Consolidated Financial Statements

9.1 Section 129(3) of the Act requires a company having a subsidiary, a joint venture, or an associate company, to prepare a ‘Consolidated Financial Statement’ (CFS), in addition to its stand-alone financial statements. The requirement for a CFS under the Act had been introduced for the first time in the Companies Act, 2013. Before 1st April 2014, such a requirement existed only for listed companies, which were required to prepare consolidated financial statements in terms of the listing agreements with stock exchanges. A number of comments received by the Committee during the consultation process related to the preparation of a CFS and associated matters, and were accordingly dealt with. The proposed changes have been noted in the following paragraphs.

9.2 General Instruction Number 4 for the preparation of a CFS, as prescribed in Schedule III of the Act, requires that the entity shall disclose a list of subsidiaries, associates or joint ventures which have not been consolidated in the CFS, along with the reasons for not consolidating. Comments received by the Committee suggested that the Instruction indicated a lack of clarity on the kind of entities to be so disclosed. The Committee noted that the Accounting Standard indicated instances where accounts of subsidiaries, associates or joint ventures was not required to be consolidated; and the recommendations in Paragraph 9.5 would resolve the issue/bring clarity.

9.3 The first proviso to Section 129 (3) of the Act requires that a statement showing salient features of the financial statements of subsidiaries are to be attached with the financial statement of a holding company. It was suggested to the Committee that in case of companies having overseas subsidiaries, the underlying subsidiaries of such subsidiaries not be statutorily required to prepare separate financials and also be exempted from having audited financial statements. The Committee recommended that in such cases, where a CFS was statutorily required to be prepared as per the law of the jurisdiction in which the overseas subsidiary is established and is placed on the website in the statutory format, there should be no requirement for standalone financial statements of the step down subsidiaries to be placed on the website as per 4th proviso to Section 136(1) and included in the salient features that are required to be attached. There should be no exemption in other cases.

9.4 A clarification was also sought during the consultation process, as to whether the financial statements of such overseas subsidiaries, which may have been prepared in accordance with the local GAAP, needed to be prepared as per the Indian GAAP, for the purpose of placing on the website /attachment to the Indian holding company’s financial statement to be filed with the Registrar. The Committee felt that such subsidiaries submit/attach the financial statements as per the statutory/GAAP requirements of the local jurisdiction. No change in the provision is required on this account.

9.5 The Explanation to Section 129(3) provides that “for the purposes of this sub-section, the word “subsidiary” shall include associate company, and joint venture.” The suggestions received stated that some difficulties arose on account of the differences in the definition of a subsidiary under Section 2(87) of the Companies Act, 2013, and the Accounting Standards. In this regard, the Committee noted that revisions in Accounting Standards, to bring them in alignment with the Companies Act, 2013, were already under consideration. It was noted that the treatment in the IndAS would also differ. The Committee, however, felt, that to ensure the same treatment for the consolidation of accounts under the Accounting Standards and the Act, the reference to ‘associates’ and ‘joint ventures’ under Section 129 ought to be amplified/clarified, to be in accordance with the applicable Accounting Standards.

9.6 Suggestions received by the Committee had referred to the provisions of Section 129(4), which provides that the provisions of the Act, applicable to the preparation, adoption and audit of the financial statements of a holding company shall, mutatis mutandis, apply to the consolidated financial statements. It had been stated that a combined reading of Sections 129(3), 129(4), and Sections 143(2) and 143(3) of the Act prescribe the same reporting requirements for the auditors of both the standalone and consolidated financial statements, and that the application of such provisions with respect to the auditor’s reporting requirements under Section 143(3) might not be practical. The Committee felt that the use of phrase “mutatis mutandis” provided sufficient flexibility, and that only applicable reporting for the CFS needs to be done by the auditor. As such, no change was required in Section 129(4). The Committee, however, felt that providing some clarity on the auditors’ reporting requirement (with respect to reporting on the Internal Financial Controls and CARO, and for overseas subsidiaries), for the convenience of stakeholders, in the form of guidance from ICAI to its members should be helpful. This matter has also been dealt with in Paragraph 10.12 of Part I of this report.

