SEBI has sought to attain this objective indirectly and, one
could even say cleverly, and with apparently more effect than it would have done
it directly. It has also attempted to kill several birds with one stone. Or has
SEBI attempted too much and ended up with a provision with limited effect?
In essence, SEBI has required that companies proposing
certain schemes of mergers, demergers, etc. shall submit, in advance, a
certificate from their auditors that the matters contemplated in the scheme are
in compliance with Accounting Standards.
Let us consider some background.
First, let us consider mergers and demergers. Schemes of
mergers, demergers, etc. provide for transfer of assets and liabilities and/or
for other matters. The implications of accounting for amalgamations are
substantial enough to warrant a separate Accounting Standard 14 on Accounting
for Amalgamations.
While AS-14 deals with several matters, it makes a special
provision for treatment of Reserves. It states that if the scheme provides for
treatment of reserves otherwise than what the AS requires, the scheme should be
followed, but certain disclosures should be made particularly about what would
be the effect if the AS was followed. In other words, deviations would be
possible but through disclosure. Thus, the scheme would, to that extent,
override the Accounting Standard, subject to the safeguard of disclosure.
In fact, as a general principle, we know that ICAI’s
Accounting Standards do not override provisions of law. As paragraphs 4.1 and
4.2 of the Preface to the Statements on Accounting Standards says, in case of
inconsistency, the provisions of law will prevail. However, in such a case, the
ICAI will determine the extent of disclosure required in the financial
statements and the auditors report. See also the general ‘Announcement’ of the
ICAI on the implications of a Court/Tribunal order sanctioning an accounting
treatment which is different from that prescribed by an Accounting Standard
which is highlighted later.
It is quite common then that such schemes provide for an
alternate accounting treatment of reserves, etc. and Courts usually approve
them. Thus, there is a fairly widespread practice of what I would call
‘deviations through disclosure’.
The SEBI amendment also covers other forms of restructuring
such as capital reduction. Even under such schemes, inter alia, capital reserves
such as securities premium and capital redemption reserves can be used for
purposes which otherwise are not allowed. Moreover, as we will see in the Bombay
High Court’s decision in Hindalco’s restructuring case, such schemes may go
beyond mere freeing up of the capital reserves. They may even provide for
debit of certain expenses to such reserves where such debit may otherwise
(allegedly in that case) not be permissible under the Accounting Standards.
Of course, it is not as if all such deviations are
necessarily attempts to avoid the spirit of the Accounting Standards and, very
often, the intention may be bona fide including avoidance of some archaic
provisions of law or simply to give a better picture of the underlying
commercial reality. There is also at least the small safeguard of disclosure.
However, it is also true that, particularly as we will see in case of other
restructuring such as reduction of capital, this was also seen to be an almost
carte blanche power.
SEBI has pointed out in the Circular that in some recent
schemes filed before the High Courts, the accounting treatment of ‘various
items’ is not in accordance with the applicable Accounting Standards (‘AS’). To
stop this, it has introduced the requirement of auditors’ certificate that the
scheme is in compliance with Accounting Standards. More importantly, the actual
amendment further provides that a mere disclosure as permitted under AS-14
giving certain details relating to a departure from the AS is not sufficient.
The amendment, as I said earlier, is clever. No regulation
has been laid down (which would have required certain law-making procedures to
be followed) to make such requirement. Nor has SEBI needed to plead to the MCA
to amend its rules relating to Accounting Standards. Indeed, no substantive
requirement has been made at all even in the listing agreement to follow the
Accounting Standards. Instead, a simple procedural requirement is made
that the auditors’ certificate will be obtained — in advance — stating that
Accounting Standards have been complied with in respect of matters covered in
the scheme. And further, the usual route of deviating by disclosing would not
be permitted.
Does this stop the accounting ‘flexibility’ through such
schemes ?
The amendment does make the listed company indirectly comply
with Accounting Standards and the specific requirement that deviation through
disclosure is not permitted makes it even more effective.
Note several implications and limitations though.
The auditors’ certificate is required for compliance of all
Accounting Standards and not merely Accounting Standard-14.
Secondly, the certificate is required for all types of
schemes — whether of mergers,
demergers, reduction of capital, etc. — in fact, all scheme/petitions to
be filed before any Court or Tribunal u/s.391, u/s.394 and u/s.101 of the
Companies Act, 1956. AS-14 is, of course, applicable only to amalgamations and
not to other type of schemes. Courts have also held that the said AS-14 applies
only to amalgamations and hence its applicability cannot be raised in other
schemes [see, e.g., Gallops Reality’s case 150 Comp. Cas. 596 (Guj.)]. However,
where other Accounting Standards apply to the particular transactions in a
scheme, the certificate would cover them too.
Having said that, the requirement applies only to compliance
of Accounting Standards and not to accounting of transactions where Accounting
Standards do not apply.
