GET-SET-GO with International Practices
The Ministry of Corporate Affairs vide its notification no. S.O. 447E dated 28-2-2011 (as clarified by notification no. F.No. 2/6/2008-CL-V, dated 30-3-2011) has issued Revised Schedule VI which lays down a new format for preparation and presentation of Financial Statements by Indian Companies for financial year commencing on or after 1st April, 2011. The pre –revised schedule VI had been in existence since 1960 without any structural overhaul. Looking at the advancements in accounting principles coupled with drastic changes in corporate Financial Reporting, a major repairing of the schedule was outstanding for a long time.
Section 211(1) of the Companies Act, 1956 requires the companies to draw up their financial statements as per the form set out in Revised Schedule VI. It is also imperative to note at the very outset that like its predecessor, Revised Schedule VI doesn’t apply to banking or insurance companies. However, for the companies engaged in generation and supply of electricity, the Revised Schedule VI may be followed till the time a format is prescribed under the relevant statue.
This Revised Schedule has set its thumb rule as “Substance over form”, which I’ll be discussing with certain examples at appropriate places. So in this context, introduction of revised schedule VI is indeed welcome.
2. General Instructions
In case of any conflict between the requirements of Revised Schedule VI and that of the Act as well as Accounting Standards, then the latter shall be considered supreme.
(This instruction is the spine of Revised Schedule VI as it brings out a very appreciable feature that whenever in present and future, any other statue requires the companies to disclose some information which is not specifically required by Revised Schedule VI then Revised Schedule VI shall stands auto upgraded. This is likely to act as the “Bramhastra” as it automatically solves many doubts and disputes.)
Each item on the face of Balance Sheet and Statement of Profit and Loss shall be cross referenced to any related information in the notes to accounts.
Except in the case of the first financial statements laid before a company after its incorporation, the corresponding amount (comparatives) for the immediately preceding reporting period for all items shall be given. It is clarified that corresponding amounts would be required in respect of notes to accounts also.
Rounding off requirements:
Less than one hundred
To the nearest hundreds ,
thousands, lakhs or millions
or decimals thereof
One hundred crore rupees
To the nearest lakhs, millions
or crores or decimals thereof
3. What constitutes current and non-current?
(To be taken into consideration after considering operating cycle as well)
The requirement to present and bifurcate the liabilities and assets into current and non -current is a paradigm shift which involves lot of issues relating to classification, interpretation and presentation. This design is a major reform to facilitate better analysis of the financial position of the company and has undisputedly increased the role and dominance of financial analysts. It is also a step forward in IFRS based presentation of financial statements. Not just this, it will also promote transparency and discourage the practices of financial shenanigans to certain extent.
A liability/asset shall be classified as current when it satisfies any of the following criteria:
It is expected to be settled within
the company’s normal operating cycle.
It is expected to be realized, sold or consumed in
the company’s normal operating cycle.
It is held primarily for the purpose of
It is held primarily for the purpose of being
It is due to be settled within 12 months
after reporting date.
It is expected to be realized within 12 months
after reporting date.
The company does not have right to defer
settlement of liability for at least 12
months after the reporting date.
It is cash or cash equivalent unless restricted
from being used to settle a liability for at least
12 months after the reporting date.
Operating Cycle: Clause 2 of Notes to Part I of Revised Schedule VI defines operating cycle as under:
“An operating cycle is the time between the acquisition of assets for processing and their realization in cash or cash equivalents. Where the normal operating cycle cannot be identified, it is assumed to have duration of twelve months.”
It is to be noted that operating cycle can vary sharply from industry to industry. Some may have operating cycle of say 3 months while others like real estate industries or alcohol producing industries can have the operating cycle of even 3 to 5 years.
It would also be worth mentioning that for companies engaged in multiple businesses, the operating cycle could be different for each line of business. Such an entity has to classify its assets and liabilities of the respective business into current and non-current depending upon the respective cycle of the respective businesses.
