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CASE NO.: Appeal (civil)  3761 of 2007

PETITIONER: J. K. Industries Ltd. & Anr

RESPONDENT: Union of India & Ors

DATE OF JUDGMENT: 19/11/2007

BENCH: S.H. Kapadia & B. Sudershan Reddy

JUDGMENT: J U D G M E N T With

Civil Appeal Nos.3478/2007, 3479/2007, 3480/2007 and 3482/2007.

KAPADIA, J.

1.      A short question which arises for determination in this  batch of civil appeals is :  

\023Whether Accounting Standard 22 (AS 22) entitled  \023accounting for taxes on income\024 insofar as it  relates to deferred taxation is inconsistent with and   ultra vires the provisions of the Companies Act,  1956 (the Companies Act), the Income-tax Act, 1961  (I.T. Act) and the Constitution of India?\024

2.      M/s. J.K. Industries Ltd. is a public limited company.  It  was incorporated in 1951.  It carries on the business of  manufacture and sale of automotive tyres, tubes, sugar and  agrigenetics.  It has a registered office at Calcutta.  It seeks to  challenge AS 22 issued by Institute of Chartered Accountants of  India (for short, \023Institute\024) which has been made mandatory for  all companies listed in Stock Exchanges in India in preparation  of their accounts for the financial year 2001-02 onwards.         3.      On 7.12.06 the Central Government prescribed AS 22 under  Section 211 (3C) of the Companies Act by the Companies (AS)  Rules 2006.  Before that date, AS 22, when issued in 2001, was  challenged in writ petitions filed before Madras, Karnataka,  Calcutta and Gujarat High Courts.  On transfer petitions, under  Section 139A of the Constitution, filed by the Institute, this Court  vide order dated 17.2.03 was pleased to transfer the writ  petitions filed in various High Courts to the Calcutta High Court.       Meaning and purpose of AS:

4.      In its origin, Accounting Standard is a policy statement or  document framed by Institute.  Accounting Standards  establishes rules relating to recognition, measurement and  disclosures thereby ensuring that all enterprises that follow them  are comparable and that their financial statements are true, fair  and transparent.  Accounting Standards (\023A.S.\024 for short) are  based on a number of accounting principles.  They seek to arrive  at true accounting income.  One such principle is the matching  principle.  The other is fair value principle.  The aim of the  Institute is to go for paradigm shift from matching to fair value

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principle.         5.      Today the revised Accounting Standards seeks to arrive at  true accounting income.   In the age of globalization the attempt  is to reconcile the accounts of Indian companies with their joint  venture partners abroad.  The aim is to harmonise Indian  Accounting Standards with International Accounting Standards.  With the object of bridging gap between IAS and IFRS, the  Institute formulated new A.S. and introduced new concepts, e.g.,  Deferred Tax Accounting (AS 22 impugned herein), Segment  Reporting (AS 17) etc.. However, as a matter of prudence and  necessary adjustment, to arrive at real income, Accounting  Standards require provision to be made for liabilities payable in  future, provision to be made for contingencies, provision to be  made for diminution, provision to reflect impairment and so on  which have the effect of reducing incomes and were, therefore,  not readily accepted by some enterprises and tax authorities.   6.      The core of Accountancy is Book-keeping.  The rules of  Book-keeping are clear.  For example, the value of a fixed asset  mentioned in a Balance Sheet is based on cost which may involve  subjective estimation of the amount to be apportioned.  Similarly,  the quantum of depreciation is again an estimate, which can vary  depending on the persons preparing the accounts as to when and  at what stage he wants to record the depreciation.  Accounting  Standards are an attempt to overcome some of these deficiencies  of Accountancy.  Accounting Standards involve codification of  fundamental accounting rules, rules which explain and  standardize the application of the fundamental rules to a variety  of uncertain situations like \026 retirement, contingencies,  intangibles, consolidation, merger etc.  Accounting Standards  basically attempt to reduce the subjectivity and lay down rules so  as to arrive at the best possible estimates.  For example, net  assets refer to the difference between total assets less liabilities  but the value attributable to each asset and each liability is often  subjective.  It depends on estimates.  This is where the  Accounting Standards help.  They reduce the subjectivity.   Therefore, Accounting Standards help to arrive at the best  possible estimates.  This estimation/subjectivity is also on  account of the conceptual difference between \023accounting  income\024 and \023taxable income\024.  Accounting income is the real  income.  Tax laws lay down rules for valuation of inventories,  fixed assets, depreciation, bad debts, etc. based on artificial rules  and not on the basis of accounting estimates, which results in  mismatch between accounting and taxable incomes.  For  example, a fixed rate of depreciation may, for some companies,  result in computing lower than the actual income if the actual  erosion in the value of the asset is lower than the depreciation  calculated at the fixed rate and higher than actual income for  others where assets erode faster.  Accounting income is normally  used as a relevant measure by most stakeholders.  However, on  account of artificial set of rules used in computation of taxable  income one finds that accounting income differs from taxable  income.  Looking to these problems, the evolution of Accounting  Standards and their greater application is necessary as it results  in reducing the need for tax laws to depend upon artificial rules.   The object of Accounting Standards is, therefore, to standardize  and to narrow down the options.  The object of Accounting  Standards is to evolve methods by which \023accounting income\024 is  determined.  The object behind the Accounting Standards is to  evolve methods by which accounting income is determined, made  more transparent and leave less and less room for subjective  selection of methods and provide for more attention to the quality  of estimates used in arriving at accounting income.         7.      The main object sought to be achieved by Accounting

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Standards which is now made mandatory is to see that  accounting income is adopted as taxable income and not merely  as the basis from which taxable income is to be computed.   Thus, if the rules by which inventories are to be valued are laid  down in the Accounting Standards and are followed in the  determination of accounting income, then tax laws do not need to  lay down the rules and the tax authorities do not need to  examine the computation of the value of inventories and its effect  on computation of income.  Similarly, if there is an accounting  standard on depreciation which requires estimation of the useful  life and prescribes the appropriate method for apportionment of  cost of fixed assets over their useful life, it is unnecessary for tax  laws to apply an artificial rule to decide the extent of allowance  for depreciation.   8.      Finally, the adoption of Accounting Standards and of  accounting income as \023taxable income\024 would avoid distortion of  accounting income which is the real income.         Reasons for introducing AS 22: 9.      In the backdrop of globalization and liberalization the world  has become an economic village.  Today, the capital market all  over the world knows no barriers.  Fiscal distances and barriers  have been removed by developments in transport,  communication and e-commerce.  In this backdrop, Convergence  of Accounting Standards is aimed at removing barriers in the  flow of financial information and capital.  Based on the above  developments in the global economy and the Indian economy, the  conceptual differences and consequent deviations in the National  Accounting Standards and IFRS have got to be eliminated.  For  example, exchange difference in respect of unpaid liability for  acquisition of an imported asset has been allowed in the past to  be adjusted with the carrying costs of the fixed assets instead of  recognizing the exchange difference in the profit and loss  account.         10.     Lastly, it is important to note that Accounting Standards  and taxation of income are two independent subjects. The object  behind AS is to remove this divergence by making Accounting  Income a Taxable Income. Accounting income can never negate  True Income.        Relevant provisions of  the Companies Act, 1956 and  Analysis thereof:

11.     Before analyzing the provisions of the Companies Act, we  quote hereinbelow the following provisions from the Companies  Act which read as follow:                \023PREAMBLE \026  The Companies Act, 1956 (ACT 1 OF 1956) [18th January, 1956]         An Act to consolidate and amend the law  relating to companies and certain other  associations.         Be it enacted by Parliament in the Sixth Year  of the Republic of India as follows:-\024  

\023PRELIMINARY

Section 2(33) "prescribed" means, as respects the  provisions of this Act relating to the winding up of  companies except sub-section (5) of section 503,  sub-section (3) of section 550, section 552 and sub- section (3) of section 555, prescribed by rules made  by the Supreme Court in consultation with The

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Tribunal, and as respects the other provisions of  this Act including sub-section (5) of section 503,  sub-section (3) of section 550, section 552 and sub- section (3) of section 555, prescribed by rules made  by the Central Government;\024

\023ACCOUNTS

Section 209. Books of account to be kept by  company (1) Every company shall keep at its registered office  proper books of account with respect to- (a) all sums of money received and expended by the  company and the matters in respect of which the  receipt and expenditure take place; (b) all sales and purchases of goods by the  company;  (c) the assets and liabilities of the company; and   (d) in the case of a company pertaining to any class  of companies engaged in production, processing,  manufacturing or mining activities, such particulars  relating to utilisation of material or labour or to  other items of cost as may be prescribed, if such  class of companies is required by the Central  Government to include such particulars in the  books of account: Provided that all or any of the books of account  aforesaid may be kept at such other place in India  as the Board of directors may decide and when the  Board of directors so decides, the company shall,  within seven days of the decision, file with the  Registrar a notice in writing giving the full address  of that other place.     (2) Where a company has a branch office, whether  in or outside India, the company shall be deemed to  have complied with the provisions of sub-section (1),  if proper books of account relating to the  transactions effected at the branch office are kept at  that office and proper summarised returns, made  up to dates at intervals of not more than three  months, are sent by the branch office to the  company at its registered office or the other place  referred to in sub-section (1).   (3) For the purposes of sub-sections (1) and (2),  proper books of account shall not be deemed to be  kept with respect to the matters specified therein,-  (a) if there are not kept such books as are necessary  to give a true and fair view of the state of the affairs  of the company or branch office, as the case may  be, and to explain its transactions; and (b) If such books are not kept on accrual basis and  according to the double entry system of accounting. (4) The books of account and other books and  papers shall be open to inspection by any director  during business hours.   (4A) The books of account of every company relating  to a period of not less than eight years immediately  preceding the current year together with the  vouchers relevant to any entry in such books of  account shall be preserved in good order :

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Provided that in the case of a company incorporated  less than eight years before the current year, the  books of account for the entire period preceding the  current year together with the vouchers relevant to  any entry in such books of account shall be so  preserved. (5) If any of the persons referred to in sub-section  (6) fails to take all reasonable steps to secure  compliance by the company with the requirements  of this section, or has by his own wilful act been the  cause of any default by the company thereunder, he  shall, in respect of each offence, be punishable with  imprisonment for a term which may extend to six  months, or with fine which may extend to ten  thousand rupees,  or  with  both :  Provided that in any proceedings against a person  in respect of an offence under this section  consisting of a failure to take reasonable steps to  secure compliance by the company with the  requirements of this section, it shall be a defence to  prove that a competent and reliable person was  charged with the duty of seeing that those  requirements were complied with and was in a  position to discharge that duty : Provided further that no person shall be sentenced  to imprisonment for any such offence, unless it was  committed wilfully. (6) The persons referred to in sub-section (5) are the  following namely :- (a) where the company has a managing director or  manager, such managing director or manager and  all officers and other employees of the company;  and;   (d) where the company has neither a managing  director nor manager, every director of the  company;

Section 210. Annual accounts and balance sheet (1) At every annual general meeting of a company  held in pursuance of section 166, the Board of  directors of the company shall lay before the  company- (a) a balance sheet as at the end of the period  specified in sub-section (3); and (b) a profit and loss account for that period. (2) In the case of a company not carrying on  business for profit, an income and expenditure  account shall be laid before the company at its  annual general meeting instead of a profit and loss  account, and all references to "profit and loss  account", "profit" and "loss" in this section and  elsewhere in this Act, shall be construed, in relation  to such a company, as references respectively to the  "income and expenditure account", "the excess of  income over expenditure", and "the excess of  expenditure over income".   (3) The profit and loss account shall relate- (a) in the case of the first annual general meeting of  the company, to the period beginning with the  incorporation of the company and ending with a day  which shall not precede the day of the meeting by  more than nine months; and (b) in the case of any subsequent annual general

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meeting of the company, to the period beginning  with the day immediately after the period for which  the account was last submitted and ending with a  day which shall not precede the day of the meeting  by more than six months, or in cases where an  extension of time has been granted for holding the  meeting under the second proviso to sub-section (1)  of section 166, by more than six months and the  extension so granted. (4) The period to which the account aforesaid relates  is referred to in this Act as a "financial year" and it  may be less or more than a calendar year, but it  shall not exceed fifteen months :   Provided that it may extend to eighteen months  where special permission has been granted in that  behalf by the Registrar.   (5) If any person, being a director of a company,  fails to take all reasonable steps to comply with the  provisions of this section, he shall, in respect of  each offence, be punishable with imprisonment for  a term which may extend to six months, or with fine  which may extend to ten thousand rupees, or  with   both :   Provided that in any proceedings against a person  in respect of an offence under this section, it shall  be a defence to prove that a competent and reliable  person was charged with the duty of seeing that the  provisions of this section were complied with and  was in a position to discharge that duty :

Provided further that no person shall be sentenced  to imprisonment for any such offence unless it was  committed wilfully.     (6) If any person, not being a director of the  company, having been charged by the Board of  directors with the duty of seeing that the provisions  of this section are complied with, makes default in  doing so, he shall, in respect of each offence, be  punishable with imprisonment for a term which  may extend to six months, or with fine which may  extend to ten thousand rupees, or with both :   Provided that no person shall be sentenced to  imprisonment for any such offence unless it was  committed wilfully.

