital adequacy ratio, the banks are required to take into account which of the following risks? a) Credit risk and Operational risk b) Credit risk and Market risk c) Market Risk and Operational Risk d) Credit Risk, Market risk and Operational risk 4. As per the Basel III implementation in India, minimum Tier 1 capital must be % of risk weighted assets on ongoing basis a) 5.5% b) 7% c) 9% d) 11% 5. Basel III capital regulations were released by Basel Committee on Banking Supervision (BCBS) as a Global Regulatory Framework for more resilient banks and banking systems on a) December 2010 b) March 2011 c) December 2011 d) December 2012 6. Basel III recommendations shall be completely implemented in India by: 179 CU IDOL SELF LEARNING MATERIAL (SLM)

a) 31.03.2020 b)31.03.2019 c)31.03.2618 d)31.03.2017 7. World's oldest international financial organization is the Bank for International Settlements(BIS). It was established on 17 May ........ a) 1919 b) 1966 c) 1930 d) 1945 8. The BASEL II committee recommendations given below. Pick up correct one. a) BASEL II committee combined all the types of banking risks into three categories. b) They are Credit risk, market risk and operations risk c) The committee identified three pillars of risk management d) The pillars are Minimum capital requirement (also called Capital Adequacy Ratio), Supervisory review process and Market discipline. e) All of these 9. Capital Adequacy Ratio (CAR) means ....... 180 a) a ratio of bank's Profits to its risk b) a ratio of central bank's deposits to its risk c) a ratio of a bank's capital to its risk d) a ratio of bank's capital to its total deposits e) None of these 10. As per Basel III norms, total Tier I Capital Ratio would be .......... a) 9.5 percent b) 4.0 percent c) 10.5 percent d) 11.75 percent e) 14.5 percent Answers CU IDOL SELF LEARNING MATERIAL (SLM)

1. c 2. d 3. d 4. b 5. a 6. b 7. c 8. e 9. c 10. a REFERENCES • Monga, J.R. (2005). Financial Accounting: Concepts and Applications. New Delhi: Mayor Paper Backs • Lal, Jawahar. & Srivastava, Seema. (2009). FinancialAccounting Text &Problems. Mumbai: Himalaya Publishing House • Singh, S. K. (2012). Corporate Accounting. Blackwell, Parts III and IV • Hanif, M. &Mukherjee, A. (2015). Corporate Accounting. South West: Thomson • Fundamental Accounting Principles -(McGraw Hill, 20 October 2008) • Accounting: Tools for Business Decision Making, 5th Edition - (Wiley, 10 December 2012 ) 181 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT-7 CONSIGNEMNT ACCOUNT I Structure Learning Objective Introduction Meaning of Consignment Meaning and Features of Consignment Why is Consignment not a Sale? What is Consignment? Consignor and Consignee. Summary Key words Learning Activity Unit -End Questions References LEARNING OBJECTIVES After studying this unit, you will be able to: • Describe consignment Accounts • State accounting procedure of consignment accounting • Explain meaning of consignor and consignee INTRODUCTION Consignment accounting is a term used to refer to an arrangement whereby goods are sent by their owner (consignor) to an agent (consignee) who holds and sells the goods on behalf of the owner for a commission. It is important to understand that the agent never owns the goods. MEANING OF CONSIGNMENT Due to increasing size of market, it is quite obvious that manufacturers or whole sellers cannot approach directly to every customer around the state or nation. To overcome this limitation, manufacturers normally appoint reliable agents at every desired location to reach the customers directly. He makes an agreement with local traders who can sell goods on his behalf on commission basis. 182 CU IDOL SELF LEARNING MATERIAL (SLM)

Meaning and Features of Consignment Consignment is a process under which the owner consigns/handovers his materials to his agent/salesman for the purpose of shipping, transfer, sale etc. Following are the points that throw more light on the nature and scope of a consignment − • Here, ultimate ownership of the goods remains with the manufacturer or whole seller who handovers goods to his agent for sale on commission basis. Consignment is merely a transfer of possession of goods not an ownership. • Since ownership of goods remain with the manufacturer (consignor), consignee (agent) is not responsible for any loss or destruction of goods. • The goods are sold on owner’s risk and hence, profit/loss goes to owner. • Consignee only gets re-imbursement of expenses incurred by him and commission on sale made by him, because sale that proceeds, belongs to owner (consignor). Why is Consignment not a Sale? Following are the reasons that explain why consignment is not a sale − • Ownership − Ownership of goods need to be transferred from seller to buyer in case of sale, but ownership of goods remains with the consignor, till the goods are sold by theconsignee. • Risk − In case of a consignment, normally, risk remains with the consignor in the event of goods being lost or destroyed. • Relationship − The relation between a seller and a buyer will be of debtor and creditor in case where goods are sold on credit basis. On the other hand, the relationship between a consignor and a consignee is that of principal and agent. • Goods Return − Usually, the sold goods cannot be returned back; however, if there is any manufacturing defect or any other technical fault, seller is obliged to take them back. On the other hand, consignee may return the unsold stock of goods to consignor anytime. What is Consignment? Before understanding the difference between consignor vs. consignee, it’s important to understand what consignment is. Consignment is the process by which a person gives over something to the care of another party, retaining full ownership until the property is sold. It is often done during auctions, shipping, transferring goods, or any time that something is put up for sale not by the owner but by a third party who will make the property available to a buyer. 183 CU IDOL SELF LEARNING MATERIAL (SLM)

