1.42 Query: Preparation of profit and loss account during construction period
1 A company was incorporated under the provisions of the Companies Act, 1956, on 24th March, 1988. The certificate of commencement of business was obtained by the company on 9th May, 1988. It is a Government company within the meaning of section 617 of the Companies Act, 1956. The authorised share capital of the company is Rs. 2000 crores divided into equity share capital of Rs. 1000 crores and unclassified share capital of Rs. 1000 crores. At present, the issued, subscribed and paid up share capital of the company is Rs. 890.7361 crores and is entirely held by the relevant State Government and its nominees.
2. As stated in Clause III A (1) of the Memorandum of Association, the main object of the company is to undertake execution of a project comprising a dam across a river, a canal system emanating from the reservoir impounded by the construction of the said dam, power houses at the foot of the said dam and at the canal head and all other works incidental or ancillary to the said project in accordance with the directions of the relevant Government.
3. The company has undertaken unique, multi-purpose inter-state project in four states envisaging supply of water for irrigation, drinking and industrial purposes and power generation. The total cost of the project as approved by the Planning Commission is Rs. 6406 crores (at 1986-87 price level). On completion of the project, about 17.92 lac hectares of land spread over 12 districts, 62 talukas and 93 villages in relevant state and 75,000 hectares of land in another state would come under irrigation every year. Power generating capacity of 1450 MW will be added. Besides these advantages, 4720 villages and 131 urban centers would get a permanent solution as regards the drinking water supply needs.
4. The Government of India has secured financial credit and loan assistance of 450 million dollars from the World Bank towards the first phase of the construction of the main components of the project, namely, the concrete dam, civil works of the power houses and the initial reach of the main canal system upto a river. The Overseas Economic Cooperative Fund of Japan will be providing yen credit upto Rs. 150 crores for the electrical components of the power houses.
5. The relevant Government has, vide a resolution, transferred to the company the assets of Rs. 5.09 crores of the project.
6. Section 210 (1) and (3) of the Companies Act, 1956, state as under:
“210 (1) At every annual general meeting of a company held in pursuance of section 166, the Board of Directors of the company shall lay before the company-
(a) a balance sheet as at the end of the period specified in sub-section (3); and
(b) a profit and loss account for that period.
(3) The profit and loss account shall relate –
(a) In the case of the first annual general meeting of the company to the period beginning with the incorporation of the company and ending with a day which shall not precede the day of the meeting by more than nine months; and
(b) In the case of any subsequent annual general meeting of the company to the period beginning with the day immediately after the period for which the account was last submitted and ending with a day which shall not precede the day of the meeting by more than 6 months, or in cases where an extension of time has been granted for holding the meeting under the second proviso to sub-section (1) of section 166 by more than six months and the extension granted.” 7. According to the querist, para 14.7 of “The Guidance Note on the Treatment of Expenditure during Construction Period” issued by the Research Committee of the Institute of Chartered Accountants of India, clarifies the position regarding preparation of the profit and loss account during the construction stage, and recommends as under:
“14.7 There is some doubt on the question whether or not a company is obliged to prepare a profit and loss account during the period of construction when it is not in fact engaged in any revenue operations. In view of the requirements of section 210(3) of the Companies Act, every company has to prepare its profit and loss account from the date of incorporation. However, to prepare a profit and loss account during the period of construction might be somewhat misleading as it may give an impression to the lay shareholder that the company was engaged in revenue operations during this period and has incurred a substantial loss in those operations. It is true that the requirements of Part II of Schedule VI to the Companies Act relating to disclosure of specific items of expenditure have to be complied with. However, these requirements can be adequately complied with if the relevant items of expenditure requiring specific disclosure are suitably disclosed under the heading “Development Account”, “Expenditure During Construction Account”, “Statement of Incidental Expenditure During Construction” or by any other suitable name. This practice has also been recommended by the Department of Company Affairs, Government of India as per their circular No. 2/17/64 dated 29th January, 1964 which is given in Appendix B.
Where the aforesaid practice is followed, it is desirable that a note be inserted in the financial statements explaining the reason for not preparing a profit and loss account. It appears that this would represent reasonable compliance with the legal requirements, since the specific disclosure requirements of Schedule VI, Part II are complied with. Whether the disclosure should be made in the conventional profit and loss account form or through an account/statement as per the recommendation made in the above paragraph, is a matter for each company to decide. In this connection, it may be noted that Schedule VI, Part II of the Act only contains disclosure requirements and does not prescribe a specific form of profit and loss account unlike Schedule VI, Part I which does so for the balance sheet.”
8. The querist has also stated that the Department of Company Affairs, Government of India, has, as per their Circular No. 2/17/64-PR dated 29.1.1964, clarified the position on section 210 as under:
“210 The intention underlying this section is that every company should render to its shareholders an account of its expenditure and income even though they may have been incurred or received during the period of construction. It is no doubt true that a company does not really commence its business operations till the period of construction is over. There will of course be no objection if such account is called “Development Account”, “Expenditure During Construction Account” or by any other suitable name so long as these accounts give details of the revenue expenditure and income during the period covered, in the manner required by Part II of Schedule VI to the Act. Sub-section (3) of section 210 makes it quite clear that it is mandatory for every company to prepare a “profit and loss account” from the date of its incorporation.”