Section 210A. Constitution of National Advisory  Committee on Accounting Standards

(1) The Central Government may, by notification in  the Official Gazette, constitute an Advisory  Committee to be called the National Advisory  Committee on Accounting Standards (hereafter in  this section referred to as the "Advisory Committee")  to advise the Central Government on the  formulation and laying down of accounting policies  and accounting standards for adoption by  companies or class of companies under this Act. (2) The Advisory Committee shall consist of the  following members, namely :-

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(a) a Chairperson who shall be a person of eminence  well versed in accountancy, finance, business  administration, business law, economics or similar  discipline; (b) one member each nominated by the Institute of  Chartered Accountants of India constituted under  the Chartered Accountants Act, 1949, the Institute  of Cost and Works Accountants of India constituted  under the Cost and Works Accountants Act, 1959  and the Institute of Company Secretaries of India  constituted under the Company Secretaries Act,  1980; (c) one representative of the Central Government to  be nominated by it; (d) one representative of the Reserve Bank of India  to be nominated by it; (e) one representative of the Comptroller and  Auditor-General of India to be nominated by him; (f) a person who holds or has held the office of  professor in accountancy, finance or business  management in any university or deemed  university; (g) the Chairman of the Central Board of Direct  Taxes constituted under the Central Boards of  Revenue Act, 1963 or his nominee;   (h) two members to represent the chambers of  commerce and industry to be nominated by the  Central Government, and   (i) one representative of the Securities and Exchange  Board of India to be nominated by it. (3) The Advisory Committee shall give its  recommendations to the Central Government on  such matters of accounting policies and standards  and auditing as may be referred to it for advice from  time to time.

(4) The members of the Advisory Committee shall  hold office for such terms as may be determined by  the Central Government at the time of their  appointment and any vacancy in the membership in  the Committee shall be filled by the Central  Government in the same manner as the member  whose vacancy occurred was filled.   (5) The non-official members of the Advisory  Committee shall be entitled to such fees, travelling,  conveyance and other allowances as are admissible  to the officers of the Central Government of the  highest rank.

Section 211. Form and contents of balance sheet  and profit and loss account (1) Every balance sheet of a company shall give a  true and fair view of the state of affairs of the  company as at the end of the financial year and  shall, subject to the provisions of this section, be in  the form set out in Part I of Schedule VI, or as near  thereto as circumstances admit or in such other  form as may be approved by the Central  Government either generally or in any particular  case; and in preparing the balance sheet due regard  shall be had, as far as may be, to the general  instructions for preparation of balance sheet under

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the heading "Notes" at the end of that Part : Provided that nothing contained in this sub-section  shall apply to any insurance or banking company or  any company engaged in the generation or supply of  electricity, or to any other class of company for  which a form of balance sheet has been specified in  or under the Act governing such class of company. (2) Every profit and loss account of a company shall  give a true and fair view of the profit or loss of the  company for the financial year and shall, subject as  aforesaid, comply with the requirements of Part II of  Schedule VI, so far as they are applicable thereto :  Provided that nothing contained in this sub-section  shall apply to any insurance or banking company or  any company engaged in the generation or supply of  electricity, or to any other class of company for  which a form of profit and loss account has been  specified in or under the Act governing such class of  company.   (3) The Central Government may, by notification in  the Official Gazette, exempt any class of companies  from compliance with any of the requirements in  Schedule VI if, in its opinion, it is necessary to grant  the exemption in the public interest.    Any such exemption may be granted either  unconditionally or subject to such conditions as  may be specified in the notification.    (3A) Every profit and loss account and balance  sheet of the company shall comply with the  accounting standards.    (3B) Where the profit and loss account and the  balance sheet of the company do not comply with  the accounting standards, such companies shall  disclose in its profit and loss account and balance  sheet, the following, namely:- (a)     the deviation from the accounting standards; (b)     the reasons for such deviation; and (c) the financial effect, if any, arising due to such  deviation. (3C) For the purposes of this section, the expression  "accounting standards" means the standards of  accounting recommended by the Institute of  Chartered Accountants of India constituted under  the Chartered Accountants Act, 1949 as may be  prescribed by the Central Government in  consultation with the National Advisory Committee  on Accounting Standards established under sub- section (1) of section 210A :   Provided that the standard of accounting specified  by the Institute of Chartered Accountants of India  shall be deemed to be the Accounting Standards  until the accounting standards are prescribed by  the Central Government under this sub-section.    (4) The Central Government may, on the  application, or with the consent of the Board of  directors of the company, by order, modify in  relation to that company any of the requirements of  this Act as to the matters to be stated in the  company’s balance sheet or profit and loss account

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for the purpose of adapting them to the  circumstances of the company.   (5) The balance sheet and the profit and loss  account of a company shall not be treated as not  disclosing a true and fair view of the state of affairs  of the company, merely by reason of the fact that  they do not disclose- (i) in the case of an insurance company, any  matters which are not required to be disclosed by  the Insurance Act, 1938;   (ii) in the case of a banking company, any matters  which are not required to be disclosed by the  Banking Companies Act, 1949;    (iii) in the case of a company engaged in the  generation or supply of electricity, any matters  which are not required to be disclosed by both the  Indian Electricity Act, 1910, and the Electricity  (Supply) Act, 1948; (iv) in the case of a company governed by any other  special Act for the time being in force, any matters  which are not required to be disclosed by that  special Act; or   (v) in the case of any company, any matters which  are not required to be disclosed by virtue of the  provisions contained in Schedule VI or by virtue of a  notification issued under sub-section (3) or an order  issued under sub-section (4). (6) For the purposes of this section, except where  the context otherwise requires, any reference to a  balance sheet or profit and loss account shall  include any notes thereon or documents annexed  thereto, giving information required by this Act, and  allowed by this Act to be given in the form of such  notes or documents.   (7) If any such person as is referred to in sub- section (6) of section 209 fails to take all reasonable  steps to secure compliance by the company, as  respects any accounts laid before the company in  general meeting, with the provisions of this section  and with the other requirements of this act as to the  matters to be stated in the accounts, he shall, in  respect of each offence, be punishable with  imprisonment for a term which may extend to six  months, or with fine which may extend to ten  thousand rupees, or with both :   Provided that in any proceedings against a  person in respect of an offence under this  section, it shall be a defence to prove that a  competent and reliable person was charged  with the duty of seeing that the provisions of  this section and the other requirements  aforesaid were complied with and was in a  position to discharge that duty : Provided further that no person shall be  sentenced to imprisonment for any such  offence, unless it was committed wilfully.     (8) If any person, not being a person referred to in

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sub-section (6) of section 209, having been charged  by the managing director or manager, or Board of  directors, as the case may be, with the duty of  seeing that the provisions of this section and the  other requirements aforesaid are complied with,  makes default in doing so, he shall, in respect of  each offence, be punishable with imprisonment for  a term which may extend to six months or with fine  which may extend to ten thousand rupees, or with  both:  

      Provided that no person shall be sentenced to  imprisonment for any such offence, unless it was  committed wilfully.

SCHEDULE VI  (See section 211)  1[PART I  Form of Balance-sheet] The balance sheet of a company shall be either in horizontal form or  vertical form A. HORIZONTAL FORM] Balance sheet of \005\005\005\005\005\005\005\005\005\005\005\005\005. [Here enter the name of the Company] As at \005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005\005 [Here enter the date as at which the balance-sheet is made out.] Instructions  in accordance  with which  liabilities  should be  made out LIABILITIES ASSETS Instructions in  accordance with  which assets  should be made  out

Figures for  the  previous  year Rs.  (b) Figur es  for  the  curre nt  year  Rs.  (b) Figures for the  previous year  Rs. (b) Figu res  for  the  curr ent

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year  Rs.  (b)

 *SHARE  CAPITAL   *FIXED ASSETS     Terms of  redemption or  conversion  (if any), or  any  redeemable  preference  capital to be  stated,  together with  earliest date  of redemption  or  conversion. Authorised\005 \005shares of  Rs.\005\005each.   Distinguishing  as far as  possible  between  expenditure  upon (a)  goodwill, (b)  land, (c)  buildings, (d)  leaseholds, (e)  railway  sidings, (f)  plant and  machinery, (g)  furniture and  fittings, (h)  development of  property, (i)  patents, trade  marks and  designs, (j)  live-stock and  (k) vehicles,  etc.    *Under each head the  original cost, and  the additions  thereto and  deductions therefrom  during the year, and  total depreciation  written off or  provided up to the  end of the year to  be stated.

