Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

Query No. 10

Subject:

Applicability of AS 3 and AS 18. 1

 

A. Facts of the Case

1. A not-for-profit company was incorporated on 13th January, 1992 under section 25 of the Companies Act, 1956. Its authorised capital is Rs.700 crore and paid up capital is Rs. 425.35 crore as on 31st March, 2005. It is a Government company within the meaning of section 617 of the Companies Act, 1956. Its shares are not listed and its turnover (interest income) during the year 2004-05 was Rs. 20.39 crore. The company is exempted from payment of income-tax under section 10(26 B) of the Income-tax Act, 1961.

2. The main objects to be pursued by the company, as per its memorandum and articles of association, are reproduced hereunder:


(i) To promote economic and developmental activities for the benefit of backward classes;


(ii) To assist, subject to such income and/or economic criteria as may be prescribed by the Government from time to time, individuals or groups of individuals belonging to backward classes by way of loans and advances for economically and financially viable schemes and projects. Under micro-financing schemes, self help groups having members of target groups to the extent of at least 75% could be considered for financial support. The groups of the individuals belonging to the backward classes will include such groups in which predominantly (75% and above) members belong to backward classes provided other members belong to weaker sections (as per income and/or economic criteria prescribed by the Government) including scheduled castes/scheduled tribes, minorities and disabled persons;


(iii) To promote self-employment and other ventures for the benefit of backward classes;


(iv) To grant concessional financial assistance in selected cases for persons belonging to backward classes below the poverty line in the country in collaboration with Government Ministries/Departments at the national and state level to the extent of the budgetary assistance granted by the Government of India to the company;


(v) To extend loans to the backward classes for pursuing general /professional/technical education or training at graduate and higher levels;


(vi) To assist in the upgradation of technical and entrepreneurial skills of backward classes for proper and efficient management of production units;


(vii) To assist the state level organisations dealing with the development of the backward classes by way of providing financial assistance and in obtaining commercial funding or by way of refinancing;


(viii) To work as an apex institution for coordinating and monitoring the work of all corporations/Boards set up by the State Government/Union Territory Administrations for schedule castes, schedule tribes, backward classes and minorities insofar as it relates to the economic development of the backward classes;


(ix) To help in furthering the Government policies and programmes for the development of backward classes.

3. In order to achieve its objects as outlined above, the company is providing finances at concessional rate of interest (4% p.a. to 6% p.a.) to persons belonging to backward classes (OBCs - notified by the State Government/Central Government) living below the poverty line/double the poverty line in the country. The loans are provided to the eligible target groups through state level companies/ corporations/cooperatives (wholly owned/controlled by the State Governments). These are referred to as state channelising agencies (SCAs). The loans are provided to the SCAs after obtaining guarantee from the State Government. The individual borrowers obtain financial assistance from SCAs. The loans are provided for setting-up small business, agricultural activities, viz. STD, PCO shop, electric repair shop, barber shop, minor irrigation, tailoring shop, carpentry, blacksmithy shop, pottery, general store, vegetable vendors or other self employment ventures etc. The loan limit per beneficiary is Rs. 5 lakh, out of which generally 85% to 95% is financed by the company and the balance by the SCAs/individual borrowers. The company also provides educational loans at concessional rates, to the target group for pursuing higher studies. As part of its developmental activities, the company is also providing grants-in-aid to the target group for the upgradation of their technical and entrepreneurial skills.

4. The querist has informed that the company was initially classified as an investment company (Industrial Classification Code No. 803.1) by the Registrar of Companies. Therefore, the Reserve Bank of India had initially directed the company to file ‘First Schedule’ returns, which are applicable to non-banking financial companies. Consequent to the company’s representation dated 8th January 1996, on the basis of its objects and nature of activities, the Department of Company Affairs, vide its letter dated 1st February, 1996, decided to change the Industrial Activity Code number of the company from 803.1 to 94 (Community Services). Thereafter, on submission of the revised industrial classification code on 20th August, 1998, the Reserve Bank of India, vide its letter dated 2nd September, 1998, informed that it has deleted the name of the company from the mailing list w.e.f. 15th February, 1996. Further, vide the company’s representation to the Reserve Bank of India on 7th April, 1999, the company sought a clarification from the RBI, as to whether RBI directives and prudential norms etc., applicable to NBFCs, are applicable to the company. On July 23, 1999, the RBI informed and “certified that the company is not an NBFC and as such no RBI directives and prudential norms etc. are applicable to the company”. Copies of the relevant correspondence have been provided by the querist separately for the perusal of the Committee. The querist has also drawn the attention of the Committee to the fact that the company is also not covered under the definition of ‘Public Financial Institution’ as per the Companies Act, 1956.