9. The querist has stated that in view of the circular of the Department of Company Affairs, the Guidance Note of the Institute of Chartered Accountants of India and the fact that the project of the company was under construction, for the first financial year commencing on 24th March, 1988 and ending on 31st March, 1989, no profit and loss account was prepared. But in schedules forming part of the accounts, incidental expenditure and income which would otherwise be stated in the profit and loss account, are stated under separate schedule titled “Incidental Expenditure pending Capitalisation” with adequate disclosure as required in Part II of Schedule VI to the Companies Act, 1956.
10.The above position is suitably disclosed in notes forming part of accounts, as under:
“No profit and loss account for the period from 24th March, 1988 to 31st March, 1989 has been prepared as the projects of the company are under construction and the company’s operation of supply of water and power has not commenced by 31st March, 1989.”
11. The statutory auditors of the company have in their report stated as under:
“Since the projects of the company are under construction, no profit and loss account has been prepared”.
12. The Comptroller and Auditor General of India, have in their comments under section 619 (4) of the Companies Act, 1956 on the accounts of the company for the period ended on 31.3.1989, observed as under:
“In terms of section 210(3) of the Companies Act, 1956, it is mandatory for every company to prepare a profit and loss account by whatever name it may be called, detailing its revenue expenditure and income even when the company is in construction stage. Such profit and loss account should be an account and not a schedule to the balance sheet. The company has disclosed vide Note-7 (a) in Schedule-I that profit and loss account has not been prepared as the company was in construction stage. As the requirement is mandatory, the company should have prepared profit and loss account.”
13. In view of what is stated above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the company has adequately complied with the requirements of section 210 and Schedule VI, Part-II of the Companies Act, 1956 by presenting the expenditure and income during construction period under a separate schedule of “Incidental Expenditure Pending Capitalisation” and giving adequate disclosure by way of separate note on accounts stating reasons for not preparing profit and loss account in presenting the accounts of the company for the period from 24.3.1988 to 31.3.1989?
(ii) Is it mandatory for the company to prepare profit and loss account under the provisions of section 210 of the Companies Act, 1956 as commented by the Office of the Comptroller and Auditor General of India for the accounts of the company for the period from 24.3.1988 to 31.3.1989?
(iii) Whether the company will adequately comply with the provisions of section 210 and Schedule VI, Part –II of the Companies Act, 1956 in presenting the accounts of subsequent years in the manner the accounts have been presented for the period ended 31.3.1989, until the project is in construction stage?
Opinion November 26, 1990
1. The Committee notes that in view of the requirement of section 210 of the Companies Act, a company has to prepare a profit and loss account from the date of its incorporation. However, in the view of the Committee the requirement can be adequately complied with if the relevant items of expenditure requiring specific disclosure are suitably disclosed under the heading “Development Account”, “Expenditure During Construction Account”, “Statement of Incidental Expenditure During Construction” or by any other suitable name, as recommended by the Research Committee of the Institute in the ‘Guidance Note on Treatment of Expenditure During Construction Period’. This practice has also been recommended by the Department of Company Affairs, Government of India as per their circular No. 2/17/64 dated 29th January, 1964.
2. The Committee is of the view that the expenditure incurred by the company before the commencement of commercial production is accumulated till the commercial production commences and is allocated to fixed assets or is treated as deferred revenue expenditure once the commercial production commences. The Committee is accordingly of the view that if a company prepares a separate statement or account of the expenditure during the construction period and incomes, if any, in that period, in accordance with the requirements of Part II of Schedule VI to the Companies Act, there will be sufficient compliance with the provisions of section 210 as far as the preparation of profit and loss account is concerned provided the reasons for not preparing the profit and loss account are adequately disclosed. The Committee is also of the view that such statement or account can be an annexure to the balance sheet provided the reasons for not preparing the profit and loss account are adequately disclosed and disclosures as required in Part II of Schedule VI to the Companies Act are made.
3. The Committee is accordingly of the following opinion:
(a) It is permissible for the company to present the expenditure and income during the construction period in accordance with the disclosure requirements of Part II of Schedule VI, under a separate schedule of “Incidental Expenditure Pending Capitalisation”. This schedule may form an annexure to the balance sheet. However, apart from disclosing the reasons for not preparing the profit and loss account, the company should have disclosed that:
(i) The schedule of ‘Incidental Expenditure Pending Capitalisation’ has been prepared instead of profit and loss account, and,
(ii) The said schedule is prepared in accordance with the disclosure requirements of Part II of Schedule VI.
(b) Same as (a) above.
(c) Same as (a) above for years until the project is in construction stage. ___________________________ |