Query No. 5

Subject:           Disclosure of items exceeding the quantitative threshold in the Notes to Accounts.[1]
 
A.        Facts of the Case  
                                                  

1.         The querist is a defence public sector undertaking (hereinafter referred to as ‘the company’) under the Ministry of Defence and is engaged mainly in the construction of warships and submarines for Indian Navy. 

2.         The company has been outsourcing some of the production processes of shipbuilding and has been accounting the expenses under line item ‘Sub-contract’.  Various outsourcing activities, such as, cleaning, insulation, machining, fittings and machine seats, pipe fitting / bending etc., are considered under natural head ‘Sub-contract Expenses’.  At times, out of these aforesaid activities, one or two activities may exceed one per cent of the revenue from the operations or Rs.1,00,000, whichever is higher.

3          The company is following the practice of disclosing few categories of expenses towards sub-contracting/outsourcing, though the amount is more than one per cent of revenue from the operations, on the grounds of homogeneity and is clubbing the same as ‘Sub-contract charge’ and a separate line item has been inserted in the statement of profit and loss. 

4.         The Govt. Audit, while quoting the provisions of the Revised Schedule VI to the Companies Act, 1956, stated that any item of income or expenditure which exceeds one per cent of the revenue from operations or Rs.1,00,000, whichever is higher, needs to be disclosed separately in the Notes to Accounts.

5.         In reply to the observation of the Govt. Audit, the company has stated that the disclosure in respect of line items under Revised Schedule VI is by nature of expenditure.   The value of individual sub-contract activity may not be relevant for the readers of the financial statements.  Therefore, the disclosure of activity-wise expenditure under such category is not intended by the Revised Schedule VI.

B.        Query

6.         The querist has sought the opinion of the Expert Advisory Committee as to whether the disclosure of expenses towards sub-contracting/outsourcing on a homogenous group and reporting as sub-contracting expenses is appropriate.

C. Points considered by the Committee

7.         The Committee notes that the basic issues raised by the querist relate to disclosure of expenses towards various sub-contracting/outsourcing activities as single separate line item, ‘sub-contracting expenses’ in the statement of profit and loss and separate disclosure of expenses in the Notes to Accounts, if the amounts of such expenses individually exceed the quantitative threshold prescribed in the Revised Schedule VI to the Companies Act, 1956. The Committee has, therefore, considered only this issue and has not examined any other issue that may be contained in the Facts of the Case. Further, the Committee presumes that the relationship between the company and the sub-contractors is neither a principal-agent relationship nor a employer-employee relationship.

8.         The Committee notes that the Form of the Statement of Profit and Loss prescribed under the Revised Schedule VI contains minimum line items, which include some items of expenditure (classified by nature). The Revised Schedule VI also requires disclosure of some items of income and expenditure in the Notes to Accounts. The Instructions appearing above Part I of the Revised Schedule VI require that “line items, sub-line items and sub-totals shall be presented as an addition or substitution on the face of the Financial Statements when such presentation is relevant to an understanding of the company’s financial position or performance”. The Committee notes that in the extant case, the company has been outsourcing some of the production processes of ship-building and is clubbing expenses on various outsourcing activities, such as, cleaning, insulation, machining, fittings and machine seats, pipe fitting / bending etc., and disclosing the same under the  head ‘Sub-contract Expenses’, though, at times, expenditure on one or more activities may individually exceed one per cent of revenue from the operations or Rs.1,00,000, whichever is higher. This, as per the querist, is done on the grounds of homogeneity. The Committee further notes Clause (c) of Note 5(i) of the ‘General Instructions for Preparation of Statement of Profit and Loss’, which is reproduced as below:

“5.          Additional Information

A Company shall disclose by way of notes additional information regarding aggregate expenditure and income on the following items:-

(i)       (a)       …

(c)        Any item of income or expenditure which exceeds one per cent of the revenue from operations or Rs.1,00,000, whichever is higher;”

The Committee also notes the Note appearing after the ‘General Instructions for Preparation of Statement of Profit and Loss’ to the Revised Schedule VI to the Companies Act, 1956, which states as follows:

“Note:- Broad heads shall be decided taking into account the concept of materiality and presentation of true and fair view of Financial Statements.”

The question that arises is whether, for the purposes of  above disclosure, various expenses which pertain to an item should be considered as separate items or can be aggregated as a single item even if such expenses individually exceed 1% of revenue or Rs. 1,00,000, whichever is higher. The Committee is of the view that various expenses pertaining to an item can be aggregated as a single item, only if the expenses aggregated are of homogeneous/similar nature and the nature of the expenses covered by the item are clearly represented by the nomenclature used. In the extant case, the matter relates to ‘sub-contracting expenses’. The Committee is of the view that the expenses aggregated under this head should relate to only ‘sub-contracting’ charges paid by the company for sub-contracting a part of the production process. If it includes any expense which is not in the nature of sub-contracting charges, such as, cost of raw material supplied to the sub-contractor to be machined by it then it cannot be included under the said head. Such raw materials are to be included under ‘raw materials consumed’ or any other appropriate head. The Committee is further of the view that the term ‘sub-contracting expenses’ does not clearly explain the nature of expenses aggregated under this head and therefore, is not an appropriate nomenclature. Thus, if the nature of sub-contracting expense can also be indicated by the nomenclature, viz., sub-contracting machining charges, sub-contracting cleaning charges, etc., it would be an appropriate presentation of such expenses.

As regards the separate disclosure of expenses so included if they individually exceed Rs. 1,00,000 or 1% of revenue, whichever is higher, the Committee is of the view that if the nature of all the charges included under the single head are being appropriately explained by the nomenclature used, these need not be disclosed as separate items in the statement of profit and loss or in the Notes to Accounts.

D.        Opinion

9.         On the basis of the above, the Committee is of the opinion on the issue raised by the querist in paragraph 6 above that the disclosure of expenses towards sub-contracting/outsourcing activities pertaining to a homogenous group and reporting as a single item would be appropriate, provided the expenses aggregated under this head relate to only sub-contracting charges paid by the company for sub-contracting a part of the production process. A proper nomenclature should be used for the head to explain clearly the nature of items aggregated under a particular head. The term ‘sub-contracting expenses’ is not an appropriate nomenclature as it does not clearly explain the nature of expenses aggregated. The Committee is also of the opinion that if the nomenclature used appropriately represents the nature of expenses clubbed therein, there would be no need for separate disclosure of various sub-contracting expenses even if they individually exceed the threshold limit as prescribed under the Revised Schedule VI to the Companies Act, 1956.

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