Company accounts must be prepared
according to the accrual basis of accounting and on a
historical-cost basis, but revaluation of capital assets is
permissible.
The Companies Act prescribes the form and
content of the balance sheet and the information to be disclosed
in the income statement.
Most companies have voluntarily adopted
March 31 as the date for preparing their financial statements
because a uniform accounting year ending on March 31 is required
for tax purposes.
There is no statutory requirement for
deferred tax accounting or to prepare consolidated financial
statements.
The development of accounting practice in
India has largely been influenced by the practice in the United
Kingdom. No regulatory body is specifically responsible for the
establishment of accounting principles. In several accounting
areas, mandatory requirements for accounting practices are
included in the Companies Act. The Institute of Chartered
Accountants of India (ICAI) has during the last few years issued
the following accounting standards and guidance notes.
AS 1: Disclosure of accounting policies.
AS 2: Valuation of investors.
AS 3: Changes in financial position.
AS 4: Contingencies and events occurring after the balance
sheet date.
AS 5: Prior-period and extraordinary items and changes in
account policies.
AS 6: Depreciation accounting.
AS 7: Accounting for construction contracts.
AS 8 : Accounting for research and development
AS 9: Revenue recognition.
AS 10: Accounting for fixed assets.
AS11: Accounting for the effects of changes in foreign
exchange.
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AS12: Accounting for government grants.
AS13: Accounting for investments.
AS14: Accounting for amalgamations.
AS15: Accounting for retirement benefits in the financial statement.
Expenditure during construction.
Treatment of reserves created on revaluation of fixed assets.
Accounting treatment for excise duty.
Accounting for changes in price.
Accounting treatment of treatment of reserves in amalgamation.
Accounting treatment for MODVAT.
Accrual basis of accounting.
Accounting for leases.
Accounting for depreciation in companies.
Accounting for taxes on income.
Accounting Standards 1, 4, 5, 7, 8, 9, 10, and 12
have already been mandatory. Accounting Standards 6 and 11 have been
revised and already with the new standards 13, 14 and 15 became
mandatory for financial years commencing on or after April 1, 1995.
Others are still at a recommended mandatory stage as are the Guidance
Notes.
The following are illustrative of some important
areas of differences in accounting practices in India as compared
with those followed in the United Kingdom or in the United States.
Fixes assets
1. Corporate management in India may at its
discretion revalue the fixed assets and state such assets in the
balance sheet at revalued amounts instead o at their historical cost.
The revaluation surplus is regarded as not available for
distribution, but it is permissible to utilize the revaluation
surplus to offset the incremental depreciation arising out of
revaluation.
Additional depreciation upon depreciation upon revaluation can be
adjusted against the revaluation surplus or charged to the income
statement.
2. Interest on money borrowed to finance fixed-assets and not charged
off to income.
3. Exchange gains and losses related to borrowings meant for capital
additions are included in the original cost of the capital asset and
not included in the income for the year.
4. Corporate law in India recognizes the straight-line as well as the
written-down-value methods of depreciation.
5. Every compnay in India must provide for depreciation at the
statutorily prescribed minimum rates before declaring any dividend.
Where, however, the management considers such depreciation to
inadequate, they may make their own assessment of the pertinent
factors, such as useful life, residual value and expected economic
obsolescence, so as to provide for a higher depreciation.
Investments
Investments classified as "current"
should be carried at the lower of cost and fair value; investments
classified as "long term" should be carried at cost
adjusted for permanent diminution in value. Market values of quoted
investments must be disclosed. Investments in associate undertakings
have no disclosure requirements; however, loans and advances to
companies "under the same management" must be disclosed.
Inventory
Conventionally, inventory is valued at the lower
of cost and net realizable value. Costs maybe determined either on a
full-absorption basis or direct-cost basis.
Other
1. There is as yet no mandatory requirement in
India to prepare a funds statement and to include it as an integral
part of the financial statements.
2. Provisions for income tax is based on taxable income, and deferred
tax accounting is not generally followed. However, deferred tax
accounting is now recognized by the ICAI as a preferred practice.
3. The fact of noninsurance or self-insurance with respect to
concerned assets is not required to be disclosed in the accounts.
4. Disclosure of segmented information for diverse activities,
particularly with respect to profit contribution from each segment,
is not customer.
