2.1  Query:     

Treatment of Bond Redemption Reserve and Miscellaneous Expenditure,under

Sick Industrial Companies (Special Provisions) Act, 1985

1. The querist has stated that as per Clause No. 20 of part 4 of the Manufacturing and Other Companies (Auditor’s Report) Order, 1988, an auditor has to state whether a company is a sick industrial company within the meaning of Clause (O), Sub-Section (1) of Section 3 of the Sick Industrial Companies (Special Provisions) Act, 1985. As per the provisions of the Act, reference under Section 15 of the Act has to be made if the accumulated loss as per the latest financial statements exceeds the share capital and net worth of the company.

2. The querist has further stated that in the case of the company in question as per the balance sheet as at 31.03.94, the Share Capital is Rs. 153.18 crores and the Reserve & Surplus is Rs. 22.85 crores which includes Rs. 22.09 crores being the Bond Redemption Reserve, i.e., the shareholders funds are Rs. 176.03 crores. The debit balance in the profit and loss account as on that date is Rs. 159.58 crores. There is also an amount of Rs. 25.80 crores shown as Miscellaneous Expenditure to the extent not written off or adjusted. The querist has separately provided details of the ‘Miscellaneous Expenditure’ as below:

(i)         Research and Development Expenses

 

The company has been deferring the salary and other expenses of R & D expenses including interest and a portion of administrative overheads. This was qualified by the current auditors and the earlier auditors as they were not agreeing with the basis and deferment of R & D expenses.

 

(ii)        Technical know-how charges

 

This consists of the know-how expenses relating to the manufacturing process of a new product. Even though the period of agreement has expired, the know-how charges have not been written off fully.

 

(iii)       Voluntary Retirement Compensation

 

This consists of the compensation paid by the company to employees who retired under the Voluntary Retirement Scheme in the years 1992-93 and 1993-94.

 

(iv)       Indirect/Incidental Expenditure relating to the new Polyster X-Ray Project

 

3. As per the querist, the company is putting up a Polyster X-Ray project from 1988. Upto 1991-92, the company had been transferring certain expenditure relating to the existing operations to the ‘New Project’ as expenditure relating to the new project and capitalised under the head ‘Capital Work in Progress’. The basis of transfer was, in the opinion of the auditors, not proper and hence the existing auditors as well as the earlier auditors had qualified their reports accordingly. Now, in 1993-94, the management has decided to treat the same as Deferred Revenue Expenditure (DRE) instead of ‘Capital Work in Progress’ and hence has transferred the same to DRE from Capital Work in Progress. The project could not be completed for want of funds and is already delayed by more than 3 years.

4. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a)        For the purpose of arriving at free reserves, can the Bond Redemption Reserve be considered as part of free reserves?

 

(b)        Whether Miscellaneous Expenditure not written off or adjusted can be considered as a part of the accumulated loss for the purpose of Sick Industrial Companies (Special Provisions) Act, 1985.

 

(c)        Whether the company, in the opinion of the Institute, is a sick industrial company to be referred to the Board for Industrial Finance and Reconstruction.

 

                                                                                            Opinion                        April 6, 1995

1. The Committee notes that net worth is defined in Clause (ga) of sub-section (1) of Section 3 of Sick Industrial Companies (Special Provisions) Act, 1985, as amended, “to mean the sum total of the paid-up capital and free reserves.

Explanation: For the purpose of this clause, “free reserves” means all reserves credited out of the profits and share premium account, but does not include reserves credited out of re-valuation of assets, write back of depreciation provision and amalgamation.”

 

2. The Committee is of the view that since the Act has specifically mentioned the reserves which are to be excluded from free reserves, and Bond Redemption Reserve is not excluded, the said reserve would be considered as part of free reserves, provided it is created out of profits.

3. The Committee further notes that since the Act is silent on the definition of the term ‘accumulated losses’, the opinion given hereafter is based on the substance of the facts and the spirit of the scheme of the Act.

4. The Committee is of the view that in determining the quantum of ‘accumulated losses’, management of a company should logically and in terms of proper accounting practice take into account not only the debit balance of profit and loss account to the extent not adjusted against reserves, but also such expenditure carried forward which is not expected to provide any future benefits. Each item under Miscellaneous Expenditure will, therefore, have to be seen in this light. For example, only such R & D expenditure can be considered to have been properly deferred if the deferral is in accordance with the criteria laid down in para 9 of Accounting Standard (AS) 8 on ‘Accounting for Research and Development’ issued by the Institute of Chartered Accountants of India. Similarly, with regard to know-how fees, Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, has prescribed the conditions under which such expenses could be rightly capitalised. Propriety of deferral of voluntary retirement compensation would depend upon the facts and circumstances, e.g., whether such compensation would result into demonstrable and commensurate benefits in future. With regard to capitalisation/deferral of indirect expenditure during construction period, a reference may be made to the Guidance Note on Expenditure During Construction Period, issued by the Institute of Chartered Accountants of India.

5.  On the basis of the above, the Committee is of the following opinion in respect of the issues raised by the querist in para 4 of the query:

(a)      Bond Redemption Reserve should be considered as part of free reserves provided it is created out of profits.

 

 (b)      Please see para 4 above.

 

(c)      This is a broader question than the issues raised in (a) and (b) above, which will depend on the totality of the facts and circumstances of the case and the legal position as per SICA/BIFR regulations. The Committee, therefore, is unable to offer an opinion on this aspect in view of Rule 2 of the Advisory Service Rules, under which the Committee is prohibited from giving opinions on matters involving legal interpretation.

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