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         Where the original  cost aforesaid and  additions and  deductions thereto,  relate to any fixed  asset which has been  acquired from a  country outside  India, and in  consequence of a  change in the rate  of exchange at any  time after the  acquisition of such  asset, there has  been an increase or  reduction in the  liability of the  company, as  expressed in Indian  currency, for making  payment towards the  whole or a part of  the cost of the  asset or for  repayment of the  whole or a part of  moneys borrowed by  the company from any  person, directly or  indirectly in any  foreign currency  specifically for the  purpose of acquiring  the asset (being in  either case the  liability existing  immediately before  the date on which  the change in the  rate of exchange  takes effect), the  amount by which the  liability is so  increased or reduced  during the year,  shall be added to,  or, as the case may  be deducted from the  cost, and the amount  arrived at after  such addition or  deduction shall be  taken to be the cost  of the fixed asset.          

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Explanation 1: This  paragraph shall  apply in relation to  all balance-sheets  that may be made out  as at the 6th day of  June, 1966, or any  day thereafter and  where, at the date  of issue of the  notification of the  Government of India,  in the Ministry of  Industrial  Development and  Company Affairs  (Department of  Company Affairs),  G.S.R. No. 129,  dated the 3rd day of  January, 1968, any  balance sheet, in  relation, to which  this paragraph  applies, has already  been made out and  laid before the  company in Annual  General Meeting, the  adjustment referred  to in this paragraph  may be made in the  first balance-sheet  made out after the  issue of the said  notification.           Explanation 2:-In  this paragraph,  unless the context  otherwise requires,  the expressions  "rate of exchange",  "foreign currency"  and "Indian  Currency" shall have  the meanings  respectively  assigned to them  under sub-section  (1) of section 43A  of the Income-tax  Act, 1961 (43 of  1961), and  Explanation 2 and  Explanation 3 of the  said sub-section  shall, as far as may  be, apply in  relation to the said  paragraph as they

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apply to the said  sub-section (1).           In every case where  the original cost  cannot be  ascertained, without  unreasonable expense  or delay, the  valuation shown by  the books shall be  given. For the  purposes of this  paragraph, such  valuation shall be  the net amount at  which an asset stood  in the company\022s  books at the  commencement of this  Act after deduction  of the amounts  previously provided  or written off for  depreciation or  diminution in value,  and where any such  asset is sold, the  amount of sale  proceeds shall be  shown as deduction. Particulars  of any option  on un-issued  share capital  to be  specified. Issued  (distinguis hing  between the  various  classes of  capital and  stating the  particulars  specified  below, in  respect of  each class)  \005\005 shares  of Rs. \005\005  each       Where sums have been  written off on a  reduction of capital  or a revaluation of  assets, every

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balance sheet,  (after the first  balance sheet)  subsequent to the  reduction or  revaluation shall  show the reduced  figures and with the  date of the  reduction in place  of the original  cost. Particulars  of the  different  classes of  preference  shares to be  given. Subscribed  (distinguis hing  between the  various  classes of  Capital and  stating the  particulars  specified  below in  respect of  each  class.)       Each balance sheet  for the first five  years subsequent to  the date of the  reduction, shall  show also the amount  of the reduction  made.   (c)  \005\005shares of  Rs. \005\005  each.       Similarly, where  sums have been added  by writing up the  assets, every  balance-sheet  subsequent to such  writing up shall  show the increased  figures with the  date of the increase  in place of the  original cost. Each  balance sheet for

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the first five years  subsequent to the  date of writing up  shall also show the  amount of increase  made.   Rs. \005\005  called up.        Explanation.-  Nothing contained in  the preceding two  paragraphs shall  apply to any  adjustment made in  accordance with the  second paragraph.   Of the  above  shares  \005\005shares  are  allotted as  fully paid- up pursuant  to a  contract  without  payments  being  received in  cash.         Specify the  source from  which bonus  shares are  issued, e.g.,  capitalisatio n of profits  or Reserves  or from Share  Premium  Account. Of the  above  shares ___  shares are  allotted as  fully paid- up by way  of bonus  shares+         Any capital

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profit on  reissue of  forfeited  shares should  be  transferred  to Capital  Reserve. Less: calls  unpaid:           1[(i) By  managing  agent or  secretaries  and  treasurers  and where  the  managing  agent or  secretaries  and  treasurers  are a firm,  by the  partners  thereof,  and where  the  managing  agent or  secretaries  and  treasurers  are a  private  company by  the  directors  or members  of that  company.]           (ii) By  directors.           (iii) By  others.        

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 Add:  Forfeited  shares  (amount  originally  paid up)].         Additions and  deductions  since last  balance sheet  to be shown  under each of  the specified  heads.  *RESERVES  AND SURPLUS   INVESTMENTS   *Aggregate amount of  company\022s quoted  investment and also  the market value  thereof shall be  shown. The word  "fund" in  relation to  any "Reserve"  should be  used only  where such  Reserve is  specifically  represented  by earmarked  investments. (1) Capital  Reserves.   Showing nature  of investments  and mode of  valuation, for  example, cost  or market value  and  distinguishing  between-   Aggregate amount of  company\022s unquoted  investments shall  also be shown.   (2) Capital  Redemption  Reserve.   *(1)

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Investments in  Government or  Trust  Securities.   All unutilised  monies out of the  issue must be  separately disclosed  in the Balance Sheet  of the company  indicating the form  in which such  unutilised funds  have been invested.   (3) Share  Premium  Account  (cc).   *(2)  Investments in  shares,  debentures or  bonds (showing  separately  shares fully  paid-up and  partly paid-up  and also  distinguishing  the different  classes of  shares and  showing also in  similar details  investments in  shares,  debentures or  bonds of  subsidiary  companies.       (4) Other  Reserves  specifying  the nature  of each  Reserve and  the amount  in respect  thereof.   (3) Immovable  properties.       Less: Debit  balance in  profit and  loss

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account (if  any) (h).   (4) Investments  in the Capital  of partnership  firms.        (5) Surplus  i.e.,  balance in  profit and  loss  account  after  providing  for  proposed  allocations , namely:-   (5) Balance of  unutilised  monies raised  by issue.       Dividend,  Bonus or  Reserves.           (6)  Proposed  additions  to  Reserves.           (7) Sinking  Funds.]            SECURED  LOANS:   CURRENT ASSETS,  LOANS AND  ADVANCES:     Loans from  Directors,  