5. It is not customary to prepare consolidated group accounts or to
disclose earnings per share and employee pension plans.
6. Lessees are not required to capitalize finance leases, and lease
rental are accounted for on an accrual basis over the lease term.
Future obligations are disclosed as off-balance-sheet items. Lessors
are require to capitalize asse ets given on lease and charged to the
income statement on the basis of the implicit rate of return over the
period of lease finance through a lease equalization account.
7. Disclosure of the financial impact of a change in accounting
policies to the previous year's income statement is not customary.
8. Expenditure incurred until the date of commencement of commercial
production, including interest, which is regarded as indirect cost of
construction, is allocated to the fixed assets. Other preoperative
expenditure is treated as deferred revenue expenditure and is
generally amortized over three to five years.
9. Goodwill is capitalized and amortized over the estimated useful
life, normally not exceeding five years unless a longer period can be
justified. A surplus generated upon the sale of a business is
retained as capital reserve.
10. Patents and Trademarks may be written off over the period of use
or legal term of validity, whichever is shorter, while other
intangibles such as deferred revenue expenditure as generally written
off over three to five years. Technical know-how fees are written off
in the year in which incurred, except for expenditure on plans,
designs and drawings for plant and machinery, which is capitalized
along with the respective assets.
11. Write-off of research and development costs can be deferred,
provide the product or process is technically and economically
feasible and the undertaking has adequate resources to market the
product or process. There is no separate standard on treatment of
cost of development of computer software.
12. Loans that fall due within one year are not classified as current
liabilities, but disclosure is required to be made as a note to the
accounts.
13. Disclosure of related-party transactions is limited to publishing
details of balances outstanding at year-end and the maximum
outstanding during the year in the annual accounts. Auditors are
required to comment on the reasonableness of certain related-party
transactions.
A balance sheet and a profit and loss account
(income statement) are the basic financial statements that are to be
circulated to shareholders and trustees of debenture holders before
the annual general meeting. The auditor's report and the directors'
report, however, must be attached to the basic financial statements.
Schedule VI of the Companies Act prescribes the
form and content of the balance sheet and the information to be
disclosed in the income statement. Corresponding figures for the
immediately preceding year must be given in these statements. The
requirements of Schedule VI apply to all companies except insurance
companies, banks and electric utilities, which are all governed by
special acts. Irrespective of the size of the company, the volume of
information required to be disclosed in the financial statements is
the same. Apart from this information, the accounting standards also
specify disclosure requirements such as those to disclose the
previous period's corresponding figures and accounting policies.
Furthermore, under a recent amendment to the
stock exchange listing agreements, all listed companies must, for
financial years ended in March 1996 and thereafter, prepare a cash
flow statement. Such a statement is to be prepared in accordance
with the requirements prescribed by the Stock Exchange Board of
India and duly certified by the statutory auditors.
A set of financial statements without the
detailed schedules referred to therein is given in Appendix XI.
There is no special form of presentation of the financial statements
of a wholly owned subsidiary of a foreign company.
Matters covered in the directors' report
accompanying the financial statements should include the following.
1. State of the company's affairs.
2. Amounts proposed to be set aside to reserves.
3. Proposed dividends.
4. Post-balance-sheet events.
5. Changes in the nature of the company's business.
6. Changes in the subsidiaries and in the nature of their business.
7. Comments on qualification in the auditor's report.
8. Conservation of energy, technology absorption, and foreign
exchange earning and outgo in the manner prescribed.
9. Particulars of employees who receive remuneration of Rs 300,000
per year or Rs 25,000 per month.
10. Particulars of every employee who receives remuneration in
excess of that drawn by the managing or full-time director or
manager, provide the director or manager, together with spouse and
dependent children holds 2 percent or more of the equity share
capital of the company.
11. For quoted companies, a statement showing the variation between
projected utilization of funds and / or projected profitability as
contained in its prospectus or letter of offer and the actual
utilization of funds and / actual profitability for each of the
years for which projections have been provided in the prospectus or
letter of offer. Any material variations between the projections
and actuals and the reasons thereof should be included in the
directors' report.
