The issuance of Revised Schedule VI to the Companies Act applicable from 1-4-2011 was a landmark event in financial reporting in India. As could be expected, there were numerous interpretation issues that arose. To address them the Institute of Chartered Accountants of India (ICAI) issued the Guidance Note on the Revised Schedule VI to the Companies Act, 1956 (GNRVI). Further, in May 2011 Frequently Asked Questions FAQ — Revised Schedule VI was posted on the ICAI website to provide further guidance. At the time of writing this article, none of the following was clear with respect to the FAQ’s — (a) the unit of ICAI that issued the FAQ’s (b) the review process — whether the Accounting Standard Board or the Technical Directorate of the ICAI reviewed the FAQ’s, and most importantly (c) the authority attached to the FAQ’s.
In this article, we take a look at some of the contentious FAQ’s.
A company, having December year-end, will prepare its first revised Schedule VI financial statements for statutory purposes for the period 1 January to 31 December 2012. Whether such a company needs to prepare its tax financial statements for the period from 1 April 2011 to 31 March 2012 in accordance with revised Schedule VI or pre-revised Schedule VI?
Response in FAQ
It is only proper that accounts for tax filing purposes are also prepared in the Revised Schedule VI format for the year ended 31 March 2012.
Author’s view with respect to companies to which MAT is applicable
S.s (2) of section 115JB states as follows “Every assessee, being a company, shall, for the purposes of this section, prepare its profit and loss account for the relevant previous year in accordance with the provisions of Part II and III of Schedule VI to the Companies Act 1956 . . . . . . ” The Finance Act, 2012, enacted recently, has removed reference to part III from section 115JB of the Income-tax Act. This amendment is applicable for A.Y. 2013-14, i.e., for tax financial year 2012-13.
From the above amendment to section 115JB, it is clear that a company will use revised Schedule VI format for preparing its tax financial statements for the tax financial year 2012-13 (i.e., 1 April 2012 to 31 March 2013). For preparing tax financial statements for the tax financial year 2011-12 (i.e. 1 April 2011 to 31 March 2012), the fact that the Finance Act removes reference to part III of schedule VI only for previous year beginning 1 April 2012 suggests that the company may need to prepare its tax financial statements for the period 1 April 2011 to 31 March 2012 in accordance with pre-revised Schedule VI. This appears to be a straight forward interpretation of the amendment to the Income-tax Act.
Note: Generally in determining the tax liability, it should not matter whether the accounts are prepared in accordance with pre-revised Schedule VI or revised Schedule VI. However, in certain situations it may have a significant impact, for example, where the company has to pay MAT . The P&L account in pre-revised Schedule VI had the P&L appropriation account. Therefore typically certain adjustments to reserves (e.g., debenture redemption reserve) would appear in the P&L appropriation account, and the net balance would be added to the retained earnings in the balance sheet. In the revised Schedule VI, the P&L ends with PAT (profit after tax) and all the appropriations are carried out under the caption ‘Reserves’ in the balance sheet. For determining the book profits under 115JB, and consequently the MAT liability, one would achieve different results if one were to start with PAT (under revised Schedule VI) or start with the net appropriated P&L (under pre-revised Schedule VI) and treat debenture redemption reserve as an allowable expenditure (in accordance with certain favourable judicial precedents) for determining book profits for MAT purposes.
There is a breach of major debt covenant as on the balance sheet date relating to long-term borrowing. This allows the lender to demand immediate repayment of loan; however, the lender has not demanded repayment till the authorisation of financial statements for issue. Can the company continue to classify the loan as current? Will the classification be different if the lender has waived the breach before authorisation of financial statements for issue?
Response in FAQ
As per the Guidance Note on the Revised Schedule VI, a breach is considered to impact the noncurrent nature of the loan only if the loan has been irrevocably recalled. Hence, in the Indian context, long-term loans, which have a minor or major breach in terms, will be considered as current only if the loans have been irrevocably recalled before authorisation of the financial statements for issue.
Author’s view
In accordance with revised Schedule VI, a liability is classified as non-current if and only if the borrower has unconditional right to defer its payment for atleast 12 months at the reporting date. GNRVI clarifies that if a term loan becomes repayable on demand because of violation of a minor debt covenant (for e.g., submission of quarterly financial information), the company can continue to classify the same as non-current unless the lender has demanded repayment before approval of financial statements.
GNRVI does not clarify the classification where a company has violated a major debt covenant as on the reporting date. However, a reading of GNRVI suggests that the exemption is given only with regard to violation of minor debt covenants and not for violation of major covenants. Thus, if major debt covenant is violated, there can be three situations — (a) the banker has asked for repayment before approval of financial statements, (b) the banker has not asked for repayment and has not forgiven the violation before approval of financial statements, and (c) the banker has forgiven the violation before the approval of financial statements. In situations (a) and (b), the author believes that the loan should be classified as current liability. In situation (c), where the banker has actually forgiven the violation before approval of financial statements, one may argue that the intention of the ICAI is that a company should continue to classify the loan as non-current, if the possibility of loan being recalled is negligible. Subsequent waiver of breach confirms this aspect and therefore the company may continue to classify the loan as non-current.
