1.51 Query
Change in the Accounting Method and Hybrid System of Accounting. An Industrial & Investment Corporation has been established as a wholly owned company of the State Government, set up specifically to promote the development of industry in backward areas of the State.
The Corporation seeks to industrialise backward areas by a combination of preparation of project ideas, provisions of techno-economic feasibility studies, contribution to equity capital, term loans, interest free sales tax incentive loans, and above all, liaison with all the other State Government bodies, concerned with the establishment of industries all over the State. A copy of the Annual Report of the corporation for the year 1976-77 is enclosed.
Since its inception, the Corporation has been following the mercantile system of accounting under which all the incomes and expenses are accounted on the basis of accruals irrespective of the fact whether the income is actually received or the expenditure is actually defrayed in cash during the year.
During the last few years, the Corporation has been facing the problem of increasing overdues. This is mainly due to the general recessionary conditions prevailing in the industry due to which, the industrial units set up in the backward areas have been finding it difficult to service the loans given to them for setting up these industries. As the corporation has been following the Mercantile system of accounting, the Income-tax had to be paid on the income from interest on loans debited to the accounts of the borrowers irrespective of the fact whether it was actually received or not. This in fact meant that we have been paying the taxes not from the income but from the capital and the borrowings. During the last four years, we have paid taxes to the extent of Rs. 115 lacs out of which as much as Rs. 105 lacs have been paid out of the capital.
To remedy the situation, in the year 1976-77, we decided to credit the amount of interest on loans, which is not likely to be realised in cash, in the foreseeable future, to an account styled “Interest Suspense Account” and not to include it in the return of income to be filed with the Income-tax Department. However, the Income-tax Department did not agree to this method of accounting and indicated that it would levy tax also on the interest held in the “Interest Suspense Account”.
Under the circumstances mentioned above, we have been now advised that the only alternative is to maintain the books of accounts on cash basis, either totally (i.e. both income and expenditure on cash basis) or partly i.e. income on cash basis and expenditure on mercantile basis). We have been advised that such a system should acceptable to the Income-tax department keeping in view the provisions of Section 145 (1) of the Income-tax Act, 1961 and the case law in this regard.
We have accordingly taken a decision to switch over to the cash system of accounting from the year 1977-78 onwards. However, the Government Auditors have now made an observation that the Department of Company Affairs, Ministry of Law, Justice and Company affairs, Government of India in their Circular No. 8/68(209)/64-PR dated 21.1.1965 has indicated clearly that keeping the accounts of a company on cash or receipt basis would not amount to keeping proper books of accounts in terms of Section 209(1), (2) & (3) of the Companies Act, 1956. To our knowledge many companies have been following the cash system of accounting either in respect of both the income and expenditure or in respect of income only, with suitable explanatory notes in their statements of accounts. In this connection, we invite a reference to the decision given by the Calcutta High Court in the case of commissioner of Income tax vs. Eastern Bengal Jute Trading Company Limited. (Reports of company cases including cases on banking and insurance by Shri A.N. Aiyar, Vol. 48 Part 7, 1st April, 1978). Though the said decision essentially pertains to Income-tax matters, it will be seen therefrom that the court has also inter alia, observed that under section 291 of the Companies Act, the directors of the company have powers to change the method of accounting.
Although we are of the opinion that the Companies Act does not prescribe any particular method of accounting, yet as a measure of abundant caution and without prejudice to our contention, we have already applied to the Company Law Board under Section 211 (4) of the Companies Act to permit us to maintain our books of account on cash basis. The reply from the company Law Board is awaited.
In view of the foregoing, we shall be glad to have your considered opinion on the following: -
(i) Whether it is mandatory for a company under the Companies Act to maintain its books of accounts on the mercantile basis only?
(ii) If a company is maintaining its books of account on cash basis, whether it would be a sufficient compliance with the provisions of the Companies Act if suitable notes are appended to the statements of profit and loss account and balance sheet as some of the companies are known to be doing. We would also like to know the nature of the contents of the notes which should be appended to the statements of accounts.
(iii) If it is permissible to maintain the accounts on cash basis, can we maintain the same on cash basis only partly i.e. only income on cash basis and expenditure on mercantile basis?
Opinion September 25, 1978
In the opinion of the Committee, having regard to the nature of the business of the corporation, a cash system of accounting would not disclose a true and fair view of the state of affairs of the corporation or of its profit or loss for a period.
However it is not unusual for a company to account for items of income on cash basis where the recovery of the income cannot be quantified. This would be in accordance with the concept of prudence under which financial statements are prepared. On this basis, there should not be any objection to the corporation not taking credit for accrued interest in accordance with the practice presently followed by many banks and financial institutions.
If such a change will amount to a change in the basis of accounting, it will, in the opinion of the Committee, be necessary for the company to obtain the approval of the Board of directors and also to indicate the amount in the year of change, the fact of the change and its effect, if material, on the profits/losses for the year. __________________________ |