1.32 Query: Disclosure of investment made in an Association of Persons (AOP) and recognition of its income.
1. A Government company is engaged in petroleum refining and manufacture of certain petrochemical products. In the year 1986, it co-founded with 8 other oil companies in India, an Association of Persons (AOP), primarily with a view to reduce the exodus of trained manpower from the petroleum sector.
2. The initial contribution to the corpus of the AOP of Rs. 5 lakhs each was contributed by the nine participating oil companies. Profits and losses are shared equally amongst the constituents. The AOP suffered losses in the initial year of operation. Thereafter, it has been making profits. The AOP’s practice is to retain a substantial portion of its profits in furtherance of its objectives. The profits/losses are credited/debited to the individual accounts of the constituents and a part of it is distributed in cash.
3. Since the AOP does not have any legal identity which is distinct and separate from that of its members, the company has been consistently accounting the surplus generated by the AOP as income of the relevant year. The querist has informed that treatment is similar to the accounting treatment of capital contribution in a partnership firm under “Fluctuating Capital Method”, where the initial contributions and accretions thereto are accumulated and the drawings deducted therefrom. The company absorbed its share of losses of the AOP in its initial year, i.e., 1986-87, by suitable reduction in the seed capital. While the company had been disclosing the balance with the AOP under the head “Investments” till 1991-92, as a consequence of objection of the Government Audit, the same is now being shown by the company under “Loans and Advances – advances recoverable in cash or in kind or for value to be received”.
4. As per the querist, the Government Auditors have now objected to the accounting treatment of recognising as income, amounts which are not distributed since, in their view, the company is recognising “unearned income” in the accounts. The querist has further informed that the Government Auditors’ view is that only the seed capital should be shown under “assets” and the income to the extent declared and distributed by the AOP is only to be taken credit for, from year to year.
5. The querist is of the view that since the amount of profit share is ascertained and allocated to it as disclosed in the audited accounts of the AOP, accounting of only realised income will amount to cash basis of accounting. The querist has pointed out that as per clause B(4) of Part II in Schedule XII to the Companies Bill 1993 “Investments in Capital of Association of Persons”, has to be disclosed separately. As per the querist, clause 3 of Part III of the said schedule relating to Requirements of Profit and Loss Account, “extent of profits earned or losses incurred on account of membership of other similar entities” is to be shown separately in the Profit and Loss Account. The querist is of the view that the above clearly shows the intention of the Government that income from all investments in an AOP should be accounted for on accrual basis.
6. The querist has sought the opinion of the Expert Advisory Committee as to whether:
(a) the disclosure of investment in the seed capital of an AOP and the accretions thereto under “Advances Recoverable in cash or in kind or for value to be received” is appropriate; and
(b) the recognition of income in the company’s accounts without actual distribution of surplus in the case of investment in an AOP is correct.
Opinion March 7, 1995
1. The Committee notes Circular Letter No.28/1/71 CL-V., dated 13.10.1976, issued by Company Law Board, the relevant extracts of which are reproduced below:
“In cases where the capital account of each partner is maintained at a constant figure, or in other words where the capital of the partner is fixed, this should be shown under “Investment”. Similarly, in other cases where the capital is not fixed or not specified by the partnership deed, if any, and all transactions between the partner and the firm are merged in a single accounts in the books of partnership firm, the total of such account should be shown under the “Investments” and not under the “Current Assets, Loans and Advances”. In other words, the net amount standing to the credit of the partner (i.e., aggregate of capital, profits, deposits, if any, etc., as reduced by share of loss, if any, and drawings of the partners) should be shown under the head “Investments” and not under the head “Current Assets, Loans and Advances.”
As regards the disclosure of total capital of the partnership firm, the same may be preferably shown as on the date of the balance sheet of the company. Where, however, the capital of the firm fluctuates from day to day, and the accounts of the firm and the company are closed on different dates, the same may be exhibited in the balance sheet of the company as per the last authenticated balance sheet of the firm.”
2.The Committee is of the view that since as AOP is similar to a partnership firm, the investment by a company in an AOP should also be disclosed as specified in the above mentioned circular of the government.
3.The Committee is further of the view that once the amount of profit share is ascertained and credited to the company’s account in the books of the said AOP and confirmed by it, it should be recognised as income in the company’s books of account, even though the said amount has not been actually received in cash.
4. On the basis of the above, the Committee is of the following opinion in respect of issues raised in para 6 of the query: -
(a) No. The disclosure of investment made in the seed capital of the AOP and accretions thereto should be disclosed under “Investments”. The particulars as mentioned in para 1 above should be disclosed.
(b) No. The recognition of income from investment made in an AOP, in the company’s books, should be made as mentioned in para 3 above. ____________________________
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