The income statement must clearly disclose
the results of the operation of the company for the period covered
by the accounts and every material item, Including receipts and
expenses with respect to nonrecurring transaction or transaction
of an exceptional nature, as well as any material effect of the
changes in the basis of accounting. There are also considerable
requirements for statutory disclosure of information in the income
statement as shown below, which maybe given by way of footnote
disclosure where appropriate.
1. Sales:
a. Aggregate turnover showing amount of sales for each class of
goods, including quantities, and, where companies are rendering
services, the gross income derived from services rendered;
b. Commission paid to sole selling agents and other selling
agents;
c. Brokerage and discount on sales other than usual trade
discounts.
2. Consumption of raw materials:
For manufacturing enterprises, the total value of raw materials
consumed, giving separately, as far as possible, the value of such
raw materials consumed for each type is more than 10 percent of
the total value.
3. Licensed capacity, installed capacity and actual production:
For manufacturing enterprises, quantitative information for each
class of goods manufactured.
4. .Stock (inventory):
a. The opening and closing stocks of goods produced, giving the
quantity and value of each class of goods; and
b. The value of work in progress, if any, at the beginning and the
end of the accounting period. In the case of trading companies,
the value of purchases made and the opening and closing stock,
giving an item-by-item breakdown and indicating quantities
thereof.
6. For a company that falls under more than one of the above
categories, it is sufficient if the total amounts are shown for
opening and closing stock, purchases, sales, and consumption of
raw materials, with value and quantitative breakdown and gross
income from services rendered.
7. For other companies, the gross income derived under different
heads.
8. Amount provided for depreciation, renewals or diminution in the
value of fixed assets. If no provision is made for depreciation,
this must be disclosed together with the quantum of arrears of
depreciation.
9. Interest on debentures and other fixed loans.
10. Income tax provisions.
11. The amounts reserved for repayment of redeemable preference
stock and borrowings.
12. Remuneration paid to managerial personnel, defined in the
Companies Act to include directors and managers.
13. Computation of net profit under Section 349 of the Companies
Act for commission payable to directors or managers.
14. Expenditure incurred on various other heads, such as
consumption of stores and spare parts, power and fuel, rent,
repairs to buildings, repairs to machinery, salary wages and
bonus, contribution to provident and other funds, workers and
staff welfare expenses, insurance, taxes other than income tax,
and miscellaneous expenses. Expenditure on any item of
miscellaneous expenses in excess of 1 percent of total revenue or
Rs 5,000, whichever is higher, must be shown separately.
15. Payments to auditors separately for audit, taxation matters,
company law matters, management services, and any other services.
16. Reserves and provisions :
a. The aggregate, if material, of amounts set aside or proposed to
be set aside to reserves (but no including provisions to meet any
specific liability, contingency or commitment know at the balance
sheet date) are required to be disclosed separately for each item.
b. The aggregate, if material, of amounts drawn from such reserves
or provisions, separately for each item.
17. Amount of income from investments, distinguishing between
trade and other investments.
18. Other income by way of interest, specifying the nature of the
income.
19. Amount of income tax deducted at source where gross income
from investments or interest is stated.
20. Profits or losses from investments.
21. Profit or loses from extraordinary transactions.
22. Miscellaneous income.
23. Dividends from subsidiary companies.
24. Provision for losses of subsidiary companies.
25. Dividends paid and proposed.
26. The amount by which any item shown in the income statement is
affected by any change in the basis of accounting.
27. Transactions in foreign currency:
A. Value of imports;
B. Value of imported materials consumed;
C. Expenditure in foreign currency under various heads;
D. Dividends remitted abroad; and
E. Foreign exchange earnings.
1. The amounts authorized, issued,
subscribed, and paid up on each class of shares (namely), common
or preferred stock) should be stated, indicating the number of
shares allotted as fully paid up pursuant to a contract without
payment being received in cash, and the number of shares allotted
as fully paid up by way of bonus shares. The par value of shares
is presented on the face of the balance sheet for each class of
shares.
2. Where shares are issued at a value in excess of par, the
excess must be transferred to a share premium account. Section 78
of the Companies Act restricts the utilization of the amount
lying in such an account.
3. The issue of bonus shares involves the issue of new shares to
existing shareholders by way of a transfer of an equivalent par
value from reserves to share capital.