Re-opening of accounts

9.7 Section 130 of the Act provides for the re-opening of accounts, after due approval from a court or a Tribunal. The Proviso to Section 130(1) provides that the court or the Tribunal shall give notice to the Central Government, the Income-tax authorities, SEBI or any other statutory regulatory body or authority concerned and shall take into consideration any representations made by them before passing any order under this Section. A suggestion was made during the consultation process that in the interest of the principle of natural justice, other concerned parties, like a company or the Auditor/Chartered Accountant of the company should also be given an opportunity to present their point of view. The Committee deliberated and felt that while a court/Tribunal always had the inherent power to call/give notice to any concerned party in the process, it would be appropriate if a provision was specifically made in the Section enabling the Court/Tribunal to give notice to any other party/person concerned, in addition to those specifically referred to in the provisions.

9.8 A concern was also raised on the absence of any mention about the period up to which the accounts could be re-opened under Section 130. It would be a heavy burden on companies if they have to maintain their accounts forever, or beyond a reasonable time limit because of this provision of re-opening of accounts. The Committee noted that Section 128 of the Act required a company to keep its accounts for a minimum period of eight years, unless a direction was issued under a proviso to Section 128(5) by the Central Government. Thus, it was decided that the applicability of provisions of Section 130 for the re-opening of accounts could be restricted to eight years, unless a longer period is required through a specific direction issued by Central Government, under Section 128(5).

National Financial Reporting Authority

9.9 The Committee noted that ICAI has submitted a letter dated 18th August 2015, wherein ICAI had raised concerns with respect to constitution of National Financial Reporting Authority (NFRA). It was stated that the ICAI is already discharging its regulatory functions with regard to discipline through a robust mechanism wherein a Board of Discipline and Disciplinary Committee with Government nominees has been entrusted with the responsibility, the Chartered Accountants profession sees constitution of NFRA as an interference in the functioning of the profession, multiple layers of regulation would lead to delay/duplication of work and therefore suggested for omission of Section 132. The Committee deliberated in detail on the matter and felt that in view of the critical nature of responsibilities wherein lapses have been seen to cause serious repercussions, the need for an independent body to oversee the profession is a requirement of the day. Major economies of the world have already established such regulatory bodies. The Committee by a majority view recommended that NFRA should be established early. Consultation may, however, be carried out with ICAI with regard to the jurisdiction of NFRA and the ICAI representation on NFRA.

Board’s Reports, etc.

9.10 Section 134(1) of the Act states that the financial statement, including the CFS, is to be signed by the chairperson of the company, where he is so authorised by the Board, or by two directors, out of which one has to be the Managing Director, and the Chief Executive Officer, if he is a director in the company, the Chief Financial Officer and the Company Secretary of the company, wherever they are appointed. It was noted by the Committee that in case a company did not have a managing director, the Chief Executive Officer, irrespective of whether he was a director or not, being a KMP, and responsible for the overall management of the company; should be mandated to sign the financial statements. The Committee also noted that since the appointment of a managing director was not mandatory for all companies, the words “if any”, may be inserted after the words “managing director”.

9.11 Several suggestions pointed out that due to the numerous disclosures in the Board’s Report, the Report had become lengthier, and more expensive to produce. The Committee felt that while some of the disclosures in the Board’s Report under the Companies Act, 1956 was insufficient and had become redundant, there was a need to fine-tune the current requirements, without reducing the information content of the Report. Form MGT-9 be omitted with details regarding shareholding, etc. to be specifically prescribed under section 134(3). Salient points of the CSR Policy, Remuneration Policy may be included in the Report and the detailed documents/policies provided on the website of the company, if any, and web address or link of these documents/policies provided. Changes in the policies should be specifically highlighted in the salient points. Disclosures with regard to loans or investments under section 186 and particulars of contracts with related parties under section 188, if provided in the financial statements, may be only referred, and salient points discussed, in the Board’s Report. Disclosure requirements under Companies (Appointment and Remuneration of Managerial Personnel) Rules, 2014 may be pruned (refer para 13.2 of Part II the report). For small companies, separate format for the Board’s Report may be prescribed.

9.12 The Committee also noted that the Board’s Report and the Financial Statements and the Corporate Governance reporting requirements of SEBI, which together are also called the Annual Report of the company, have duplication in disclosures. It recommended that these need to be harmonized so that the Report is structured, repetition is avoided and made more readable.

