Introduction to Exemptions/Relaxations in Accounting Standards for SMCs

Table of Contents

1. Cash Flow Statements
2. AS 15 – Employee Benefits
3. AS 17 – Segment Reporting
4. AS 19 – Leases

Check out Taxmann's Accounting Standards (AS) which provides the updated Accounting Standards Rules, 2021, notified under the Companies Act, 2013, [Enforced with effect from 01-04-2021]. It also incorporates a guide on various exemptions for Small and Medium Companies (SMCs) and a checklist for the applicability of these standards for both SMCs and Non-SMCs.

1. Cash Flow Statements

As per the definition of ‘financial statements’ under the Companies Act, 2013, financial statements include cash flow statement. In the case of one-person company, small company and dormant company, financial statements may not include cash flow statements.

SMCs often do not have the required accounting/financial reporting resources. AS 3 exempts one-person company, small company and dormant company from the requirement to prepare cash flow statements.

It is to be noted here that the exemption does not refer to the companies which meet the SMC definition but extends the definition to a one-person company, small company, and dormant company.

Section 2(62) of the Companies Act, 2013 defines a one-person company to mean a company that has only one person as a member.

Section 2(85) defines a small company to mean a company, other than a public company—

(a) paid-up share capital of which does not exceed Rs. 50 lakh or such higher amount as may be prescribed which shall not be more than Rs. 5 crore; or

(b) turnover of which as per its last profit and loss account does not exceed Rs. 2 crore or such higher amount as may be prescribed which shall not be more than Rs. 20 crores:

Provided that nothing in this clause shall apply to:

(a) a holding company or a subsidiary company;

(b) a company registered under section 8; or

(c) a company or body corporate governed by any special Act;

To be a small company, company would have to satisfy the criteria in sub-clause (i) as well as the criteria in sub-clause (ii) of clause (85) of section 2. In other words, both the paid-up share capital threshold as well as the turnover threshold should not be exceeded.

In the Companies (Specification of Definitions Details) Rules, 2014, in the rule 2, in sub-rule (1), clause (t) provides that “For the purposes of sub-clause (i) and sub-clause (ii) of clause (85) of section 2 of the Act, paid up capital and turnover of the small company shall not exceed rupees two crores and rupees twenty crores respectively.”

Clause (t) as above is effective from 1-4-2021.

Accordingly, w.e.f. 1-4-2021, the paid up share capital limit for small companies stand increased from ` 50 lakhs to ` 2 crores and the turnover limit for small companies have been increased from ` 2 crores to ` 20 crores.

Section 455 of the Companies Act, 2013 deals with dormant companies. It states as follows:

(a) Where a company is formed and registered under this Act for a future project or to hold an asset or intellectual property and has no significant accounting transaction, such a company or an inactive company may make an application to the ROC in such manner as may be prescribed for obtaining the status of a dormant company;

(b) “inactive company” means a company that has not been carrying on any business or operation, or has not made any significant accounting transaction during the last two financial years, or has not filed financial statements and annual returns during the last two financial years;

(c) Significant accounting transaction means any transaction other than:

• • • payment of fees by a company to the Registrar;
    • payments made by it to fulfil the requirements of this Act or any other law;
    • allotment of shares to fulfil the requirements of this Act; and
    • payments for maintenance of its office and records.

(d) The ROC on consideration of the application shall allow the status of a dormant company to the applicant and issue a certificate in such form as may be prescribed to that effect.

(e) A dormant company shall have such minimum number of directors, file such documents and pay such annual fee as may be prescribed to the Registrar to retain its dormant status in the register and may become an active company on an application made in this behalf accompanied by such documents and fee as may be prescribed.

(f) The ROC shall strike off the name of a dormant company from the register of dormant companies, which has failed to comply with the requirements of Section 455.

Although, this exemption does not directly refer to SMC under the Rules, but it is expected that one-person companies, small companies or dormant companies would also meet the definition of SMC under these Rules.

2. AS 15 – Employee Benefits

2.1 Short term compensated absences or employee leave benefits

A company may compensate employees for absence for various reasons, including vacation, sickness and short-term disability, and maternity or paternity. Entitlement to compensated absences falls into two categories:

(a) accumulating; and

(b) non-accumulating.