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Manager  should be  shown  separately. (1)  Debentures     A. CURRENT  ASSETS    Mode of valuation of  stock shall be  stated and the  amount in respect of  raw material shall  also be stated  separately where  practicable. Interest  accrued and  due on  Secured Loans  should be  included  under the  appropriate  sub-heads  under the  head "SECURED  LOANS". (2) Loans  and  Advances  from Banks.   (1) Interest  accrued on  Investments   Mode of valuation of  works-in-progress  shall be stated. The nature of  the security  to be  specified in  each case.  (3) Loans  and  Advances  from  subsidiarie s.   (2) Stores and  spare parts.   In regard to Sundry  Debtors particulars  to be given  separately of- (a)  debts considered  good and in respect  of which the company  is fully secured;

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and (b) debts  considered good for  which the company  holds no security  other than the  debtor\022s personal  security; and (c)  debts considered  doubtful or bad. Where loans  have been  guaranteed by   managers  and/or  directors, a  mention  thereof shall  also be made  and the  aggregate  amount of  such loans  under each  head (4) Other  Loans and  Advances.   (3) Loose  Tools.   Debts due by  directors or other  officers of the  company or any of  them either  severally or jointly  with any other  person or debts due  by firms or private  companies  respectively in  which any director  is a partner or a  director or a  members to be  separately stated. Terms of  redemption or  conversion  (if any) of  debentures  issued to be  stated  together with  earliest date  of redemption  or  conversion.     (4) Stock-in- trade.   Debts due from other

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companies under the  same management  within the meaning  of sub-section (1B)  of section 370, to  be disclosed with  the names of the  Companies.        (5) Works-in- Progress.   The maximum amount  due by directors or  other officers of  the company at any  time during the year  to be shown by way  of a note.       (6) Sundry  debtors-   The provisions to be  shown under this  head should not  exceed the amounts  of debts stated to  be considered  doubtful or bad and  any surplus of such  provision if already  created, should be  shown at every  closing under  "Reserves and  Surplus" (in the  liabilities side)  under a separate  sub-head "Reserve  for Doubtful or Bad  Debts".       (a) Debts  outstanding for  a period  exceeding six  months.   In regard to bank  balances,  particulars to be  given separately of-       (b) Other  debts.  

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(a) the balances  lying with Scheduled  Banks on current  accounts, call  accounts and deposit  accounts;        Less: Provision   (b) the name of the  bankers other than  Scheduled Banks and  the balance lying  with each such  banker on current  accounts, call  accounts and deposit  account the maximum  amount outstanding  at any time during  the year from each  such banker; and       (7A) Cash  balance on  hand.   (c) the nature of  the interest, if  any, of any director  or his relative or  the  in each of the  bankers (other than  Scheduled Banks)  referred to in (b)  above.       (7B) Bank  balances-   All unutilised  monies out of the  issue must be  separately disclosed  in the Balance Sheet  of the company  indicating the form  in which such  unutilised funds  have been invested.       (a) with  Scheduled  Banks, and      

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   (b) with  others.           B.LOANS AND  ADVANCES   *The above  instructions  regarding "Sundry  Debtors" apply to  "Loans and Advances"  also.       (8) (a)  Advances and  loans to  subsidiaries.           (b) Advances  and loans to  partnership  firms in which  the company or  any of its  subsidiaries is  a partner.           (9) Bills of  Exchange.           (10) Advances  recoverable in  cash or in kind  or for value to  be received,  e.g., Rates,  Taxes,  Insurance, etc.           (11) ***]  

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       (12) Balances  with Customs,  Port Trust,  etc. (where  payable on  demand).       UNSECURED  LOANS:   MISCELLANEOUS  EXPENDITURE           (to the extent  not written off  or adjusted):     Loans from  directors,   manager  should be  shown  separately.  Interest  accrued ant  due on  Unsecured  Loans should  be included  under the  appropriate  sub-heads  under the  head  "Unsecured  Loans".] (1) Fixed  Deposits.    (1) Preliminary  expenses.    

Where loans  have been  guaranteed by  managers and/  or directors,  a mention  thereof shall  be made and  also  aggregate  amount of

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such loans  under each  head. (2) Loans  and  Advances  from  subsidiarie s.   (2) Expenses  including  commission or  brokerage on  underwriting or  subscription of  shares or  debentures.     See note (d)  at foot of  Form (3) Short  Term Loans  and  Advances:   (3) Discount  allowed on the  issue of shares  or debentures.       (a) From  Banks.   (4) Interest  paid out of  capital during  construction  (also stating  the rate or  interest.)       (b) From  others.   (5) Development  expenditure not  adjusted.       (4) Other  Loans and  Advances:   (6) Other items  (specifying  nature).  

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   (a) From  Banks.           (b) From  others.           CURRENT  LIABILITIES  AND  PROVISIONS:   PROFIT AND LOSS  ACCOUNT.   Show here the debit  balance of profit  and loss account  carried forward  after deduction of  the uncommitted  reserves, if any. The name(s)  of the small  scale  industrial  undertaking(s  to whom the  Company owe a  sum exceeding  Rs. 1 lakh  which is  outstanding  for more than  30 days, are  to be  disclosed. A. CURRENT  LIABILITIES            (1)  Acceptances           (2) Sundry  creditors.      

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   (i) Total  outstanding  dues of  small scale  industrial  undertaking (s); and           (ii) Total  outstanding  dues of  creditors  other than  small scale  industrial  undertaking s(s).           (3)  Subsidiary  companies.           (4) Advance  payments  and  unexpired  discounts  for the  portion for  which value  has still  to be given  e.g., in  the case of  the  following  classes of  companies:-           Newspaper,  Fire  Insurance,  Theatres,  Clubs,  Banking,  Steamship  Companies,

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etc.           (5)  Unclaimed  Dividends.           (6) Other  Liabilities  (if any).           (7)  Interest  accrued but  not due on  loans.           B.  PROVISIONS            (8)  Provisions  for  taxation.           (9)  Proposed  dividends.           (10) For  contingenci es.           (11) For

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provident  fund  scheme.           (12) For  insurance,  pension and  similar  staff  benefit  schemes.           (13) Other  provisions.           A foot-note  to the  balance- sheet may  be added to  show  separately:           (1) Claims  against the  company not  acknowledge d as debts.           (2)  Uncalled  liability  on shares  partly  paid.         The period  for which the  dividends are  in arrear of  if there is  more than one

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class of  shares, the  dividends on  each such  class are in  arrear, shall  be stated.  (3)  Arrears of  fixed  cumulative  dividends.         The amount  shall be  stated before  deduction of  income-tax,  except that  in the case  of tax-free  dividends the  amount shall  be shown free  of income-tax  and the fact  that it is so  shown shall  be stated. (4)  Estimated  amount of  contracts  remaining  to be  executed on  capital  account and  not  provided  for.         The amount of  any  guarantees  given by the  company on  behalf of  Directors or  other  officers of  the company  shall be  stated and  where  practicable,  the general  nature and  amount of

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each such  contingent  liability, if  material,  shall also be  specified. (5) Other  money for  which the  company is  contingentl y liable.         

