ACCOUNTS OF COMPANIES
Introduction
Companies act, 2013 lays down the broad framework, detailed procedure is prescribed in rules covering 60%/70% of the working of the act. Companies’ act, 2013 has recognized the fact of term “control” being disbanded by giving emphasis to regulation or self-regulation through transparency and disclosures. Onus of compliance has shifted to management whose definition has been widened by various definitions including of key-management-personnel. In the event self-regulation fails, regulation moves to outside regulator with implications of high penalties. Statutory recognition has been given to “Corporate governance” and “Corporate social responsibility” for protection of various stake-holders including investors. Professionals focusing on “protecting transactions” would find it easy to navigate the Act.
An attempt is made to discuss critical new provisions brought in by companies act through Chapter IX:
- Cash flow becoming part of financial statements for all companies
- Consolidated financial statements for all companies
- Provisions for re-opening or revision of accounts
- National financial reporting authority being vested with powers of monitoring and implementing accounting and auditing standards
- Directors report to make critical statements on internal controls and compliance with all applicable laws
- Expenditure on corporate social responsibility (CSR)
Reminding us of basics Sec 128 (1) requires “books of account and other relevant books, papers and financial statement” for every financial year to be prepared in accordance with – “accrual basis and double entry system” to give “true and fair view” of the state of affairs and explain transactions effected at registered office and branch offices.
Almost every term in Sec 128(1) is inclusively defined by Companies Act. Through these definitions Companies Act recognizes maintenance of books of accounts or other papers in electronic mode. Electronic record is defined in draft rules as data, record or data generated, image or sound stored, received or sent in an electronic form or micro film or computer generated micro fiche and accessible in India.
Cash flow becoming part of financial statements for all companies
Financial statements have to be prepared as per format stated in Schedule III which is in line with Schedule VI. The major change is financial statements includes - cash flow statement and statement of changes in equity. Cash flow statement is part of financial statements for all companies except one-person-company, small-company and dormant-company. Cash flow statement need to be prepared as per AS 3 ie direct method or indirect method, but for listed companies indirect-method is to be followed. Statement of changes in equity is included keeping in view applicability of IndAs when notified. Expenditure on CSR has to be shown as a separate line item in profit and loss account.
Financial statements are defined to include any explanatory note annexed to accounts. Thus auditors would have to read the notes carefully and ensure they comply with statutes and standards, as they would be signing the same.
Consolidated financial statements for all companies
Companies Act has made it mandatory for “all companies” to prepare and present before annual general meeting of the company consolidated financial statements of the company and all its subsidiaries in the format required by Schedule III. Definition of “subsidiary” has been expanded to include “associate company and joint venture”. Associate company has been defined to include control of at least 20% of share capital or of business decisions under an agreement. This is essentially moving towards compliance with IFRS. Thus even if a company has no subsidiary but has associate or joint venture companies, it will have to prepare consolidated FS.
When preparing financial statements as per schedule III the order of compliance with requirements would be - Companies Act, Accounting standards and Sch III. Thus if Companies Act or Accounting standards requirements are different from Sch III, Companies Act or Accounting standards would prevail. Understanding of this fact is important as Consolidated FS require application of accounting standard 21. All Subsidiaries would have to be consolidated, including foreign subsidiaries, except in case of certain companies where control is temporary as exempted by AS 21. MCA has notified that shares held in trust by company will not be considered when determining whether the company is a subsidiary.
As per requirement of Companies Act even intermediate holding companies having subsidiaries have to prepare consolidated financial statements. This is quite an onerous task, even IFRS requires preparation of consolidation FS only at ultimate holding company level for all subsidiaries within the same jurisdiction.
Consolidated financial statements would be prepared in accordance with methods stated in accounting standard 21. Accounting standard 21 had visualized consolidation only in case of subsidiaries ie where holding company has more than 50% control of voting rights or board control of subsidiary company. Thus accounting standard 21 had recommended use of line-by-line method when preparing consolidation FS. Question would be how correct it would be to consolidate FS of associate company and joint venture using line-by-line method. It appears it is envisaged that while consolidating accounts of subsidiaries line-by-line method would be followed but while consolidating accounts of associates and joint ventures equity-method need to be followed. This would ensure correct reflection of holding company interests in associates and joint ventures.
Companies Act has dispensed with requirement of giving out separate financial statements of subsidiaries along with holding company accounts. Certified statement giving salient features of financial statement of each of the subsidiaries need to be given as per prescribed format in rules. Schedule III requires additional information to be given, with regards to each of the subsidiaries, of net assets and share of profit/ loss.
When preparing consolidated financial statements we were following AS 21 requirements only. Thus we were giving additional information with regards to expenditure / income in foreign currency of imports, exports, dividends, royalty, etc only for parent company and not for subsidiaries. Schedule III specifically requires this information to be given for each of subsidiaries also. When giving this information we need to understand whether we can set-off inter-company transactions.