Issues / case studies related to current and non-current classification:
a. X Ltd. is a company having operating cycle of 5 years. Its trade receivables are realizable within 3 years. In such a case , even though expected realization period exceeds 12 months but lies within operating cycle period, the same should be shown under the head ‘current assets’. The same concept shall be applied while classifying trade payables of such company.
b. Y Ltd. has prepaid expenses of `50,000, which have been paid for next 5 years. Operating cycle of the company is less than a year. In such a case, assuming that `10,000 pertains to next year, it will be shown as current asset whereas the balance `40,000 shall be shown as non current asset as the same is going to consume / its benefit is going to be realized after first year. Such classification shall be made at the end of each year. Similar criteria shall be applied for classification of preliminary expenses.
c. Z Ltd. after considering its operating cycle vis-à-vis expected realization period classifies its trade receivables separately in current and non - current assets. In such a case, the company should divide provision for bad and doubtful debts on same basis.
Commentary on Balance Sheet:
4. Points to ponder under the ‘Equity and Liabilities’ side:
a. Share Capital: Presentation requirements under this head have become very much detailed and give rise to many related issues which are as discussed below:
· Different classes of the preference capital are to be treated separately. Example: If a co. has 12% compulsory convertible preference shares (CCPS) and some optionally convertible preference shares then these two will be disclosed as separate classes for purpose of schedule.
· Disclosure is required for shareholders holding more than 5 % shares specifying the number of shares. This is a welcome note so as to understand the controlling interest and the holding pattern. Following issues arise in this regard:
Whether 5 % limit is for single shareholder?
Whether this limit is to be checked on aggregate of equity and preference shares?
No, it has to be checked on each class of shares.
Whether this limit is to be checked at any point of time in the financial year or at the end of the year? At the end of the year. (Also being clarified by way of Guidance Note on Revised Schedule VI issued by our Institute)
· Disclosure is also required for reconciliation of number of shares outstanding at beginning and at end of the reporting period.
· Disclosure is also required of the following for the period of 5 years immediately preceding the date of Balance Sheet:
1. Aggregate no. and class of shares allotted as fully paid up under any contractual obligation without payment being received in cash.
2. Aggregate no. and class of shares allotted as bonus.
3. Aggregate no. and class of shares bought back.
b. Reserves and Surplus:
Reserves and Surplus shall be classified under following heads as it has been specifically provided:
a. Capital Reserves
b. Capital Redemption Reserve
c. Securities Premium Reserve*
d. Debenture Redemption Reserve
e. Revaluation Reserve
f. Share option outstanding account
g. Other Reserves (like foreign exchange translation reserve arising on translation of non integral foreign operations)
* In revised schedule there are certain special nomenclatures which need to be taken care of. Like – securities premium written as securities premium reserve, P&L A/c as Statement of Profit & Loss, sources of fund and application of fund with equity and liabilities and assets and many more.
Many companies which have been incurring heavy losses used to inflate their Balance sheet by writing such bulky amount of losses under the heading miscellaneous expenditure in the assets side. This was the practice of ‘Form over the substance’ as it can really mislead the stakeholders who can’t interpret the Balance Sheet. In order to promote transparency and to give thrust to principle of ‘substance over form’, this practice is completely forbidden now, as a result of which, debit balance of statement of P&L shall be shown as a –ve figure under the head ‘Surplus’ . Similarly, the balance of Reserves and Surplus, after adjusting -ve balance of surplus, if any shall be shown under the head Reserves and Surplus even if the resulting figure is –ve.
Point to be noted:
Whether the new nomenclature of securities premium as ‘securities premium reserve’ is really effective?
