Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 18

 

Subject:        Determination of the average net profit for the purpose of incurring Corporate Social Responsibility                      (CSR) expenses and disclosure of CSR expenses in the financial statements.1

 

A.        Facts of the Case

 

1.        A corporation (company) is a Central Public Sector Undertaking (CPSU) under the Ministry of Textiles. During the course of audit of accounts by the office of Comptroller and Auditor General of India (C&AG), the audit team commented that for calculating average profit of the company during three years for the calculation purpose of Corporate Social Responsibility(CSR) expenses, the loss suffered in any preceding three financial years should not be considered and it should be treated as zero. Further, it has also been observed by them that CSR expenses should be disclosed as a separate line item on the face of the profit and loss statement. (The query raised by the office of C&AG and management reply thereon have been supplied by the querist for the perusal of the Committee.)

 

2.        However, the querist has stated that in pursuance to the provisions of section 198 of the Companies Act, 2013, while calculating the amount to be spent on CSR activities, the corporation has adjusted the loss suffered in the financial year 2013-14 against the profit earned in the financial years 2011-12 and 2012-13. The expenditure incurred on CSR was shown as separate line item under the head of administrative expenses of the statement of profit and loss.

 

3.        The office of the C&AG has desired that opinion from the Institute of Chartered Accountants of India (ICAI) may be obtained to ensure adequate provision towards CSR activities and disclosure of the same in the statement of profit and loss.

 

B.        Query

 

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

(a) Whether negative profit (loss) suffered during the three immediately preceding financial years is to be treated as zero for the purpose of arriving at 2% of the average net profit of the company for incurring CSR expenses

or

the average so required shall be arrived at after adjusting the negative profit, i.e., loss against profit of the company.

 

(b) Whether the CSR expenses incurred are to be shown as separate line item on the face of the profit and loss statement or a separate line item under the note of Administrative Expenses’.

C.         Points considered by the Committee

 

5.        The Committee notes that the basic issues raised in the query relate to whether in case of loss incurred in a year, profit should be taken as zero or as a negative balance while calculating the average net profit for the purposes of incurring CSR expenses and the disclosure of CSR expenses in the statement of profit and loss. The Committee has, therefore, considered only these issues and has not examined any other issue that may arise from the Facts of the Case, such as, determination of the amount to be spent on CSR activities as per the requirements of Companies Act, 2013, etc. At the outset, the Committee wishes to point out that the opinion expressed hereinafter is purely from accounting perspective and not from the perspective of interpretation of legal enactments, such as, Companies Act, 2013 or Rules made thereunder, etc.

 

6.        With regard to the first issue raised as to whether profit should be taken as ‘zero’ or as a negative balance while computing average net profit of the company for incurring CSR expenses, the Committee notes the requirements of the Guidance Note on Terms Used in Financial Statements, issued by the Institute of Chartered Accountants of India, as follows:

 

“11.03 Net Loss

See Net Profit

11.04 Net Profit

The excess of revenue over expenses during a particular accounting period. When the result of this computation is negative, it is referred to as net loss. The net profit may be shown before or after tax.”

 

From the above, the Committee notes that in the accounting parlance, the result of computation of revenue over expenses during a period, even though negative, is referred to as ‘net profit'. Thus, the Committee is of the view that from accounting perspective, average net profit should be arrived at after adjusting the negative profit, i.e., loss against profit of the company.

 

7.        With regard to the second issue raised relating to the disclosure of CSR expenses in the statement of profit and loss, the Committee notes the requirement of the Guidance Note on Accounting for Expenditure on Corporate Social Responsibility Activities, issued by the Institute of Chartered Accountants of India, as follows:

"16. Item 5 (A)(k) of the General Instructions for Preparation of Statement of Profit and Loss under Schedule III to the Companies Act, 2013, requires that in case of companies covered under Section 135, the amount of expenditure incurred on ‘Corporate Social Responsibility Activities' shall be disclosed by way of a note to the statement of profit and loss. From the perspective of better financial reporting and still be in line with the requirements of Schedule III in this regard, it is recommended that all expenditure on CSR activities, that qualify to be recognised as expense in accordance with paragraphs 10-14 above should be recognised as a separate line item as ‘CSR expenditure' in the statement of profit and loss. Further, the relevant note should disclose the break-up of various heads of expenses included in the line item ‘CSR expenditure'.”

From the above, it is clear that from the perspective of better financial reporting, the Guidance Note recommends that the company should disclose the CSR expenditure as a separate line item in the statement of profit and loss. However, if the company does not disclose CSR expenditure as a separate line item in the statement of profit and loss; instead includes it under another appropriate head(s) in the statement of profit and loss and explains it by way of a note in the notes to the financial statement, it would also be in accordance with the requirements of Schedule III to the Companies Act, 2013. In this context, the Committee notes that the company is including the CSR expenditure under the head ‘administrative expenses' in the statement of profit and loss and disclosing its details in the notes to the financial statements. The Committee is of the view that CSR expenses should be included under an appropriate head in the statement of profit and loss, for example, ‘other expenses' and not ‘administrative expenses'.

 

D.         Opinion

 

8.         On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 4 above: 

 

(a) For the purpose of arriving at 2% of the average net profit of the company for incurring CSR expenses, from accounting perspective, the average profit so required should be arrived at after adjusting the negative profit, i.e., loss against profit of the company, as discussed in paragraph 6 above.

 

(b) From the perspective of better financial reporting, the Guidance Note on Accounting for Expenditure on Corporate Social Responsibility Activities recommends that the CSR expenses incurred should be shown as a separate line item in the profit and loss statement. However, if the company does not disclose CSR expenditure as a separate line item in the statement of profit and loss; instead includes it under another appropriate head(s), for example, ‘other expenses' in the statement of profit and loss and explains it by way of a note in the notes to the financial statement, it would also be in accordance with the requirements of Schedule III to the Companies Act, 2013. Further, the CSR expenditure should not be included under the head ‘administrative expenses' in the statement of profit and loss, as discussed in paragraph 7 above.

 

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1 Opinion finalised by the Committee on 1.2.2016.