Paragraph 2 of the Order provides that it shall not apply to:
- a banking company as defined in clause (c) of section 5 of the Banking Regulation Act, 1949 (10 of 1949);
- an insurance company as defined in clause (21) of section 2 of the Companies Act, 1956 (1 of 1956);
- a company licensed to operate under section 25 of the Companies Act, 1956 (1 of 1956); and
- a private limited company with a paid-up capital and reserves not more than rupees fifty lakh and which does not have outstanding loan exceeding rupees twenty five lakhs from any bank or financial institution and does not have a turnover exceeding rupees five crores at any point of time
during the financial year.
The Order specifically exempts banking companies, insurance companies and companies which have been licensed to operate under section 25 of the Act. Section 25 applies to companies which have been formed or are about to be formed as limited companies for promoting commerce, art, science, religion, charity or any other useful object and which apply or intend to apply their profits, if any, or other income in promoting their objects and prohibit the payment of any dividend to their members. Such companies are usually in the form of clubs, chambers of commerce, research institutions, etc. Further,
the Order would not also apply in case of non-banking finance company, which converts into a banking company and as on the balance sheet date is a banking company. The specific exemption under the Order is given to companies licensed under section 25 of the Act. However, it would appear that in view of the provisions of section 656 of the Act, the exemption would also extend to similar companies registered under any earlier Companies Act.
The Order also exempts from its application a private limited company which fulfils all the following conditions throughout the reporting period covered by the audit report:
- its paid-up capital and reserves are rupees fifty lakh or less;
- its outstanding loan from any bank or financial institution are rupees twenty five lakh or less; and
- its turnover does not exceed rupees five crore.
A private limited company, in order to be exempt from the applicability of the Order, must satisfy all the conditions mentioned above cumulatively. In other words, even if one of the conditions is not satisfied, a private limited company’s auditor has to report on the matters specified in the Order.
Private Limited Company: The term “private limited company”, as used in the Order, should be construed to mean a company registered as a “private company” {as defined in clause (iii) of sub-section (1) of section 3 of the Act} and which has a limited liability. In other words, the Order would be applicable to private unlimited companies irrespective of the size of their paid-up capital and reserves, turnover, borrowings from banks/financial institutions2. Another important issue to consider in respect of reporting under the Order is the reporting responsibilities of the auditor of a branch of a private limited company in case the branch fulfills the conditions for exemption from the applicability of the Order. In this regard, it may be noted that the
conditions to be satisfied for being exempt from the applicability of the Order have been laid down in respect of the company taken as a whole. Therefore, a branch of a company does not qualify to be exempted from the applicability of the Order, if the Order is applicable to the company. The branch auditor has the same reporting responsibilities in respect of the branch as those of the auditor appointed under section 224 of the Act has in respect of the company. The comments of the branch auditor in respect of the branch are dealt with by the auditor of the company appointed under section 224 of the Act while finalizing his report under the Order.
Paid-up Capital and Reserves
Sub-section (32) of section 2 of the Act defines the term “paid-up capital” as capital credited as paid-up. The Guidance Note on Terms Used in Financial Statements, issued by the Institute of Chartered Accountants of India, defines the term “paid-up share capital” as, “that part of the subscribed share capital for which consideration in cash or otherwise has been received. This includes bonus shares allotted by the corporate enterprise”. Paid-up share capital would include both equity share capital as well as the preference share capital. While calculating the paid-up capital, amount of calls unpaid should be deducted from and the amount originally paid-up on forfeited shares should be added to the figure of paid-up capital. Share application money received should not be considered as part of the paid-up capital. The Guidance Note on Terms Used in Financial Statements defines the term “reserve” as, “The
portion of earnings, receipts or other surplus of an enterprise (whether capital or revenue)appropriated by management for a general or specific purpose other than provision for depreciation or diminution in the value of assets or for a known liability. The reserves are primarily of two types: capital reserves and revenue reserves”. Clause 7(1)(b) of Part III of Schedule VI to the Act also defines the term “reserve” by way of a negative explanation. According to the said definition, the expression “reserve” does not include any amount written off by way of providing for depreciation, renewals or diminution in the value of assets or retained by way of providing for any known liability. Thus, a reserve has to be clearly distinguished from a provision. As mentioned in the preceding paragraph, reserves are primarily of two types–capital reserves and revenue reserves. According to the Guidance Note on Terms Used in Financial Statements, the term “capital reserve” means “a reserve of a corporate enterprise which is not available for distribution as dividend”. The said Guidance Note defines the term “revenue reserve” as “any reserve other than capital reserve”. For determining the applicability of the Order to a private
limited company, both capital as well as revenue reserves should be taken into consideration while computing the limit of rupees fifty lakhs prescribed for paid-up capital and reserves. Revaluation reserve, if any, should also be taken into consideration while determining the figure of reserves for the limited purpose of determining the applicability of the Order. The credit balance in the profit and loss account should also be considered as a part of reserve since the balance in the profit andloss account is available for general purposes like declaration of dividend. The debit balance of the profit and loss account, if any, should be reduced from the figure of revenue reserves only. Therefore, if the company does not have revenue reserves, debit balance of profit and loss account cannot be reduced from the figures of paid-up capital, capital reserves and revaluation reserves. For example, if the company has Rs. 40 lakhs of paid up share capital, Rs. 5 lakhs as Revaluation Reserve, Rs. 6 lakhs in Capital Reserve and Rs. 6 lakhs as debit balance in the Profit and Loss Account, the amount of Rs. 6 lakhs standing to the debit of Proft and Loss Account cannot be deducted from the figures of Rs. 11 lakhs, being the total of the Revaluation Reserve and the Capital Reserve. However, miscellaneous expenditure to the extent not written off should not be deducted from the figure of reserves for the purpose of computing the above limit.
