RVSBELL Analytics Private Limited
Interest accounting affects reported profitability, loan balances, impairment and regulatory compliance. Yet the interest appearing in a repayment schedule is not necessarily the amount recognised in financial statements. Fees, concessional terms, credit deterioration, restructuring and collection timing can all change the accounting outcome.
This article explains the principal requirements for lenders and borrowers under Ind AS, alongside RBI prudential and customer protection requirements. The starting point is to identify the entity’s applicable reporting framework: an Ind AS accounting conclusion cannot automatically be applied to every bank or NBFC, and a regulatory provisioning framework does not itself constitute adoption of Ind AS.
1 The accounting framework
Ind AS 109 governs recognition and measurement of loan assets, borrowing liabilities, effective interest and expected credit losses. Ind AS 23 determines whether borrowing costs are expensed or capitalised. Ind AS 107 addresses financial instrument disclosures; Ind AS 32, Ind AS 21 and Ind AS 7 govern presentation, foreign currency effects and cash flows respectively. Interest within Ind AS 109 falls outside the revenue recognition requirements of Ind AS 115.
For a lender, amortised cost requires a business model of holding assets to collect contractual cash flows and cash flows comprising solely payments of principal and interest, commonly called SPPI. Interest may compensate for time value, credit risk, basic lending costs and a profit margin. Equity-linked or other non-basic lending returns require closer assessment. Qualifying collect-and-sell portfolios use fair value through other comprehensive income, with effective interest recognised in profit or loss. Other loans may require fair value through profit or loss. [1]
2 The effective interest rate
The effective interest rate, or EIR, discounts estimated contractual receipts or payments over the instrument’s expected life to its relevant initial carrying amount. It incorporates integral fees, directly attributable incremental transaction costs, premiums and discounts. Expected credit losses are excluded from the ordinary EIR calculation; purchased or originated credit-impaired assets follow a separate approach.
Consider a one-year loan with principal of Rs.100 lakh, contractual interest of Rs.10 lakh payable at maturity and an integral origination fee of Rs.2 lakh retained upfront. Assuming fair value equals the transaction price and no other costs, the lender initially records Rs.98 lakh. Receipt of Rs.110 lakh produces an EIR of 12.2449% and interest income of Rs.12 lakh. Recording Rs.2 lakh immediately as fee income would misstate its timing.
The borrower’s corresponding effective finance cost is also Rs.12 lakh, assuming identical relevant cash flows. Its initial liability is Rs.98 lakh. At year-end, the lender debits the loan and credits interest income by Rs.12 lakh; the borrower debits finance cost and credits the liability by the same amount. Settlement extinguishes Rs.110 lakh. [1]
3 Processing fees and other charges
Fees for evaluating creditworthiness, negotiating terms and originating a loan are generally integral to EIR. Direct incremental origination costs also enter the calculation; general administration and internal overhead allocations do not qualify merely because they relate to lending.
Fees for separately identifiable services, such as servicing a loan, require separate assessment under Ind AS 115. Commitment fees depend on whether entry into a specific lending arrangement is probable and on the commitment’s classification. Fees associated with instruments measured at fair value through profit or loss do not follow the same deferral model as amortised-cost loans. Classification must follow substance, rather than the label “processing fee”. [1]
4 Floating rates and repayment changes
For floating-rate instruments, contractual resets reflecting market interest movements generally update the effective rate prospectively. They should be distinguished from renegotiated concessions and other revisions of cash-flow estimates, which may require an immediate adjustment using the applicable original EIR.
Expected prepayments, extension options, reset dates and permitted foreclosure charges affect cash-flow modelling. EMI schedules, contractual coupon calculations and EIR schedules therefore need reconciliation. RBI’s borrower-facing annual percentage rate, or APR, is also not automatically the accounting EIR: its disclosure scope can include third-party charges that do not constitute the lender’s yield. [1, 7]
5 Interest on stressed loans under Ind AS
For loans within the ECL framework, the commonly used stages have different consequences. Stage 1 carries 12-month ECL. Stage 2 carries lifetime ECL after a significant increase in credit risk. For both, interest ordinarily uses EIR on the gross carrying amount, before deducting the loss allowance.
Once an asset becomes credit-impaired after initial recognition, interest in subsequent reporting periods uses EIR on amortised cost, meaning the gross carrying amount less the loss allowance. This is commonly called Stage 3 net interest recognition.
