- November 24, 2015 at 5:39 pm
Please review the below given technical terms and their mechanism, and then guide an accounting treatment for LG (Bank Guarantees) as per IAS on Financial Instruments.
Bank Guarantees and Cash Margins:
Bank Guarantee / LG is the guarantee given by contractor (Construction Company) to the client. The most famous Bank Guarantees used Construction Industry in Pakistan are;
1. Bid Bond Guarantee
Bid Bond is the guarantee given at the time of Bidding and winning of a Construction Contract. And is often of small Cash Margins.
Main guarantees are Performance guarantee and Mobilization Bond.
2. Performance Bond
After winning the contract, Performance guarantee is issued which spans over the contract life and it remains unchanged throughout the life of a construction contract. However, note that contractor has to deposit a lumsum amount of Cash Margin for the issue of each guarantee by the bank. This cash margin rates vary from bank to bank.
Now let say amount of performance bond is 296 Million issued by JS bank. Contractor must have paid 25% (JS Bank Rate) of 296 Million = 74 Million for the guarantee to be issued. For a performance bond, this cash margin also remains unchanged throughout the contract.
3. Mobilization Bond
However, client also pays an upfront amount of cash to the contractor to Mobilize the contractor to start the construction work. Mobilization advance is a kind of interest free loan of finance by the client to the contractor. It’s paid upfront and an agreed % of Mobilization advance is deducted on each subsequent IPC (Interim Payment Certificate) of the contract. And at the end of a contract, Mobilization advance gets reduced to zero.
As the mobilization advance changes over the life of a contract, therefore Value of Mobilization Bond as well as Value of LG Margin paid for Mobilization Guarantee also changes. At the end of the project / contract, this Mobilization LG as well as LG Margin is also reduced to zero.
Let say Mobilization Guarantee is 250 Million issued by Askari bank and We paid 20% (Askari Bank Rate) of 250 Million as Cash Margin = 50 Million to the bank. When the LG Margin is paid, we make the following double entry;
Dr LG Margin Mobilization Bond 50 Million
Cr Askari Bank 50 Million
Now this Cash margin paid on mobilization advance is capitalized on balance sheet. And whenever, an IPC (say 100 Million) is submitted by the contractor, an agreed %age (say 10%) i-e 10 Million shall be deducted by the client as repayment of mobilization advance. Now 20% of this 10 Million = 2 Million shall be refunded by the bank to you as reduction / refund of Cash Margin Paid. On refund of Cash Margin, we make the following double entry;
Dr Askari Bank 2 Million
Cr LG Margin Mobilization Bond 2 Million
Please be noted that for the simplicity, I have ignored the double entry on receipt and repayment of mobilization advance. But has maintained the Cash Margins / LG Margins status in our accounts.
But also, as you see I have not recorded the Bank Guarantees itself. Probably, these guarantees are issued by the bank against some collateral. And further, these guarantees are financial instruments. And this is really never recorded in my company accounts. Now my boss wants me to incorporate the guarantees as well. If I need to capitalize these bank guarantees in my accounts, I simply need your serious advice and in anticipation, I appreciate your kind favour.November 25, 2015 at 8:43 am
Why did you still not answer my question ??
I am still waiting for your reply.
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