9.13 The Committee deliberated on the suggestion of replacing the specific requirement for disclosure, pursuant to the provisions of Section 197(12), of the ratio of the remuneration of each director to the median employee’s remuneration, with a comparison of the director’s remuneration with the weighted average of all the employees, since big companies had a large numbers of workers. The Committee decided to retain this requirement, and not affect any changes. The matter has been also dealt with in Paragraph 13.2 of Part I of this report.

Reporting on Internal Financial Controls

9.14 Section 134(5)(e) of the Act provides that the Board’s Responsibility Statement shall state that the directors of the company, in the case of a listed company, had laid down the internal financial controls to be followed by the company, and that such controls were adequate, and operating effectively. Suggestions received by the Committee stated that directors were facing difficulties in certifying that the directors had laid down the internal financial controls to be followed by the company, and that it should be sufficient for the managing/executive directors to confirm that the company had a mechanism in place for internal financial controls. However, the Committee observed that it was essential to cast this responsibility on the Board in consonance with the fiduciary responsibilities bestowed on the Directors under the Act, and hence, these provisions needed to be retained.

Corporate Social Responsibility

9.15 The Committee, during discussions on the suggestions made with respect to Section 135 of the Act, also considered the recommendations relating to changes in the Act/Corporate Social Responsibility Policy Rules (CSRP Rules) made by the High Level Committee, to suggest measures for improved monitoring of the implementation of the ‘Corporate Social Responsibility Policies’ (High Level CSR Committee), constituted by the MCA.

9.16 Section 135 (1) requires every company having a net worth of Rupees Five Hundred Crore or more; or a turnover of Rupees One Thousand Crore or more; or a net profit of Rupees Five Crore or more, during any financial year, to constitute a ‘Corporate Social Responsibility Committee’ of the Board, consisting of three or more directors, out of which at least one director has to be an independent director. Rule 5(1) of CSR Policy Rules, 2014, allows unlisted companies, private companies, and foreign companies, to have the Committee with less than three directors, and without Independent Directors, where they were not required to be appointed. In this regard, the Committee recommended that, the composition of CSR Committee for companies not required to appoint Independent Directors be prescribed as ‘having two or more Directors’.

9.17 The High Level CSR Committee, in its recommendation at para number 4.17 of the report have suggested clarity to be brought in with regard to ‘any financial year’ as used in Section 135(1) for determining whether the threshold of specified net worth or turnover or net profit is met to constitute the CSR Committee. The Committee recommended that the words “any financial year” be replaced by the words ‘preceding financial year’.

9.18 Rule 2(1)(f) of CSRP Rules, 2014, requires dividend income, etc. to be excluded while calculating the net profit for the purposes of CSR spending. This would lead to an incongruous situation, wherein companies which were not required to spend on CSR, would nevertheless, be required to constitute CSR Committees. Thus, the Committee recommended for this inconsistency to be removed by providing prescriptive powers to exclude certain sums from net profit in Section 135(1) itself.

9.19 Rule 3 of the CSR Policy Rules, 2014 clarifies that foreign companies are also required to comply with the provisions of CSR. The Committee agreed with the principle that the CSR provisions should be applicable to foreign companies, as provided in the Rules. The High Level CSR Committee had also recommended vide its recommendation at para number 4.15 of its Report that clarity be provided on the applicability of the section to foreign companies. The Committee, therefore, recommended that Section 384 of the Act may specifically include this requirement.

9.20 Section 135(3)(a) requires that the CSR Policy shall indicate ‘the activities to be undertaken by the company as specified in Schedule VII’. Schedule VII indicates broad areas, which have been further explained to be interpreted liberally in circular no. 21/2014 issued by MCA. The Committee felt that it would be appropriate for the said clause to be modified to refer to subjects in Schedule VII within which CSR activities could be taken up by an eligible company.

9.21 The Explanation below Section 135(5) provides that for the purpose of this provision, the ‘average net profit’ shall be calculated in accordance with Section 198. The High Level CSR Committee has recommended in para 4.16 of the report for the term “average net profit” to be replaced with the words “net profit”, to remove any ambiguity. The Committee also agreed with the recommendation. Further, prescriptive powers were also recommended to be introduced for specifying the manner of calculation of ‘net profits’ of a foreign company, through Rules, while referring to Section 381.