For example, a credit-impaired loan with gross carrying amount of Rs.100 lakh, allowance of Rs.40 lakh and EIR of 10% produces annualised interest of Rs.6 lakh on Rs.60 lakh, assuming unchanged balances throughout the illustration. Neither Rs.10 lakh on the gross balance nor an automatic zero-interest policy represents the Ind AS rule.
Where the asset subsequently ceases to be credit-impaired and the improvement is objectively linked to a later event, interest returns to the gross basis. Purchased or originated credit-impaired assets instead use a credit-adjusted EIR that incorporates initial expected credit losses, applied to amortised cost from inception. [1]
6 How RBI prudential rules interact
Under RBI’s traditional income recognition, asset classification and provisioning framework, interest on NPAs is generally recognised on realisation, and previously recognised unrealised interest is reversed, subject to specified exceptions. A standard term-loan trigger is principal or interest remaining overdue for more than 90 days; agricultural and other specified exposures have different rules. Regulatory NPA classification and Ind AS credit impairment require a documented reconciliation. [3, 4]
For NBFCs implementing Ind AS, RBI’s March 13, 2020 guidance requires Ind AS impairment alongside parallel prudential classification and provisioning calculations. Where the Ind AS allowance is lower than the prescribed prudential provision, the difference is appropriated to an Impairment Reserve, which is excluded from regulatory capital. This reserve is not an additional Ind AS impairment expense. [2]
Consequently, a lender should maintain distinct, reconcilable records of contractual dues, Ind AS carrying amounts and interest, and regulatory figures. It should not indiscriminately replace Stage 3 net interest with cash accounting in Ind AS financial statements. Entity-specific directions and their effective dates must govern the regulatory calculation.
7 Moratoriums and funded interest
A moratorium usually postpones payment; it does not necessarily waive interest. Where interest remains contractually payable, the accounting follows EIR, applicable credit impairment requirements and any modification assessment. Adding unpaid interest to principal does not generate cash recovery or eliminate credit deterioration.
RBI’s November 12, 2021 clarification permits accrual during an interest moratorium for accounts remaining standard, subject to the specified conditions. It also provides a limited exception from reversal for capitalised interest relating to a moratorium permitted at sanction where the account becomes NPA after that period. This must not be extended automatically to subsequently restructured facilities. [4]
Conversion into a funded interest term loan requires assessment of contractual substance, derecognition, revised cash flows and applicable prudential restrictions. A new account number alone cannot support fresh income recognition.
8 Restructuring and waivers
When a lender modifies contractual cash flows without derecognising the asset, it recalculates the gross carrying amount using the original EIR, or credit-adjusted EIR where applicable, and recognises the modification gain or loss immediately. ECL is reassessed separately. Restructuring does not automatically restore Stage 1 or standard classification.
Borrowers assess whether modified liabilities are substantially different. The quantitative 10% test and relevant qualitative changes inform derecognition; the test should not be mechanically imported as a mandatory rule for loan assets. A non-derecognising liability modification generally produces an immediate recalculation adjustment using the original EIR.
A lender’s write-off does not itself release the borrower. The borrower derecognises the obligation only when discharged, cancelled or expired. A legally effective interest waiver may therefore create different accounting dates from the lender’s earlier impairment or write-off. [1]
9 Recoveries and settlement receipts
A settlement receipt may represent principal, accrued interest, recovery of amounts previously written off or an improvement in expected recoveries. Classification must reflect the agreement, previous accounting and relevant recognition requirements.
Suppose principal at default was Rs.100 lakh and the eventual receipt is Rs.110 lakh. Calling Rs.10 lakh “interest recovered” does not establish that the lender suffered no economic loss: recovery may have taken several years and involved substantial costs. ECL considers discounted cash shortfalls, including relevant collateral realisation costs and timing.
Equally, an improvement in expected collections may produce an impairment reversal, rather than additional interest revenue. Systems must prevent the same recovery being credited twice through interest recognition and allowance release. Under RBI prudential rules, interest recovery funded by fresh or additional credit from the same lender does not qualify in the same manner as genuine collection. [1, 3]
10 Penal charges and fair interest collection
RBI’s August 18, 2023 penal-charge framework requires penalties for non-compliance with material loan terms to be levied as penal charges rather than additions to the interest rate. Penal charges cannot be capitalised or themselves attract further interest. The instructions do not prohibit ordinary contractual compounding of interest and contain product-specific exclusions. Charges must be reasonable, proportionate and transparently disclosed. Their Ind AS classification and recognition require separate analysis; changing their name does not automatically make them service revenue. [5]
RBI’s April 29, 2024 circular identifies unfair practices including charging from sanction instead of actual disbursement, charging a full month for part-month utilisation, and ignoring instalments collected upfront when computing the interest-bearing balance. It requires corrective action and addresses refunds of excess collections. Accounting models must therefore use lawful, supportable cash flows. [6]
The April 15, 2024 KFS circular requires covered retail and MSME term loans to disclose APR and an amortisation schedule, with restrictions on undisclosed charges. These disclosures should reconcile with the contractual schedule, while explaining any difference from accounting EIR. [7]
11 Borrowing costs and capitalisation
Borrowers generally recognise effective interest as finance cost. Ind AS 23 requires capitalisation when borrowing costs are directly attributable to acquiring, constructing or producing a qualifying asset that takes substantial time to become ready for intended use or sale.