Since, section 78 of the Companies Act, 1956 requires us to open an account called as ‘Securities Premium A/c’ (and not Securities Premium Reserve A/c), so as mentioned earlier, we just need to hold the ‘Bramhastra’ and the requirement of the Act shall prevail. This point has also been clarified by way of Guidance Note on Revised Schedule VI issued by our Institute. However, on this very particular point there are different practices being followed by different corporates, as is evident from their Annual Report of the year 2011-12. Just for the reference, I would like to mention that in Annual Report of Kingfisher Airlines, we shall find the nomenclature as per the Act.
c. Increased Focus on Share Application Money Pending Allotment (Quasi- Equity Concept):
It has to be shown under the head ‘Equity’ on the face of the Balance Sheet. However, share application money (or application money for other securities) which is due for refund (e.g., in the event of over-subscription, or minimum subscription requirement not met) has to be presented under ‘other current liabilities’ along with interest accrued thereon, if any. This disclosure is also likely to act as a check against the practice by some companies that receive substantial funds in the guise of share application money from their parent company or others and against which the shares are not allotted for several years. In some cases, the shares are not allotted and the money is refunded after a few years. But in substance, the true nature of funding is that of a loan. So this grey area needs to be looked upon by the auditor.
MCA Notification No. F. 2/21/2011-CL V dated 14.12.2011 in relation to unlisted public co. :
As per this notification, any allotment of securities shall be completed within 60 days from the receipt of application money and in case the company is unable to allot the securities within the said period of 60 days, it shall repay the application money within fifteen days thereafter, failing which it will be required to be repaid with interest @ 12 % p.a.
d. Liability Classification:
Classification shall be made as depicted in the chart.
Here, I would like to discuss following 2 issues particularly:
Treatment of Proposed Dividend: Revised Schedule VI just requires the amount of proposed dividend to be stated separately. However, as per AS 4, such an event is an adjusting event, hence needs to entered in books of accounts. So, requirements of AS 4 shall override the requirements of Revised Schedule VI and entry shall be made for proposed dividend.
Presentation requirement for immediate and future redeemable installments of debentures/loan: The portion which is repayable within 12 months shall be considered as current liability as shown as ‘current maturities of long term debt’ under the head ‘Other Current Liabilities’ whereas the balance portion shall be shown as ‘long term maturities’ under the head ‘Long-term borrowings’. Therefore, classification of a single loan can be seen at two different places. This major change will assess the real liquidity position and will facilitate better analysis.
5. Points to Ponder under the ‘Assets’ side:
Important revisions and provisions are as under:
a. On the face of the balance sheet, only the net block is required to be disclosed.
b. Assets under lease shall be separately specified under each class of asset. The reference is to fixed assets acquired by the company under finance leases as well as to those given by it under operating leases.
c. Where sums have been written off on reduction of capital or revaluation of assets or where sums have been added on revaluation of assets, every balance sheet subsequent to date of such write off or addition shall show the reduced or increased figures as applicable and also show the amount of reduction or increase as applicable together with the date thereof for the first five years subsequent to the date of such reduction or increase.
Broad classification is depicted as below:
It is to be noted that Long Term Loans and Advances shall specifically include “Capital Advances”. They would not be shown under capital work in progress or under intangible assets under development. Capital advances should be treated as non-current assets irrespective of when the fixed assets are expected to be received. This is because on receipt of fixed asset, the capital advance would get transferred into another non- current asset i.e. Fixed Assets.
Conflict between Revised and Pre Revised Schedule VI on Trade Receivables:
As per the pre-revised Schedule VI, debts outstanding for a period exceeding six months were required to be disclosed separately. The revised Schedule includes a requirement for disclosure of trade receivables under the current category that are outstanding for more than six months but the period is to be reckoned ‘from the date they are due for payment’. Thus, this period should be determined after excluding the contractual credit period.
The pre-revised Schedule required disclosure of ‘sundry debtors’ which, as per the definition of this term in ICAI’s Guidance Note on Terms used in Financial Statements, covers not only trade receivables, but also amounts in respect of other contractual obligations. Amounts due in respect of such ‘other contractual obligations’ cannot be included within trade receivables under the revised schedule. Similar criteria shall be applied for using ‘Trade payables’ as against creditors.
