1.21 Query: Set-off of revaluation reserve against debit balance of capital reorganisation account.
1. Company ‘Z’ is a closely held deemed public company. Company ‘X’, also a closely held deemed public company, has been amalgamated with company ‘Z’ with effect from 1.4.1992. The querist has informed that the amalgamation of company ‘X’ with company ‘Z’ is in the nature of merger as per para 9(e) of Guidance Note on Accounting Treatment of Reserves in Amalgamations.
2. Company ‘X’ prior to its amalgamation with company ‘Z’ had 3 divisions, viz., (a) Specialty Oils Division, (b) Rubber Division and (c) Lamps Division. However, prior to amalgamation of company ‘X’ with company ‘Z’, the Lamps Division of company ‘X’ was spun-off to a new company also with effect from 1.4.1992 at its book value. The spin off was approved by the shareholders and the court prior to their respective approvals to amalgamation. The net book value of the assets spun-off was Rs. 805 lakhs in the books of company ‘X’. The spin-off scheme which was between company ‘X’, the new company and their respective shareholders, provided for issuing the shares of Rs. 805 lakhs by the new company to the shareholders of company ‘X’, reduction of Rs. 81 lakhs in the paid-up share capital of company ‘X’, and debiting in the books of company ‘X’, the balance of Rs. 724 lakhs to ‘Capital Reorganisation Account’.
3. As aforesaid, company ‘X’ (after the spin-off) has amalgamated with company ‘Z’ also with effect from 1.4.1992 and pursuant to the scheme of amalgamation the debit balance in Capital Reorganisation Account of company ‘X’ has been taken over by company ‘Z’ as its debit in the Capital Reorganisation Account. In the accounts of the amalgamated company ‘Z’ for the year ended 31.3.1993 the debit balance in the ‘Capital Reorganisation Account’ has been included in the schedule of ‘Reserves and Surplus’ as shown below:
Summarised Schedule of Reserve and Surplus Annexed to the Balance Sheet as on 31.3.1993
(Rs/Million) Capital Reserve 7.20 Debenture Redemption Reserve 8.00 Investment Allowance Reserve Account 9.01 Investment Allowance Reserve Utilised Account 27.96* Export Reserve Account 0.04* General Reserve 73.04 Less: Debit balance of profit and loss account deducted per contra 28.62 44.42* Less: Capital Reorganisation Account 72.42* Total 24.21
*Against Capital Reorganistion Account the following are the reserves: -
Investment Allowance Reserve Utilised Account 27.96 Capital Reserve Account 0.04 General Reserve Account 44.42 Total 72.42 ====
4. As per the querist, in effect, the uncommitted reserves of the amalgamated company (i.e., Investment Allowance Reserves Utilised Account, Export Reserves Account and the General Reserve Account) have been set-off against the Capital Reorganisation Account, as aforesaid, for presentation purposes only. However, insofar as the books are concerned, the capital reorganisation account appears as a debit balance, since it has not been appropriated in the books against free reserves mentioned above. The querist has given the following schedule to make the presentation clear:
Rs. million Rs. million Capital Reserves 7.20 Debenture Redemption Reserves 8.00 Investment Allowance Reserves 9.01 Investment Allowance Reserves Utilised Account 27.96 Export Reserves 0.04 General Reserves 73.04 101.04 Less: Retained for debit balance of Capital Reorganisation Account 72.42 72.42 Surplus set-off against debit balance of profit & loss account 28.62
Total 24.21 ===== [The total of uncommitted reserves aggregates to 101 million, out of which 72.42 million equivalent to the debit in Capital Reorganisation Account has been retained in reserves for presentation purposes, the surplus of 28.62 million has been deducted from 33.44 million which was the debit balance of profit and loss account of the amalgamated company (this debit balance, as per the querist represents the loss of the company and has nothing to do with the Capital Reorganisation Account)].
5. The querist has further stated that company ‘Z’ intends to revalue some of its assets and approximate surplus on revaluation would be about Rs. 40 crores. The querist is of the view that the debit balance of Capital Reorganisation Account can be set-off against revaluation reserve and that there is no bar in doing so, either on fundamental accounting principles or in any of the guidelines issued by the Institute of Chartered Accountants of India.
6. The querist has sought the opinion of the Expert Advisory Committee as to whether the Capital Reorganisation Account’s debit balance can be set-off against the revaluation reserve? If not, is it permissible to reflect the revaluation reserve as a deduction from the Capital Reorganisation Account for presentation purposes only, without actually passing the relevant entries in the books?
Opinion February 8, 1995
1. The Committee notes that the specific point raised by the querist in the above query relates to accounting of surplus that would arise on revaluation of the assets of company ‘Z’ vis-à-vis Capital Reorganisation Account. The opinion of the Committee is, therefore, restricted to this specific point only. The Committee has not gone into the other issues which might arise from the query.
2. The Committee notes from the facts of the query and other relevant documents provided by the querist, that the debit balance in the ‘Capital Reorganisation Account’, in substance, is a loss incurred by company ‘X’ on the transfer of its Lamps Division to a new company, prior to its amalgamation with company ‘Z’.
3.The Committee notes para 8 of ‘Guidance Note on Treatment of Reserve Created on Revaluation of Fixed Assets’, issued by the Institute of Chartered Accountants of India, which reads as follows:
“8. When accumulated losses and depreciation (including arrears of depreciation) are adjusted against Revaluation Reserve it will amount to setting off actual losses against unrealised gains. If dividend is declared out of the current profits after adjusting accumulated losses or arrears of depreciation against the Revaluation Reserve, it will mean that dividend is declared out of profits which should, in fact, have been utilised is setting-off past losses and arrears of depreciation. In effect, the company will be declaring dividend out of profits which are not available for distribution. By adopting this method, the company will be declaring dividend out of unrealised gains appearing in the accounts in the form of Revaluation Reserve. Accordingly, accumulated losses or arrears of depreciation should not be set off against Revaluation Reserve.”
4. The Committee further notes para 30 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, which reads as follows:
“30. An increase in net book value arising on revaluation of fixed assets should be credited directly to owners’ interests under the head of revaluation reserve, except that, to the extent that such increase is related to and not greater than a decrease arising on revaluation previously recorded as a charge to the profit and loss statement, it may be credited to the profit and loss statement. A decrease in net book value arising on revaluation of fixed asset should be charged directly to the profit and loss statement except that to the extent that such a decrease is related to an increase which was previously recorded as, credit to revaluation reserve and which has not been subsequently reversed or utilised, it may be charged directly to that account.”
5.On the basis of the above, the Committee is of the opinion, subject to para 1 above, that the debit balance in ‘Capital Reorganisation Account’, being in the nature of accumulated loss, can not be set-off either by passing an entry or for presentation purposes against the reserve created out of the surplus arising on revaluation of the assets of company ‘Z’. The surplus arising on revaluation should be credited directly to the shareholders’ funds under the head revaluation reserve, and should be disclosed as such in the balance sheet. _________________________
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