TMI Blog2007 (11) TMI 401X X X X Extracts X X X X X X X X Extracts X X X X ..... llenge was pleaded in the writ petition, when the matter came for hearing before the High Court, it appears that the said grounds were not argued. According to the appellants, implementation of AS 22 would result in reduction of profits and reserves. In the circumstances, we do not wish to express any opinion on the constitutional validity of the said AS 22. Whether the said Standard constitutes a restriction on the rights of the appellants to carry on business under article 19(1)(g) or whether the said Standard is violative of article 14 are questions on which we express no opinion. We keep those questions open. Suffice it to state that, in the present case, we are of the view that the said AS 22 is neither ultra vires nor inconsistent with the provisions of the Companies Act, including Schedule VI. - CIVIL APPEAL NOS. 3478, 3479, 3480, 3482 AND 3761 OF 2007 - - - Dated:- 19-11-2007 - S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ. A. Sharan, Dr. Debiprosad Pal, S.K. Bagaria, J.P. Khaitan, Arvind P. Datar, N.K. Poddar, Ananda Sen, R.K. Raghavan, K.V. Mohan, K.V. Balakrishnan, Raj Shekhar Rao, N.P. Agarwalla, P.C. Sharma, Amit Agarwalla, Dr. Anita Sumanth, V.S. Jay Kumar, Nikhi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the accounts of Indian companies with their joint venture partners abroad. The aim is to harmonise Indian Accounting Standards with International Accounting Standards. With the object of bridging gap between IAS and IFRS, the Institute formulated new A.S. and introduced new concepts, e.g., Deferred Tax Accounting (AS 22 impugned herein), Segment Reporting (AS 17) etc. However, as a matter of prudence and necessary adjustment, to arrive at real income, Accounting Standards require provision to be made for liabilities payable in future, provision to be made for contingencies, provision to be made for diminution, provision to reflect impairment and so on which have the effect of reducing incomes and were, therefore, not readily accepted by some enterprises and tax authorities. 6. The core of Accountancy is Book-keeping. The rules of Book-keeping are clear. For example, the value of a fixed asset mentioned in a Balance Sheet is based on cost which may involve subjective estimation of the amount to be apportioned. Similarly, the quantum of depreciation is again an estimate, which can vary depending on the persons preparing the accounts as to when and at what stage he wants to reco ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y of estimates used in arriving at accounting income. 7. The main object sought to be achieved by Accounting Standards which is now made mandatory is to see that accounting income is adopted as taxable income and not merely as the basis from which taxable income is to be computed. Thus, if the rules by which inventories are to be valued are laid down in the Accounting Standards and are followed in the determination of accounting income, then tax laws do not need to lay down the rules and the tax authorities do not need to examine the computation of the value of inventories and its effect on computation of income. Similarly, if there is an accounting standard on depreciation which requires estimation of the useful life and prescribes the appropriate method for apportionment of cost of fixed assets over their useful life, it is unnecessary for tax laws to apply an artificial rule to decide the extent of allowance for depreciation. 8. Finally, the adoption of Accounting Standards and of accounting income as taxable income would avoid distortion of accounting income which is the real income. Reasons for introducing AS 22 9. In the backdrop of globalization and liberal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t of which the receipt and expenditure take place; ( b )all sales and purchases of goods by the company; ( c )the assets and liabilities of the company; and ( d )in the case of a company pertaining to any class of companies engaged in production, processing, manufacturing or mining activities, such particulars relating to utilisation of material or labour or to other items of cost as may be prescribed, if such class of companies is required by the Central Government to include such particulars in the books of account: Provided that all or any of the books of account aforesaid may be kept at such other place in India as the Board of directors may decide and when the Board of directors so decides, the company shall, within seven days of the decision, file with the Registrar a notice in writing giving the full address of that other place. (2) Where a company has a branch office, whether in or outside India, the company shall be deemed to have complied with the provisions of sub-section (1), if proper books of account relating to the transactions effected at the branch office are kept at that office and proper summarised returns, made up to dates at intervals of not more t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s and other employees of the company; and ** ** ** ( d )where the company has neither a managing director nor manager, every director of the company; Section 210. Annual accounts and balance sheet. (1) At every annual general meeting of a company held in pursuance of section 166, the Board of directors of the company shall lay before the company ( a )a balance sheet as at the end of the period specified in sub-section (3); and ( b )a profit and loss account for that period. (2) In the case of a company not carrying on business for profit, an income and expenditure account shall be laid before the company at its annual general meeting instead of a profit and loss account, and all references to profit and loss account , profit and loss in this section and elsewhere in this Act, shall be construed, in relation to such a company, as references respectively to the income and expenditure account , the excess of income over expenditure , and the excess of expenditure over income . (3) The profit and loss account shall relate ( a )in the case of the first annual general meeting of the company, to the period beginning with the incorp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e on Accounting Standards (hereafter in this section referred to as the Advisory Committee ) to advise the Central Government on the formulation and laying down of accounting policies and accounting standards for adoption by companies or class of companies under this Act. (2) The Advisory Committee shall consist of the following members, namely : ( a )a Chairperson who shall be a person of eminence well versed in accoun-tancy, finance, business administration, business law, economics or similar discipline; ( b )one member each nominated by the Institute of Chartered Accountants of India constituted under the Chartered Accountants Act, 1949, the Institute of Cost and Works Accountants of India constituted under the Cost and Works Accountants Act, 1959 and the Institute of Company Secretaries of India constituted under the Company Secretaries Act, 1980; ( c )one representative of the Central Government to be nominated by it; ( d )one representative of the Reserve Bank of India to be nominated by it; ( e )one representative of the Comptroller and Auditor-General of India to be nominated by him; ( f )a person who holds or has held the office of professor in accountancy ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o : Provided that nothing contained in this sub-section shall apply to any insurance or banking company or any company engaged in the generation or supply of electricity, or to any other class of company for which a form of profit and loss account has been specified in or under the Act governing such class of company. (3) The Central Government may, by notification in the Official Gazette, exempt any class of companies from compliance with any of the requirements in Schedule VI if, in its opinion, it is necessary to grant the exemption in the public interest. Any such exemption may be granted either unconditionally or subject to such conditions as may be specified in the notification. (3A) Every profit and loss account and balance sheet of the company shall comply with the accounting standards. (3B) Where the profit and loss account and the balance sheet of the company do not comply with the accounting standards, such companies shall disclose in its profit and loss account and balance sheet, the following, namely :- ( a )the deviation from the accounting standards; ( b )the reasons for such deviation; and ( c )the financial effect, if any, arising due to such dev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to be given in the form of such notes or documents. (7) If any such person as is referred to in sub-section (6) of section 209 fails to take all reasonable steps to secure compliance by the company, as respects any accounts laid before the company in general meeting, with the provisions of this section and with the other requirements of this Act as to the matters to be stated in the accounts, he shall, in respect of each offence, be punishable with imprisonment for a term which may extend to six months, or with fine which may extend to ten thousand rupees, or with both : Provided that in any proceedings against a person in respect of an offence under this section, it shall be a defence to prove that a competent and reliable person was charged with the duty of seeing that the provisions of this section and the other requirements aforesaid were complied with and was in a position to discharge that duty : Provided further that no person shall be sentenced to imprisonment for any such offence, unless it was committed wilfully. (8) If any person, not being a person referred to in sub-section (6) of section 209, having been charged by the managing director or manager, or Board o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ildings, ( d ) leaseholds, ( e ) railway sidings, ( f ) plant and machinery, ( g ) furniture and fittings, ( h ) development of property, ( i ) patents, trade marks and designs, ( j ) live- stock and ( k ) vehicles, etc. thereto and deductions therefrom during the year, and the total depreciation written off or provided up to the end of the year to be stated. Where the original cost aforesaid and additions and deductions thereto, relate to any fixed asset which has been acquired from a country outside India, and in consequence of a change in the rate of exchange at any time after the acquisition of such asset, there has been an increase or reduction in the liability of the company, as expressed in Indian currency, for making payment towards the whole or a part of the cost of the asset or for repayment of the whole or a part of moneys borrowed by the company from any person, directly or indirectly in any foreign currency specifically for the purpose of acquiring the asset (being in either case the liability existing immediately before Instructions in accordance w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... said sub-section shall, as far as may be, apply in relation to the said paragraph as they apply to the said sub-section (1). In every case where the original cost cannot be ascertained, without unreasonable expense or delay, the valuation shown by the books shall be given. For the purposes of this paragraph, such valuation shall be the net amount at which an asset stood in the company s books at the commencement of this Act after deduction of the amounts previously provided or written off for depreciation or diminution in value, and where any such asset is sold, the amount of sale proceeds shall be shown as deduction.] +Particulars of any option on un-issued share capital to be specified. +Issued (distinguis- hing between the various classes of capital and stating the particulars specified Where sums have been written off on a reduction of capital or a revaluation of assets, every balance sheet, (after the first balance sheet) subsequent to the reduction or Instructions in accordance with which liabilities should be made out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... +Specify the soure from which bonus shares are issued, e.g., capitalisation of profits or Reserves or from Share Premium Account. Of the above shares... shares are allotted as fully paid- up by way of bonus shares+ +Any capital profit on re-issue of forfeited shares should be transferred to Capital Reserve. Less : calls unpaid : 1 [( i ) By managing agent or secretaries and treasurers and where the managing agent or secretaries and treasurers are a firm, by the partners thereof, and where the managing agent or secretaries and treasurers are a private company by Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. ( b ) Figur- es for the curre- nt year Rs. ( b ) Figures for the previous year Rs. ( b ) Figu- res for the curr- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Less: Debit balance in profit and loss account (if any) ( h ). (4) Investments in the Capital of partnership firms. (5) Surplus i.e., balance in profit and loss account after providing for proposed allocations, namely: (5) Balance of unutilised monies raised by issue. Dividend, Bonus or Reserves. (6) Proposed additions to Reserves. (7) Sinking Funds.] Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. ( b ) Figur- es for the curre- nt year Rs. ( b ) Figures for the previous year Rs. ( b ) Figu- res for the curr- ent year Rs. ( b ) SECURED LOANS: CURRENT ASSETS, LOANS AND ADVANCES: Loans from Directors, Man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Debts due from other companies under the same management within the meaning of sub-section (1B) of section 370, to be disclosed with the names of the Companies. ++(5) Works-in- Progress. The maximum amount due by directors or other officers of the company at any time during the year to be shown by way of a note. @(6) Sundry debtors The provisions to be shown under this head should not exceed the amounts of debts stated to be considered doubtful or bad and any surplus of such provision if already created, should be shown at every closing under Reserves and Surplus (in the liabilities side) under a separate sub-head Reserve for doubtful or bad debts . ( a ) Debts outstanding for a period exceeding six months. In regard to bank balances, particulars to be given separately of ( b ) Other debts. ( a ) the balances lying with Scheduled Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (11) [***] (12) balances with customs, port trust, etc., (where payable on de-mand). UNSECURED LOANS: MISCELLANEOUS EXPENDITURE (to the extent not written off or adjusted): +Loans from directors, manager should be shown separately. Interest accrued ant due on Unsecured Loans should be included under the appropriate sub-heads under the head Unsecured Loans .] (1) Fixed Deposits. (1) Preliminary expenses. +Where loans have been +(2) Loans and (2) Expenses including Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. ( b ) Figur- es for the curre- nt year Rs. ( b ) Figures for the previous year Rs. ( b ) Figu- res for the curr- ent year Rs. ( b ) gua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on for which value has still to be given e.g., in the case of the following classes of companies: Newspaper, Fire Insurance, Theatres, Clubs, Banking, Steamship Companies, etc. Instructions in accordance with which liabilities should be made out Liabilities Assets Instructions in accordance with which assets should be made out Figures for the previous year Rs. ( b ) Figur- es for the curre- nt year Rs. ( b ) Figures for the previous year Rs. ( b ) Figu- res for the curr- ent year Rs. ( b ) (5) Un-claimed Dividends. (6) Other Liabilities (if any). (7) Interest accrued but not due on loans. B. PROVI-SIONS (8) Provisions for taxation. (9) Proposed dividends. (10) For contingen-cies. (11) For provident fund scheme. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion to Rupees, if desired. ( c )In the case of subsidiary companies the number of shares held by the holding company as well as by the ultimate holding company and its subsidiaries must be separately stated.The auditor is not required to certify the correctness of such shareholdings as certified by the management. ( cc )The item "Share Premium Account" shall include details of its utilisation in the manner provided in section 78 in the year of utilisation. ( d )Short Term Loans will include those which are due for not more than one year as at the date of the balance-sheet. ( e )Depreciation written off or provided shall be allocated under the different asset heads and deducted in arriving at the value of fixed assets. ( f )Dividends declared by subsidiary companies after the date of the balance sheet should not be included] unless they are in respect of period which closed on or before the date of the balance sheet. ( g )Any reference to benefits expected from contracts to the extent not executed shall not be made in the balance sheet but shall be made in the Board s report. [( h )The debit balance in the profit and loss Account shall be shown as a deduction from ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the balance sheet shall be also given in the balance sheet. The requirement in this behalf shall, in the case of companies preparing quarterly or half-yearly accounts, etc., relate to the balance sheet for the corresponding date in the previous year. ( o )The amounts to be shown under Sundry Debtors shall include the amounts due in respect of goods sold or services rendered or in respect of other contractual obligations but shall not include the amounts which are in the nature of loans or advances. ( p )Current accounts with directors, and Manager, whether they are in credit or debit, shall be shown separately ( q )A small scale industrial undertaking has the same meaning as assigned to it under clause ( j ) of section 3 of the Industries (Development and Regulation) Act, 1951. B. VERTICAL FORM Name of the Company...................... Balance Sheet as at ..................... Schedule No. Figures as at the end of current financial year Figures as at the end of previous financial year 1 2 3 4 5 I. Sources of funds: (1)Shareholder s funds ( a )Ca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ( a )The turnover, that is, the aggregate amount for which sales are effected by the company, giving the amount of sales in respect of each class of goods dealt with by the company, and indicating the quantities of such sales for each class separately. ( b )Commission paid to sole-selling agents within the meaning of section 294 of the Act. ( c )Commission paid to other selling agents. ( d )Brokerage and discount on sales, other than the usual trade discount. ( ii )( a )In the case of manufacturing companies, (1)The value of the raw materials consumed, giving item-wise break-up and indicating the quantities thereof. In this break-up, as far as possible, all important basic raw materials shall be shown as separate items. The intermediates or components procured from other manufacturers may, if their list is too large to be included in the break-up, be grouped under suitable headings without mentioning the quantities, provided all those items which in value individually account for 10 per cent or more of the total value of the raw material consumed shall be shown as separate and distinct items with quantities thereof in the break-up. (2)The opening and closing stoc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... unting period. ( iv )The amount provided for depreciation, renewals or diminution in value of fixed assets. If such provision is not made by means of a depreciation charge, the method adopted for making such provision. If no provision is made for depreciation, the fact that no provision has been made shall be stated and the quantum of arrears of depreciation computed in accordance with section 205(2) of the Act shall be disclosed by way of a note. ( v )The amount of interest on the company s debentures and other fixed loans, that is to say, loans for fixed periods, stating separately the amount of interest, if any, paid or payable to the managing director and the manager, if any. ( vi )The amount of charge for Indian income-tax and other Indian taxation on profits, including, where practicable, with Indian income-tax any taxation imposed elsewhere to the extent of the relief, if any, from Indian income-tax and distinguishing, where practicable, between income-tax and other taxa-tion. ( vii )The amounts reserved for ( a )repayment of share capital; and ( b )repayment of loans. ( viii )( a )The aggregate, if material, of any amounts set aside or proposed to be se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stances of an exceptional or non-recurring nature, if material in amount. ( c )Miscellaneous income. ( xiii )( a )Dividends from subsidiary companies. ( b )Provisions for losses of subsidiary companies. ( xiv )The aggregate amount of the dividends paid, and proposed, and stating whether such amounts are subject to deduction of income-tax or not. ( xv )Amount, if material, by which any items shown in the profit and loss account are affected by any change in the basis of accounting. 4. The profit and loss account shall also contain or give by way of a note detailed information, showing separately the following payments provided or made during the financial year to the directors (including managing directors), or manager, if any, by the company, the subsidiaries of the company and any other person : ( i )managerial remuneration under section 198 of the Act paid or payable during the financial year to the directors (including managing directors), manager, if any; ( ii ) to ( iv )** ** ** ( vi )other allowances and commission including guarantee commission (details to be given); ( vii )any other perquisites or benefits in cash ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of imports calculated on CIF basis by the company during the financial year in respect of : ( i )raw materials; ( ii )components and spare parts; ( iii )capital goods; ( b )expenditure in foreign currency during the financial year on account of royalty, know-how, professional, consultation fees, interest, and other matters; ( c )value of all imported raw materials, spare parts and components consumed during the financial year and the value of all indigenous raw materials, spare parts and components similarly consumed and the percentage of each to the total consumption; ( d )the amount remitted during the year in foreign currencies on account of dividends, with a specific mention of the number of non-resident shareholders, the number of shares held by them on which the dividends related; ( e )earnings in foreign exchange classified under the following heads, namely: ( i )export of goods calculated on FOB basis; ( ii )royalty, know-how, professional and consultation fees; ( iii )interest and dividend; ( iv )other income, indicating the nature thereof. 5. The Central Government may direct that a company shall not be obliged to show the amount set aside ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been allotted for cash, whether cash has actually been received in respect of such allotment, and if no cash has actually been so received, whether the position as stated in the account books and the balance-sheet is correct, regular and not misleading. (2) The auditor shall make a report to the members of the company on the accounts examined by him, and on every balance-sheet and profit and loss account and on every other document declared by this Act to be part of or annexed to the balance-sheet or profit and loss account which are laid before the company in general meeting during his tenure of office, and the report shall state whether, in his opinion and to the best of his information and according to the explanations given to him, the said accounts give the information required by this Act in the manner so required and give a true and fair view ( i )in the case of the balance-sheet, of the state of the company s affairs as at the end of its financial years; and ( ii )in the case of the profit and loss account, of the profit or loss for its financial year. (3) The auditor s report shall also state ( a )whether he has obtained all the information and explanations ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aving been, and the auditors report shall not state that those accounts have not been properly drawn up on the ground merely that the company had not disclosed certain matters if ( a )those matters are such as the company is not required to disclose by virtue of any provisions contained in this or any other Act, and ( b )those provisions are specified in the balance-sheet and profit and loss account of the company." [Emphasis supplied] " SCHEDULES, FORMS AND RULES Section 641. Power to alter Schedules. (1) Subject to the provisions of this section, the Central Government may, by notification in the Official Gazette, alter any of the regulations, rules, tables, forms and other provisions contained in any of the Schedules to this Act, except Schedules XI and XII. (2) Any alteration notified under sub-section (1) shall have effect as if enacted in this Act and shall come into force on the date of the notification, unless the notification otherwise directs : Provided that no such alteration in Table A of Schedule I shall apply to any company registered before the date of such alteration. (3) Every alteration made by the Central Government under sub-section (1) shal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f thirty days which may be comprised in one session or in two or more successive sessions, and if, before the expiry of the session immediately following the session or the successive sessions aforesaid, both Houses agree in making any modification in the regulation or both Houses agree that the regulation should not be made, the regulation shall thereafter have effect only in such modified form or be of no effect, as the case may be; so however, that any such modification or annulment shall be without prejudice to the validity of anything previously done under that regulation." 