6. Let’s have a glance on ‘Statement of Profit & Loss’-
Statement of Profit & Loss (name changed from P&L A/c) has become quite comprehensive and gives some requirements which are in tandem with the requirements of the Accounting Standards. On the face of statement of profit and loss, ‘revenue from operations’ and ‘other income’ are to be presented along with the total of the two, i.e., ‘total revenue’.
Revenue from operations:
The aggregate of ‘Revenue from operations’ needs to be disclosed on the face of the Statement.
As per the instructions for preparation of the Statement, a company other than a finance company is required to disclose by way of a note the break-up of revenue into–
a. sale of products
b. sale of services
c. other operating revenues*
d. Less: excise duty
* This would include revenue from a company’s operating activities incidental to principal revenue producing activities of sale of products or rendering of services e.g., sale of by-products or scrap in a manufacturing company.
It shall include interest expenses and other borrowing costs. Paragraph 4(e) of AS 16, “Borrowing Costs”, states that borrowing costs may include ‘exchange differences arising from foreign currency borrowings to the extent that they are regarded as an adjustment to interest costs.’
Payments to auditors:
Details of payments to auditors have to be given in notes as follows:
a. As auditor,
b. for taxation matters,
c. for company law matters,
d. for management services,
e. for other services,
f. for reimbursement of expenses.
Thus, a separate disclosure of reimbursement of auditors’ expenses is now required.
Extract of RS VI is being reproduced here:
As per AS 5, exceptional items are either disclosed as a separate line item(s) on the face or included in the relevant line item and explained by way of notes to the financial statements. But considering the specific requirements of the revised Schedule, companies no longer have the option to not disclose exceptional items as a separate line on the face of the statement of profit and loss.
Para 14 of AS 5 gives certain examples of such exceptional items:
1. The write down of inventories to NRV
2. Disposal of items of fixed assets
3. Disposal of long term investments
4. Legislative changes having retrospective application (e.g. increase in D.A. with retrospective effect after revision by Sixth Pay Central Commission)
5. Litigation settlement
The catch note of some relevant paragraphs of AS 5 requiring attention is as under:
Para 10 - Whether an event or transaction is clearly distinct from the ordinary activities of the enterprise is determined by the nature of the event or transaction in relation to the business ordinarily carried on by the enterprise rather than by the frequency with which such events are expected to occur. Therefore, an event or transaction may be extraordinary for one enterprise but not so for another enterprise because of the differences between their respective ordinary activities.
Para 11- Examples of events or transactions that generally give rise to extraordinary items for most enterprises are:
– attachment of property of the enterprise; or
– an earthquake.
Profit / (loss) from discontinuing operations: As is evident from the given extract, profits from continuing and discontinuing operations shall have to be shown separately on face of statement of P&L:
The profit after tax from continuing profits have been arrived in step XI. Thereafter, profits from discontinuing operations shall be written on face of the statement by showing working in the notes and tax expenses shall also be disclosed separately for that. This major reform is really directed to promote transparency and to forecast the earnings in a better manner.
Preparation of financial statements as per RS VI is a challenging task involving various practical issues. It would be quite apt to say, “Changes may come and changes may go but the company will go on forever”. Efforts have been made to discuss some of the prominent and fundamental issues raising presentation level by Indian Corporate out of the plethora of the possible issues. Issues may vary from company to company as well as industry to industry. Compiling various information for the purpose of disclosures, educating the staff whether related to accounts and finance or not is one of the challenges posed by RS VI for the companies. This major change is definitely a path breaking initiative aiming at adoption of international financial reporting practices. The following lines of Sir Robert Frost can exactly fill the hole to describe the position of India Inc. in this all-changing scenario:
“The woods are lovely, dark and deep,
But we have promises to keep,
And miles to go before we sleep,
And miles to go before we sleep.”