Many times, we see that many companies which are in startup stage i.e. during construction period and before it is ready for commencing commercial operations do not prepare Profit and Loss Account for the year / period and the total expenditure incurred during such year / period is kept under the head "Pre-Operative Expenditure, pending allocation" - Whether this treatment is correct as per Companies Act, 1956 and whether it complies with the Accounting Standards and Guidance notes issued by the ICAI?
Let us have a glance on the various relevant statutory provisions relating to the same.
Under the Companies Act, 1956:
Section 210(1) states: "At every annual general meeting of a company held in pursuance of Section 166, the Board of Directors of the company shall lay before the company - (a) a balance sheet as at the end of the period specified in sub-section (3); and (b) a profit and loss account for that period."
Section 210(3) states: "The profit and loss account shall relate - (a) in the case of the first annual general meeting of the company, to the period beginning with the incorporation of the company and ending with a day which shall not precede the day of the of the meeting by more than nine months..."
Hence, from the above, every company is required to prepare a profit and loss account from the date of incorporation of the company.
DCA Circular (Letter No.2/17/64-PR, dated 29-1-1964) states: "The intention underlying Section 210 is that every company should render to its shareholders an account of its expenditure, and income even though they may have been incurred or received during the period of construction. It is no doubt true that a company does not really commence its business operations till the period of construction is over. There will, of course be no objection if such account is called “Development Account”, Expenditure during construction account” or by any other suitable name so long as these accounts, give details of the revenue expenditure and income during the period covered, in the manner required by Part II of Schedule VI. Subsection (3) of section 210 makes it quite clear that it is mandatory for every company to prepare a “profit and loss account” from the date of its incorporation."
As per Schedule VI, Part II, "The profit and loss account shall be so made out as clearly to disclose the result of the working of the company during the period covered by the account". It cannot be regarded as only Commencement of commercial operations reflects the 'result of the working' of the company rather other activities like construction or winding up activities also denote the working of the company.
Under the Companies (Accounting Standards) Rules 2006:
Now, the accounting pronouncements applicable to capitalisation of assets are AS 10: Accounting for Fixed Assets and AS 26: Intangible Assets and the Guidance Note on Treatment of Expenditure during Construction Period has been withdrawn by the ICAI. Hence, now there is no concept of accumulating all the expenditure incurred into one account and then charging it off to revenue once the Commercial Operations are commenced.
As per para 9.3 of AS 10 Accounting for Fixed Assets, Administration and other general overhead expenses are usually excluded from the cost of fixed assets because they do not relate to a specific fixed asset. Hence, all the general expenses cannot be capitalized and should be charged off profit and loss account i.e. Profit and loss account has to be prepared.
From the above, it is mandatory for each and every company to prepare Profit and loss account.