General instructions for preparation of balance sheet.- (a) The information required to be given under any of the  items or sub-items in this Form, if it cannot be  conveniently included in the balance sheet itself, shall  be furnished in a separate Schedule or Schedules to be  annexed to and to form part of the balance sheet. This is  recommended when items are numerous.  

(b) Naye Paise can also be given in addition to Rupees,  if desired.   (c) In the case of subsidiary companies the number of  shares held by the holding company as well as by the  ultimate holding company and its subsidiaries must be  separately stated. The auditor is not required to certify the correctness of  such shareholdings as certified by the management. (cc) The item "Share Premium Account" shall include  details of its utilisation in the manner provided in  section 78 in the year of utilisation. (d) Short Term Loans will include those which are due for  not more than one year as at the date of the balance- sheet. (e) Depreciation written off or provided shall be  allocated under the different asset heads and deducted in  arriving at the value of Fixed Assets. (f) Dividends declared by subsidiary companies after the  date of the balance sheet should not be included] unless  they are in respect of period which closed on or before  the date of the balance sheet. (g) Any reference to benefits expected from contracts to  the extent not executed shall not be made in the balance  sheet but shall be made in the Board’s report. (g) Any reference to benefits expected from contracts to  the extent not executed shall not be made in the balance  sheet but shall be made in the Board’s report. [(h) The debit balance in the Profit and Loss Account  shall be shown as a deduction from the uncommitted  reserves, if any. (i) As regards Loans and Advances, amounts due by the  Managing Agents or Secretaries and Treasurers, either  severally or jointly with any other persons to be  separately stated; the amounts due from other companies  under the same management within the meaning of sub- section (1B) of section 370 should also be given with the  names of the companies the maximum amount due from every  one of these at any time during the year must be shown. (j) Particulars of any redeemed debentures which the

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company has power to issue should be given. (k) Where any of the company’s debentures are held by a  nominee or a trustee for the company, the nominal amount  of the debentures and the amount at which they are stated  in the books of the company shall be stated. (l) A statement of investments (whether shown under  "Investment" or under "Current Assets" as stock-in-trade)  separately classifying trade investments and other  investments should be annexed to the balance sheet,  showing the names of the bodies corporate (indicating  separately the names of the bodies corporate under the  same management) in whose shares or debentures,  investments have been made (including all investments  whether existing or not, made subsequent to the date as  at which the previous balance sheet was made out) and the  nature and extent of the investment ; so made in each  such body corporate; provided that in the case of an  investment company that is to say, a company whose  principal business is the acquisition of shares, stock,  debentures or other securities, it shall be sufficient if  the statement shows only the investments existing on the  date as at which the balance sheet has been made out. In  regard to the investments in the capital of partnership  firms, the names of the firms (With the names of all  their partners total capital and the shares of each  partner) shall be given in the statement. (m) If, in the opinion of the Board, any of the current  assets, loans and advances have not a value on  realisation in the ordinary course of business at least  equal to the amount at which they are stated, the fact  that the Board is of that opinion shall be stated. (n) Except in the case of the first balance sheet laid  before the company after the commencement of the Act, the  corresponding amounts for the immediately preceding  financial year for all items shown in the balance sheet  shall be also given in the balance sheet The requirement  in this behalf shall, in the case of companies preparing  quarterly or half-yearly accounts, etc., relate to the  balance sheet for the corresponding date in the previous  year. (o) The amounts to be shown under Sundry Debtors shall  include the amounts due in respect of goods sold or  services rendered or in respect of other contractual  obligations but shall not include the amounts which are  in the nature of loans or advances. (p) Current accounts with directors,  and Manager,  whether they are in credit or debit, shall be shown  separately. (q) A small scale industrial undertaking has the same  meaning as assigned to it under clause (j) of section 3  of the Industries (Development and Regulation) Act, 1951.

B. VERTICAL FORM   Name of the Company \005\005\005\005\005\005\005    Balance Sheet as at \005\005\005\005\005\005\005\005

Schedule  No. Figures as  at the end  of current  financial  year

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Figures  as at the  end of  previous  financial  year 1  2 3 4 5     I.      Sources of funds:         (1) Shareholder’s funds (a) Capital    (b) Reserves and Surplus         (2) Loan funds (a) Secured loans    (b) Unsecured loans TOTAL: II. Applications of funds:         (1) Fixed assets (a) Gross block    (b) Less depreciation    (c) Net block    (d) Capital work-in-progress (2) Investments    (3) Current assets, loans, and advances: (a) Inventories    (b) Sundry debtors    (c) Cash and bank balances    (d) Other current assets    (e) Loans and advances Less:   Current liabilities and provisions: (a) Liabilities    (b) Provisions                 Net current assets         (4) (a) Miscellaneous expenditure to the extent          not written off or adjusted    (b) Profit and Loss account                         TOTAL: Notes.- 1.      Details under each of the above items shall be given  in separate Schedules. The Schedules shall  incorporate all the information required to be given  under A-Horizontal Form read with notes containing  general instructions for preparation of balance  sheet. 2.      The Schedules, referred to above, accounting  policies and explanatory notes that may be attached

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shall form an integral part of the balance sheet. 3.      The figures in the balance sheet may be rounded off  to the nearest "000" or "00" as may be convenient or  may be expressed in terms of decimals of thousands.  (TO BE COMPARED) 4.      A foot-note to the balance sheet may be added to  show separately contingent liabilities.

PART II  Requirements as to Profit and Loss Account 1. The provisions of this Part shall apply to the income  and expenditure account referred to in sub-section (2) of  section 210 of the Act, in like manner as they apply to a  profit and loss account, but subject to the modification  of references as specified in that sub-section. 2. The profit and loss account- (a) shall be so made out as clearly to disclose the  result of the working of the company during the  period covered by the account; and   (b) shall disclose every material feature, including  credits or receipts and deb  its or expenses in respect of non-recurring transactions  or transactions of an exceptional nature.   3. The profit and loss account shall set out the various  items relating to the income and expenditure of the  company arranged under the most convenient heads; and in  particular, shall disclose the following information in  respect of the period covered by the account:- (i)     (a) The turnover, that is, the aggregate amount  for which sales are effected by the company,  giving the amount of sales in respect of each  class of goods dealt with by the company, and  indicating the quantities of such sales for  each class separately. (b) Commission paid to sole selling agents  within the meaning of section 294 of the Act.   (c) Commission paid to other selling agents.   (d) Brokerage and discount on sales, other than  the usual trade discount.       (ii)      (a) In the case of manufacturing  companies,- (1) The value of the raw materials consumed,  giving item-wise break-up and indicating the  quantities thereof. In this break-up, as far as  possible, all important basic raw materials  shall be shown as separate items. The  intermediates or components procured from other  manufacturers may, if their list is too large  to be included in the break-up, be grouped  under suitable headings without mentioning the  quantities, provided all those items which in  value individually account for 10 per cent or  more of the total value of the raw material  consumed shall be shown as separate and  distinct items with quantities thereof in the  break-up.   (2) The opening and closing stocks of goods  produced, giving break-up in respect of each  class of goods and indicating the quantities  thereof.

