BACKGROUND
The main provisions of section 135 of the Companies Act, 2013 as amended can be summarised as under:
* Certain specified companies are required to spend 2% of the average net profit made in the immediately preceding three years on CSR activities as specified in the relevant schedule;
* Earlier, in case of unspent CSR amounts, Boards were required to specify the reasons for not spending the amount in the Board report;
* On the basis of the recent amendment notified in the Official Gazette, in case of unspent CSR amounts, the companies are required to transfer these to a separate government fund within six months of the expiry of the financial year, unless that unspent amount pertains to ongoing CSR projects;
* In case of unspent CSR amounts pertaining to ongoing CSR projects, the companies are required to transfer such amounts within a period of thirty days from the end of the financial year to a special account opened
with a scheduled bank and to be called ‘Unspent Corporate Social Responsibility Account’; such amount shall be spent by the company within a period of three financial years from the date of such transfer, failing which they are required to transfer the unspent CSR amount in a separate government fund;
* Further, if the company spends an amount in excess of its obligation in a year, the excess amount so incurred can be set off against the CSR obligation of the immediately succeeding three financial years subject to certain conditions.
QUESTION
On the basis of this amendment, the company has a clear statutory obligation as at balance sheet date to transfer the unspent amount to the government fund / special account; accordingly, a liability for unspent amount needs to be recognised in the financial statements. If the company decides to adjust such excess incurred amount against future obligation, then to the extent of such excess an asset as prepaid expense needs to be recognised in the financial statements.
How should the amount required to be spent on CSR in a financial year be accounted for? Can it be recognised evenly over the four quarters or on an as-incurred basis, or should the obligation be provided for on Day 1 of the financial year?
RESPONSE
The following references in Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets are relevant for the purpose of responding to the question.
Definitions under Paragraph 10
A liability is a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits.
An obligating event is an event that creates a legal or constructive obligation that results in an entity having no realistic alternative to settling that obligation.
Appendix C Levies
1. A government may impose a levy on an entity. An issue arises when to recognise a liability to pay a levy that is accounted for in accordance with Ind AS 37, Provisions, Contingent Liabilities and Contingent Assets.
4. For the purposes of this Appendix, a levy is an outflow of resources embodying economic benefits that is imposed by governments on entities in accordance with legislation (i.e. laws and / or regulations), other than:
a) those outflows of resources that are within the scope of other Standards (such as income taxes that are within the scope of Ind AS 12, Income Taxes); and
b) fines or other penalties that are imposed for breaches of the legislation.
8. The obligating event that gives rise to a liability to pay a levy is the activity that triggers the payment of the levy, as identified by the legislation. For example, if the activity that triggers the payment of the levy is the generation of revenue in the current period and the calculation of that levy is based on the revenue that was generated in a previous period, the obligating event for that levy is the generation of revenue in the current period. The generation of revenue in the previous period is necessary, but not sufficient, to create a present obligation.
11. The liability to pay a levy is recognised progressively if the obligating event occurs over a period of time (i.e., if the activity that triggers the payment of the levy, as identified by the legislation, occurs over a period of time). For example, if the obligating event is the generation of revenue over a period of time, the corresponding liability is recognised as the entity generates that revenue.
ANALYSIS
On the basis of paragraph 4, Appendix C Levies, CSR liability is a levy. The obligating event for incurring CSR expenditure occurs on Day 1 of the financial year, because if the company is in existence on that day and had an average net profit in the preceding three financial years, the liability is crystallised. The company is liable to incur the CSR expenditure, even if later during the financial year it was wound up or merged with another company or incurred heavy losses.
Accordingly, although the CSR expenditure would be incurred throughout the financial year, the obligating event that gives rise to the CSR liability isthe existence of the company on Day 1 of the financial year, and the average net profit of the preceding three financial years of the Company should be a positive number. This analysis is clear from a combined reading of Paragraphs 8 and 11 of Appendix C Levies.
The expenditure on the CSR liability may occur evenly or unevenly throughout the financial year. That is of no relevance to the recognition of the liability. The liability will be recognised on Day 1 of the financial year. The actual expenditure is the adjustment of the already crystallised CSR liability.
Even if a company does not incur the expenditure in the financial year, it will have to transfer the unspent amount to an ‘Unspent CSR’ account. Such amount shall be spent by the company in pursuance of its obligation towards the CSR policy within a period of three financial years from the date of such transfer, failing which, the company shall transfer the same to a Fund specified in Schedule VII within a period of thirty days from the date of completion of the third financial year.
CONCLUSION
Currently there appears to be a mixed practice on when a CSR liability is recognised. Some listed companies recognise the liability on Day 1, whereas others recognise the liability over four quarterly periods. This has to change, and the CSR liability should be recognised on Day 1 of the financial year. For companies that are not listed and do not present quarterly accounts, this issue will be largely theoretical.
