Query No. 23
Subject: Share of a member in the undistributed surplus of an association of persons - whether accrued income.[1] A. Facts of the Case
1. A public sector undertaking (hereinafter referred to as ‘the company’) is engaged in refining and manufacturing of petroleum and petrochemical products. The company, along with other oil companies, formed an ‘association of persons’ in 1986 (hereinafter referred to as ‘AOP’). The net surplus generated by AOP is allocated to all the member companies equally and shown as members’ share in the books of AOP. This amount goes on accruing annually and AOP pays a small amount to the oil companies every year as dividend.
2. The company records the share of surplus, as shown in the books of AOP, as accrued income in its books and includes the balance in this account under ‘deposits’. This practice has been followed by the company consistently since beginning.
3. While conducting the audit of accounts for the year 1997-98, the government auditors opined that the said surplus should not be taken as income as, in their opinion, “recognition of such income is appropriate only when it is reasonably certain that the ultimate collection will be made”. Further, they also observed that “realisation of deposit amount is uncertain; it is only realisable when AOP will go into liquidation”.
4. In response to the above comments of the government auditors, the company observed that there was no doubt about the realisability of the amount and that the income had correctly been clubbed in the company’s books as a member of ‘association of persons’. Further, the company also referred to Article 5.2 of the Memorandum of Understanding signed by AOP with all the member oil companies. The said article is reproduced below:
“5.2 If any participating company desires to withdraw from AOP such withdrawal shall be permitted provided a notice in writing of not less than 30 days is served to the management committee. The withdrawal will be subject to settlement of outstanding obligations and commitment, if any.”
5. While finalising the audit, though the government auditors dropped the aforesaid observations, the company was advised to take an opinion from the Institute of Chartered Accountants of India as to the correct treatment of such income in the books of the company.
B. Queries
6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
C. Points Considered by the Committee
7. Schedule VI to the Companies Act, 1956, requires the disclosure in the profit and loss account of ‘the extent of the profits earned or losses incurred on account of membership of a partnership firm’. While interpreting the above requirement, the ‘Statement on the Amendments to Schedule VI to the Companies Act, 1956’ issued by the Institute of Chartered Accountants of India provides that a company can take credit for its entire share of the profits of the partnership firm, irrespective of whether they are actually received or not (see paragraphs 4.13 - 4.16) 2. It is also provided that “the term ‘partnership firm’ for the purpose of the various provisions relating to disclosure may be given a fairly wide connotation having regard to the basic intention of the ..... requirement. Consequently, similar disclosure may be made in a case where a company has entered into a joint venture agreement or arrangement” (paragraph 4.21).
8. The Committee is of the view that while the Statement does not specifically deal with profits on account of membership of an association of persons, keeping in view the similarities between a partnership firm/joint venture and an association of persons, the Statement is equally applicable to such profits. Accordingly, the Committee is of the view that recognition by the company of its share in profits of AOP is in order.
9. The Committee notes that the government auditors have objected to recognition of share in profits of AOP on the ground that the amount will be realised only when AOP goes into liquidation and that the realisation of the amount is therefore uncertain. The Committee does not agree with this observation and is of the view that ‘realisability’ does not imply that the amount must be recoverable within a short period. The Committee is of the view that the test of realisability is met so long as it is not unreasonable to expect ultimate collection, even though the same may take place at a distant time in future.
10. The Committee notes that the company is presenting its share in profits of AOP (net of dividends received) under the head ‘deposits’ in the balance sheet. In this regard, the Committee takes note of the following definition of the term ‘deposits’ as given in the ‘Statement on Qualifications in Auditor’s Report’ (paragraph 2.5):
“A ‘deposit’ may be defined as the placing of money or money’s worth with a third party, either for safe keeping, or by way of security for the performance of the depositor’s obligations, or for the purpose of earning interest; in the last case deposit being with a party who customarily accepts deposits.”
The Committee is of the view that the balance of company’s share in profits of AOP does not have the characteristics of a deposit as defined above. As such, its classification under the head ‘deposits’ is not appropriate.
11.Schedule VI to the Companies Act, 1956, requires the disclosure of the investment in the capital of partnership firms under the head ‘investments’ in the balance sheet. The Committee is of the view that the nature of the interest of the company in AOP is similar to that in the capital of a partnership firm. As such, the balance of share in the profits of AOP should be included under the head ‘investments’. In order to enable the readers to appreciate its nature and significance, the same should be disclosed separately if the amount involved is material.
12. Accounting Standard 1, ‘Disclosure of Accounting Policies’, defines ‘accounting policies’ as “the specific accounting principles and the methods of applying those principles adopted by the enterprise in the preparation and presentation of financial statements” (paragraph 11). The Standard requires that “all significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed” (paragraph 24). The Committee is of the view that the manner of treatment of share in profits of AOP constitutes an accounting policy and should, therefore, be disclosed, if significant.
D. Opinion
13. Based on the above, the Committee is of the following opinion on the issues raised in paragraph 6 above:
_______
[1] Opinion finalised by the Committee on 28.5.1999.
2 It may be mentioned that the aforesaid Statement was issued in 1976 when the Companies Act, 1956, did not specifically require companies to adopt accrual basis of accounting. |