12. Analysing the above provisions of the Companies Act the position is that at every AGM of a company the Board of Directors is required to place before it a balance-sheet and a P L account for the financial year. Section 210 of the Companies Act requires a company to place before AGM, a balance-sheet and a P L account for the relevant period. The function of a balance-sheet is to show the share capital, reserves and liabilities of the company at the date on which it is prepared and the manner in which the total moneys representing them are distributed over several types of assets. A balance-sheet is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in the preparation of P L account and balance-sheet. By virtue of the said amendment, Accounting Standards are required to be prescribed by the Central Government in consultation with the NAC established under section 210A. Until the NAC is established and Accounting Standards are prescribed by the Central Government, the Accounting Standards specified by the Institute shall be followed by all the companies. In the present case, the NAC has been established. In the present case, by the impugned notification dated 7-12-2006, the Accounting Standards have been prescribed by the Central Government. In the present case, by the impugned notification, AS 22 earlier specified by the Institute has been adopted by the Central Government in the form of a Rule. Therefore, vide the impugned notification, AS 22 stands prescribed by the Central Government in consultation with NAC which has been established under section 210A of the Companies Act. It is made clear that the Accounting Standards prescribed by the Central Government in consultation with NAC need not be identical with the Accounting Standards specified by the Institute. In the present case, the impugned notification indicates that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uld disclose arithmetically accuracy. Adherence to the disclosure requirements as per Schedule VI is subservient to the overriding requirement of true and fair view as regards the state of affairs. Therefore, the annual financial statements should convey an overall fair view and should not give any misleading information or impression. All the relevant information should be disclosed in the balance-sheet and the P L account in such a manner that the financial position and the working results are shown as they are. There should be neither an overstatement nor an understatement. Further, the information to be disclosed should be in consonance with the fundamental accounting assumptions and commonly accepted accounting policies. Therefore, failure to make provision for taxation would not disclose true and fair view of the state of affairs. Non-compliance for taxation would, therefore, amount to contravention of sections 209 and 211 of the Companies Act. Accordingly, it is necessary for the auditor to qualify in his report, and such qualification should bring out in what manner the accounts do not disclose a true and fair view of the state of affairs of the company as well as the pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Government and to carry out the purposes of the Companies Act. Therefore, section 641 and section 642 form part of the same scheme. Under section 642, the Central Government exercises power of delegated legislation by prescribing rules. Under various provisions of the Act, Rules are to be prescribed. Rules can also be prescribed vide clause ( b ) to section 642(1) to carry out the purposes of the Act. 20. In exercise of the powers conferred by clause ( a ) to sub-section (1) of section 642 of the Companies Act read with sub-section (3C) of section 211 and section 210A(1), the Central Government in consultation with NAC on Accounting Standards has made the following Rules vide the impugned notification dated 7-12-2006. The said Rules are called as the Companies (Accounting Standards) Rules, 2006. We quote hereinbelow the said impugned notification in entirety together with annexures : "Ministry of Company Affairs NOTIFICATION New Delhi, 7th December, 2006 ACCOUNTING STANDARDS GSR 739 (E). In exercise of the powers conferred by clause ( a ) of sub-section (1) of section 642 of the Companies Act, 1956 (1 of 1956), read with sub-section (3C) of section 211 and sub-s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... blication of these Accounting Standards. 1. Obligation to comply with the Accounting Standards. (1) Every company and its auditor(s) shall comply with the Accounting Standards in the manner specified in Annexure to these rules. (2) The Accounting Standards shall be applied in the preparation of General Purpose Financial Statements. 2. An existing company, which was previously not a Small and Medium Sized Company (SMC) and subsequently becomes an SMC, shall not be qualified for exemption or relaxation in respect of Accounting Standards available to an SMC until the company remains an SMC for two consecutive accounting periods. [No. 1/3/2006/CL-V] Jitesh Khosla, Jt. Secy. ANNEXURE ( See rule 3) ACCOUNTING STANDARDS 1. General Instructions. SMCs shall follow the following instructions while complying with Accounting Standards under these rules : 1.1the SMC which does not disclose certain information pursuant to the exemptions or relaxations given to it shall disclose (by way of a note to its financial statements) the fact that it is an SMC and has complied with the Accounting Standards insofar as they are applicable to an SMC on the following lines : "The Com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd in accordance with these General Instructions. ACCOUNTING STANDARD (AS) 22 Accounting for Taxes on Income. (This Accounting Standard includes paragraphs set in bold italic type and plain type, which have equal authority. Paragraphs in bold italic type indicate the main principles. This Accounting Standard should be read in the context of its objective and the General Instructions contained in part A of the Annexure to the Notification.) Objective. The objective of this Standard is to prescribe accounting treatment for taxes on income. Taxes on income is one of the significant items in the statement of profit and loss of an enterprise. In accordance with the matching concept, taxes on income are accrued in the same period as the revenue and expenses to which they relate. Matching of such taxes against revenue for a period poses special problems arising from the fact that in a number of cases, taxable income may be significantly different from the accounting income. This divergence between taxable income and accounting income arises due to two main reasons. Firstly, there are differences between items of revenue and expenses as appearing in the statement of profit and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nces between taxable income and accounting income can be classified into permanent differences and timing differences. Permanent differences are those differences between taxable income and accounting income which originate in one period and do not reverse subsequently. For instance, if for the purpose of computing taxable income, the tax laws allow only a part of an item of expenditure, the disallowed amount would result in a permanent difference. 7. Timing differences are those differences between taxable income and accounting income for a period that originate in one period and are capable of reversal in one or more subsequent periods. Timing differences arise because the period in which some items of revenue and expenses are included in taxable income do not coincide with the period in which such items of revenue and expenses are included or considered in arriving at accounting income. For example, machinery purchased for scientific research related to business is fully allowed as deduction in the first year for tax purposes whereas the same would be charged to the statement of profit and loss as depreciation over its useful life. The total depreciation charged on the machine ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... deferred tax assets as set out in paragraphs 15-18. Explanation ( a )The deferred tax in respect of timing differences which reverse during the tax holiday period is not recognised to the extent the enterprises gross total income is subject to the deduction during the tax holiday period as per the requirements of sections 80-IA/80-IB of the Income-tax Act, 1961 (hereinafter referred to as the Act ). In case of sections 10A/10B of the Act (covered under Chapter III of the Act dealing with incomes which do not form part of total income), the deferred tax in respect of timing differences which reverse during the tax holiday period is not recognised to the extent deduction from the total income of an enterprise is allowed during the tax holiday period as per the provisions of the said sections. ( b )Deferred tax in respect of timing differences which reverse after the tax holiday period is recognised in the year in which the timing differences originate. However, recognition of deferred tax assets is subject to the consideration of prudence as laid down in paragraphs 15 to 18. ( c )For the above purposes, the timing differences which originate first are considered to rev ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... .g., to a credit agency for obtaining loans and accepted by that agency cannot, in isolation, be considered as convincing evidence. (2)( a ) As per the relevant provisions of the Income-tax Act, 1961 (hereinafter referred to as the Act ), the loss arising under the head Capital gains can be carried forward and set-off in future years, only against the income arising under that head as per the requirements of the Act. ( b ) Where an enterprise s statement of profit and loss includes an item of loss which can be set-off in future for taxation purposes, only against the income arising under the head Capital gains as per the requirements of the Act, that item is a timing difference to the extent it is not set-off in the current year and is allowed to be set-off against the income arising under the head Capital gains in subsequent years subject to the provisions of the Act. In respect of such loss , deferred tax asset is recognised and carried forward subject to the consideration of prudence. Accordingly, in respect of such loss , deferred tax asset is recognised and carried forward only to the extent that there is a virtual certainty, supported by convincing evidence, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the enterprise will be able to generate sufficient taxable income in the future. 20. Measurement. Current tax should be measured at the amount expected to be paid to (recovered from) the taxation authorities, using the applicable tax rates and tax laws. 21. Deferred tax assets and liabilities should be measured using the tax rates and tax laws that have been enacted or substantively enacted by the balance sheet date. Explanation ( a )The payment of tax under section 115JB of the Income-tax Act, 1961 (hereinafter referred to as the Act ) is a current tax for the period. ( b )In a period in which a company pays tax under section 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising during the period, tax effect of which is required to be recognised under this Standard, is measured using the regular tax rates and not the tax rate under section 115JB of the Act. ( c )In case an enterprise expects that the timing differences arising in the current period would reverse in a period in which it may pay tax under section 115JB of the Act, the deferred tax assets and liabilities in respect of timing differences arising du ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nd liability representing current tax when they relate to income taxes levied under the same governing taxation laws and the taxation laws permit the enterprise to make or receive a single net payment. 