CONSIGNOR AND CONSIGNEE Consignor When goods are sent by the manufacturer or the producer to the buyer, the act is referred to as consignment where the owners of the goods send the goods to their agents in another location. The goods that are sent in this manner are referred to as consignment while the sender is called the consignor. The main document that is drawn up as a contract by the carrier enters the name of the sender as the consignor. Consignee In a consignment, the receiver of the goods is termed as the consignee. A consignee is only a receiver and not the owner of the goods. The ownership is transferred only when the consignee has paid the consignor, in full, for the goods. In most cases, a consignee is only an agent receiving the goods from the consignor. It is important to remember that the person who receives the goods in a consignment is always a consignee. Whether he is the buyer or an agent receiving the goods with the intention of selling is of no concern to the carrier who enters his name as the consignee in the documents pertaining to consignment. Now that the idea of consignment is clear, the matter of consignor vs. consignee can be discussed. A consignor is an individual or party that brings a good to be sold on their behalf by another party, which is called the consignee. The consignee acts as a sort of middleman, which is the individual that buys or retains the goods and passes them along to a third party or the final buyer. Regardless of whether the item is being sold and purchased or simply transferred from one party to the other through the consignee, ownership remains in the hands of the consignor until the deal is finalized, either through payment by or delivery to the final buyer. The consignor may also be referred to as the shipper, obtaining shipping or transfer documents for the goods they are selling to the consignee. The consignor keeps the title/ownership of the property until it is transferred to or sold to the final party. Example of a Consignor/Consignee Relationship To understand the consignor/consignee relationship better, consider the following example. A family is looking to sell its collection of valuable items. They make an arrangement with an auction house to sell the items. Here, the family is the consignor and the auction house is the consignee. The auction house markets the items, but the family retains ownership of them until a third party purchases the items. 184 CU IDOL SELF LEARNING MATERIAL (SLM)

Once payment’s been made – from the third-party buyer to the auction house – the money is turned over to the consignor, minus a fee for the consignee for hosting the items and facilitating the sale. Ownership is then transferred to the buyer. SUMMARY Consignment accounting is a term utilized to allude to a course of action whereby products are sent by their proprietor (consignor) to a specialist (proctor) who holds and offers the products on sake of the proprietor for a commission. It is imperative to get it that the specialist never possesses the merchandise. Consignment occurs when goods are sent by their owner (the consignor) to an agent (the consignee), who undertakes to sell the goods. The consignor continues to own the goods until they are sold, so the goods appear as inventory in the accounting records of the consignor, not the consignee. The nature of the consignment account is nominal which means it is drawn up to show the results of the consignment business for a specific period. If consignor sends goods to more than one consignees working in different cities or areas, a separate consignment account is required for each consignment so that the profit or loss for each consignment can be determined separately. If consignor maintains more than one consignment accounts, he can distinguish them from each other by adding to the account title the name of the consignee or the name of the city or area to which the particular consignment belongs. For example, Consignment to David, Consignment to John, Consignment to Ottawa and consignment to New York etc. KEY WORDS • Consignment: Merchandise that its owner (the consignor) places on the premises of another company (the consignee) with the understanding that payment is expected only when the merchandise is sold and that unsold items may be returned to the consignor. • Invoice: A form that a vendor sends to a purchaser describing the goods delivered andthe quantity, price, and terms of payment • Net loss: The difference between expenses and revenues when expenses exceed revenues. • Net sales: The gross proceeds from sales of merchandise (gross sales) less sales returns and allowances and any discounts allowed. Often called sales. • Profit: The increase in stockholders' equity that results from business operations. LEARNING ACTIVITY 1. Name items which are recorded at the invoice price in the Consignment Account. 185 CU IDOL SELF LEARNING MATERIAL (SLM)