Further, if certain restructuring of reserves is carried out
under a statutory provision, the clause cannot apply. A good example is
restructuring of capital reserves such as share premium or other similar capital
surpluses. Even though SEBI has sought to cover schemes involving reduction of
capital, it is arguable that since the accounting of share premium is strictly
not covered by Accounting Standards, the new provisions will not apply.
Consider another aspect that is not touched by the Accounting Standards and therefore remains untouched by the amendment. If a reserve is treated as a ‘capital reserve’ as so required by the AS, does that, by itself, make it a ‘capital reserve’ for the purposes of the Companies Act, 1956, particularly for the provisions relating to reduction of capital
Thus, for example, would such reserve would become thereby at par with ‘Share Premium’ ? To take it further, would it make at par with ‘Revaluation Reserve’ — particularly when, in reality, its source may be revaluation ? Would the statutory restrictions relating to dividends, bonus shares, etc. apply to such a reserve ? I believe that this would continue to remain a grey area even after this amendment.
Then there is a larger issue and this can be explained by a case study in the form of a recent Bombay High Court decision in the case of Hindalco Industries Limited (2009) 94 SCL 1 (Bom.). In this case, to summarise the essence, the company proposed a scheme of restructuring u/s.391 of the Companies Act, 1956, under which the Securities Premium Account of the company would be transferred to a ‘Reconstruction Reserve Account’. To this account, certain specified expenses and losses would be debited. The question was, if such adjustment was otherwise not in compliance with Accounting Standards, whether such a scheme could be permitted and generally whether non-compliance with accounting standards was permissible.
Essentially, the Court stated that, firstly, the provisions of S. 211(3A)-(3C), while they do create a requirement of compliance with accounting standards, do also provide that where they are not followed, certain disclosures shall be made. In other words, it held that there is also a form of ‘deviation through disclosure’ possible.
The Court also referred to ICAI’s ‘Announcement on Disclosures in cases where a Court/Tribunal makes an order sanctioning an accounting treatment which is different from that prescribed by an Accounting Standard’. This substantive part of this Announcement reads as under :
Paragraph 4.2 of the ‘Preface to the Statements of Accounting Standards’ (revised 2004) provides as under :
“4.2 The Accounting Standards by their very nature cannot and do not override the local regulations which govern the preparation and presentation of financial statements in the country. However, the ICAI will determine the extent of disclosure to be made in financial statements and the auditor’s report thereon. Such disclosure may be by way of appropriate notes explaining the treatment of particular items. Such explanatory notes will be only in the nature of clarification and therefore need not be treated as adverse comments on the related financial statements.”
In the case of companies, S. 211(3B) of the Companies Act, 1956, provides that “Where the profit and loss account and the balance sheet of the company do not comply with the Accounting Standards, such companies shall disclose in its profit and loss account and balance sheet, the following, namely :
a) the deviation from the accounting standards;
b) the reasons for such deviation; and
c) the financial effect, if any, arising due to such deviation.”
In view of the above, if an item in the financial statements of a company is treated differently pursuant to an order made by the Court/Tribunal, as compared to the treatment required by an Accounting Standard, following disclosures should be made in the financial statements of the year in which different treatment has been given :
(1) A description of the accounting treatment made along with the reason that the same has been adopted because of the Court/Tribunal Order.
(2) Description of the difference between the accounting treatment prescribed in the Accounting Standard and that followed by the company.
(3) The financial impact, if any, arising due to such a difference.It is recommended that the above disclosures should be made by enterprises other than companies also in similar situations.
(c) The question then is whether this decision is now overridden by the SEBI amendment ? The answer does not seem to be wholly clear. One view can be that the company has to obtain an auditor’s report stating that the Scheme is in compliance of the Accounting Standards. If it can be held on the facts that the scheme is not and therefore the auditor’s certificate states so accordingly, then, despite the aforesaid decision, the requirement would not be complied with. The other view can be that since SEBI has specifically stated that ‘deviation through disclosure’ of only the specified requirements of AS-14 would not be permitted and therefore, in case of ‘deviation through disclosure’ for other Accounting Standards remains open.
(i) Incidentally, there can also be two views whether, particularly in light of the Supreme Court’s decision in J. K. Industries v. UOI, (2007) 80 Comp. Cas. 415 (SC), whether the aforesaid decision in Hindalco’s case is, with respect, correct. This is specifically on the Bombay High Court’s view that ‘deviation through disclosure’ is permissible and that, in that sense, the Accounting Standards are not strictly mandatory. However, this controversy is best left open here and may be a subject of a separate discussion.
In the end, it is seen that SEBI’s shot, howsoever well intended, has limited effect. It has limited cover-age of types of transactions and schemes. It does not cover all types of reserves — indeed, in practice, it may not cover statutory reserves such as share premium, etc. and the impact on other reserves is also limited. With slightly better wording, it could have covered assuredly even covered matters other than treatment of reserves.
However, the amendment is likely to bring a partial end to the route of deviation through disclosure.
SEBI has thus attempted to hit several birds with one stone, but apparently it has brushed, not even hit, one bird, but that, I guess, is better than nothing.