9.22 The High Level CSR Committee, in paragraph 4.10 of its report, had recommended for allowing a carry forward of unspent amounts, from a particular year; and for transfer of any unspent balance, after a period of five-years, to one of the funds listed in Schedule VII of the Act. The Committee felt that while a carry forward might be desirable, the requirement of mandatorily transferring the unspent amount at the end of five-years would go against the principle of ‘comply or explain’ and would not be appropriate. In view of this, the Committee recommended the continuance of the current provisions, where the actual expenditure was reported with no obligation to carry over.

9.23 The suggestion to allow CSR spends in kind was not agreed to by the High Level Committee on CSR (as specified in para 3.13.2 of its report), in view of various issues (including the valuation issue) involved. The Committee concurred with the aforementioned observation and did not recommend any amendment.

9.24 Section 135 (5) provides that a company has to give preference to the local area, and areas around its areas of operations, for spending the amount earmarked for CSR activities. It had been suggested that government companies be allowed to deposit CSR funds into state coffers/ any CSR Authority established by the State Government, so that it could channelize these according to its priorities. The Committee felt that this would defeat the intent behind the provision and take away the flexibility available with the company. Further, the Committee felt that the requirement with respect to CSR are new provisions, and as such, all companies should be given the required flexibility for a reasonable period, say five-years, to experience the implementation of this provision. Accordingly, no amendment was recommended.

9.25 The High level CSR Committee had recommended for Section 8 companies to be exempted from the provisions on CSR. It had been noted by the said Committee that “Section 8 companies are ‘not for profit’ companies registered under Section 8 of the Companies Act, 2013 (Section 25 of Companies Act, 1956) with the basic object of working in social and developmental sector. Their involvement in charitable and philanthropic activities is already 100 percent. These companies prepare income and expenditure statements which reflect the surplus/deficit of an organization and not the profit of the company. The surplus accrued to such company is not distributed amongst members, but is ploughed back to the expenditure of the company, that in-turn is spent on social welfare activities already included in Schedule VII. Therefore, it may be not necessary for these companies to undertake CSR activities outside the ambit of their normal course of business.” The Committee, however, felt that it would not be appropriate to give differential treatment to section 8 companies in the matter of providing exemptions from compliance of CSR provisions, as there are certain areas where examples could be found of section 8 and other companies co-existing, for example, companies in microfinance business. Further, there should not be a difficulty in section 8 companies using the prescribed percentage of its surplus for CSR activities. Thus, it was decided not to recommend for exemption of Section 8 companies from the CSR provisions of the Act.

Right of member to copies of audited financial statement

9.26 Section 101 of the Act provides for a twenty-one day notice period to call for a general meeting, and also provides for a meeting to be called for at a shorter notice, provided at least ninety-five percent of the voting power consented to such shorter notice. However, under Section 136, for the circulation of annual accounts to the members, the Section requires twenty-one days’ notice, and does not provide for a shorter notice period to circulate the annual accounts. In this regard, the Ministry of Corporate Affairs had issued a circular dated 21st July 2015, in which it had clarified that the shorter notice period would also apply to the circulation of annual accounts. The Committee felt that it would be appropriate that clarity allowing financial statements to be circulated at a shorter period in accordance with the provision for shorter notice meeting under Section 101 be provided in Section 136.

9.27 Item (a) of the 4th proviso to Section 136 (1), provides that every company having a subsidiary or subsidiaries, shall place separate audited accounts in respect of each of its subsidiaries on its website, if any. The Committee considered the suggestion to exempt unlisted companies from the requirement of uploading financial statements of all subsidiaries on the website of the holding company. In this regard, the Committee recommended that requirement should be limited to listed companies in view of their dispersed shareholding and the need for greater regulatory oversight as compared to unlisted companies. However, the Committee did not agree to the suggestion that for listed companies, item (a) would apply only in respect of its Indian subsidiaries. Further, the Committee felt that the requirements under item (b) of the 4th proviso to Section 136 ought to continue to be applicable to all companies, including unlisted companies.