29. An enterprise should offset deferred tax assets and deferred tax liabilities if : ( a )the enterprise has a legally enforceable right to set off assets against liabilities representing current tax; and ( b )the deferred tax assets and the deferred tax liabilities relate to taxes on income levied by the same governing taxation laws. 30. Deferred tax assets and liabilities should be distinguished from assets and liabilities representing current tax for the period. Deferred tax assets and liabilities should be disclosed under a separate heading in the balance sheet of the enterprise, separately from current assets and current liabilities. Explanation. Deferred tax assets (net of the deferred tax liabilities, if any, in accordance with paragraph 29) is disclosed on the face of the balance sheet separately after the head Investments and deferred tax liabilities (net of the deferred tax assets, if any, in accordance with paragraph 29) is disclosed on the face of the bal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esenting that expenditure would have a balance only for tax purposes but not for accounting purposes. The difference between balance of the asset for tax purposes and the balance (which is nil ) for accounting purposes would be a timing difference which will reverse in future when this expenditure would be allowed for tax purposes. Therefore, a deferred tax asset would be recognised in respect of this difference subject to the consideration of prudence ( see paragraphs 15 - 18)." Submissions 21. Dr. D. Pal, learned senior counsel appearing on behalf of M/s. Simplex Infrastructures Ltd. submitted that under para 9 of AS 22 tax expense for the period, comprising current tax and deferred tax, is now required to be included in the determination of net profit (loss) for that period. That, deferred tax is now defined under the said AS 22 to mean the tax effect of timing differences. Timing difference in turn is defined to mean the difference between the taxable income and the accounting income for a period that originates in one period and is capable of reversal in one or more subsequent periods. Therefore, DTL along with Current Tax Liability (CTL) are now required to be inclu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ise of power under section 642 of the Companies Act. Therefore, Accounting Standard has been prescribed by the rules framed under that section. The rules so framed are placed before the Parliament. However, section 642(1) has not the effect as if it is enacted in the Act. That, on the other hand, under section 641(1) the Central Government has been given the power to alter any of the existing regulations, rules, tables or forms or any of the schedules to the Act including Schedule VI. Therefore, any alteration notified in section 641(1) has the effect as if enacted in the Act and shall come into force on the date of the notification unless the notification otherwise directs. These rules are also required to be placed before the Parliament. Therefore, Schedule VI can be amended or altered by a notification issued under section 641(1) of the Companies Act. If Schedule VI is not altered or amended in exercise of power under section 641(1) of the said Act, then, Schedule VI being part of the Act, the rule adopting the AS under section 642(1) of the Act cannot modify or amend the provisions of Schedule VI to the Companies Act. In this connection, learned counsel urged that AS 22 has now ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... AS 22 under section 642(1) is not only contrary to and inconsistent with section 209 but also with Schedule VI to the Companies Act insofar as it requires the DTL to be included in the determination of net profit (loss) for the current year. That, it is in excess of the provisions of section 209 and Schedule VI to the Companies Act. According to the learned counsel, if the accounts are to be maintained on accrual basis, DTL cannot be considered as an accrued liability. That, the requirements of giving true and fair view can be made only on accrual basis and on double entry system of accounting. However, if DTL is a notional and contingent liability, it cannot be charged to the P L account. It can only be disclosed by way of a Note in the balance-sheet and P L account which will give a true and fair view of the state of affairs of the company. 25. Lastly, learned counsel submitted that clause 33 of AS 22 gives a retrospective effect to the transactions which have taken place much earlier and in respect of which the DTL is to be calculated as if the said AS 22 has been in effect from the beginning and the entire amount of such DTL is now required to be provided for in the openin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pecific revenues as having been used in generating those specific revenues or by matching expenses against the revenues of a given period in general on the basis that the expenditure pertains to that period. The former is termed as "matching principle on revenue basis" and the latter is termed as "matching principle on time basis". According to learned counsel, the said principle applies only where the assessee has a choice of debiting or crediting expenditure or income in a particular financial year (time basis) or for correlating a particular expenditure against particular revenue (revenue basis). That, matching principle cannot be extrapolated to divergent results that arise under two statutes and, therefore, Accounting Profits and Taxable Profits computed under the Companies Act and the Income-tax Act respectively cannot be reconciled by applying the matching principle or on the basis of effect of Time Differences. In this connection, learned counsel pointed out that in India the timing difference arises mainly because different rates of depreciation are statutorily prescribed by Schedule XIV to the Companies Act and by Rule 5, Appendix-I to the Income-tax Rules. It is submitte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ount as not disclosing the true and fair view. 29. On the question of effect of AS 22, learned counsel urged that the effect of implementation of AS 22 would result in drastic reduction in profits of a company. In this connection, learned counsel urged that AS 22 provides for TOI. That, the difference between accounting profit (profit under the Companies Act after providing for depreciation and taxation) and the taxable profit (profit as per Income-tax Act) are to be multiplied by the rate of income-tax. This amount has to be reduced/deducted from the accounting profit. Therefore, the formula would be read as under : (AP-TP) rate of Income-tax = DTL In other words, if the accounting profit is Rs. 50 crores and the taxable profit is Rs. 30 crores and the rate of income-tax is 30 per cent then DTL will be Rs. 6 crores (50 - 30 30/100). 30. Similarly, (loss/unabsorbed depreciation) rate of income-tax is = DTA. If a company has a loss and carry forward depreciation of Rs. 40 crores and the rate of income-tax is 30 per cent then DTA will be: 40 30/100 = Rs. 12 crores In such a case the loss of Rs. 40 crores will be reduced to Rs. 28 crores (40 - 12). Relying up ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cannot be utilized if the company runs into financial difficulty. 31. According to learned counsel, under para 33 of AS 22 companies are required to rework the entire liability from the beginning of the existing assets. For example, in the case of Indian Railway Finance Corporation Ltd., provision is required to be made in respect DTL of Rs. 940.55 crores. The transitional provision took place for the year ended 2001-02. The said provision of Rs. 940.55 crores has diminished Bond Redemption Reserve. Similarly, according to learned counsel, in the case of M/s. First Leasing Company of India Ltd., application of para 33, as transitional provision, has resulted in DTL of Rs. 62 crores. 32. On the question of legal status of AS 22, learned counsel submitted that the said Standard is a subordinate legislation and, therefore, it cannot create a tax liability. DTL is neither a liability nor a tax. It is not a deferral. That, the levy of tax can either be by the Central Government or State Government under List I or List II of Schedule VII to the Constitution. That, under Article 366(28), taxation includes imposition of any tax or impost. Under Article 265, taxes can be levied only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and fair view can be easily achieved by making AS 22 a disclosure requirement as Notes to the Accounts, rather than inserting it in Schedule VI, Parts I and II to the Companies Act. 34. Mr. S.K. Bagaria, learned counsel appearing on behalf of J.K. Tyre Industries Ltd. (formerly known as "J.K. Industries Ltd."), submitted that AS 22 requires charging the P L account for an assumed liability on account of deferred tax which is not payable according to the provisions of Income-tax Act for the accounting period nor does it represent any tax which would become payable in future. That, AS 22 requires provision to be made for alleged tax liabilities and recognition of alleged tax assets which are not at all accrued liabilities or assets. According to learned counsel, AS 22 requires provision for assumed tax liabilities and recognition of assumed tax assets which are in reality non-existent, commercially or under the law. According to the learned counsel, notional and imaginary working is required to be made for AS 22; that, deferred tax is neither an asset nor a liability; that, the accrual basis of accounting requires a provision to be made for a known liability existing on the bal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le income, for example, on account of depreciation, may or may not have any impact on the computation of the total income of a future year or it may or may not entail any tax liability. Therefore, it cannot be said with certainty that deferred tax in respect of an individual transaction of the accounting period would result in any cash outflow on account of tax in a future year. According to learned counsel, AS 22 has been framed on the fundamental accounting assumption of "going concern". However, it is one thing to assume that business would go on and quite another to assume that it will produce profits. If there is no taxable income in future, the tax effect of the transactions of the accounting period will not translate into any actual liability or cash outflow. According to learned counsel, AS 22 assumes that there would be sufficient taxable income in future entailing tax liability in future and that the tax effect of the transactions in the accounting period would have a role to play in the determination of future taxable income and liability. According to learned counsel, the above is also an assumption. According to learned counsel, the accrued liability for tax is the lia ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... last date of the accounting year and that if anything is provided in excess of such tax liability, it will not be a provision but it will be a reserve ( See : the judgment of this Court in Metal Box Co. of India Ltd. v. Their Workmen AIR 1969 SC 612). Therefore, according to learned counsel, if the Income-tax Act does not create any liability for tax, there is no liability for tax either in fact or in law. Learned counsel, however, invited our attention to the difference between contractual liability in case of cars sold with warranties and tax liabilities which, according to learned counsel, stand on a totally different footing as it is to be determined in accordance with the principles laid down in various judgments of this Court under the Income-tax Act. 36. Learned counsel next contended that under section 209(3)( b ) of the Companies Act read with section 209(1), income and expenditure and assets and liabilities should be accounted for in the books of account on "accrual basis and according to the double entry system of accounting"; that, the concept of accrual in section 209(3)( b ) is required to be understood in the same manner as it is required to be understood ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rding to the provisions of the Income-tax Act. It is not any assumed future taxation dependent upon any assumed future working of the company. The object of incurring expenses is to produce revenue. In measuring the income for a period, revenue is to be adjusted against expenses incurred for producing that revenue. This concept of adjusting/offsetting the expenses against revenue is the matching principle. This concept is fully satisfied when provision for taxation is made for tax liability in accordance with the provisions of the Income-tax Act and it is such tax alone which is the tax liability incurred on the income earned during the period concerned. 