Accounting Treatment of Reserves Created out ofCapital Assets.

There is a Company which for the last few years has made fairly substantial losses and has set off these losses against the available Revenue Reserves which are now exhausted. The balance of the excess of the debit balance of Profit & Loss Account is now sought by the Company to be set off against the Capital Reserve which still stands in the Books. This Capital Reserve arose out of the excess of the sale price received by the company on the sale of its Fixed Assets over their original costs (not W.D.V.) I am not basically in agreement with this argument and feel that the Capital Reserve cannot be so transferred against the debit balance of the Profit & Loss Account. I would be grateful for the guidance of your Expert Committee in this regard.

Opinion March 1, 1975

Debit balance in the Profit and Loss Account can be set off against balance lying to the credit of Capital Reserve Fund which was created in the past, out of the excess of the sale price on the sale of the fixed assets of the Company over their original cost.

The opinion of the Expert Advisory Committee is given below: -

There is no specific provision in the Companies Act, 1956 or in Table A embodying Articles of Association which a Company may adopt, in regard to the treatment to be meted out to reserves created out of capital assets. However, according to accepted accounting conventions and prudent management practices, there would be no objection to such an adjustment being made, provided: -

(i) There is no prohibition in the Articles of Association of the Company for such a set-off.

(ii) There is no fall in the value of other assets.

(iii) “Capital Profit” has been realised.

In the case cited by you, there does not seem to be any prohibition in the Articles of Association of the Company and there is no evidence or material to suggest that there has been a fall in the value of other assets. Moreover, the profit credited to the Capital Reserve account is “real” having arisen as a result of actual sale of fixed assets. Accordingly, there should be no objection to the utilisation of the credit balance in the Capital Reserve Account for setting off the debit balance in the Profit and Loss Account.

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