1. A company revised the borrowing powers of its Board of Directors by passing the following special resolution at its 12thAnnual General Meeting:

2. The querist has stated that the statutory auditors of the company, in their audit report, have qualified that the Board of Directors of the company have exceeded the powers conferred upon them under section 293(1)(d) of the Companies Act, 1956, by borrowing in excess of the limits specified in the special resolution passed at the twelfth Annual General Meeting of the company.

3. According to the querist, the company does not agree with the views of the statutory auditors on the basis of the following:

(i) The remark of the statutory auditors is not acceptable in view of the fact as defined clearly in section 293(1)(d) of the Companies Act, 1956, the company has been allowed by the special resolution to borrow at any time a sum of Rs. 4,700 crore or six times of the paid-up share capital and free reserves, whichever is less.

(ii) The term ‘free reserves’ is defined as a definite appropriation made from surplus of the corporation, therefore, the debit balance in the profit and loss account cannot be treated as a part of ‘free reserves’.

(iii) The interpretation of the statutory auditors considering the debit balance of the profit and loss account as a part of ‘Reserves and Surplus’ is not in accordance with the Vertical Form of the balance sheet given in Schedule VI to the Companies Act, 1956, wherein the debit balance of the profit and loss account is shown on the assets side after netting out the uncommitted reserves. The company is, therefore, of the opinion that there is no violation of the borrowing powers of the Board under section 293(1)(d) of the Companies Act, 1956.

B . Query

4. The querist has sought the opinion of the Expert Advisory Committee on the issue as to whether the company’s practice of not considering the debit balance of the profit and loss account as a part of ‘free reserves’ is correct or not.

C. Points considered by the Committee

5. The Committee notes that the querist has sought its opinion on the limited question of whether the debit balance of the profit and loss account should be considered as part of ‘free reserves’, and not on any other aspect of section 293(1)(d) of the Companies Act, 1956. The Committee has, accordingly, restricted its opinion only to this issue.

6. The Committee notes that the term ‘free reserves’ has not been defined under section 293(1)(d) or in a general manner elsewhere in the Act. Accordingly, the Committee is of the view that whether debit balance of profit and loss account should be considered as part of free reserves would depend upon the general business and accounting parlance. In this context, the Committee notes that the querist has also argued on the basis of Schedule VI to the Companies Act, 1956, which lays down the format of the balance sheet and the information to be disclosed in the profit and loss account of a company.

7. The Committee does not agree with the querist’s contention that the debit balance of profit and loss account as a part of ‘Reserves and Surplus’ is not in accordance with the Vertical Form of the balance sheet given in Schedule VI to the Companies Act, 1956, wherein the debit balance of the profit and loss account is shown on the assets side after netting out the uncommitted reserves. The Committee notes that although in the Vertical Form of balance sheet as per Schedule VI, ‘profit and loss account’ is shown under the head ‘Application of funds’, Note 1 to the said format requires as below:

"Details under each of the above items shall be given in separate Schedules. The Schedules shall incorporate all the information required to be given under A – Horizontal Form read with notes containing general instructions for preparation of balance sheet."

8. The Committee also notes that item (4) under the head ‘reserves and surplus’ in the Horizontal Form of balance sheet as per Schedule VI to the Companies Act, 1956, requires as below:

"Other reserves specifying the nature of each reserve and the amount in respect thereof. Less: Debit balance in profit and loss account (if any) (h)."

The Committee further notes clause (h) of ‘General instructions for preparation of balance sheet’ under Schedule VI to the Companies Act, 1956, which provides as follows:

"(h) The debit balance in the Profit and Loss Account shall be shown as a deduction from the uncommitted reserves, if any."

9. On the basis of the above, the Committee is of the view that the disclosure of the ‘Profit and loss account’ under the head ‘Application of funds’ in the Vertical Form of balance sheet under Schedule VI would be required only if the debit balance of the profit and loss account can not be set off against uncommitted reserves in view of inadequacy of the amount thereof. Thus, in case a company has uncommitted reserves, the debit balance of profit and loss account has to be shown as a deduction therefrom even under the Vertical Form in view of the requirement of Note 1 to the said Form as reproduced in paragraph 7 above. The Committee is of the view that this should be the position even for the purposes of section 293(1)(d) of the Companies Act, 1956.

D. Opinion

10. On the basis of the above, the Committee is of the opinion that the practice of the company of not considering the debit balance of the profit and loss account as a part of ‘free reserves’, is not correct.

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1 Opinion finalised by the Committee on 27.1.2004