38. As regards the question of the functional utility of Accounting Stan-dards under section 211(3A), (3B) and (3C) is concerned, learned counsel submitted that section 209 provides that every company keeping proper books of account with respect to moneys received and expended and the matters in respect of which the receipt and expenditure takes place as well as the assets and liabilities of the company. According to learned counsel, therefore, section 209(1) recognizes the receipt and expenditure as well as assets and liabilit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic primary records from which the P L account and balance-sheet are prepared and since P L account and balance-sheet are not books of account but only abstracts. 39. AS 22 relating to deferred tax is directly in conflict with section 209 of the Companies Act and in excess of the powers vested under sub-sections (3A), (3B) and (3C) of section 211. In this connection, learned counsel submitted that the power conferred upon the Central Government under sub-section (3C) of section 211 for prescribing Accounting Standards by framing of rules is in the nature of delegated legislation; that under the scheme of sub-sections (3A), (3B) and (3C) of section 211, Accounting Standards can be prescribed only in relation to P L account and balance-sheet; that a delegatee of power cannot assume jurisdiction in areas or over subjects which are not delegated; that the power being limited to prescribing Accounting Standards for P L account and balance-sheet, cannot be exercised in relation to maintenance of books of account and that too on a basis different from accrual basis mandated in section 209 and any such exercise of power by prescribing any Accounting Standard affecting the maintenance of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ). Therefore, AS 22 prescribes Accounting Standards only for P L account and balance-sheet without directing that exercise to be made in respect of preparation and maintenance and proper books of account on accrual basis and, therefore, AS 22 brings about inconsistency between the provisions of section 209(3) on one hand and sub-sections (3A), (3B) and (3C) of section 211. According to learned counsel, section 217(2AA)( i ) merely relates to "preparation of annual accounts"; it does not deal at all with preparation and maintenance of books of account; that annual accounts are not books of account ( See : section 210) and, therefore, the said section 217(2AA)( i ) has nothing to do with preparation and maintenance of proper books of account which subject is independently dealt with in section 209. According to learned counsel, the provisions of AS 22 insofar as it requires making of entries in the books of account reducing the profit by accounting for DTL or increasing the profit by accounting for DTA and to reflect such entries in the P L account and balance-sheet, are ultra vires sub-sections (3A), (3B) and (3C) of section 211 and section 209 of the Companies Act. That, by AS 2 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... L account and balance-sheet shall be in consonance with the books of account. Therefore, sub-sections (3A), (3B) and (3C) can only relate to presentation of and disclosures in P L account and balance-sheet, keeping intact the statutory mandate of maintaining proper books of account on accrual basis. Therefore, if the format of a balance-sheet or the requirements of P L account is allowed to be altered by any Accounting Standards it would amount to encroachment upon the statutory mandate of keeping proper books of account on accrual basis. Therefore, according to learned counsel, Accounting Standards can provide in relation to presentation of and disclosures in P L account and balance-sheet without touching upon the basic requirement of maintaining proper books of account on accrual basis and only thereby one can comply with the concept of true and fair view . Any other interpretation would mean that AS 22 far exceeds the power conferred by sub-sections (3A), (3B) and (3C) of section 211 and it would amount to creating inconsistencies between various sections of the Companies Act. 41. Learned counsel next contended that accrual basis of accounting does not recognize DTA o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e reserve has to be reduced and conversely in case of a DTA, the revenue reserve has to be increased. This is, according to learned counsel, indicates that para 33 which is termed as transitional provision is clearly retrospective in its operation. Therefore, according to learned counsel, para 33 of AS 22 would result in reduction of the company s revenue reserves. It will erode the company s net worth. It will alter the company s debt-equity ratio. It will adversely effect the company s borrowing capacity. Therefore, according to learned counsel, the High Court had erred in dismissing the writ petitions filed by the appellants. According to learned counsel, section 211(3C) does not enable the Central Government to give any retrospective operation to the Accounting Standards. The rule-making power under section 642 of the Companies Act also does not permit the making of any rules with retrospective effect and, therefore, according to learned counsel, para 33 deserves to be set aside. For the above reasons, learned counsel submitted that AS 22 far exceeds the power and jurisdiction conferred by sub-sections (3A), (3B) and (3C) of section 211 and that it brings about inconsistencie ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing to learned counsel, when any provision made is subject to other provisions of that section, then the said provision (Part I of Schedule VI) has to give way the other provisions [AS-22 as provided by section 221(3A)]. In this connection, reliance is placed on the judgment of this Court in the case of South India Corpn. (P.) Ltd. v. Board of Revenue, Trivandrum AIR 1964 SC 207 at p. 215, in which this Court has held that the expression subject to conveys the idea of a provision yielding place to another provision or other provision(s) to which it is subject to. Reliance was also placed by the learned counsel on the judgment of this Court in the cases : State of Bihar v. Sir Kameshwan Singh AIR 1952 SC 252; K.R.C.S. Balakrishna Chetty Sons Co. v. State of Madras AIR 1961 SC 1152; and Heggade Janardhan Subbaraya v. State of Mysore AIR 1963 SC 702. In the alternative, learned counsel submitted that in any event section 641 empowers the Central Government to amend Schedule VI whereas section 642 confers powers on the Central Government to formulate rules. That, Part I of Schedule VI prescribes the form in which the balance-sheet and P L account is requ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is Court in the cases : Gadde Venkateswara Rao v. Government of Andhra Pradesh AIR 1966 SC 828; State of Bihar v. Dr. Yogendra Singh GOL [1982] 1 SCC 664; Maharashtra State Board of Secondary and Higher Secondary Education v. Paritosh Bhupeshkumar Sheth [1984] 4 SCC 27; State of Gujarat v. Patel Ramjibhai Danabhai [1979] 3 SCC 347. 44. In view of the aforestated submissions learned counsel submitted that AS 22 is intra vires the Companies Act and, therefore, the appeals deserve to be dismissed with costs. 45. Mr. N.K. Poddar, learned senior counsel appearing for the Institute, submitted that corporate accounts are required to disclose a true and fair view . It is a requirement. That requirement has to be ensured by the auditors who have to certify that the accounts are prepared so as to provide true and fair view of the state of affairs of the company. This responsibility is undertaken by accountants and auditors who are mem-bers of the Institute. If Accounting Standards are not followed, financial accounts would not be true and fair and in that case, the statutory requirement in section 211 for preparing true and fair accounts would not be sa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... requirements or even to depart from compliance with one or the other requirements. Any departure has to be disclosed in a Note to the Financial Statements giving reasons for such departure and its effects. Moreover, the concept of true and fair is not static. It is dynamic in nature. It continues to evolve in accordance with the changes in the requirements of economy. 46. It is the function of the Institute to regulate the profession of Chartered Accountants. By formulating Accounting Standards, Institute is fulfilling its statutory function. It is furthering Legislative intent of Parliament, which requires that accounts should be true and fair . Therefore, by laying down Accounting Standards, which explains what is true and fair , the Institute is merely fulfilling its statutory duty and function. 47. Learned counsel submitted that conceptually, the justification for Accounting Standards lies in the compelling logic and conceptual validity of each Standard. Those who prepare Accounting Standards are not framing the Standards without any basis. The framers review accounting policies already adopted and select those policies which are most appropriate in the presentatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... m of accounting and vis-a-vis the matching principle it is necessary to refer to the concepts that underline the preparation and presentation of such statements. The main purpose of Accounting Standards is, therefore, to assist the Accountants to prepare financial statements and to deal with topics that have yet to form the subject of an Accounting Standard. The entire object is to promote harmonization of Regulations, Accounting Standards and Procedures relating to the preparation of financial statements by providing a basis for reducing a number of alternative accounting treatments permitted by Accounting Standards. According to learned counsel, accrual basis , going concern and consistency are underlying assumptions in preparation of financial statements. Prudence is important in the prepa- ration of financial statements. It is a degree of caution in the exercise of judgments needed in making the estimates required under conditions of uncertainty so that assets or income are not overstated and liabilities or expenses are not understated. That, the principles to be followed in the recognition of assets , liabilities , income and expenses require application of the ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... must read together with each other. According to learned counsel, the accrual basis of accounting must be applied so that true and fair accounts are presented. Indeed, the requirement to present a true and fair view precedes the requirement for accrual accounting. The requirement to present true and fair accounts is wider than the require- ment of accrual accounting. Therefore, in a given case it is possible that accounts prepared on accrual basis may not present true and fair view because of certain deficiencies, however, it is not possible for accounts to be true and fair unless they are prepared on accrual basis. According to learned counsel, while section 209(3)( b ) mandates the accrual basis of accounting, it does not indicate the amount which should be recognized (accrued) in respect of specific matters. This is left to the judgment of the Accountant. According to learned counsel, accrual basis is a fundamental accounting assumption which means that all Accounting Standards including AS 22 are framed on the basis of accrual system of accounting and, therefore, the question of conflict of an Accounting Standard with the accrual basis of accounting does not arise. That, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cept of prudence , learned counsel submitted that when financial statements are prepared, sometimes, the accountant comes across uncertainties that surround many events and in such case caution in exercise of the judgments is required while making estimates, so that assets or income are not overstated and liabilities or expenses are not understated. This is the principle of prudence. The said principle applies in view of uncertainties attached to future events. Profits are not anticipated, but they are recognized only when they are realized. Similarly, provision is made for all known liabilities and losses, even though the amount cannot be determined with certainty and, therefore, provision represents only an estimate in the light of available information. The principle of prudence has also been recognized in the Accounting Standard issued by the Central Government under section 145(2) of the