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(b) In the case of trading companies, the  purchases made and the opening and closing  stocks, giving break-up in respect of each  class of goods trade in by the company and  indicating the quantities thereof.    (c) In the case of companies rendering or  supplying services, the gross income derived  from services rendered or supplied. (d) In the case of a company, which falls under  more than one of the categories mentioned in  (a), (b) and (c) above, it shall be sufficient  compliance with the requirements herein if the  total amounts are shown in respect of the  opening and closing stocks, purchases, sales  and consumption of raw material with value and  quantitative break-up and the gross income from  services rendered is shown. (e) In the case of other companies, the gross  income derived under different heads. Note 1.- The quantities of raw materials  purchases, stocks, and the turnover shall be  expressed in quantitative denominations in  which these are normally purchased or sold in  the market. Note 2.- For the purpose of items (ii)(a),  (ii)(b) and (ii)(d), the items for which the  company is holding separate industrial  licences, shall be treated as separate classes  of goods, but where a company has more than one  industrial licence for production of the same  item at different places or for expansion of  the licensed capacity, the item covered by all  such licences shall be treated as one class. In  the case of trading companies, the imported  items shall be classified in accordance with  the classification adopted by the Chief  Controller of Imports and Exports in granting  the import licences. Note 3.- In giving the break-up of purchases,  stocks and turnover, items like spare parts and  accessories, the list of which is too large to  be included in the break-up, may be grouped  under suitable headings without quantities,  provided all those items, which in value  individually account for 10 per-cent or more of  the total value of the purchases, stocks, or  turnover, as the case may be, are shown as  separate and distinct items with quantities  thereof in the break-up. (iii) In the case of all concerns having works- in-progress, the amounts for which such works  have been completed] at the commencement and at  the end of the accounting period. (iv) The amount provided for depreciation,  renewals or diminution in value of fixed  assets. If such provision is not made by means  of a depreciation charge, the method adopted  for making such provision.    If no provision is made for depreciation, the  fact that no provision has been made shall be  stated and the quantum of arrears of  depreciation computed in accordance with  section 205(2) of the Act shall be disclosed by

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way of a note. (v) The amount of interest on the company’s  debentures and other fixed loans, that is to  say, loans for fixed periods, stating  separately the amount of interest, if any, paid  or payable to the managing director  and the  manager, if any. (vi) The amount of charge for Indian income-tax  and other Indian taxation on profits,  including, where practicable, with Indian  income-tax any taxation imposed elsewhere to  the extent of the relief, if any, from Indian  income-tax and distinguishing, where  practicable, between income-tax and other  taxation. (vii) The amounts reserved for- (a) repayment of share capital; and    (b) repayment of loans. (viii) (a) The aggregate, if material, of any  amounts set aside or proposed to be set aside,  to reserves, but not including provisions made  to meet any specific liability, contingency or  commitment known to exist at the date as at  which the balance-sheet is made up. (b) The aggregate, if material, of any amounts  withdrawn from such reserves. (ix)(a) The aggregate, if material, of the  amounts to set aside to provisions made for  meeting specific liabilities, contingencies or  commitments.    (b) The aggregate, if material, of the amounts  withdrawn from such provisions, as no longer  required. (x) Expenditure incurred on each of the  following items, separately for each item:- (a) Consumption of stores and spare parts.    (b) Power and fuel.    (c) Rent.    (d) Repairs to buildings.    (e) Repairs to machinery.    (f) (1) Salaries, wages and bonus.    (2) Contribution to provident and other funds.    (3) Workmen and staff welfare expenses to the  extent not adjusted from any previous provision  or reserve. Note 1-Information in respect of this item  should also be given in the balance sheet under  the relevant provision or reserve account.    Note 2. * * * (g) Insurance.    (h) Rates and taxes, excluding taxes on income.    (i) Miscellaneous expenses:       Provided that any item under which the expenses

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exceed one per cent of the total revenue of the  company or Rs. 5,000 whichever is higher shall be  shown as a separate and distinct item against an  appropriate account head in the Profit and Loss  Account and shall not be combined with any other  item to be shown Under "Miscellaneous expenses".    (xi) (a) The amount of income from investments,  distinguishing between trade investments and other  investments.    (b) Other income by way of interest, specifying the  nature of the income.    (c) The amount of income-tax deducted if the gross  income is stated under sub-paragraphs (a) and (b)  above. (xii) (a) Profits or losses on investments showing  distinctly the extent of the profits and losses  earned or incurred on account of membership of a  partnership firm to the extent not adjusted from any  previous provision or reserve.    Note.- Information in respect of this item should  also be given in the balance sheet under the  relevant provision or reserve account.    (b) Profits or losses in respect of transactions of  a kind, not usually undertaken by the company or  undertaken in circumstances of an exceptional or  non-recurring nature, if material in amount.    (c) Miscellaneous income. (xiii) (a) Dividends from subsidiary companies.    (b) Provisions for losses of subsidiary companies. (xiv)   The aggregate amount of the dividends  paid, and proposed, and stating whether such  amounts are subject to deduction of income-tax  or not. (xv)    Amount, if material, by which any items  shown in the profit and loss account are  affected by any change in the basis of  accounting.       4. The profit and loss account shall also contain or  give by way of a note detailed information, showing  separately the following payments provided or made during  the financial year to the directors (including managing  directors), or manager, if any, by the company, the  subsidiaries of the company and any other person:-   (i) managerial remuneration under section 198 of the  Act paid or payable during the financial year to the  directors (including managing directors),  manager,  if any; (ii) ***; (iii) ***; (iv) ***; (vi) other allowances and commission including  guarantee commission (details to be given); (vii) any other perquisites or benefits in cash or  in kind (stating approximate money value where  practicable); (viii) pensions, etc.,- (a) pensions,

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 (b) gratuities,    (c) payments from provident funds, in excess of own  subscriptions and interest thereon,    (d) compensation for loss of office,    (e) consideration in connection with retirement from  office.       4A. The profit and loss account shall contain or  give by way of a note a statement showing the computation  of net profits in accordance with section 349 of the Act  with relevant details of the calculation of the  commissions payable by way of Percentage of such profits  to the directors (including managing directors), or  manager (if any).       4B. The profit and loss account shall further  contain or give by way of a note detailed information in  regard to amounts paid to the auditor, whether as fees,  expenses or otherwise for services rendered-       (a) as auditor;  (b) as adviser, or in any other capacity, in respect  of-       (i) taxation matters;   (ii) company law matters;    (iii) management services; and (c) in any other manner       4C. In the case of a manufacturing companies, the  profit and loss account shall also contain, by way of a  note in respect of each class of goods manufactured,  detailed quantitative information in regard to the  following, namely:- (a) the licensed capacity (where licence is in  force);    (b) the installed capacity; and    (c) the actual production. Note 1.- The licensed capacity and installed capacity of  the company as on the last date of the year to which the  profit and loss account relates, shall be mentioned  against items (a) and (b) above, respectively. Note 2.- Against item (c), the actual production in  respect of the finished products meant for sale shall be  mentioned. In cases where semi-processed products are  also sold by the company, separate details thereof shall  be given. Note 3.- For the purpose of this paragraph, the items for  which the company is holding separate industrial licences  shall be treated as separate classes of goods but where a  company has more than one industrial licence for  production of the same item at different places or for  expansion of the licensed capacity, the item covered by  all such licences shall be treated as one class.       4D. The profit and loss account shall also contain  by way of a note the following information, namely:- (a) value of imports calculated on C.I.F. basis by  the company during the financial year in respect  of:- (i) raw materials;    (ii) components and spare parts;