4. Indian corporate law permits stock splits, i.e., replacement
of the present number of shares with a greater number of shares
with a lower par value under current guidelines. The par value
cannot be lower than Rs 10. No capitalization of reserves is
involved in such stock splits.
5. Indian law generally prohibits a company from buying its own
shares and from giving any financial assistance for purchase of
its own shares or shares in its holding company.
The basis of valuation of fixed assets,
marketable securities and inventory must be disclosed. The
valuation of these assets is generally as follows.
1. Marketable securities:
Long-term securities not meant for resale are usually valued at
cost, but they may be required to be written down to reflect la
permanent decline in value. Marketable securities meant for
resale as trading stock are, however, carried at the lower of
cost land market value.
2. Inventory:
The normal basis of valuation of inventory is cost or market
value, which ever is lower, the cost being ascertained by the
weighted-average or FIFO method. Although not prohibited by any
pronouncement, LIFO is not generally used, either for accounting
or for tax a purposes. Certain types of stocks (e.g., tea, jute
manufacture, sugar) are conveniently valued at market
3. Fixed assets:
The statutory requirement is to disclose the original cost or,
where there has been a revaluation, the increased or the
decreased revalued amount and the total accumulated
depreciation. As far as possible, the amount of fixed assets
should be classified into land, buildings, lease holds, railroad
sidings, plant and machinery, furniture and fittings,
development of property, parents, trademarks, designs,
livestock, and vehicles. Goodwill, if included in accounts,
should be disclosed separately. Factory buildings are classified
under the category "buildings" and not under
"plant and machinery."
Depreciation
A company will not be entitled to declare
any dividend unless minimum depreciation is provided for in its
account by either the straight-line method or the
written-down-value method at the rates Specified in Schedule XIV
to the Companies Act. The depreciation method followed (as well
as the depreciation rates or the useful lives of the assets as
adopted by a company if different from those under the specified
rate) should be disclosed in the accounts.
Management may at its discretion revalue
land, buildings and other fixed assets to recognize any
appreciation. Such revaluation, however, is not carried out at
regular intervals in India.
Depletion of natural resources
In the absence of any specific
pronouncement of any regulatroy body, the accounting treatment
of cost incurred on prospecting, extraction and production of
any mineral varies from company to company. Where costs related
to lease of property, preliminary expenses, prospecting, etc.,
are to be amortized, it is done over a period within the term of
the lease.
Investment incentives
Investment incentives under income tax laws
are reflected in the income statement as a reduction of income
tax expenses in the period the incentive is derived.
The normal practice upon combination of
two businesses, whether through purchase, amalgamation or
merger, is to treat the acquisition as purchase. A merger
accounting system that is based on the pooling-of-interests
method of accounting may be possible if certain conditions are
fulfilled. There is no special treatment or tax implication of
goodwill create upon pooling, acquisition or merger, provided
it arises on amalgamation with the meaning of the Income Tax
Act. Most companies do not amortize goodwill, and amortization
of goodwill is not deductible for tax purposes. Goodwill
arising upon amalgamation in the nature of merger, however, is
immediately adjusted against reserves, since it is in the
nature of self generated goodwill.
Consolidated financial statements are not
legally required and are not generally prepared. Certain
documents and statements relating to the subsidiaries must be
attached to the accounts of the holding company.
The term "provision" is used
to denote the following.
1. Any amount written off or retained
byway of providing for depreciation renewals or diminution in
value of assets.
2. Any amount set aside to meet any
known liability the amount of which cannot be determined with
substantial accuracy. Under the Act, the amount in excess of
the required provision must be shown as a reserves and not as
a provisions.
There are two general categories of
reserves: capital reserve and revenue reserve. Capital
reserve does not include any amount regarded as free for
distribution through the income statement, and revenue
reserve is any reserve other than a capital reserve. The
credit balances in th4e share premium account and fixed
assets revaluation reserve are in the nature of capital
reserve. It may be notes, however, that capital reserves
actually realized from an activity such as the sale of assets
or the sale of a business are utilized for distribution as
dividends or transferred to the general reserve.
The Act required disclosure of capital
reserves, other reserves, specifying the nature of each
reserve: other reserves, specifying the nature of each
reserve; and the unappropriated balance in the income
statement under the head "reserves and surplus."