2. Why goods are sent to consignee at invoice price? What adjustment entries are recorded in the books of the consignor to find profit on consignment when goods are invoiced at proforma prices? UNIT END QUESTIONS A. Descriptive Type Questions Short Questions 1. What is Consignment? 2. Define 'Consignment'. What is the difference between a consignment and a sale of goods? Long Questions 1. What is the difference between Consignor and Consignee? 2. What is “consignment of goods”? Is it the same as “goods on sale or return”? 3. Describe how the consignment account is maintained in the books of (a) consignor (b) the consignee. B. Multiple Choice Questions 1. In accounting consignment means. a) Goods sent by its owner to his agent for the purpose by sale- b) Goods sent by its owner to his agent. c) Goods forwarded by a person to another. d) Goods forwarded from one place to another. 2. Goods sent on consignment should be debited by consignor to: a) Consignment A/c b) Goods sent on consignment A/c c) Consignees A/c d) Consignors A/c 186 CU IDOL SELF LEARNING MATERIAL (SLM)

3. In the books of consignor the balance of the consignment stock account would be shown: a) As an asset in the balance sheet. b) As liability in the balance sheet. c) On the credit side of trading account. d) On the debit side of consignment account. 4. In the books of consignee the sale of goods is credited to: a) consignor’s account b) sales account c) consignee’s account d) None of these 5. In the books of consignee the expenses incurred by him on consignment are debited to: a) consignor’s account b) cash account c) consignment account d) None of these 6 Goods sent on consignment should be debited by consignor to: a) Consignment A/c b) Goods sent on consignment A/c c) Consignees A/c d) Consignors A/c 7 In the books of consignor the balance of the consignment stock account would beshown: a) As an asset in the balance sheet. b) As liability in the balance sheet. c) On the credit side of trading account. d) On the debit side of consignment account. 8 In the books of consignee, on despatch of goods by the consignor the entry would be: 187 a) No entry b) Consignment account [Dr.] To goods sent on consignment account [Cr.] c) consignment account [Dr.] To consignor account [Cr.] CU IDOL SELF LEARNING MATERIAL (SLM)

d) None of these 9 Account sales is submitted by: a) Consignee b) Consignor c) Principal to his agent d) Debtor to creditor 10 The consignee acts entirely on behalf of the: a) Consignor b) Customer c) Debtor d) Creditor Answer 1.a 2. a 3. a 4. a 5. a 6. a 7. a 8. a 9. a 10. a REFERENCES • Shukla, M.C., Grewal, T.S., and Gupta, S.C. (2007). Advanced Accounts. New Delhi: S. Chand & Co. • Maheshwari, S.N., and Maheshwari, S. K. (2002). Financial Accounting. New Delhi: Vikas Publishing House • Sharpe., Alexander, G. and Bailey. (2016). Investments. New Delhi: Prentice Hall of India • Singh, S. K. (2012). Corporate Accounting. Blackwell, Parts III and IV • Accounting Principles- (John Wiley & Sons, 1 February 2007) • Financial Statements: A Step-by-Step Guide to Understanding and Creating Financial Reports - (Career Press, 11 June 1998) 188 CU IDOL SELF LEARNING MATERIAL (SLM)

UNIT -8 CONSIGNMENT ACCOUNT II Structure Learning Objective Introduction Journal Entries in the books of Consignor and Consignee. Summary Key words Learning Activity Unit -End Questions References LEARNING OBJECTIVES After studying this unit, you will be able to: • Describe accounting procedure of consignor and consignee • List the Journal entries in the books of consignor and consignee INTRODUCTION Consignment is a system where one person sends the goods to another so that the latter can sell those goods on behalf of the person who sends it in the first place. Risk related to goods will be on the part of the consignor. Let us study the consignment account in detail. JOURNAL ENTRIES IN THE BOOKS OF CONSIGNOR AND CONSIGNEE Accounting Entries in books of Consignee There are no entries passed in the books of the consignee for the consignment of goods sent by the consignee and also for any expenses incurred by the consignor. However, the advance paid to the consignor, sales made, expenses incurred on the consignment and commission earned needs to be recorded. A consignee is often allowed del-credere commission in addition to the usual ordinary commission. In the case where he is allowed del-credere commission, bad debts are borne by him and not the consignor. Journal Entries in the books of Consignee 189 CU IDOL SELF LEARNING MATERIAL (SLM)

Date Particulars Amount Amount 1. On the Cash /Bank/ Debtor’s A/c Dr. xx sale of goods xx To Consignor’s A/c (Being goods received on consignment sold) 2. For Consignor’s A/c Dr. xx advance to the Consignor To Bank/ Bills Payable A/c xx (Being advance paid to the consignor) 190 CU IDOL SELF LEARNING MATERIAL (SLM)

