Expert Advisory Committee

Query No. 29

Subject: 

 Accounting for budgeted/unspent expenditure towards Corporate Social Responsibility.1

A.   Facts of the Case

1. A company (hereinafter referred to as ‘the company’) is a public sector undertaking registered under the Companies Act, 1956, and accordingly, various provisions and notifications of the Companies Act are applicable to it. Further, the Government has also recognised the company as a ‘Public Financial Institution’ under section 4A of the Companies Act, 1956.

2. The company, being a Government of India undertaking, the circulars issued by the Department of Public Enterprises (DPE) are applicable to it. The querist has stated that as per the DPE circular dated 09.04.2010² (copy of which is supplied by the querist for the perusal of the Committee), the Central Public Sector Enterprises (CPSEs) who have profit after tax amounting to less than Rs. 500 crore are required to earmark 2% to 3% of the net profit (minimum Rs. 3 crore) towards Corporate Social Responsibility (CSR) funding and for profit after tax amounting to Rs. 500 crore or above, the CPSEs are required to earmark 0.50% to 2.00% of the net profit. Further, the unspent balances will not lapse and will have to be transferred to CSR fund which will accumulate during the years.

3.In line with the above DPE circular, the company, vide its Board meeting dated 22.2.2010, approved a special non-lapsable budget of 3% of the net profit for the financial year (F.Y.) 2009-2010 which would be used for Corporate Social Responsibility activities.  No expenditure on CSR activities was incurred till 31.03.2010. The company during the year 2010-11, allocated 3% of previous year's profit after tax towards CSR activities. The total allocation towards CSR amounted to Rs. 14.86 crore against which an expenditure of Rs. 4.99 crore was incurred on the CSR activities till 31.03.2011. Further, during the year 2011-12, the company allocated towards CSR Budget @ 2% of previous year's profit after tax amounting to Rs. 11.00 crore and during the year 2011-12, the company had incurred an expenditure of Rs. 1.00 crore towards CSR activities. Thus, for a two year period on cumulative basis, the company had allocated Rs. 25.86 crore towards CSR activities out of which Rs. 5.99 crore has been spent till 31.03.2012. The accounting treatment followed by the company with regard to CSR activities is as follows:

During the year 2009-10, no expenses were incurred on CSR activities- Note No. 16 Schedule –T, Notes forming part of the Accounts. Further during the year 2010-2011, the company charged a sum of Rs. 4.99 crore to the profit and loss account and balance Rs. 9.87 crore was kept in Memorandum Account- Note No. 15 of Schedule T, Notes forming part of the Accounts.

Summarised position of CSR Fund till 2010-11 is as under:

(Rs. In crore)

4. Phase I CAG audit for the Year 2011-12:

During phase I audit of accounts for the year 2011-12, the Comptroller and Auditor General of India (CAG) observed that the company had not spent the entire amount of CSR budget and was maintaining only a Memorandum Account for this CSR budget and expenses thereon. The expenditure on the CSR activity during the year only was being charged to the profit and loss account. Further, the CAG suggested that the unspent balances out of the budget allocated for CSR activity since not being reflected in the accounts should be routed through CSR Reserve Fund for proper reflection in the annual accounts of the company.

The company had assured that in line with the suggestion of CAG, the unspent balances out of the budget allocated for CSR activities will be routed through CSR Reserve Fund for reflection in the annual accounts of the company for the year 2011-2012 and the balance of CSR reserve fund will be shown under the Schedule – 'Reserve & Surplus' in the accounts. (Note no. 3, Reserve & Surplus, as per Revised Schedule VI ³ to the Companies Act, 1956.)

5. Thereafter, while finalising the accounts for year 2011-12, the company discontinued the practice of keeping the unspent amount in the Memorandum Account and started charging the total amount allocated during the year to the statement of profit and loss (including the unspent balance of previous years kept in the Memorandum Account) towards corporate social responsibility and created a short-term provision for the amount which is unspent during the year. The unspent amount, if any, shall keep on accumulating in the short- term provision over the years.

Accordingly, Rs. 20.87 crore (during F.Y. 2011-12) was charged to the profit and loss account (Note No. 24, other expenses of Annual Report) towards CSR and the unspent balance of Rs. 19.87 crore was shown as current liability under 'Short-Term Provisions' (Note No. 11 in Annual Report) in the annual accounts for the year 2011-12. (Copy of the annual accounts for F.Y. 2010-11 and 2011-12 have been supplied by the querist for the perusal of the Committee.)

Summarised position of CSR Fund as on 31.03.2012 is as under:

(Rs. In crore)

Further, during the course of phase II of audit of accounts for the year 2011-12, the CAG observed that contrary to the assurance given, the company has not transferred the unspent balances to the CSR fund as directed by DPE vide circular dated 09.04.2010 nor disclosed the methodology followed by it in the accounts.