Thus, there is a difference in view, with respect to situation (b). In the author’s view and based on the GNRVI, the same would be treated as current. However, as per the FAQ’s, the same would be treated as non-current.
How would rollover/refinance arrangement entered for a loan, which was otherwise required to be repaid in six months, impact current/non-current classification of the loan? Consider three scenarios: (a) rollover is with the same lender on the same terms, (b) rollover is with the same lender but on substantially different terms, and (c) rollover is with a different lender on similar/different terms? In all three cases, the rollover is for non-current period.
Response in FAQ
In general, the classification of the loan will be based on the tenure of the loan. Thus, in all the above cases, if the original term of the loan is short term, the loan would be treated as only current, irrespective of the rollover/refinance arrangement. However, in exceptional cases, there may be a need to apply significant judgment on substance over form. In such cases, categorisation could vary as appropriate.
Author’s view
If the rollover arrangements are with the same lender at the same or similar terms, the company will continue to classify the loan as non-current, provided that the rollover arrangement was in existence at the balance sheet date. If the rollover arrangement has been entered into with a different lender either on similar or different terms, the arrangement is more akin to extinguishment of the original loan and refinancing the same with a new loan. Hence, in such cases, the existing loan should be classified as current liability. If the rollover arrangement is entered into with the same lender but on substantially different terms, the position is not clear. We understand that the matter is under debate at the IASB level and mixed practices are being followed globally as well. Keeping this in view, one may argue that it can classify the loan as non-current, provided that the rollover arrangement was in existence at the balance sheet date.
The author believes that view taken in the ICAI FAQ is technically flawed, since rollover of loan with the same lender on the same terms for non-current period clearly results in non-current classification. This is because it is not due to be settled within the 12 months after the reporting date and the company has an unconditional right to defer settlement of the liability for atleast 12 months after the reporting date.
The company has received security deposit from its customers/dealers. Either the company or the dealer can terminate the agreement by giving 2 months’ notice. The deposits are refundable within one month of the termination. However, based on past experience, it is noted that deposits refunded in a year are not material, i.e., 1% to 2% of amount outstanding. The intention of the company is to continue long term relationship with their dealers. Can the company classify such security deposits as non-current liability?
Response in FAQ
As per Revised Schedule VI, a liability is classified as current if the company does not have an unconditional right to defer its settlement for at least 12 months after the reporting date. This will apply generally. However, in specific cases, based on the commercial practice, say for example electricity deposit collected by the department, though stated on paper to be payable on demand, the company’s records would show otherwise as these are generally not claimed in short term. Treating them as non-current may be appropriate and may have to be considered accordingly. A similar criterion will apply to other deposits received, for example, under cancellable leases.
Author’s view
As per revised Schedule VI, a liability is classified as current if the company does not have an unconditional right to defer its settlement for at least 12 months after the reporting date. In the given case, the company does not have such right since the customer/dealer can terminate the agreement by giving 2 months notice and deposit has to be refunded within 1 month of termination. Hence, the security deposit should be classified as current liability. The intention of the company to not terminate the agreement or past experience is not relevant.
In case of provision for gratuity and leave encashment, can current and non-current portions be bifurcated on the basis of actuarial valuation?
Response in FAQ
The actuary should be specifically requested to indicate the current and non-current portions, based on which the disclosure is to be made.
Author’s view
Paragraph 7.3(b) of GNRVI states as below:
“In case of accumulated leave outstanding as on the reporting date, the employees have already earned the right to avail the leave and they are normally entitled to avail the leave at any time during the year. To the extent, the employee has unconditional right to avail the leave, the same needs to be classified as ‘current’ even though the same is measured as ‘other long-term employee benefit’ as per AS-15. However, whether the right to defer the employee’s leave is available unconditionally with the company needs to be evaluated on a case to case basis — based on the terms of Employee Contract and Leave Policy, Employer’s right to postpone/ deny the leave, restriction to avail leave in the next year for a maximum number of days, etc. In case of such complexities the amount of Non-current and Current portions of leave obligation should normally be determined by a qualified Actuary.”
The author believes that ICAI FAQ needs to be read with GNRVI and it cannot override paragraph 7.3(b) of GNRVI. Hence, there is no question of any part of leave liability being classified as non-current liability, if a company does not have a right to postpone/ deny the leave for 12 months. In other words, if an actuary is appointed to do this classification, he or she should apply the principles set out in paragraph 7.3(b) of GNRVI.
Conclusion
In light of the above arguments, the author would request the ICAI to reconsider and reissue some of the FAQ’s.