3. For Consignor’s A/c Dr. xx expenses incurred and commission earned To Bank A/c xx (Being consignor’s account debited for expenses incurred in relation to the consignment and commission earned) 4. For Bad Bad Debts A/c Dr. xx debts xx To Customer’s A/c (Being bad debts recorded) 5. For writing off 191 CU IDOL SELF LEARNING MATERIAL (SLM)

bad debts a. The del- Consignor’s A/c Dr. xx credere commission is not allowed To Bad Debts A/c xx (Being bad debts written off as borne by the consignor) b. The del- Commission A/c Dr. xx credere commission is allowed To Bad Debts A/c xx (Being bad debts written off from the commission) 192 CU IDOL SELF LEARNING MATERIAL (SLM)

Q. On 1 October 2017 Zeal Ltd. sent goods costing ₹60000 to Kent Ltd. Packing charges were ₹2000. On 4 October 2017 Kent Ltd. received the goods and sent an advance of ₹ 40000 to Zeal Ltd. Kent Ltd. spent ₹3000 on cartage, ₹500 on insurance and ₹1000 on godown rent. On 31st March 2018, Kent Ltd. sent his Account Sales showing that 80% of the goods had been sold for ₹60000. It also remitted the balance amount to Zeal Ltd. It is entitled to a commission of 12% including the del-credere commission. One of the customers became insolvent and was unable to pay a sum of ₹1000. Pass the accounting entries in the books of the Consignee. Ans: Journal Entries in the books of Kent Ltd. Date Particulars Amount Amount (Dr.) (Cr.) 4 Oct Zeal Ltd’s A/c Dr. 40000 To Bank A/c 40000 (Being advance paid to Zeal Ltd.) 4 Oct Zeal Ltd.’s A/c Dr. 4500 To Bank A/c 4500 193 CU IDOL SELF LEARNING MATERIAL (SLM)

(Being Zeal Ltd.’s account debited for expenses on cartage, insurance and godown rent incurred in relation to the consignment) 31 Mar Zeal Ltd. A/c Dr. 20000 To Bank A/c 20000 (Being balance amount remitted to Zeal Ltd.) 31 Mar Debtor’s A/c Dr. 60000 To Zeal Ltd. A/c 60000 (Being sales effected) 31 Mar Zeal Ltd. A/c Dr. 7200 194 CU IDOL SELF LEARNING MATERIAL (SLM)

To Commission A/c 7200 (Being commission including del- credere commission received) 31 Mar Bad Debts A/c Dr. 1000 To Debtor’s A/c 1000 (Being bad debts recorded) 31 Mar Commission A/c Dr. 1000 To Bad Debts A/c 1000 (Being bad debts written off from the commission) Accounting Entries in the Books of Consignor 195 CU IDOL SELF LEARNING MATERIAL (SLM)

Consignment is a system where one person sends the goods to another so that the latter can sell those goods on behalf of the person who sends it in the first place. Risk related to goods will be on the part of the consignor. Let us study the consignment account in detail. Parties in Consignment Account There are two parties in a consignment. 1. The person sending the goods is the consignor. 2. The person receiving the goods is the consignee. Here, we will deal with the ConsignmentAccount. Accounting treatment in the Books of Consignor The relationship between consignor and consignee is that of the principal and the agent. So entire profit or loss belongs to the consignor and consignee receives the commission as his remuneration. On the consignment of the goods, the consignor also sends a Performa invoice. When the consignee remits money, he sends Account sale to the consignor.Journal entries in the books of Consignor Date Particulars Amount (Dr.) Amount (Cr.) 1.Entry for Consignment a/c Dr. xxxx sending goods To Goods send on xxxx consignment a/c (Being goods sent on the 196 CU IDOL SELF LEARNING MATERIAL (SLM)

consignment basis) 2.Entry for Consignment a/c consignor’s Dr. xxxx expenses To Cash/Bank a/c xxxx xxxx (Being expenses for consignment) 3.Entry for Consignment a/c Dr. xxxx consignee’s Dr. xxxx expenses To Consignee a/c (Being expenses for consignment by consignee) 4.Entry for Cash/Bank/B.R. a/c advance given by consignee 197 CU IDOL SELF LEARNING MATERIAL (SLM)

To Consignee a/c xxxx xxxx (Being receipt of advance) xxxx 5.Entry for Consignee a/c Dr. xxxx sales To Consignment a/c (Being sale of goods) 6.Entry for Consignment a/c Dr. xxxx commission To Consignee (Being commission recorded) 7.Entry for No Entry collection from debtors 8.Entry for Bad Debts 198 CU IDOL SELF LEARNING MATERIAL (SLM)

(a)In the No entry presence of Del-credre commission (b) In the Consignment a/c absence of Del-credre Dr. xxxx commission To Consignee a/c xxxx xxxx (Being bad debts recorded) 9.Entry for Consignment a/c Dr. xxxx the final profit To Profit and loss a/c (Being transfer of profit to P&L a/c) 10.Entry for Bank a/c Dr. xxxx final remittance 199 CU IDOL SELF LEARNING MATERIAL (SLM)