To the above observation, the company replied that as per clause No. 8.1.2.1 of the Guidance Note on the Revised Schedule VI to the Companies Act, 1956 and Guidance Note on Terms Used in Financial Statements, issued by the Institute of Chartered Accountants of India (ICAI), 'Reserve' is defined as “the portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue) appropriated by the management for a general or a specific purpose other than a provision for depreciation or diminution in the value of assets or for a known liability.” In view of above, according to the querist, a reserve is an appropriation and CSR is an expenditure of the company.

In view of the Revised Schedule VI to the Companies Act,1956 and the Guidance Note of ICAI on the same, the querist has argued that the CSR is an expenditure of the company and chargeable through the statement of profit and loss. Accordingly, the company has charged Rs. 20.87 crore (Rs. 11 crore for the year 2011-12 and Rs. 9.87 crore unspent CSR for the year 2010

11) to the statement of profit and loss (Note No. 24, Other expenses) for the year 2011-12 towards CSR expenditure / provision and the residual unspent balance of Rs.19.87 crore after year ended on 31.03.2012 has been shown under 'Short-Term Provisions' (Note No. 11) in the financial statements to give a proper reflection of unspent CSR allocation in the annual account of the company.

7. Phase III CAG audit:

Thereafter, during the course of phase III of the audit of accounts for the year 2011-12, the CAG observed that contrary to the DPE directives, the company has not maintained and transferred the unspent balances to the CSR fund despite the assurances given by the company during the Phase-I audit of accounts.

To the above observation, the company replied that the assurance given by the company during the Phase-I audit has been duly complied with by charging the total budgeted allocation of the current year as also the unspent balance of previous year on above account by creating provision in the statement of profit and loss and reflecting the upto date amount on the above account in the Note 11, 'Short-Term Provisions' in the annual accounts for the year 2011-12.

During the subsequent discussions held with the CAG auditors, they insisted that the company should create a separate bank account and put the unspent funds in that bank account, where upon the company assured them that it would seek a clarification from ICAI on the accounting treatment to be followed and the accounting shall be reviewed in the next year accounts.

B.  Query

8. In view of the above facts, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) Whether the methodology/accounting treatment being adopted by the company of charging the total budgeted allocation of the current year as also the unspent balance of previous year on above account by creating provision in the statement of profit and loss and reflecting the upto date unspent balance amount on the above account in the short term provisions in the annual accounts for the year is proper as per the accounting practices and principle of prudence and that whether the company can continue with the above practice.

 

(ii) In case the methodology/accounting treatment being followed is not proper or needs modification, then what is the alternative methodology/accounting treatment to be followed along-with the prudent accounting policy?

C.      Points considered by the Committee

9. The Committee notes that the basic issue raised in the query relates to accounting for unspent or budgeted expenditure towards Corporate Social Responsibility (CSR), viz., whether it should be recognised as a provision or reserve or should be treated in any other way. The Committee has, therefore, considered only this issue and has not examined any other issue arising from the Facts of the Case, such as, determination of the amount to be earmarked for CSR activities, legal interpretation of DPE Guidelines, whether separate bank account can be considered as earmarked investment, etc.

10. The Committee notes the definitions of ‘provision’, ‘liability’, ‘obligating event’, ‘present obligation’ and paragraphs 14, 16, 17 and 18 of AS 29, notified under the Companies (Accounting Standards) Rules, 2006 as follows:

“10.1   A provision is a liability which can be measured only by using a substantial degree of estimation.

 

10.2     A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

 

10.3     An obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation.”

 

“10.6   Present obligation - an obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not.” 

 

“14.    A provision should be recognised when:

(a)  an enterprise has a present obligation as a result of a past event;

 

(b)  it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

 

(c)  a reliable estimate can be made of the amount of the obligation.

If these conditions are not met, no provision should be recognised.”

“16. A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the enterprise has no realistic alternative to settling the obligation created by the event.

 

17. Financial statements deal with the financial position of an enterprise at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an enterprise’s balance sheet are those that exist at the balance sheet date.

18. It is only those obligations arising from past events existing independently of an enterprise’s future actions (i.e. the future conduct of its business) that are recognised as provisions. Examples of such obligations are penalties or clean-up costs for unlawful environmental damage, both of which would lead to an outflow of resources embodying economic benefits in settlement regardless of the future actions of the enterprise. Similarly, an enterprise recognises a provision for the decommissioning costs of an oil installation to the extent that the enterprise is obliged to rectify damage already caused. In contrast, because of commercial pressures or legal requirements, an enterprise may intend or need to carry out expenditure to operate in a particular way in the future (for example, by fitting smoke filters in a certain type of factory). Because the enterprise can avoid the future expenditure by its future actions, for example by changing its method of operation, it has no present obligation for that future expenditure and no provision is recognised.”