2.2 Accumulating compensated absences

Accumulating compensated absences are carried forward and can be used in future periods if the current period’s entitlement is not used in full. It may be either vesting (in other words, employees are entitled to a cash payment for unused entitlement on leaving the enterprise) or non-vesting (when employees are not entitled to a cash payment for unused entitlement on leaving).

An obligation arises as employees render service that increases their entitlement to future compensated absences. The obligation exists and is recognized, even if the compensated absences are non-vesting. However, the possibility that employees may leave before they use an accumulated non-vesting entitlement affects the measurement of that obligation.

An enterprise should measure the expected cost of accumulating compensated absences the enterprise expects to pay due to the unused entitlement accumulated at the balance sheet date.

For example, an enterprise has 100 employees, each entitled to five working days of leave for each year. Unused leave may be carried forward for one calendar year. The leave is taken first out of the current year’s entitlement and then out of any balance brought forward from the previous year (a LIFO basis).

As at 31st December 20X1, the average unused entitlement is two days per employee. Based on past experience, the enterprise expects that 92 employees will take no more than five days of leave in 20X2 and that the remaining eight employees will take an average of six and a half days each.

The enterprise expects that it will pay an additional 12 days of pay as a result of the unused entitlement that has accumulated at 31 December 20X1 (one and a half days each, for eight employees). Therefore, the enterprise recognises a liability, as at 31st December 20X2, equal to 12 days of pay.

An SMC need not comply with the above recognition & measurement requirements for short-term accumulating compensated absences which are non-vesting (i.e., short-term accumulating compensated absences in respect of which employees are not entitled to cash payment for unused entitlement on leaving).

The exemption for SMC is only for non-vesting leave benefits and not for vesting leave benefits. In other words, if the leave policy of the company provides that the employees are permitted to encash their unavailed leave balance either at the year end or at the time of their retirement/resignation, the nature of the compensated absences would be vesting. In such a case, the SMC shall follow the above general requirements of AS 15, and there is no exemption.

On the other hand, if the leave policy provides that the employees shall not encash their unavailed leave balances, the nature of the policy shall be non-vesting. Therefore, the SMC need not account for such benefits as per AS 15. In other words, the SMC may not accrue the liability in the current year for unavailed employee leave balances or employee leave balances for which there is no payment obligation on the SMC, even if there is an obligation towards the employees to carry forward the unavailed leave balance to the next year and the employee can take leave with pay against their carried forward leave balances.

2.3 Defined contribution plan obligation beyond 12 months

For example, contribution to Employee Provident Fund, State Plans and Insured Benefits are covered defined contribution plan under AS 15. These plans should be accounted as an expense on an accrual basis.

AS 15 states that where contributions to a defined contribution plan do not fall due wholly within 12 months after the end of the period in which the employees render the related service, they should be discounted.

An SMC may not discount contributions that fall due more than 12 months after the balance sheet date. The SMC, therefore, may account for the obligation on a gross undiscounted basis.

2.4 Defined benefit plan obligations and Other long-term employee benefits

Defined benefit plans are an enterprise’s obligation to provide the agreed benefits to current and former employees. For example, a gratuity scheme is a defined benefit plan. The actuarial risk (that benefits will cost more than expected) and investment risk fall, in substance, on the enterprise.

AS 15 requires accounting for defined benefit plans using the following steps:

(a) Use actuarial techniques to make a reliable estimate of the amount of benefit that employees have earned in return for their service in the current and prior periods;

(b) Discount that benefit using the Projected Unit Credit Method to de- termine the present value of the defined benefit obligation and the current service cost;

(c) Determine the fair value of any plan assets;

(d) Determining the total amount of actuarial gains and losses;

(e) Where a plan has been introduced or changed, determining the resulting past service cost; and

(f) Where a plan has been curtailed or settled, determining the resulting gain or loss Actuarial gains and losses should be recognized immediately in the Statement of Profit and Loss as income or expense.

Other long-term employee benefits are employee benefits (other than post-employment benefits and termination benefits) which do not fall due wholly within twelve months after the end of the period in which the employees render the related service.