Capitalisation begins only when expenditure, borrowing costs and necessary preparation activities are underway. It is suspended during extended interruptions in active development and ceases when substantially all preparation activities are complete. Necessary technical work or ordinary process delays do not automatically require suspension.
Specific borrowing costs are reduced by eligible temporary investment income. For general borrowings, an appropriate weighted-average capitalisation rate is applied to qualifying expenditure, subject to the borrowing-cost ceiling. Borrowing before construction begins does not alone justify capitalisation. Nor does the lender capitalising interest into the loan establish that the borrower has a qualifying asset. [8]
12 Concessional loans and foreign currency
Interest-free or below-market loans require initial fair-value assessment. The difference from cash advanced follows the transaction’s substance: it may represent a capital contribution, employee benefit or another item. Subsequent discount unwinding can create interest income and expense despite a zero contractual coupon. Demand loans require careful consideration of enforceable repayment rights rather than an invented long-term maturity.
For government loans at below-market rates, Ind AS 20 addresses the concession benefit alongside Ind AS 109 measurement. Related-party loans also require applicable Companies Act approvals and disclosures; fair-value accounting does not legalise prohibited terms.
Foreign-currency loans are monetary items retranslated under Ind AS 21. Exchange differences are generally recognised in profit or loss, with specified exceptions. Ind AS 23 permits capitalisation of exchange differences only to the extent regarded as an adjustment to interest costs. Derivatives require separate Ind AS 109 analysis; hedge accounting depends on qualifying designation and documentation. [1, 8, 9]
13 Presentation and reliable implementation
Financial statements should distinguish effective interest, service fees, impairment movements and modification gains or losses, with material policies and judgements disclosed. Ind AS 107 requires relevant credit-risk and allowance disclosures. Under Ind AS 7, interest cash flows are separately disclosed: financial institutions ordinarily classify them as operating; other entities classify interest paid as financing and interest received as investing.
Reliable implementation requires controlled fee mapping, validated disbursement dates, accurate EIR schedules, timely credit-status changes and reconciliations between the loan system, impairment engine and general ledger. These controls allow interest reporting to reflect contractual economics, expected recovery and the applicable regulatory requirements without confusing one measurement basis with another.
References
[1] Ind AS 109 Financial Instruments: paragraphs 4.1.2–4.1.2A, 5.1.1, 5.4.1–5.4.4, 5.5, 3.3.1–3.3.3, B3.3.6 and B5.4.1–B5.4.6; Appendix A definitions. Read with Ind AS 115 scope exclusions.
[2] RBI Implementation of Indian Accounting Standards, March 13, 2020, RBI/2019-20/170, Annex sections 1–3. RBI source
[3] RBI IRACP Master Circular, October 1, 2021, section 3, read with subsequent amendments and applicable entity-specific directions. RBI source
[4] RBI Prudential norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances — Clarifications, November 12, 2021, RBI/2021-2022/125, paragraphs 8–12. RBI source
[5] RBI Fair Lending Practice — Penal Charges in Loan Accounts, August 18, 2023, RBI/2023-24/53, read with implementation extensions and applicable directions. RBI source
[6] RBI Fair Practices Code for Lenders — Charging of Interest, April 29, 2024, RBI/2024-25/30. RBI source
[7] RBI Key Facts Statement for Loans and Advances, April 15, 2024, RBI/2024-25/18. RBI source
[8] Ind AS 23 Borrowing Costs: paragraphs 5–8, 12–14 and 17–25.
[9] Ind AS 20 paragraph 10A; Ind AS 21 paragraphs 21, 23 and 28; Ind AS 107; Ind AS 7 paragraphs 31–34; Ind AS 24 and applicable Companies Act requirements.