TMI Blog2007 (9) TMI 409X X X X Extracts X X X X X X X X Extracts X X X X ..... . Singhvi, Mukul Rohtagi, S. Ganesh, D.J. Kakalia, Syed Naqvi, Ms. Smieeta Inna, Gaurav Bhatia and Rajesh Kumar for the Appellant. Altaf Ahmed, Prashant Chavan, Varun Thakur and A.S. Bhasme for the Respondent. JUDGMENT S.H. Kapadia, J. - State of Maharashtra through Maharashtra State Road Development Corporation Ltd. (for short, MSRDC ) floated Global Tender for completing Mumbai Trans Harbour Link ( MTHL ) between Mumbai and Navi Mumbai on BOT basis. 2. Reliance Energy Limited is a company registered under the Companies Act, 1956. It is engaged in generation, transmission and disbursement of power in Maharashtra, Delhi etc. 3. Hyundai Engineering and Construction Company Ltd. (for short, HDEC ) is a company incorporated in Korea. It is specialized in construction of bridges. 4. At this stage, it may be noted that the above Project is to be at the cost of Rs. 26,000 million (Rs. 2,600 crores). The bidders were required to submit RFQ Document by 10-1-2005. Under the PQ Document, M/s. Jean Muller, France was appointed as consultant by MSRDC. Under the PQ Document, the bidders were required to submit financial statements of three financial years subjec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ity capital of the Project Company, until completion of construction and thereafter for a period of two years from the date of commencement of operations and meet the financial eligibility criteria of Lead Member as given below. u Those members of the Consortium committing to hold a minimum of 5 per cent of the paid up and subscribed equity capital of the Project Company until completion of construction and thereafter for a period of two years from the date of commencement of operations. The aggregate (taken as the arithmetic sum) of Net Cash Profit and Net Worth (as explained above) of all subsidiary companies in which the respective entities hold a minimum of 51 per cent of total paid up and subscribed equity capital would also taken into consideration. In the case of financials of subsidiary companies being considered as above, the dividend paid by these subsidiary companies to the parent company will be deducted from the Net Profit of the parent company for the purpose of evaluation. The financial evaluation criteria to be satisfied by a Consortium are detailed below. Criteria To be satisfied Amount by Net worth 1 (as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tements of all subsidiary companies of the Applicant for the last three financial years. In case of a Consortium audited annual reports/account statements of each member of the Consortium for the last three financial years should be provided and should include the financial statement of all subsidiary companies of the entities forming the Consortium. uThe applicant (all members of Consortium) must submit information-on all pending litigations or proceeding regarding, liquidation, winding up, court receivership or other similar proceedings that should have been initiated or pending against the Applicant (or any member of Consortium). In addition to the above, information must also be provided of all pending litigations against the Applicant (or any member of Consortium) in which the maximum value of liability that may arise in the event of adverse judgment exceeds Rs. 100 million (or equivalent foreign currency). A consistent history of litigation/arbitration awards against the applicant or any member of the consortium." [Emphasis supplied] 6. Briefly the criteria and conditions were as follows : "( a )In a consortium, the entity declared as lead member was required, to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n contracts in Iraq. On account of war in Iraq their annual report for the year 2001 showed negative income. However, the said Company achieved net profit of US $16 million in 2002, US$ 66 million in 2003 and US$ 164 million 2004. These figures have been taken from the letter of KPMG, Korea, dated 12-8-2005 giving a schedule of net income after adjusting expenses and income not in form of cash transaction. We quote hereinbelow the entire letter dated 12-8-2005 along with the schedule of net income which reads as under : "10th Floor, Star Tower,Tel + 82(2) 21120100 737 Yeoksam-dong,Fax + 82(2) 21120101 Gangnam-gu, Seoul 135-984www.kr.kpmg.com Republic of Korea The Board of Directors and Management Hyundai Engineering Construction Co., Ltd. 140-2 Kye-dong, Chongro-gu Seoul, 110-793, Korea August 12, 2005 Dear Sir, We have performed the procedures described below, which were agreed by Hyundai Engineering Construction Co., Ltd. (the Company ). The sufficiency of the procedures is solely the responsibility of the Company. Consequently, we make no representation regarding the sufficiency of the procedures described below either for the purpose for which this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... al statements are for use by those knowledgeable about Korean accounting procedures and auditing standards and their application in practice. This report is intended solely for the use of the Board of Directors and Management of Hyundai Engineering Construction Co., Ltd., and should not be used by those who have not agreed to the procedures and taken responsibility for the sufficiency of the procedures for their purposes. Very truly yours Sd/- S.H. Goo, Partner (Attached: Cash flows from operating activities) (Attached) Schedule of net income after adjusting expenses and income not in form of cash transaction. Description Dec. 31st, Dec. 31st, Dec.31st, Dec .31st, 2001 2002 2003 2004 (1) Net Income (610,507) 15,963 65,546 164,248 (2) Expenses not in form of a cash transaction 686,310 200,753 199,084 285,039 - Provision for retirement and severance benefit 27,009 39,173 32,706 39,541 - Depreciation 49,475 36,221 31,279 27,699 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... irment 