1. The querist sought the opinion of the Committee regarding the interpretation of two deductions listed in Section 349 (4) of the Companies Act-(i) the ‘usual working charges’ [S. 349 (4) (a)], and (ii) ‘Outgoings, including contributions under section 293(1) (e)’ [S. 349 (4) (j)]-from the net profits of a company for the computation of managerial remuneration under the Companies Act. In this connection, the querist specifically wanted to be advised on whether expenses incurred during a year and not debited to the profit and loss account, but adjusted against provisions or carried forward to future years (e.g. items appearing under the head Miscellaneous Expenditure) for adjustment/write-off have to be deducted while arriving at the net profits for the purpose of S. 349 of the Companies Act.
2. The querist opined that in the cases pertaining to the head ‘Miscellaneous Expenditure’ (e.g., share issue expenses, preliminary expenses and deferred revenue expenditure) if the expenditure is classified as a revenue expenditure and carried forward only for adjustment in future years, it has to be treated either as (i) the usual working charges, or (ii) the outgoings. According to him, the fact that the expenditure is carried over to future years for write-off has no relevance for the purpose of Section 349. It is the nature of the expenditure which is relevant and not the way it is disclosed in the financial statements and that the expenses included under ‘Miscellaneous Expenditure’ have to be deducted for arriving at the net profits under Section 349, in the year in which these are incurred.
3. The querist further expressed his disagreement with the usual accounting practice, according to which, only the portion of the Miscellaneous Expenditure written off during the year is deducted for arriving at the net profits for the purposes of Section 349. According to him these are neither ‘the usual working charges’ nor ‘the outgoings for the year’ because the expenditure was incurred in an earlier year.
1. The Committee noted that the Companies Act, 1956, has not defined the terms, ‘the usual working charges’ and ‘the outgoings’; therefore, they are to be interpreted from the point of view of the prevailing commercial and accounting practices. The ‘usual working charges’ may be interpreted as those charges which are incurred for the day-to-day running of the enterprise and are incidental to the working of the business. The preliminary expenses, share issue expenses etc. should be considered incidental to the working of the business, because, but for these expenses the business would not have attained the present working capacity. They are in the nature of deferred revenue expenditure, the periodical write-off of which is an acceptable accounting practice in recognition of the fact that they ensure long term benefits to the business. Thus, the amount of such an expenditure written-off in a particular year should be treated as revenue expenditure for that year.
2. Also the expenses and losses- the amounts in respect of which cannot be determined with sustained accuracy-are nevertheless incurred for the day-to-day running of the business and are incidental to the working of the business and are permitted by the accounting practice and the Companies Act, 1956, to be charged, in the form of provisions, to the Profit and Loss Account of the relevant year, even though the actual amount of the liability will be determined in a later year. Thus, provisions for expenses and losses are covered by the term ‘usual working charges’.
3. The term ‘outgoings’ appears to relate to those disbursements which do not have any long-term direct benefits to the working of the business. This interpretation is strengthened by the fact that clause (j) of Section 349 (4) includes outgoings under section 293 (1) (e) of the Companies Act i.e. contributions to charities, etc. These disbursements are made at the discretion of the management and cannot be classified as direct working charges, and yet are incurred in the course of business, for example, for discharging social responsibilities. The expenditures appearing under the head ‘Miscellaneous Expenditures’ are periodically incurred to ensure the growth and the sustenance of the business (e.g. share issue expenses and massive advertisement expenditure). Therefore, to include all types of such disbursements as ‘outgoings’ may not be appropriate, particularly if such disbursements are in the nature of usual working charges over the years.
4. The opinion of the committee is as follows:
(i) ‘The usual working charges’ may be interpreted as those charges which have been written-off or provided for in the profit and loss account of the year according to the prevailing accounting practices, even if such expenditure or losses are actually incurred in a year other than the year in which such charges are made. and if these expenses and losses arise in the day-to-day running of the enterprise and are incidental to the working of the business.
(ii) The term ‘outgoings’ may be interpreted as payments made by the management at its discretion in the course of the business, for example, for discharging social responsibilities.
(iii) In view of (i) & (ii) above, the amount written-off on a rational basis to the profit and loss account in respect of an expenditure of the nature of share issue expenses, preliminary expenses, and deferred revenue expenditure etc. should be deducted while arriving at the net profits of the company for the purposes of Section 349 of the Companies act. However, to the extent a deferred revenue expenditure is carried forward, it should not be so deducted.
(iv) It also follows that expenses incurred during the year but adjusted against provisions should not be deducted while arriving at the net profits for the purposes of Section 349 of the Companies Act unless otherwise required by the said Section, as such expenses would already have been deducted in the year in which they accrued and when the provisions were created.