Income-tax Act through its notification dated 25-2-1996 which is required to be followed by all assessees following mercantile system of accounting. In this connection, reliance was placed by learned counsel on the judgment of this Court in the case of Chainrup Sampatram v. CIT [1953] 24 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n. However, the said Act nowhere lays down as to how and when income or expendi-ture should be measured and/or recognized. This aspect is dealt with by AS 9 alone and not by the provisions of the Companies Act. According to learned counsel, events and contingencies occurring after the balance-sheet date mentioned in AS 4, net profit or loss for a given period, prior period items and changes in accounting policies mentioned in AS 5, Accounting for Construction Contracts in AS 7, Accounting for Fixed Assets in AS 10, the effect of changes in Foreign Exchange Rates as mentioned in AS 11, Accounting for Intangible Assets contained in AS 26, Accounting for Impairment of Assets in AS 28 are various aspects dealt with only under Accounting Standards and not under the Companies Act. According to learned counsel, since the Companies Act nowhere deals with recognition and measurement of various items of income and expenses, assets and liabilities, and since it deals with only presentation, there can never be any conflict between the provisions of the said Act and the Accounting Standards issued by the Institute in discharge of its statutory obligations under the Chartered Accountants Act, 19 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not only complies with the requirement for accrual accounting, but it applies the need for accrual accounting, in the context of presenting a true and fair view, rather than purely on the basis of a true and correct view. Accounting treatments contained in various Account-ing Standards issued by the Institute are based on accrual accounting and, therefore, these Standards adopt the accounting treatments mentioned therein to ensure that a company has followed the accrual basis of accounting. According to learned counsel, AS 22, therefore, fulfils, the need for accrual accounting in the context of the true and fair view requirement. According to learned counsel, there is a difference between accrual accounting on the basis of true and correct view vis-a-vis accrual accounting on the basis of true and fair view. In the case of former, the profits are likely to be overstated and in which event the investors would be misled. That, the purpose of true and fair accounts is to protect investors and, therefore, the purpose of AS 22 is to ensure that accrual is made on a true and fair basis, by reference to the Substance rather than the Form. Learned counsel urged that the very object be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he income arising therefrom during life time of such asset. However, the Income-tax Act lays down incentive rates of depreciation. While for accounting purposes, depreciation is provided for on straight line method, the Income-tax Act allows depreciation by way of incentive at much higher rate with reference to its written down value. The total depreciation charged on the plant and machinery for accounting purposes and the amount allowed as deduction for tax purposes ultimately remains constant, but period over which depreciation is charged in the accounts as compared to the period during which the deduction is allowed under Income-tax Act, will differ. This is a case of timing difference. For example, machinery purchased for scientific research is fully allowed as deduction in the very first year for tax purposes, whereas the same would be charged in the P L account, as depreciation, over its useful life of, let us say, 15 years. Unabsorbed depreciation and carry forward of losses, which can be set off against future taxable income, are also examples of timing differences. Such timing differences result in DTAs. According to learned counsel, for the above reasons para 9 of AS 22 l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be charged to the P L account as per the requirements of the Companies Act. According to the appellants DTL is a future liability and, therefore, it does not exist on the balance-sheet. Appellants have also argued that DTL is a contingent liability because it may or may not arise in future. They have argued that DTL is not in accordance with the requirement of section 209(3)( b ) of the Companies Act as it does not amount to keeping books of account on accrual basis. In reply, Mr. Poddar, submitted that DTL is not a notional tax liability, but a real liability as it results in future cash outflow in the form of tax payment to the Income-tax Department. According to learned counsel, DTL arises in the current year in which the timing difference originates, i.e., during the year the difference in the tax depreciation and accounting depreciation arises. Therefore, according to learned counsel, DTL exists on the balance-sheet date for the financial year in which it originates and, therefore, it is a real liability. According to learned counsel, the liability which arises in the current year ( i.e., the year in which timing difference arises) and is payable in a future year is not a f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... refore, it is covered by the definition of the word "Provision" as contained in Part II of Schedule VI to the Companies Act. 55. On the question of ultra vires learned counsel for the Institute had adopted the contentions advanced by learned Additional Solicitor General on behalf of Union of India. Finding : 56. For the following reasons we hold that the impugned Rule which adopts AS 22 neither suffers from the vice of excessive delegation nor is the said Rule incongruous/inconsistent with the provisions of the Companies Act, 1956. Reasons: ( i ) Preface : 57. India is an emerging economy. Globalization has helped India to achieve the GDP rate of around 8 to 9 per cent. However, with globalization, India is required to face challenges in various forms. Corporate India has been acquiring companies in India and abroad. Indian companies are partners in joint ventures. They are part of international consortium. Therefore, Indian Accounting Standards (IAS) have to harmonize and integrate with International Accounting Standards by which harmonization of various accounting policies, practices and principles could take place. 58. In its origin, an accounting s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... efore, matching principle today forms an important compo-nent of Accrual Basis of Accounting. 60. On the other hand, Fair Valuation principles are important in the context of valuing derivatives and other investments. If one were to describe one single change in accounting practice over the last few years, it would be the use of Fair Valuation principles. Today, the object behind enactment of A.S., which are now made mandatory under section 211(3A) of the Companies Act, is to shift from historical method of accounting to fair valuation. In the case of mergers and acquisitions, which is common today in the world of globalization, fair valuation principles have important role to play. Mergers and acquisitions are sometimes undertaken to defer revenue expenditure over future years by invoking the matching concept, which results in putting fictitious assets on the balance-sheet. This is one reason why fair valuation principles are accepted. 61. A.S. are established rules relating to recognition, measurement and disclosures thereby ensuring that all enterprises that follow them are comparable and that their financial statements are "true and fair". Measurements and disclosures b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the statute to exercise a particular discretionary power. In the latter case, the question may be considered on all grounds on which administrative action may be ques-tioned, such as, non-application of mind, taking irrelevant matters into consideration, failure to take relevant matters into consideration etc. A subordinate legislation may be struck down as arbitrary or contrary to statute if it fails to take into account vital facts which expressly or by necessary implication are required to be taken into account by the statute or the Constitution. This can be done on the ground that the subordinate legislation does not conform to the statutory or constitutional requirements or that it offends article 14 or article 19 of the Constitution. However, it may be noted that, a notification issued under a section of the statute which requires it to be laid before Parliament does not make any substantial difference as regards the jurisdiction of the Court to pronounce on its validity. 64. Apart from the grounds referred to by this Court in the above judgment in the case of Indian Express Newspaper ( supra ), it is important to bear in mind that where the validity of subordinate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . However, the scope of section 641 is different from the scope of section 642. Power to alter any provision of the Schedules and the power to carry out gap-filling exercise are both entrusted to the Central Government. The expression "in addition" to in section 642 indicates that both the above sections constitute one scheme. However, section 642 enables Central Government to provide details and, therefore, under section 642 the rules contemplated refers to gap-filling exercise. 68. It is well-settled that, what is permitted by the concept of "delegation" is delegation of ancillary or subordinate legislative functions or what is fictionally called as "power to fill up the details". The judgments of this Court have laid down that the Legislature may, after laying down the legislative policy, confer discretion on administrative or executive agency like Central Government to work out details within the framework of the legislative policy laid down in the plenary enactment. Therefore, power to supplement the existing law is not abdication of essential legislative function. Therefore, power to make subordinate legislation is derived from the enabling Act and it is fundamental princ ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r section 6(2) was bad as it had the effect of deletion of the exemption which had been granted. Section 6(1) of the Act contemplated exemption to be given by the State Government on certain types of transactions whereas section 6(2) empowered the State Government to amend the schedule. It is in this context that the question arose as to whether the impugned Notification was bad as being an unconstitutional delegation of legislative authority. The said contention was rejected by this Court stating that the two sub-sections together constituted integral part of a single enactment. We quote hereinbelow para 11 of the said judgment, which reads as follows : "11. The contention of the appellant that the notification in question is ultra vires must, in our opinion, fail on another ground. The basic assumption on which the argument of the appellant proceeds is that the power to amend the schedule conferred on the Government under section 6(2) is wholly independent of the grant of exemption under section 6(1) of the Act, and that, in consequence, while an exemption under section 6(1) would stand, an amendment thereof by a notification under section 6(2) might be bad. But that, in our ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... counts have to reflect "true and fair" view of the state of affairs. Therefore, the object behind insistence on compliance with the A.S. and "true and fair" accrual is the presentation of accounts in a manner which would reflect the true income/profit. One has, therefore, to look at the entire scheme of the Companies Act. In our view, the provisions of the Companies Act together with the Rules framed by the Central Government constitute a complete scheme. Without the Rules, the Companies Act cannot be implemented. The impugned Rules framed under section 642 are a legitimate aid to construction of the Companies Act as contemporanea expositio . Many of the provisions of the Companies Act, like computation of book profit, net profit etc. cannot be put into operation without the rules. 72. In the case of P. Kasilingam v. P.S.G. College of Technology 1995 Suppl. (2) SCC 348 vide para 20 this Court ruled as follows : "20. The Rules have been made in exercise of the power conferred by section 53 of the Act. Under section 54(2) of the Act every rule made under the Act is required to be placed on the table of both Houses of the Legislature as soon as possible after it is made. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... der section 642(1) of the Companies Act. In our view, the impugned Rule/Notification is valid. It has nexus with the matters entrusted to the Central Government to be covered by appropriate rules. Therefore, in our view, the impugned Rule is valid as it has nexus with statutory functions entrusted to Central Government which is the rule-making authority under the Act. It is important to bear in mind that the power to regulate a business or profession implies the power to prescribe and enforce all such proper reasonable rules as may be deemed necessary to conduct business/profession in a proper and orderly manner and the power includes the power to prescribe conditions under which business/profession can be carried on. ( See Deepak Theatre v. State of Punjab AIR 1992 SC 1519 at page 1521). The Scheme of the Companies Act indicates that Accounting Standards are made mandatory. They have to be followed by the auditors. They have to be followed by the companies. The Accounting Standards provide discipline. They provide harmonization of concepts. They provide harmonization of accounting principles. In the past, when Accounting Standards were not mandatory, various companies used to f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xes on income are considered as expenses incurred by a company in earning revenues. It is an expense which is recognized in the same period as revenue and expense to which they relate. This is called as matching principle. Such matching, results in what is called as Timing Differences. Tax effects of Timing Differences are included as tax expense in the statement of profit and loss and as Deferred Tax Asset (DTA) or as Deferred Tax Liability (DTL) in the balance-sheet. In short, deferred tax should be recognized for timing differences. This is the basic mandate of AS 22. This mandate is based on an important principle of accounting, namely, that every transaction has a tax effect. However, DTA is subject to the principle of prudence and certainty that in future the company will have adequate income. This principle of prudence states that DTAs are recognized and carried forward only to the extent of their being a reasonable certainty of their realization, i.e., in future there would be taxable income. Therefore, under the rule of prudence, DTAs are to be recognized only to the extent of their being timing differences, the reversal whereof will result in sufficient taxable income i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has to be included in the tax expenses in the P L account as DTA or DTL in the balance-sheet. Therefore, timing difference is the tax effect which forms part of tax expense in the P L account. The primary object of AS 22 adopted by the impugned Rule is to prescribe an accounting treatment for TOI. In accordance with the matching concept, TOIs are recognized in the same period as revenue and expenses to which they relate. Matching of TOI against revenue for a period poses problems due to the effect that in a number of cases, taxable income is different from accounting income. This difference arises for two reasons. Firstly, there are differences between items of revenue and expenses in the P L account and items considered as revenue expenses or taken for tax purposes. Secondly, there are differences between the amount in respect of a particular item of revenue or expenses as recognized in the P L account and the corresponding amount which is recognized for computing taxable income. Tax Expense : 80. As stated above, current tax is the amount of Income-tax determined to be payable in respect of taxable income for a period. On the other hand, deferred tax is the tax effect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... venues or against the relevant time period in order to determine the periodic income. This principle is an important component of accrual basis of accounting. As stated above, the object of AS 22 is to reconcile the matching principle with the Fair Valuation Principles. It may be noted that recognition, measurement and disclosure of various items of income, expenses, assets and liabilities is done only by Accounting Standards and not by provisions of the Companies Act. Depreciation : 84. As stated above, timing difference is the difference between taxable income and accounting income for a period. Depreciation is one of the important items in computation of income, be it taxable income or accounting income. According to Pickles Accountancy , fourth edn., at page 518, depreciation is the inherent decline in the value of an asset from any cause whatsoever. The wearing out of a machine is a simple example of depreciation. In double-entry system of accounting, there has to be complete double-entry for depreciation adjustment. The required entry under that system of Depreciation Adjustment is debit Trading and Profit Loss account and credit the asset in respect of which depre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the balance-sheet. 86. The question which arose for consideration by this Court was whether amounts set apart in the balance-sheet are provisions or reserves . The matter arose under the provisions of Companies (Profits) Surtax Act, 1964 which levied a charge on every company for every assessment year called as surtax, insofar as the chargeable profits of the previous year exceeded the statutory deduction at the rates mentioned in the Third Schedule. Rule (1) of Schedule II stipulated mandatory that the capital of the company shall be the total of the amounts including reserves. The assessee contended that the amounts set apart in the balance-sheet are reserves. The Department contended that the said amounts were provisions. The assessee succeeded. However, the reasoning given in the judgment is important. It was held by this Court, after referring to the relevant provisions of the Companies Act regarding the form of balance-sheet wherein the words reserves and surplus and current liabilities and provisions are dealt with, that if any retention or appropriation falls within the definition of provision it can never be a reserve but it does not follow that if the retent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ference between tax depreciation and accounting depreciation results in timing differences. 90. The provision for bad and doubtful debt is always made with reference to debt receivable where there is doubt about full realization of debt. The provision is made in order to cover up the probable diminution in the value of an asset, i.e., debt which is amount receivable. For example, if the receivable is Rs. 1 crore and the assessee is of the opinion that Rs. One crore might not be realized and that only 90 per cent of the debt would be realized and, therefore, he makes a provision for Rs. 10 lakhs for bad debts. By making the provision, the assessee is valuing his asset, namely, debt, which is the amount receivable, at Rs. 90 lakhs as against the book figure of Rs. 1 crore. Thus, the provision for bad and doubtful debt is the provision for diminution in the value of asset, i.e., debt. Such provision is not a provision for liability, because even if a debt is not recovered, no liability would be fastened upon the assessee. The debt is the amount receivable by the assessee. It is not any liability payable by the assessee. Therefore, any provision towards irrecoverability of debt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in conflict with accrual accounting as vehemently submitted on behalf of the appellants. Accrual Accounting is the concept recognized by sections 205 and 209 and 211 and Schedule VI to the Companies Act. However, the said provisions of the Companies Act nowhere lays down as to which asset should be recognized as an invest-ment and the method of valuing investments. That exercise is left to the accounting standards. Similarly, the Companies Act nowhere lays down as to how and when income or expenditure should be measured/recognized. That exercise is left to the accounting standards. AS 22 proceeds on the basis that a benefit obtained in one year could be reversed in the subsequent year and, therefore, it has to be recognized as a liability. One more concept needs to be mentioned. Deferred tax is the same as timing difference. It arises on account of the difference between taxable and accounting incomes. This difference arises between items of revenue and expenses as comparing in P L account vis-a-vis items considered as revenue, expenses or deduction for tax purposes. Secondly, difference also arises between the amount in respect of an item of revenue or expenses as recognized ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en liability which earlier could not be brought out. Today, we are living in the world of globalization in which, apart from merger, acquisitions play an important role. The buyer wants to know the income and liabilities of a company. He wants to know the real income of the company, which he proposes to buy. Because of the difference in the rates of depreciation statutorily prescribed under the Income-tax Act and the Companies Act, the concept of deferred taxation has been introduced in order to obliterate the difference between accounting depreciation and tax depreciation. (B)Application of above Concepts : 94. As stated above, the power to alter the Schedule is distinct and separate from the power to fill in the details, though both together form part of the same scheme. In the present case, under section 641, the Central Govern-ment is empowered vide the Notification to alter any of the Regulations, Rules, Forms and other provisions contained in any of the Schedules except Schedules XI and XII. Under section 641(2), any alteration notified under sub-section (1) has the effect as if the notified alteration stood enacted in the parent Act and shall come into force on the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... x. 97. DTL is a tax payable in future period(s) which arises out of taxable temporary differences. 98. DTA is the tax recoverable in future period(s) which arises out of deductible temporary difference, carry forward of unused tax losses and carry forward of unused tax credits. 99. Temporary difference is the difference between the carrying amount of an asset or liability in the balance-sheet and its tax base, which is an amount attributable for tax purpose. 100. Taxable temporary difference will result in future period(s) when carrying amount of the asset or liability is recovered. It will arise when the tax base of an asset/liability is lower than the balance-sheet amount. Tax base of an asset gets reduced by over-charge of depreciation as per the tax law. The tax base of a liability gets reduced by over-charge of a liability which is to be written back as income in the future period(s). This analyses can be explained by the following examples: Example-1 : 101. A Plant costs Rs. 100 lakhs. Accelerated depreciation is charged on the Plant to the extent of Rs. 70 lakhs as per the Income-tax Rules. Therefore, the tax base of the Plant is (100 70) Rs. 30 lakhs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompany recognizes its liability for Provident Fund in its accounts at Rs. 30 lakhs which is not allowed by the Income-tax Department unless actually paid and if the tax rate is 30 per cent then the DTA will be Rs. 30 lakhs 30/100 = Rs. 9 lakhs as in such a case the tax base is Nil whereas the carrying amount is Rs. 30 lakhs. Example-4 (Matching Concept) : 110. A leasing company deducts an amount of lease equalization charges from lease rental income. For that purpose, the company makes a provision for the said charges in accordance with the guidelines issued by the Institute on Accounting of income, depreciation and other aspects for leasing company . This charge is created to equalize the imbalance between lease rentals and depreciation charges over the period of lease. It is based on the rationale of matching costs with revenues so that the periodic net income from a finance lease is true and fair. Such matching is achieved by showing the lease rentals received under finance lease separately under Gross Income in the P L account of the relevant period and against such lease rental income, a matching lease annual charge is made to the P L account. This annual lease ch ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tated above, the form of balance-sheet is prescribed by Part I of Schedule VI. The Act does not prescribe a proforma of P L account. However, Part II of Schedule VI prescribes the particulars which must be furnished in a P L account. As far as possible, the P L account must be drawn up according to the requirements of Part II of Schedule VI. As stated above, section 211(1) emphasizes true and fair view in place of true and correct view of accounting. As stated above, the legislative policy is to obliterate the difference between the accounting income and the taxable income. As stated above, the accounting income/book profit is the real income. Therefore, section 211(1) emphasizes the concept of true and fair view . As stated above, it is a stand-alone consideration. It is the controlling element underlying the scheme of sections 209, 211 and 227. However, as stated above, the Companies Act does not deal with Recognition, Measurement and Disclosure. As stated above, how much amount should be recognized in respect of a specific matter is not covered by section 209(3)( b ). Recognition, measurement and disclosure are the three items which can only be done by way of Accounting Sta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he same as that which would have resulted if this Statement had been in effect from the beginning." 