AS 15 requires the amount recognised as a liability for other long-term employee benefits as follows:

(a) the present value of the defined benefit obligation at the balance sheet date

(b) minus the fair value at the balance sheet date of plan assets (if any) out of which the obligations are to be settled directly

An enterprise should recognise the net total of the following amounts as expense or (subject to paragraph 59 of AS 15) income, except to the extent that another Accounting Standard requires or permits their inclusion in the cost of an asset:

(a) current service cost

(b) interest cost

(c) the expected return on any plan assets and on any reimbursement right recognised as an asset

(d) actuarial gains and losses, which should all be recognised immediately

(e) past service cost, which should all be recognised immediately

(f) the effect of any curtailments or settlements.

In case of SMCs, recognition and measurement principles in respect of ac- counting for defined benefit plans and other long-term employee benefits are not mandatory. However, SMCs should actuarially determine and provide for the accrued liability in respect of defined benefit plans as follows:

(a) The method used for actuarial valuation should be the Projected Unit Credit Method; and

(b) The discount rate used should be determined by reference to market yields at the balance sheet date on government bonds.

2.5 Offset and Presentation requirements

AS 15 states that an enterprise should offset an asset relating to one plan against a liability relating to another plan when, and only when, the enterprise:

(a) has a legally enforceable right to use a surplus in one plan to settle obligations under the other plan; and

(b) intends either to settle the obligations on a net basis or realise the surplus in one plan and simultaneously settle its obligation under the other plan.

AS 15 does not specify whether an enterprise should present current service cost, interest cost, and the expected return on plan assets as components of a single item of income or expense on the face of the statement of profit and loss.

SMCs may not apply the presentation above requirements in respect of accounting for defined benefit plans.

2.6 Disclosures of Defined Benefit Plan

AS 15 prescribes detailed disclosures for defined benefit plan obligations, including:

(a) Accounting policies;

(b) Description of the plan;

(c) Reconciliation of opening and closing balances;

(d) Analysis of unfunded defined benefit obligations;

(e) Reconciliation of the present value of the defined benefit obligation;

(f) The total expense recognised in the statement of profit and loss;

(g) Narrative description of the basis used to determine the overall expected rate of return on assets;

(h) Actual return on plan assets; and

(i) Principal actuarial assumptions used.

SMC may not apply the disclosure requirements laid down in AS 15 in respect of accounting for defined benefit plans. However, such a company should disclose actuarial assumptions as per paragraph 120(l) of the Standard.

2.7 Termination benefits

Termination benefits are employee benefits payable as a result of either:

(a) an enterprise’s decision to terminate an employee’s employment before the normal retirement date; or

(b) an employee’s decision to accept voluntary redundancy in exchange for those benefits (voluntary retirement).

AS 15 requires an enterprise to recognise termination benefits as a liability and an expense when, and only when:

(a) the enterprise has a present obligation as a result of a past event;

(b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

(c) a reliable estimate can be made of the amount of the obligation.
SMCs need not discount contributions that fall due more than 12 months after the balance sheet date.

2.8 Transitional Provisions for defined benefit obligation

An enterprise may disclose the amounts required by paragraph 120(n) (the amounts for the current annual period and previous four annual periods of the present value of the defined benefit obligation, the fair value of the plan assets and the surplus or deficit in the plan; and the experience adjustments) as the amounts are determined for each accounting period prospectively from the date the enterprise first adopts AS 15 under the Rules.

This is a useful transition provision for a company applying the disclosure paragraph 120(n) for first time, for example, by virtue of the company not meeting the SMC criteria under the definition and becoming a non-SMC.

2.9 Transition provision for defined benefit plan

On first adopting this Standard, an enterprise should determine its transitional liability for defined benefit plans at that date as:

(a) the present value of the obligation at the date of adoption;

(b) minus the fair value, at the date of adoption, of plan assets (if any) out of which the obligations are to be settled directly;

(c) minus any past service cost that, under paragraph 94, should be recognised in later periods.

If the transitional liability is more than the liability that would have been recognised at the same date as per the pre-revised AS 15, the enterprise should make an irrevocable choice to recognise that increase as part of its defined benefit liability under paragraph 55

(a) immediately as an adjustment against the opening balance of revenue reserves and surplus (as adjusted by any related tax expense), or

(b) as an expense on a straight-line basis over up to five years from the date of adoption.

(c) If an enterprise chooses (b), the enterprise should:

• • • apply the limit described in paragraph 59(b) in measuring any asset recognised in the balance sheet;
    • disclose at each balance sheet date (1) the amount of the increase that remains unrecognised; and (2) the amount recognised in the current period;
    • limit the recognition of subsequent actuarial gains (but not negative past service cost) only to the extent that the net cumulative unrecognised actuarial gains (before recognition of that actuarial gain) exceed the unrecognised part of the transitional liability; and
    • include the related part of the unrecognised transitional liability in determining any subsequent gain or loss on settlement or curtailment.