1,879 - 1,167 2,386 - Gain on valuation of investment in affiliates using equity method (*) - 2,722 4,941 4,771 - Gain on Debt exemption (*) 305,317 6,987 30,342 18,164 - Gain on redemption of debentures - 1,933 - 95 - Miscellaneous gains (Including other extraordinary gain) - - - 19,729 - Gain on prior year adjustment - 9,739 - - (4) Net income after adjusting expenses and income not in form of cash transaction [(1) + (2) (3)] (262,179) 140,432 220,143 393,564 (*) Gain on Debt exemption, Loss (gain) on valuation of investment affiliates using equity method. Loss (gain) on disposal property, plant and equipment are included for calculation of net income after adjusting expenses and income not in form of cash transaction. (Note) We translated Korean Won into U.S. dollars at the basic exchange rates on December 31, 2001, 2002, 2003 and 2004 to US $. The corresponding rates are as follows : Dec. 31, 2001 D ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e time up to 19-8-2005 to furnish such clarifications. By the said letter, MSRDC stated that there were no queries in respect of REL, but there were queries in respect of HDEC. By the said letter, MSRDC referred to the break-up of net cash profit submitted by REL/HDEC and asked for the basis for classifying certain heads of expenditure under the heading non-cash expenditure . By reply dated 18-8-2005, REL/HDEC submitted its clarification by pointing out that as on 10-1-2005 when RFQ document was submitted the audited accounts for financial year ending 31-12-2004 were not ready, so far as HDEC was concerned and, therefore, it had submitted the audited accounts of HDEC for the years 2001, 2002 and 2003. By the said letter dated 18-8-2005, the REL/HDEC also submitted audited accounts of HDEC for financial year ending 31-12-2004. In other words, by 18-8-2005 ( i.e., before 6-10-2005 which was date up to which REL/HDEC had kept its Offer open) the said Consortium had submitted the audited accounts for the financial years ending 31st December, 2002, 2003 and 2004. Therefore, according to REL/HDEC, they had also complied with the conditions mentioned in the PQ document by supplying audi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... re, out of abundant caution they decided to exclude REL/HDEC. However, the Peer Committee did not concur with this accounting interpretation. According to the Peer Committee the major provision for bad debt was in the accounts for the year 2001 and it related to receivables from their contract in Iraq affected by war and since it was only a provision for bad debt and not a write-off, the Committee came to the conclusion that there would be no cash impact in future. The Committee took the view that even without taking into account the audited accounts for the year 2004, REL/HDEC fulfilled the financial criteria in clause 7.2-2. Accordingly, the Peer Committee opined that REL/HDEC should not be excluded from the second stage of the bidding process. At this stage, it may be noted that after receipt of the said report, made by the Peer Committee dated 1-10-2005, MSRDC placed the report of the Peer Committee before their Consultants. Needless to add that the Consultants of MSRDC retained their original position, namely, that since the audited accounts for the year ending 31-12-2004 could not have been submitted after 10-1-2005, the said accounts of HDEC could not have been taken into ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 007 the High Court ruled that admittedly HDEC had suffered net loss of approximately US $ 610 million in 2001; that they had earned net profits in 2002, 2003 and 2004; that audited accounts for 2004 were made available only after 10-1-2005 and, therefore, could not have been taken into account by the Peer Committee and, therefore, MSRDC was right in excluding REL/HDEC from the second stage of the bidding process. According to the impugned judgment, the basic debate was about accounting treatment to be given to non-cash expenses . The High Court was of the view that it had no jurisdiction under Article 226 of the Constitution to interfere with the decision of MSRDC, particularly, when there were two different opinions regarding adjustment to net income. According to the High Court, the decision of MSRDC on the future cash impact of the provision for bad debts made by HDEC in its accounts for 2001 cannot be said to be arbitrary or unreasonable. For the aforestated reasons, without going into the question whether provision for bad debts is or is not a non-cash expense liable to be added back to arrive at net cash profit, the High Court dismissed the writ petition, hence this civi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tted that provision for doubtful debts in the present case has not been written-off till 31-12-2004; that by adding back provision for doubtful debts made by HDEC in 2001, the Consortium had met the requirement of NCP for the years 2001, 2002 and 2003; that the said provision was made only in the accounts of 2001; that Iraq contract receivables had nothing to do with the years 2001, 2002 and 2003 (reference years); that provision for doubtful debts is only appropriation of profits and not a charge on profits and that in fact regarded as Reserve for purpose of sur-tax and since it is only appropriation the amount under it has to be added back to determine the NCP in terms of the definition in the PQ document. Learned counsel further urged that provision for doubtful debts ought to be included in the net profit; that since NCP is always more than the net profit it is obvious that the said provision for doubtful debt has to be included in the NCP. Learned counsel further urged that there was no write-off during 2001, 2002 and 2003 and, therefore, during those years there was no cash impact on the cash profit of REL/HDEC or on the net profit of the said Consortium. 