11.The Committee further notes the following features of the DPE Guidelines:

(i) The CSR budget will be mandatorily created through a Board Resolution as a percentage of net profit in the manner specified in the DPE Guidelines. (Clause 5.1 of DPE Guidelines)

 

(ii) Loss-making companies are not mandated to earmark specific funding for CSR activities. (Clause 5.2 of DPE Guidelines)

 

(iii)The CSR budget should be fixed for each financial year. This funding will not lapse. It will be transferred to a CSR Fund, which will accumulate as in the case of non-lapsable pool – for the North East. (Clause 5.4 of DPE Guidelines)

 

(iv)The implementation of CSR guidelines will form a part of the Memorandum of Understanding that is signed each year between CPSEs and Government. (Clause 8.4 of DPE Guidelines)

 

(v)  In MoU Guidelines from 2010-11 onwards, 5 marks have been earmarked out of the non-financial parameters for CSR activities.

 

… (Clause 8.6 of DPE Guidelines)

(Emphasis supplied by the Committee.)

From the above, the Committee notes that as per the DPE Guidelines, there is a mandate for creation of a budget/fund and not to spend on CSR activities as a percentage of profits, which would only form a basis for evaluation of the performance of an enterprise. However, there is no mandate on the amount of expenditure, which has to be necessarily incurred by an enterprise during a period of its operation. Thus, there is a mandate only on the creation of a budget or fund rather than an obligation to incur expenditure during a period. Further, neither there is any time limit for incurring the expenditure out of CSR fund nor any penalty is prescribed for non-incurrence of such expenditure.  The Committee also notes that as per the provisions of AS 29, a provision should be recognised when there is a present obligation involving incurrence of expenditure, arising from a past event that leaves no realistic alternative apart from settling that obligation and that obligation exists independently of an enterprise’s further actions. Since as per DPE Guidelines, there is no such obligation on the enterprise, provision should not be recognised. Accordingly, the Committee is of the view that the requirement in the DPE Guidelines for creation of a CSR budget is to be met through creation of a reserve as an appropriation of profits rather than creating a provision as per AS 29.

12. On the basis of the above, the Committee is of the view that in the extant case, it is not appropriate to recognise a provision in respect of budgeted or unspent expenditure on CSR activities. However, a CSR reserve may be created as an appropriation of profits.  The balance in the reserve so created may be suitably reflected under the head ‘Reserves’ as prescribed in the Revised Schedule VI to the Companies Act, 1956. However, in the view of requirements of paragraph 5 of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, on the crystallisation of a liability on account of an expense on CSR activities, the amount in this regard cannot be adjusted directly against the reserve. It has to be recognised in the statement of profit and loss as a charge for determination of the profit of the relevant year.

13. As regards classification of ‘funds’ in respect of reserve created for CSR activities, the Committee  notes from the DPE Guidelines that terms ‘fund’ and ‘funding’ have been used interchangeably. The Committee notes the definition of the term ‘Fund’ as contained in the Guidance Note on the Terms Used in Financial Statements, issued by the Institute of Chartered Accountants of India, as below:

“6.15 Fund

An account usually of the nature of a reserve or a provision which is represented by specifically earmarked assets.”

From the above, the Committee is of the view that from accounting point of view, a reserve can be regarded as a ‘fund’ provided it is represented by specifically earmarked assets.  However, whether under the DPE Guidelines, the term ‘fund’ has been used in the above accounting sense involves legal interpretation of the DPE Guidelines, which in view of Rule 2 of its Advisory Service Rules, is not within the purview of the Committee.

D. Opinion

14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 8 above:

(i) No, the methodology/accounting treatment being adopted by the company of charging the total budgeted allocation of the current year as also the unspent balance of previous year on above account by creating provision in the statement of profit and loss and reflecting the upto date unspent balance amount on the above account in the short term provisions in the annual accounts for the year is not proper, as discussed in paragraphs 10 to 12 above.

 

(ii) CSR Reserve may be created as an appropriation of profits. For correct accounting treatment and accounting policy, refer paragraphs 10 to 12 above.

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¹Opinion finalised by the Committee on 7.2.2013.

²The opinion is based on the Guidelines as referred by the querist. These Guidelines have subsequently been revised.

³Revised Schedule VI came into force for the Balance Sheet and Profit and Loss Account for the financial year commencing on or after 01.04.2011.