Loan Outstanding
Loans from banks or financial institution are normally in the form of term loans, demand loans, export credits, working capital limits, cash credits, overdraft facilities, bills purchased or discounted. Outstanding balances of such loans should be considered as loan outstanding for the purpose of computing the limit of rupees twenty five lakhs. Non-fund based credit facilities, to the extent such facilities have devolved and have been converted into fund-based credit facilities, should also be considered as outstanding loan. The figures of outstanding loan would also include the amount of bank guarantees issued by the company where such guarantee(s) has (have) been invoked and encashed or where, say, a Letter of Credit has devolved on the company. In case of term loans, interest accrued and due is considered as a loan whereas interest accrued but not due is not considered as a loan. Further, in case the company enjoys a facility, say, a cash credit facility, whose balance is fluctuating in nature, the Order would apply to the company in case on any day during the financial year concerned, the amount outstanding in the cash credit facility exceeds Rs. 25 lakhs. The condition laid down in the Order is that the outstanding loan from a bank or financial institution is exceeding Rs. 25 lakh. There is no stipulation in the Order that the loan should be a long-term loan or a short-term loan or that it should be a secured loan or an unsecured loan. Therefore, the Order would be applicable to a private limited company even if the loan outstanding is a short-term loan. Further, the condition would also apply notwithstanding the fact that the company has been granted an overdraft facility against, say, fixed deposits, of the company with the concerned bank. Moreover, outstanding dues in respect of credit cards would also be considered while calculating the limit of Rs. 25 lakh in respect of loan outstanding from a bank or financial institution. It is clarified that since the words used by the Order are ‘any bank or financial institution’, the limit of “exceeding twenty five lakh rupees” would apply in aggregate to all
loans and not with reference to each bank or financial institution. For example, if a private limited company has three outstanding loans of rupees nine lakhs each from two banks and a financial institution, the Order would be applicable to such a private limited company. Another important point to note with respect to loans outstanding is that even in case where the company had taken a loan from a bank in excess of Rs. 25 lacs but the year end balance of the same is NIL, the company would be covered by the Order notwithstanding that it fulfills all other conditions for exemption from the Order.
Financial Institution
Explanation to sub-clause (xi) of Rule 2(b) of the Companies (Acceptance of Deposits) Rules, 1975 explains the term “financial institution”. The term “financial institution” used in the Order should be construed to have the same meaning as assigned to it in the explanation to the said sub-clause in the Companies (Acceptance of Deposits) Rules, 1975. It may, however, be noted that a non-banking financial company is not a “financial institution”. A list of financial institutions covered under the Rules is given in Appendix VI to this Statement. Further, private banks or foreign banks are banking institutions under the Banking Regulation Act, 1949. Therefore, loans taken from a private bank or a foreign bank would also be taken into consideration while examining the applicability of the Order
Turnover
The term, “turnover”, has not been defined by the Order. Part II of Schedule VI to the Act, however, defines the term “turnover” as the aggregate amount for which sales are effected by the company. It may be noted that the “sales effected” would include sale of goods as well as services rendered by the company. In an agency relationship, turnover is the amount of commission earned by the agent and not the aggregate amount for which sales are effected or services are rendered. The term “turnover” is a commercial term and it should be construed in accordance with the method of accounting regularly employed by the company. For ascertaining the limit of rupees five crores:
- sales tax collected or excise duty collected should not be taken into account if they are credited separately to sales tax account or excise duty account;
- trade discounts should be deducted from the figure of turnover;
- commission allowed to third parties should not be deducted from the figure of turnover;
- sales returns should be deducted from the figure of turnover even if the returns are from the sales made in the earlier years. As a corollary, any sales returns etc., in respect of the sales made during the year under report, if received after the end of that year, would not be deductible from the figure of turnover of such year; and
- The income received by way of rent or dividend/interest would not form part of “turnover”. However, Part II of Schedule VI to the Companies Act, 1956 clarifies that in case of companies rendering or supplying services, gross income derived from services rendered or supplied, would be shown as turnover. Therefore, in cases where the principal business of the company is letting out of property of the company or it is an investment company, the rent or dividend/interest, respectively, would constitute “turnover”.
Date of Determination of Limits
The Order clarifies the point of time at which various limits laid down by the Order are to be tested for determining its applicability to a private limited company. It clarifies that the Order would become applicable to a private limited company if, at any point of time, during the financial year covered by the audit report:
- its paid-up capital and reserves exceed the limit of rupees fifty lakh; or
- it has loan outstanding exceeding rupees twenty five lakh, or
- its turnover exceeds rupees five crore.