116. As regards para 9, the appellants had no objection to the disclosure of DTL/DTA in their financial statements. They object to a charge being created qua P L account for DTL mainly because it results in reduction of reserves and net profits. Therefore, the main contention is that the DTL is a notional concept. According to the appellants, DTL is not a liability. Therefore, according to the appellants, there cannot be a charge for DTL to the P L account of the company. According to the appellants, DTL distorts their financial statements. According to the appellants, Schedule VI forms part of the Companies Act. According to the appellants Part II of Schedule VI contains clause 3( vi ). According to the appellants, the said clause 3( vi ) refers to the amount of charge for income-tax on the profits. According to the appellants when AS 22 states that tax expense for the period shall consist of current tax and deferred tax and that such tax expense should be included in the determination of net profit or loss, it amounts to alteration of clause 3( vi ) of Schedule VI to the Comp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ants segment reporting. For example in RIL we have three segments, namely, refining, industry and infrastructure. Similarly, in the case of Sterlite Industries (India) Ltd., it has different segments. Each segment earns its own revenue. For example, revenue from copper, revenue from aluminium and revenue from others. Under clause 3( vi ) of Part II non-provision for taxation would amount to contravention of the provisions of sections 209 and 211 of the Companies Act. Accordingly, it is necessary for the auditor to say in what manner the accounts do not disclose a "true and fair" view of the state of affairs of the company and the P L account of the company. AS 22 is mandatory. Therefore, it is the duty of the members of the Institute to examine whether the accounting standard is complied with the said standard in the presentation of financial statement. [ see also section 227(3)( d )] 119. In our view, para 9 only provides for details which are necessary for giving effect to the concept of true and fair accrual of accounts contemplated by section 211(1). As stated above, the concept of "true and correct" accrual is different from the concept of "true and fair" accrual. Both ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xation is contemplated by the said clause. Para 9 of AS 22 merely provides for a liability which arises on account of timing difference as explained hereinabove. As stated above, it is known on the balance-sheet date. One has to therefore consider matching principle and fair valuation principles as important concepts in Accrual Accounting. Further, as stated above, recognition and measurement is not covered by the provisions of the Companies Act, therefore, one has to read the presentation of balance-sheet and P L account together with recognition and measurements. Therefore, one has to read the provisions of the Companies Act along with the impugned Rule which adopts AS 22 as recommended by the Institute. The matching principle recognizes cost against revenue or against the relevant time period to determine the periodic income. Therefore, the said principle constitutes an important component of the accrual basis of accounting. The concept of accrual, in case of mergers and acquisition, is not limited to one year. DTL/DTA arises out of timing differences. Therefore, such differences have got to be reflected in Deferred Tax Accounting. DTL in most cases arises on account of the diff ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2001 2002 2003 Profit before depreciation and taxes 200 200 200 Less: Depreciation for accounting Purposes 50 50 50 Profit before taxes 150 150 150 Less: Tax expense Current tax 0.40 (200-150) 20 0.40 (200) 80 80 Deferred tax Tax effect of timing differences originating during the year 0.40 (150-50) 40 Tax effect of timing differences reversing during the year 0.40 (0-50) - (20) (20) Tax expense 60 60 60 Profit after tax 90 90 90 Net timing differences 100 50 0 Deferred tax liability 40 20 0 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to an obligation to deliver cash. This example is given to show that DTL is a liability because it results in cash outflow in future on account of timing differences. 124. A company has an option to designate a financial asset at fair value through profit or loss. A financial asset held for trading should be classified as an asset at fair value through profit or loss. The difference in the fair value of financial asset at the beginning of the period and at the end of the period is generally recognized as profit or loss in the P L account. Similarly, loans and receivables are carried at amortized cost unless the company intends to sell the same immediately. Similarly, there are certain assets like Held-to-maturity-investments which are required to be carried in the balance-sheet at the amortized cost. In all such cases, the company will now have to classify such assets or liabilities at fair value through profit or loss. Therefore, fair value under the new A.S. has become the basis for measurement of financial assets. Application of new standards will require a change in the mind-set. At present, non-financial companies carry current investments at cost or market value, whicheve ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... into operation only if the Act and the Rules are read together. In the present case, in our view, the impugned Rule constitutes a legitimate aid to construction of the provisions of the Companies Act. Further, as stated above, the Central Government is the rule-making authority under section 211( 3C ). As rule-making authority, the Central Government is empowered to enact accounting standards in consultation with NAC which may be at variance with the Standards issued by the Institute. 128. In the case of Union of India v. Cynamide India Ltd. [1987] 2 SCC 720 one of the arguments advanced on behalf of the company was that, in calculating the "net worth" the cost of works-in-progress and the amount invested outside business were excluded from "free reserves" and that such exclusion could not be justified on any known principle of commercial accountancy ( See para 33). The matter related to price fixation. In the Control Order vide para 2( g ) the word "free reserve" was defined. Similarly, in the Form prescribed in the Fourth Schedule, several items like bonus, bad debts and provisions, loss/gain on sale of assets etc., were required to be excluded from the cost of product ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... accrual system of accounting. Moreover, we are concerned with presentation of balance-sheet and P L account. These are financial statements. An investor, shareholder or stake-holder is entitled to know the real income which the company has earned during the year. Provision for diminution in value of an asset results in emergence of liability. In the past, when timing difference concept was not there, in many cases, profits were overstated, particularly because provision for DTL (deferred taxation) was not recognized. With the introduction of the timing difference concept, it cannot be said that the accrual system of accounting is violated. As stated above, it is the concept of timing difference which obliterates the difference between accounting and tax incomes. Ultimately, the object is to obliterate the difference between accounting income and taxable income. Accounting income is the real income, therefore, in our view, para 9 of AS 22 is not inconsistent with the provisions of the Companies Act, including Schedule VI. 129. In the case of Bharat Hari Singhania v. CWT AIR 1994 SC 1355 valuation of unquoted equity shares based on the break-up method was challenged. That c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... suit the purposes of the persons controlling the companies. Maintainable profits rather than the dividends declared represent the correct index of the value of their shares. The break-up method based upon the balance-sheet of the company, incorporated in rule 1-D, is a fairly simple one. Indeed, no serious objection can also be taken to this course since the basis of the rule is the balance-sheet of the company prepared by the company itself - subject, of course, to certain modifications provided in Explanation-II. 14. We are not satisfied that the break-up method adopted by rule 1-D does not lead to proper determination of the market value of the unquoted shares. The argument to this effect, advanced by the learned counsel for the assessees, is based upon the assumption/premise that the value determined by applying the yield method is the correct market value. We do not see any basis for this assumption. No empirical data is placed before us in support of this submission or assumption. It may be more advantageous to the assessees but that is not saying the same thing that it alone represents the true market value. It cannot be stated as a principle that only the method that l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... l data produced before us to show that break-up method does not lead to the determination of market value of the shares. Merely because yield method may be more advantageous from the assessee s point of view, it does not follow that it alone leads to the ascertainment of true market value and that all other methods are erroneous or misleading. This aspect we have emphasised hereinbefore too." (p. 1364) Validity of Para 33 of AS 22 : 130. We have already quoted hereinabove para 33. The said para is challenged on the ground that a subordinate legislation cannot be retrospective unless there is provision to that effect in the parent Act. Therefore, the short question which we have to decide is whether the said para is retrospective. 131. To decide the said question, we have to analyse the scope of para 33. For the purpose of determining accumulated deferred tax in the period in which the Standard is applied for the first time, the opening balances of assets and liabilities for accounting purposes and for tax purposes are to be compared and the differences, if any, are to be determined. The tax effect of these differences have got to be recognized as DTA or DTL, if such dif ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Calcutta High Court, the impugned Notification adopting AS 22 was also challenged on the ground that the provisions of AS 22 insofar as it relate to deferred taxation is violative of articles 14 and 19(1)( g ) of the Constitution of India. In this connection, it was pleaded that by making AS 22 mandatory, the appellants companies will suffer erosion of its net worth. That, as a result, the debt equity ratio will also increase and that the lenders may recall the loans and thereby the appellants rights to carry on business in future would be violated. Although, the aforestated challenge was pleaded in the writ petition, when the matter came for hearing before the High Court, it appears that the said grounds were not argued. According to the appellants, implementation of AS 22 would result in reduction of profits and reserves. In the circumstances, we do not wish to express any opinion on the constitutional validity of the said AS 22. Whether the said Standard constitutes a restriction on the rights of the appellants to carry on business under article 19(1)( g ) or whether the said Standard is violative of article 14 are questions on which we express no opinion. We keep those ..... X X X X Extracts X X X X X X X X Extracts X X X X
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