20. Mr. Al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n BOT, therefore, global tenders were invited. It is an important project which is required to be given to the bidder who qualifies and goes successfully through both the stages of the bidding process; that REL had entered into an agreement with HDEC; that it was a consortium; that the said Consortium did not fulfil the financial criteria of Rs. 200 crores (NCP); that according to the annual accounts of HDEC there was a loss of US$ 610 million in the year 2001; that in Form F-S submitted by the appellant s Consortium, non-cash expenses for financial years ending December 31, 2001, 2002 and 2003 in respect of HDEC were US$ 686 million, US$ 201 million and US$ 199 million respectively which cannot be added back to net profit/loss. Learned counsel further contended that according to the Consultants of MSRDC adding back was not permissible and even if it is held to be permissible it is not advisable as it would result in future cash impact on the net profits of HDEC. Learned counsel submitted that provision for bad debts were examined by the consultants and upon examination of bad debts expenses, the consultants opined that the said expenses may not involve a direct cash outflow in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... clarify that this doctrine is, however, subject to public interest. In the world of globalization, competition is an important factor to be kept in mind. The doctrine of level playing field is an important doctrine which is embodied in Article 19(1)( g ) of the Constitution. This is because the said doctrine provides space within which equally-placed competitors are allowed to bid so as to subserve the larger public interest. Globalization , in essence, is liberalization of trade. Today India has dismantled licence-raj. The economic reforms introduced after 1992 have brought in the concept of "globalization". Decisions or acts which results in unequal and discriminatory treatment, would violate the doctrine of level playing field embodied in Article 19(1)( g ). Time has come, therefore, to say that Article 14 which refers to the principle of equality should not be read as a stand alone item but it should be read in conjunction with Article 21 which embodies several aspects of life. There is one more aspect which needs to be mentioned in the matter of implementation of the aforestated doctrine of level playing field . According to Lord Goldsmith - commitment to rule of law ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... In the case of Reliance Airport Developers (P.) Ltd. v. Airports Authority of India [2006] 10 SCC 1, the Division Bench of this Court has held that in matters of judicial review the basic test is to see whether there is any infirmity in the decision-making process and not in the decision itself. This means that the decision-maker must understand correctly the law that regulates his decision-making power and he must give effect to it otherwise it may result in illegality. The principle of judicial review Cannot be denied even in contractual matters or matters in which the Government exercises its contractual powers, but judicial review is intended to prevent arbitrariness and it must be exercised in larger public interest. Expression of different views and opinions in exercise of contractual powers may be there, however, such difference of opinion must be based on specified norms. Those norms may be legal norms or accounting norms. As long as the norms are clear and properly understood by the decision-maker and the bidders and other stakeholders, uncertainty and thereby breach of rule of law will not arise. The grounds upon which administrative action is subjected to control b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amortization is not restricted only to AS 26. Similarly, the concept of cash flow analysis is not restricted to AS 3. Therefore, different methods are prescribed for estimating net profits and/or net cash profits. There are no two views on this point. Provisioning for doubtful debts cannot be equated to write-off . In the case of provisioning there is no cash outflow . This proposition is undisputed. What is being argued is that once there is provisioning , the write-off does not get routed through the P L account and, therefore, there will be cash impact in future . This argument amounts to begging the question. If this argument is to be accepted then we are obliterating the difference between provisioning and write-offs . The question of cash impact in future is a separate question. It has to be answered in terms of cash flow reporting which falls in AS 3 which has been invoked by the chartered accountnats of REL/HDEC. In the case of CIT EPT v. Jwala Prasad Tiwari [1953] 24 ITR 537, the Division Bench of the Bombay High Court speaking through Chagla, CJ. has held as follows : " Writing Off is a technical term used by financiers and auditors. There are t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ari ( supra ) and Metal Box Co. of India Ltd. ( supra )] it is clear that the concept of provision for doubtful debts is different from the concept of write-off . The effect of the two is quite different. Provisions made against anticipated losses are charges against profits and, therefore, to be taken into account against gross receipts in the P L account and the balance-sheet. Provisions are usually shown in the balance-sheet by way of deduction from the assets whereas reserves are shown as part of the interest of the proprietor. In the present case, there is no dispute regarding the aforestated concepts. However, according to the consultants for MSRDC though provision for doubtful debt is a non-cash expense it has to be treated as a cash expense because once a provision has been made, the write-offs cannot be routed through P L account and, therefore, what is conceptually a non-cash expense is being treated as a cash expense. As stated above, this is begging