1.73     Query

Presentation in company balance sheet of receivables against sales on deferred credit terms,where such

receivables are hypothecated as security for equivalent loans receivedby the company.

A government company had obtained medium term post shipment packing credit jointly from the Industrial Development Bank of India and two nationalised banks for Rs. 246 lakhs some years ago on the security of the full value of the amount of deferred credit allowed to a foreign buyer on account of export of wagons by the company.  The loan granting institutions have obtained irrevocable powers of attorney in their favour from the company, empowering them to directly receive the deferred credit payments from the foreign buyer as they fall due.  In the year 1979-80, the amount of the loan had come down to roughly Rs. 196 lakhs and the deferred credit also had come down correspondingly, due to recoveries by the institutions of the deferred credit receipts.

Before 1979-80, the company had netted the loan by the deferred credit receivable and extended a “nil” figure under the head “Secured loans” in the balance sheet and had not included the balance amount due at future dates from the foreign buyer under the head “Sundry debtors” on the assets side of the balance sheet.  In off-setting the figures of loan by that receivable, an explanation had been added in parenthesis, “recoverable by Financial Institutions”.  Apparently, the company had felt that the presentation was more meaningful.

The statutory auditors of the company for the year 1979-80 did not agree with the presentation, as they felt that the export receivables (i.e. the deferred credit), instead of being shown under “Sundry Debtors” on the Assets side, had been shown as deduction from “Medium Term Loans” on the Liabilities side.  In their opinion, the treatment of deducting from the loans the security offered against such loans was not in accordance with normally accepted accounting principles and also did not fairly reflect the position of secured loans and current assets as required by Schedule VI of the Companies Act, 1956.

The relevant notes forming part of the audited accounts of the company for 1979-80 are as follows:

 “5.        Medium Term Loan—Industrial Development Bank of India……….Bank and………Bank have jointly sanctioned a medium term loan of Rs. 246 lakhs to the full extent of the deferred credit value of the deliveries of the wagons under the Export contract with the foreign buyer to be recovered by the Financial Institutions under an irrevocable Power of Attorney given by the company”.

“14.      Contingent liabilities not provided for:

(h)        Medium Term Loan Rs. 196 lakhs (Previous year Rs. 215.08 lakhs)—vide Note 5”.

The note ‘5’ on the 1979-80 Accounts as quoted above had appeared as note ‘4’ on the 1978-79 Accounts with the additions at the end thereof, of the following: “and, therefore, Deferred Receivables have been shown as deduction against the Medium Term Loan as a matter of meaningful presentation”.

Note No. 14 (h) of 1979-80 reproduced above did not appear in the earlier years.

The Committee’s opinion is solicited.

                                                                                                     Opinion                                                            August 25, 1981

 Section 211(1) of the Companies Act 1956, requires every balance sheet of a company to give a true and fair view of the state of affairs of the company as at the end of a financial year and, subject to the provisions of the sections, to be “in the form set out in Part I of the Schedule VI, or as near thereto as circumstances admit or in such other form as may be approved by the Central Government either generally or in any particular case, and in preparing the balance sheet due regard shall be had, as far as may be, to the general instructions for preparation of balance sheet under the heading “Notes” at the end of that part”.  Other provisions of Section 211 are not relevant for our present purposes.  However, mention may be made of Section 211 (5) (v) which reads as follows:

“(5)      The balance sheet and the profit and loss account of a company shall not be treated as not disclosing a true and fair view of the state of affairs of the company, merely by reason of the fact that they do not disclose—

………………………………………………………………………………………….…………………………………………………………………………………………..

(v)  in the case of any company, any matters which are not required to be disclosed by virtue of the provisions contained in Schedule VI or by virtue of a notification issued under sub-section (3) or an order issued under sub-section (4).  Under Section 227 (2) the auditor has to state in his report, inter alia whether the accounts give the information required by the Act in the manner so required and give a true and fair view in the case of the balance sheet of the state of the company’s affairs as at the end of the financial year.”

The duty of the auditor is to express his independent, expert opinion on the required matters.  It is generally recognised that two equally eminent experts may bona fide hold different opinions on matters within their professional expertise.  Sec. 211 (5) (v) quoted above may be paraphrased as providing that if all the matters required to be disclosed by the provisions in Schedule VI have been disclosed, the balance sheet shall be treated as disclosing a true and fair view of the state of affairs of the company.  It is undoubtedly true that in both alternative forms in Part I of Schedule VI there is a requirement for disclosure under the head “Current Assets” of an item headed “Sundry debtors”.  Note (e) of the “General instructions for preparation of balance sheet” in Part-IA of Schedule I reads follows:

 “The amounts to be shown under sundry debtors shall include the amount due in respect of goods sold or services rendered or in respect of other contractual obligations but shall not include the amounts which are in the nature of loans or advances”.

It cannot be seriously disputed that the amounts receivable by the company at future dates against wagons sold by it to the foreign buyer represent amounts due in respect of goods sold.  Therefore, they clearly fall under the statutory definitions of “Sundry debtors”.  It follows that for compliance with the requirements in Section 211 (1), the balance sheet shall be in the form set out in Part-I of Schedule VI.  The amounts receivable for supplies of wagons to foreign buyer outstanding as at each balance sheet date, to be received on the respective future due dates under the credit terms, should be shown in the sub-head “Sundry debtors” under the main head “Current Assets”.  It further follows that unless this is done the auditor would be justified in qualifying his report on the issue as to whether the accounts give the information required by the Act in the manner so required.  To that extent, fault should not be found with the auditors for 1979-80 for insisting on including a remark in their report in this regard; and the company would be well advised to adopt a presentation which meets the requirements of Part I of Schedule VI, if interpreted literally.

However, in the view of the Expert Advisory Committee, normally accepted accounting principles do not categorically prohibit a presentation such as that adopted by the company, particularly when full disclosure of all relevant facts has been made and the linkage between the liability and the asset is highlighted by this presentation.  It is also perhaps arguable that the words “or as near thereto as circumstances admit” in Section211 (1) allow sufficient flexibility to permit the presentation favoured by the company being adopted, without the auditor having to necessarily qualify his expression of opinion, even on the “format” requirement.  The Accounting Standard-1 on “Disclosure of Accounting Policies” issued by the Institute has recognised the principle of “substance over form” as one of the major considerations governing the selection and application of accounting policies. In this context, the following extract from the Standard is relevant:

“Consideration in the selection of Accounting Policies ……………………………….. ……………………………………………..For this purpose, the major considerations governing the selection and application of accounting policies are: -

…………………………………………………………………………………………………..

  b.         Substance over form

            The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form.”

On this consideration also, in the opinion of the Committee, the presentation made by the Company of the related transactions in the particular context of the lending institutions having irrevocable power of attorney to realise the amount from the foreign buyer is permissible.

 The foregoing discussion should, in the opinion of the Expert Advisory Committee, serve to bring out that—

(i)         presentation of items in a Balance Sheet should primarily be governed by the requirement of a true and fair disclosure;

(ii)        accordingly, a rigid adherence to Part I of Schedule VI is neither statutorily required nor consistent with the foregoing requirement of true and fair disclosure, although adherence to the requirements of Schedule VI should be sufficient compliance with that requirement.

(iii)       It would, therefore, be appropriate if the Government and the Institute start a dialogue on rationalising the disclosure requirements so as to better subserve the overriding requirements of a true and fair disclosure.

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