If the transitional liability is less than the liability that would have been recognised at the same date as per the pre-revised AS 15, the enterprise should recognise that decrease immediately as an adjustment against the opening balance of revenue reserves and surplus.

For Example, As at 31st March 20X7, an enterprise’s balance sheet includes a pension liability of Rs. 100, recognised as per the pre-revised AS 15 issued by the ICAI in 1995. The enterprise adopts the Standard as of 1st April 20X7, when the present value of the obligation under the Standard is Rs. 1,300 and the fair value of plan assets is Rs. 1,000. On 1st April 20X1, the enterprise had improved pensions (cost for non-vested benefits: Rs. 160; and average remaining period at that date until vesting: 10 years).

The transitional effect is as follows:

(Amount in Rs.)

An enterprise may choose to recognise the increase in liability (as adjusted by any related tax expense) either immediately as an adjustment against the opening balance of revenue reserves and surplus as on 1 April 20X7 or as an expense on straight line basis over up to five years from that date. The choice is irrevocable.

At 31 March 20X8, the present value of the obligation under the Standard is Rs. 1,400 and the fair value of plan assets is Rs. 1,050. Net cumulative unrecognised actuarial gains since the date of adopting the Standard are Rs. 120. The enterprise is required, as per paragraph 92, to recognise all actuarial gains and losses immediately.

The effect of the limit in paragraph 145(b)(iii) is as follows:

(Amount in Rs.)

2.10 Transition provision for employee benefit obligation other than defined benefit plan and termination benefits

Where an enterprise first adopts AS 15 under these Rules for employee benefits, the difference (as adjusted by any related tax expense) between the liability in respect of employee benefits other than defined benefit plans and termination benefits, as per this Standard, existing on the date of adopting this Standard and the liability that would have been recognised at the same date, as per the pre-revised AS 15 issued by the ICAI in 1995, should be adjusted against opening balance of revenue reserves and surplus.

3. AS 17 – Segment Reporting

AS 17 is not mandatory for SMCs. Such Companies are, however, encouraged to comply with AS 17.

4. AS 19 – Leases

4.1 Disclosures by lessee in case of finance lease

SMCs have been exempted from following disclosures by lessee for finance leases:

(a) Reconciliation between the total of minimum lease payments at the balance sheet date and their present value. In addition, an enterprise should disclose the total of minimum lease payments at the balance sheet date, and their present value, for each of the following periods:

• • • not later than one year;
    • later than one year and not later than five years;
    • later than five years;

(b) Total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date; and

(c) General description of the lessee’s significant leasing arrangements including, but not limited to, the following:

• • • the basis on which contingent rent payments are determined;
    • the existence and terms of renewal or purchase options and escalation clauses;
    • restrictions imposed by lease arrangements, such as those and concerning dividends, additional debt, and further leasing.

4.2 Disclosures by lessee in case of operating lease

SMCs have been exempted from the following disclosures by lessee for operating leases:

(a) the total of future minimum lease payments under non-cancellable operating leases for each of the following periods:

• • • not later than one year;
    • later than one year and not later than five years;
    • later than five years

(b) the total of future minimum sublease payments expected to be received under non-cancellable subleases at the balance sheet date;

(c) a general description of the lessee’s significant leasing arrangements including, but not limited to, the following:

• • • the basis on which contingent rent payments are determined;
    • the existence and terms of renewal or purchase options and escalation clauses; and
    • restrictions imposed by lease arrangements, such as those concerning dividends, additional debt, and further leasing.

4.3 Disclosures by the lessor in case of finance lease

SMCs have been exempted from the following disclosures by lessor for finance leases:

(a) a reconciliation between the total gross investment in the lease at the balance sheet date, and the present value of minimum lease payments receivable at the balance sheet date.

(b) In addition, an enterprise should disclose the total gross investment in the lease and the present value of minimum lease payments receivable at the balance sheet date, for each of the following periods:

• • • not later than one year;
    • later than one year and not later than five years;
    • later than five years;

(c) a general description of the significant leasing arrangements of the lessor.