5. The querist has reiterated that the main objects of the company, as mentioned in paragraph 2 above, are to promote economic and developmental activities to help the poor persons belonging to other backward classes. The query pertains to the applicability of Accounting Standard (AS) 3, ‘Cash Flow Statements’ and Accounting Standard (AS) 18, ‘Related Party Disclosures’, issued by the Institute of Chartered Accountants of India. AS 3 and AS 18 are applicable to ‘financial institutions’ and certain other institutions/organisations. The querist has stated that in view of the objects of the company and the background note given above, in the opinion of the company, it is neither a financial institution nor falls under any category of the other institutions/organisations within the scope of AS 3 and AS 18. Therefore, the company did not make disclosures required as per AS 3 and AS 18 in the annual accounts for the year ending 31st March, 2005. However, the government auditors representing the Office of the C&AG, during the course of the supplementary audit u/s 619(4) of the Companies Act, 1956, for the said year had issued two half margins (copies supplied separately for the perusal of the Committee) to the company stating that though being a financial institution, it has not complied with the aforesaid accounting standards. The company in its reply (copy supplied separately for the perusal of the Committee) had submitted the aforesaid facts and had also given an assurance to the government auditors that it shall seek clarification/ opinion from the Institute of Chartered Accountants of India on this subject. Consequently, the Office of the C&AG agreed to drop the half margins issued to the company and therefore, no audit qualification was issued by them on this account.

B. Query

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


          (a) Whether AS 3 and AS 18 are applicable to the company.


          (b) If yes, whether the company can claim exemption from the applicability of AS 3 and AS 18 and how.

C. Points considered by the Committee

7. The Committee notes that the term ‘financial institution’ is not defined in the applicability paragraphs of Accounting Standard (AS) 3, ‘Cash Flow Statements’, and Accounting Standard (AS) 18, ‘Related Party Disclosures’, issued by the Institute of Chartered Accountants of India (ICAI). The Committee is, therefore, of the view that the term ‘financial institutions’ for the purpose of applicability of Accounting Standards, in the absence of a specific definition thereof in the Accounting Standards, should be construed to have its meaning in the general commercial parlance, which may be different from that given in various legislations. In the view of the Committee, any enterprise engaged in the activities of providing loans and advances and/or providing financial services and/or engaged in financial transactions involving financial products, etc., is considered to be a financial institution in terms of the general commercial parlance. Keeping in view the aforesaid, the company in question should be considered as a financial institution. Accordingly, AS 3 and AS 18 apply to the company.

8. The Committee notes the contention of the querist stated in paragraph 5 of the ‘Facts of the Case’ that in view of the objects of the company being primarily for the development of backward classes, AS 3 and AS 18 should not be applied to it. In this context, the Committee notes paragraph 3.3 of the ‘Preface to the Statements of Accounting Standards’, issued by the ICAI, reproduced below:

 

“3.3 Accounting Standards are designed to apply to the general purpose financial statements and other financial reporting, which are subject to the attest function of the members of the ICAI. Accounting Standards apply in respect of any enterprise (whether organised in corporate, co-operative or other forms) engaged in commercial, industrial or business activities, irrespective of whether it is profit oriented or it is established for charitable or religious purposes. Accounting Standards will not, however, apply to enterprises only carrying on the activities which are not of commercial, industrial or business nature, (e.g., an activity of collecting donations and giving them to flood affected people). Exclusion of an enterprise from the applicability of the Accounting Standards would be permissible only if no part of the activity of such enterprise is commercial, industrial or business in nature. Even if a very small proportion of the activities of an enterprise is considered to be commercial, industrial or business in nature, the Accounting Standards would apply to all its activities including those which are not commercial, industrial or business in nature”.

 

9. On the basis of the above, the Committee is of the view that for the purpose of applicability of the Accounting Standards to an enterprise, the objective of setting up the enterprise is not relevant; what is of relevance is the nature of the activities carried on by it. Since the company in question is carrying on the activities of providing loans and advances on which it earns income by way of interest, in the view of the Committee, the activities carried on by the company are of commercial nature. Accordingly, Accounting Standards issued by the Institute of Chartered Accountants of India are applicable to the company, subject to specific exemptions/ relaxations available in the Standards.

10. With regard to disclosure of related party information by the company, the Committee notes paragraph 9 of AS 18, reproduced below:

 

“9. No disclosure is required in the financial statements of state-controlled enterprises as regards related party relationships with other state-controlled enterprises and transactions with such enterprises.”

 

11. The Committee notes from the Facts of the Case that the company in question is a state controlled enterprise. In view of this, no disclosure is required in its financial statements in respect of related party relationships and related party transactions with other state controlled enterprises.

D. Opinion

12. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6 above:


(a) AS 3 and AS 18 are applicable to the company.


(b) The company is exempted from disclosures under AS 18 only to the extent stated in paragraph 11 above. There are no exemptions from AS 3.

1 Opinion finalised by the Committee on 27.3.2006