1.36 Query: Whether revaluation reserve can be used for adjustment of accumulated losses and unprovided depreciation of past years.
1. A company is a manufacturer of steel castings. The company’s year-ending is on 30th September. During the year ended 30.9.96, the company has incurred heavy losses to the extent of Rs. 19 crores and it has also got unadjusted (not charged in the profit and loss account) depreciation of Rs. 4 crores in respect of previous years. The company has revalued its fixed assets as on 30th September, 1996, and the surplus of Rs. 26 crores arising out of such revaluation has been set off against the above losses and depreciation and the balance amount of Rs. 3 crores arising out of such adjustment is transferred to the balance sheet as revaluation reserve. The summarised balance sheet of the company after such adjustments is as follows: Balance-Sheet as on 30.9.96
2. The legal consultants of the company has opined that as per para 30 of Accounting Standard (AS) 10 on ‘ Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, the difference arising out of decrease in revaluation of fixed assets should be debited to the profit and loss account. The converse of it is when there is an increase in revaluation, it has to be credited to profit and loss account.
3. According to the querist, as per clause 3(1)(o) of the Sick Industrial Companies (Special Provisions) Act, 1985 (SICA), a company is a sick industrial company.
(i) which has at the end of any financial year accumulated losses equal to or exceeding its entire net worth, and
(ii) suffered cash losses in such financial year and the financial year immediately preceding such financial year.
4. The company in question has suffered cash losses during the year ended 30.9.96 and is expected to suffer cash losses during the subsequent financial year 30.9.97 also. According to the querist, during the year ended 30.9.97, as per the balance sheet of the company, the net worth of the company will not be eroded as there are no accumulated losses due to the above treatment of writing off of losses against revaluation surplus. In this regard, a question arises that since the auditor has to report whether the company is a Sick Industrial Company u/s 3(1) (o) of SICA in his report, should he take into account the accumulated losses before such write off (In which case the entire net worth of the company will be eroded) for the purpose of determining the company as a sick industrial company u/s 3(1) (o) of SICA, for the year ended 30.9.97.
5. The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from above:
(i) Whether surplus arising out of revaluation of fixed assets can be utilised to write off the accumulated losses and unprovided depreciation?
(ii) Whether a qualified report should be given by the auditor in the above event?
(iii) If a qualified report is not necessary, should the violation of para 30 of AS 10, be disclosed in the report and is such disclosure sufficient?
(iv) Whether the accumulated losses so written off should be taken into account, i.e., written back, for the purpose of determining the company as a Sick Industrial Company as per section 3(1) (o) of Sick Industrial Companies (Special Provisions) Act, 1985, in the subsequent year?
Opinion October 17, 1997
1. The Committee notes that paras 29 and 30 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, state as below:
“29. When a fixed asset is revalued upwards, any accumulated depreciation existing at the date of the revaluation should not be credited to the profit and loss statement.
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 in 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.”
2. The Committee further notes that the ‘Guidance Note on Availability of Revaluation Reserve for Issue of Bonus Shares’, issued by the Institute of Chartered Accountants of India, after quoting the above paragraphs from AS 10, states the nature of revaluation reserve as below:
“4. It may be noted that the excess of the revalued amount over the net book value of fixed assets, which is credited to revaluation reserve, is created as a result of a book adjustment only. The revaluation reserve does not result from an arm’s length transaction; it represents an expert’s perception of value. The revaluation reserve thus does not represent a realised gain.”
3. On the basis of the above, the Committee is of the view that accumulated losses and unprovided depreciation can not be adjusted against the revaluation reserve created on revaluation of the fixed assets. The Committee is further of the view that in case the company in question does so, the balance sheet of the company will not reflect a true and fair view of the state of affairs of the company keeping in view the magnitude of the amounts involved, i.e., accumulated losses and unprovided depreciaton amount to Rs. 23 crores and share capital and reserves amount to Rs. 8.3 crores (excluding revaluation reserve).
4. Since the accumulated losses and unprovided depreciation can not be written off against the revaluation reserve, the question raised in 5(iv) of the query in respect of Sick Industrial Companies (Special Provisions) Act, 1985, does not arise.*
5. On the basis of the above, the Committee is of the following opinion in respect of issues raised in para 5 of the query:
(i) No.
(ii) The auditor should give an adverse opinion stating that the balance sheet of the company does not give a true and fair view of its state of affairs.
(iii) In view of (ii) above the question does not arise.
*The Committee notes that the definition of ‘sick industrial company’ as per the section 3(1) (o) of the Sick Industrial Companies (Special Provisions) Act, 1985 as amended in 1993, is as below and not that as quoted by the querist in para 3 of the query :
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