Current additions and deductions must be shown for each
reserve account. A debit balance in the income statement must
be deducted from the uncommitted reserves.
Reserves created in any year are not
deductible for tax purposes, although some reserves may have
to be created for claiming a tax incentive. Provisions are
normally deductible for tax purposes except in the cases of
unascertained liability and certain statutory dues that are
deductible on a payments basis only.
Footnotes must be added, to disclose
various additional information.
1. Claims against the company not
acknowledged as debts.
2. Uncalled liability on shares partly paid.
3. Arrears of fixed cumulative dividends.
4. Estimated amount of unexecuted contracts on capital
account.
5. Any other amounts for which the company is contingently
liable, including guarantees given by the company on behalf
of directors or other officers of the company.
These footnotes maybe added to the
balance sheet or included separately as "Notes to the
Accounts," which comprise the balance sheet and the
income statement.
Apart from the disclosure requirement
as specified in the Companies Act, accounting standards
stipulate disclosure of research and development costs,
amount of exchange differences included in the income
statement and that adjusted in fixed assets, significant
restrictions on the right of ownership, realizability of
investments, etc.
Financial statements for presentation
to share holders are prepared annually. A uniform
accounting year up to March 31 is now required for tax
purposes. Consequently, most companies have adopted March
31 as the date for preparation of financial statements.
Income and expenses arising during the period, irrespective
of whether they relate to ordinary business operations,
prior periods or other events, are usually recorded through
the income statement as a credit or charge before arriving
at the net profit. However, the Institute of Charted
Accountants of India has prescribed that prior-period and
extraordinary items should be separately disclosed in the
income statement for the current year.
All companies must follow the accrual
basis of accounting.
Basically, business profits for tax
purposes are determined with reference to accounts
prepared on recognized accounting principles, but such
profits are subject to many statutory adjustments,
Accounting and Taxable Profit
Differences
Financial aspect
Difference between
accounting and taxable Profits
Depreciation on fixed assets
Books rates differ from tax
rates.
Interest payable to financial
institutions: Contributions to employee benefit funds,
Taxes and duties payable to the government
Expense is allowable for
accounting statements upon accrual; however, tax
deductible only if paid within specified period.
Preliminary expenses; expenditure
on pros-Prospecting for certain minerals
Expense is allowed for accounting
statements upon accrual; however, tax deductible only
if over a specified period.
Travel and entertainment expenses
and gifts
Expense is allowable for
accounting statements Upon accrual; however,
deductibility under tax is Subject to certain limits.
Guest house expenses
Expenses are allowable for
accounting statements upon accrual, but are not tax
deductible.
Agriculture income
Considered as income in
accounting statements; however exempt from central
income tax.
Corporate entities are eligible to
claim various types of tax deductions and incentives,
which result in different profit figures.
Deferred tax accounting is not
prevalent in India. Nor is it statutorily required. The
ICAI, however, considers it preferable to the traditional
taxes-payable methods.
The Institute of Chartered
Accountants of India issued a Guidance Note on Accounting
for Changing Prices in 1982, but it has not yet been made
mandatory in view of worldwide rethinking on the methods
of current-cost accounting.
The accrual basis of accounting has
been overwhelmingly prevalent in practice in India; and
it was made legally mandatory by an amendment to the
Companies Act 1956, which provides that books of account
will not be deemed to have been properly kept if they do
not use the accrual basis and double-entry bookkeeping.
The ICAI is increasingly emerging as
the major standard-setting body in the profession.
Greater emphasis is being given to the harmonization of
Indian industry and accounting standards with those
accepted internationally. Some of the projects in
progress include the following.
Financial strategies : Working
-capital management.
Financial strategies : Long-term funds management.
Accounting in telecommunications industry.
Foreign-currency-exposure risk management.
Study on futures and options.
. Accounting of off-balance-sheet events.
Guidance notes on industry-specific audits such as
cement, mining and steel.
There are no special accounting
requirements for foreign investment in an Indian company
other than disclosing, in case of a subsidiary, the
number of shares held by the immediate as well as by the
ultimate holding company and, for all companies, details
of dividends remitted abroad. Disclosure is also
necessary, as is the case for all companies, of the
amount due by companies under the same management from
trade and other receivables other than trade
receivables.
General Section
