Is P/L Cr Bal part of NW, Free Reserves under CA2013

Most companies have been following the practice of retaining their excess profit under the Profit & Loss Account under the Companies Act, 1956.Suchprofit was usually not transferred to any reserve becausepayingdividendbyutilisingsuchfreereserveswouldentailcertaincomplianceascompared todirectlydistributingitbyutilisingthecreditbalancelyingintheprofitandlossaccount.

However, under the Companies Act,2013 (CA2013),the definition of free reserves does not include the surplus or credit balance in the profit and loss account. Similar is the observation, when one reads the definition of networth under the said Act.

Definition of Reserves

Theterm‘reserve’or‘reserves’havenotbeendefinedintheCA2013.

Definition of Free Reserves

Theterm‘freereserves’hasbeendefinedunderSec2(43)ofCA2013.

Ithasbeendefinedtomean

‘such reserve which, as per the latest audited balance sheet of a company, are available for distributionofdividend

Providedthat-

i.any amount representing unrealised gains, notional gains or revaluation of assets, whethershownasreserveorotherwiseor

ii.anychangeincarryingamount ofanasset or ofaliabilityrecognizedinequity,including surplus intheprofit andloss account onmeasurementoftheassets or theliabilityat the fairvalue,

shallnotbetreatedasfreereserve.’

DefinitionofNetWorth

Theterm‘networth’hasbeendefinedunderSec2(57)ofCA2013.

It has been defined to mean ‘the aggregate value of the paid-up share capital and all reserves created out of profits of the company and securities premium account after deducting aggregate valueoftheaccumulatedlosses,deferredexpenditureandmiscellaneousexpenditurenotwrittenoff, as per the audited balance sheet, but does not include reserves created out of revaluation of assets,write-backofdepreciationandamalgamation’

Isprofitandlossaccounta‘reserve’or‘surplus’?

As mentionedabove, CA2013 does not define Reserve. However, uponreadingTable FofSchedule I of CA 2013, one would notice that Clause 82(ii) of Table F states that “the Board may also carry forward any profits which it may consider necessary not to divide, without setting them aside as a reserve”. The above clause, though not mandatory to be adopted by all companies suggests that profits carriedforward,if any wouldnotformpartofreserves.Inother words,the aboveexpression brings out the distinction between reserve and carried forward profits (i.e. which has not been set asideasreserve).Hence,TableFimpliesthatacompanymayopttosetasidecarriedforwardprofits asreserveorcarryitforwardas“profit”inthebalancesheetwhichwouldbeconsideredasSurplus.

In order to substantiate the above view, it would also be pertinent to refer to General Instructions forpreparationofbalancesheetinScheduleIIIoftheCA2013whereinitismentionedthat‘Surplus’ refers to balance in Statement of Profit and Loss Account after disclosing allocation and appropriations made by the company such as dividend, bonus shares and transfer to/from reserves and further Debit balance of statement of profit and loss shall be shown as a negative figure under thehead‘Surplus’.

Schedule III, therefore, lays down the difference between reserves and surplus. Clearly, credit balance in profit and loss account is to be treated as surplus and not reserve. The intention of the lawmakersisquiteevidentfromtheabove.

While calculating net worth under CA 2013, will credit balance in profit and loss account (i.e. not setasideasreserve)beincluded?

No.

From the definition of net worth prescribed under the CA 2013, it is clearly evident that the aggregate value of reserves created out of the profits of the company will only be considered and profits/surplusshallnotbeincluded.

While calculating net worth under CA 2013, will debit balance in profit and loss account be excluded?

Yes.Accumulatedlossesaretobeexcludedasisevidentfromtheabovedefinition.

While calculating free reserves under CA 2013, will credit balance in profit and loss account (i.e. notsetasideasreserve)beincluded?

No. As evident from the definition, while calculating free reserves only the specified reserves are to be considered. The definition does not mention inclusion of surplus or credit balance of profit and lossaccount.

Whatistheimpactoftheabove?

ThecompaniesshouldtakecarewhiledealingwiththefollowingprovisionsoftheCA2013

i.CalculatingthelimitsunderSec180

ii.CalculatingthelimitsunderSec186

iii.CalculatingNetWorthwhilefillingupMGT-7andalsowheneverrequired.