the question. If the aforestated argument is to be accepted it would obliterate the conceptual difference between provision and write-off . The above reasoning shows that the only reason for excluding REL/HDEC i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erating activities : (1) Advance Accounts by Shukla, Grewal and Gupta, Vol. II, Edition 2008, pages 23.20 - 23.21, which read as under : "( ii )Indirect Method : Zed Ltd. Case Flow Statement for the year ended 31-3-2001 Rs. Rs. Cash Flows from Operating Activities Net profit before income-tax and extra- ordinary item : 7,77,000 Adjustments for : Depreciation 1,80,000 Rs. Rs. Provision for bad debts 1,000 Underwriting commission amortised 1,200 Profit on sale of investments (7,500) Income from investments (21,000) Interest on debentures 66,000 Operating profit before working capital Changes 9,96,700 Adjustments for : Increase in inventory (93,800) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... under the direct method are also relevant under the indirect method." [Emphasis supplied] (2) Fundamentals of Corporate Accounting by J.R. Monga, 11 Edition 2005-06, pages 12.15, 12.16, 12.17, 12.20, which read as under : "12.15 Cash flows from operating activities [Cash provided by (or used in) operating activities] - One of the major items of information in the cash flow statement is the net cash flow provided by (or used in) operating activities. In fact it is the regular source of cash in any enterprise that determines whether or not an enterprise will continue to exist in the long run. The logic for determining the net cash flow from operating activities is to understand why net profit (loss) as reported in the profit and loss account must be converted. As we know that financial statements are generally prepared on accrual basis of accounting which requires that revenues be recorded when earned and the expenses be recorded when incurred. Earned revenues more often include credit sales that have not been collected in cash and expenses incurred that may not have been paid in cash during the accounting period. Thus under accrual basis of accounting net income will ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eceipts) to determine the net cash provided (or used) by operating activities. 12.16 - 12.17. The indirect method provides less information because it does not disclose the individual cash inflows and cash outflows from the operating activities. Instead under this method we start with net profit (or loss) and adjusts this figure to obtain net cash flows from operating activities. The indirect method is also known as Reconciliation Method because it involves reconciliation between net profit (or loss) as given in the profit and loss account and the net cash flow from operating activities as calculated on the cash flow statement. Direct v. Indirect methods Direct Method Cash Flows from operating Activities (A)Cash receipts from customers. (B)Cash paid to suppliers and employees. (A-B)Cash generated from operations. Less: Interest and tax. (C)Cash before extraordinary items. Adjust for extraordinary items to get : (1)Net cash from operations. (2)Net cash from (used on) investing activities. (3)Net cash from (used on) financing activities. (D)Net increase (decrease) in cash and cash equivalents (1+2+3) Opening balance of cash and cash equivalents. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... natively Depreciation AccountDr. To Fixed Asset Account In either case the depreciation account would be closed be transfer to Profit and Loss Account. The net affect would be : Either Profit and Loss AccountDr. To Provision for Depreciation Account Or Profit and Loss AccountDr. To Fixed Asset Account It is clear that cash is not affected in the above journal entries. The depreciation does not require any expenditure in cash. Thus, the amount of depreciation charge must be added to be reported net income in order to arrive at the total increase in cash provided from the operations. Amortization of intangibles - goodwill, patents, etc.: The amortization of (i.e., writing off) goodwill, trademarks, patents copyrights, etc., has the same effect as the depreciation expense. The amount of amortization reduces the profit but does not involve any flow of cash as is evident from the following entry : Profit and Loss AccountDr. To Goodwill etc. Account There is no change in cash. Thus amount of intangibles so written off must also be added back to the reported net profit (income) . 12.20 Stage-2 : Adjustments in respect of current assets and current liab ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... i.e., direct and indirect. Both give identical results in the matter of the final total. They differ only in presentation of the data. They differ only in presentation of the data contained in the cash flows from operational activities. No reason has been given by the Consultants of MSRDC for rejecting the indirect method invoked by KPMG, Chartered Accountants of REL/HDEC in their letter dated 12-8-2005. The said method is known as reconciliation method . In this case, as stated above, the only reason given by the Consultants of MSRDC to exclude REL/HDEC was the negative impact on the future cash flows on account of the provisioning for doubtful debts in the accounts of HDEC for the financial year 2001. If future cash impact was the basis to exclude REL/HDEC, then the Consultants for MSRDC should have considered cash flow reporting methods, which includes Reconciliation Method. There is no question of difference of opinion or different views as far as the application of cash flow reporting, which also falls in AS 3. There is nothing to show whether indirect method has at all been considered by Crisil, particularly when KPMG had invoked that method. There is no reason given for ..... X X X X Extracts X X X X X X X X Extracts X X X X
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