Provisions for re-opening or revision of accounts and financial statements
Companies Act has provided for forcible re-opening, by a court or tribunal, and voluntary revision by directors, with approval of tribunal, of financial statements in certain specific circumstances. Stepping back we are aware that, all listed companies need to file a form giving details of qualifications in auditors reports, clarifications in notes and directors explanations of the same. The forms would be reviewed by QARC committee of SEBI and where necessary SEBI has the powers to force the companies to restate accounts. As there are no statutory provisions for restatement of accounts, SEBI has clarified that pro-forma accounts be filed with stock-exchanges and effects of revision be shown in subsequent financial years as prior period item. Exposure draft of AS 5 (Accounting policies, Changes in estimates and errors) also envisages revision of accounts and method of doing the same. IFRS and USGAAP permit revision of financial statements.
Revision by force is envisaged through an application by a statutory body to court or tribunal on the grounds that accounts were prepared in a fraudulent manner or affairs of the company were mismanaged. Importantly there is no time limit fixed for such revision of financial statements.
Voluntary revision of financial statements can be taken up by directors if they believe that financial statement or board report does not give a true and fair view of state of affairs of company, comply with accounting standards or schedule III (Sec 129), or give the information prescribed by Sec 134. Directors can carry out voluntary revision after applying and receiving approval from tribunal for any of the three preceding financial years. Detailed procedure to be followed for voluntary revision is laid down in the draft rules.
National financial reporting authority
Companies Act has replaced NACAS with NFRA with much wider role, duties and powers. Apart from giving recommendations to government on accounting and auditing standards, NFRA has to monitor compliance with accounting and auditing standards including quality of service of professionals responsible for compliance of standards. Thus NFRA would be taking over functions of ‘Quality review board’ and ‘Financial reporting review board’ of ICAI. As per draft rules NFRA can take up investigation, on its own initiative, into companies and audit firms in certain prescribed situations and in other cases on receipt of complaint.
Critical statements in Board of directors report
Companies Act requires certain critical affirmative statements be made in Board of directors report, including proper systems are in place and are operating adequately to “ensure compliance with all applicable laws”. In case of listed companies, adequate internal financial controls are in place and operating effectively. Companies act requires statements on development and implementation or risk policy, and details of CSR activities taken up by the company. These statements are quite critical and need to be understood by all key personnel of companies.
Directors’ report does not from part of financial statements but, may have to be looked into before auditors give their report. Directors’ report could consist of critical material information which may have an impact on financial statements.
Expenditure on corporate social responsibility (CSR)
Schedule VII and draft rules give guidance to understand what constitutes / qualifies as expenditure on CSR. Expenditure on CSR could enable integration of business models with social and environmental priorities and processes in order to create shared value. CSR excludes activities undertaken in pursuance of normal course of business and is also not a charity or mere donations.
Every company meeting certain criteria, of net-worth, turnover and profits, shall have to spend two percent of average net profits for three preceding years as expenditure on CSR. There are no penal provisions for not spending, but Board shall in its report give reasons for not spending the said amount. Draft rules clearly lay down modus operandi for spending the amount. Practically there could be border-line cases making it difficult to clearly state this-is/not expenditure on CSR. Couple of examples - expenditure on staff quarters would not be CSR but a hospital built for general public and incidentally used by staff could qualify as CSR. Similarly road from a railway siding to factory which is open to public use and is also used by company would be CSR expenditure. Company supplying its products to families below poverty line at 50% of cost may not qualify as CSR expenditure if it is part of sale promotion.
Availability of Financial statements
Every listed company needs to place its financial statements, including consolidated financial statements, and all other documents to be attached thereto on its web-site. There are penal provisions for not complying.
Filing of financial statements with Registrar
Copy of financial statements, along with all documents required to be attached thereto, shall be filed with ROC within 30 days from date of AGM. If financial statements are not adopted by the AGM or adjourned AGM, the un-adopted financial statements, along with documents to be attached, filed with ROC within 30 days of from date of AGM /adjourned-AGM. Companies are given additional time, upto 300 days from date of AGM, to file financial statements and attached documents with ROC. Privilege given to private companies to file profit and loss account and balance sheet separately has been removed. These time-lines for filing are to be carefully monitored as penalty provisions for not complying with these requirements are severe.
Conclusion
Companies Act 2013 is being enacted in phases which throws’ up challenges and confusion in compliance, requiring professionals to focus little more on keeping themselves updated. Professionals need to keep four items, Companies Act 2013, Prescribed rules, Prescribed Forms and Companies Act 1956, on their table to ensure they do not attract NFRA. Companies Act 2013 can be seen as an effort by Ministry of Corporate affairs to move away from registry functions, by delegating the same to professionals, and move towards regulation and enforcement. If professionals focus on protecting the transaction, rather than individuals, there could be more opportunities.
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