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 (iii) capital goods; (b) expenditure in foreign currency during the  financial year on account of royalty, know-how,  professional, consultation fees, interest, and other  matters; (c) value of all imported raw materials, spare parts  and components consumed during the financial year  and the value of all indigenous raw materials, spare  parts and components similarly consumed and the  percentage of each to the total consumption;     (d) the amount remitted during the year in foreign  currencies on account of dividends, with a specific  mention of the number of non-resident shareholders,  the number of shares held by them on which the  dividends related; (e) earnings in foreign exchange classified under  the following heads, namely:- (i) export of goods calculated on F.O.B. basis;    (ii) royalty, know-how, professional and  consultation fees;    (iii) interest and dividend;    (iv) other income, indicating the nature  thereof.       5. The Central Government may direct that a company  shall not be obliged to show the amount set aside to  provisions other than those relating to depreciation,  renewal or diminution in value of assets, if the Central  Government is satisfied that the information should not  be disclosed in the public interest and would prejudice  the company, but subject to the condition that in any  heading stating an amount arrived at after taking into  account the amount set aside as such, the provision shall  be so framed or marked as to indicate that fact.    6.      (1) Except in the case of the first profit and loss  account laid before the company after the commencement of  the Act, the corresponding amounts for the immediately  preceding financial year for all items shown in the  profit and loss account shall also be given in the profit  and loss account.               (2) The requirement in sub-clause (1) shall, in the  case of companies preparing quarterly or half-yearly  accounts, relate to the profit and loss account for the  period which entered on the corresponding date of the  previous year.\024

\023AUDIT Section 227. Powers and duties of auditors (1) Every auditor of a company shall have a right of  access at all times to the books and accounts and  vouchers of the company, whether kept at the head  office of the company or elsewhere, and shall be  entitled to require from the officers of the company  such information and explanations as the auditor  may think necessary for the performance of his  duties as auditor.  

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(lA) Without prejudice to the provisions of sub- section (1), the auditor shall inquire- (a) whether loans and advances made by the  company on the basis of security have been  properly secured and whether the terms on which  they have been made are not prejudicial to the  interest of the company or its members;   (b) whether transactions of the company which are  represented merely by book entries are not  prejudicial to the interests of the company;   (c) where the company is not an investment  company within the meaning of section 372 or a  banking company, whether so much of the assets of  the company as consist of shares, debentures and  other securities have been sold at a price less than  that at which they were purchased by the company; (d) whether loans and advances made by the  company have been shown as deposits; (e) whether personal expenses have been charged to  revenue account;    (f) where it is stated in the books and papers of the  company that any shares have been allotted for  cash, whether cash has actually been received in  respect of such allotment, and if no cash has  actually been so received, whether the position as  stated in the account books and the balance-sheet  is correct, regular and not misleading. (2) The auditor shall make a report to the members  of the company on the accounts examined by him,  and on every balance-sheet and profit and loss  account and on every other document declared by  this Act to be part of or annexed to the balance- sheet or profit and loss account which are laid  before the company in general meeting during his  tenure of office, and the report shall state whether,  in his opinion and to the best of his information and  according to the explanations given to him, the said  accounts give the information required by this Act  in the manner so required and give a true and fair  view- (i) in the case of the balance-sheet, of the state of  the company’s affairs as at the end of its financial  years; and (ii) in the case of the profit and loss account, of the  profit or loss for its financial year. (3) The auditor’s report shall also state- (a) whether he has obtained all the information and  explanations which to the best of his knowledge and  belief were necessary for the purposes of his audit; (b) whether, in his opinion, proper books of account  as required by law have been kept by the company  so far as appears from his examination of those  books, and proper returns adequate for the  purposes of his audit have been received from  branches not visited by him;  (bb) whether the report on the accounts of any  branch office audited under section 228 by a person  other than the company’s auditor has been awarded  to him as enquired by clause (c) of sub-section (3) of  that section and how he has dealt with the same in  preparing the auditor’s report;  

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(c) whether the company’s balance-sheet and profit  and loss account dealt with by the report are in  agreement with the books of account and returns; (d) whether, in his opinion, the profit and loss  account and balance-sheet comply with the  accounting standards referred to in sub-section (3C)  of section 211; (e) in thick type or in italics the observations or  comments of the auditors which have any adverse  effect on the functioning of the company;    (f) whether any director is disqualified from being  appointed as director under clause (g) of sub- section (1) of section 274. (g) whether the cess payable under section 441A  has been paid and if not, the details of amount of  cess not so paid. (4) Where any of the matters referred to in clauses  (i) and (ii) of sub-section (2) or in clauses (a), (b),  (bb) (c) and (d)] of sub-section (3) is answered in the  negative or with a qualification, the auditor’s report  shall state the reason for the answer.  (4A) The Central Government may, by general or  special order, direct that, in the case of such class  or description of companies as may be specified in  the order, the auditor’s report shall also include a  statement on such matters as may be specified  therein:     Provided that before making any such order the  Central Government may consult the Institute of  Chartered Accountants of India constituted under  the Chartered Accountants Act, 1949 (38 of 1949),  in regard to the class or description of companies  and other ancillary matters proposed to be specified  therein unless the Government decides that such  consultation is not necessary or expedient in the  circumstances of the case.   (5) The accounts of a company shall not be deemed  as not having been, and the auditors report shall-  not state that those accounts have not been  properly drawn up on the ground merely that the  company had not disclosed certain matters if- (a) those matters are such as the company is not  required to disclose by virtue of any provisions  contained in this or any other Act, and   (b) those provisions are specified in the balance- sheet and profit and loss account of the company.\024 (emphasis supplied) \023SCHEDULES, FORMS AND RULES Section 641. Power to alter Schedules. (1) Subject to the provisions of this section, the  Central Government may, by notification in the  Official Gazette, alter any of the regulations, rules,  tables, forms and other provisions contained in any  of the Schedules to this Act, except Schedules XI  and XII.   (2) Any alteration notified under sub-section (1)  shall have effect as if enacted in this Act and shall  come into force on the date of the notification,  unless the notification otherwise directs :  

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Provided that no such alteration in Table A of  Schedule I shall apply to any company registered  before the date of such alteration.    (3) Every alteration made by the Central  Government under sub-section (1) shall be laid as  soon as may be after it is made before each House  of Parliament while it is in session for a total period  of thirty days which may be comprised in one  session or in two or more successive sessions, and  if, before the expiry of the session immediately  following the session or the successive sessions  aforesaid, both Houses agree in making any  modification in the alteration, or both Houses agree  that the alteration should not be made, the  alteration shall thereafter have effect only in such  modified form or be of no effect, as the case may be,  so, however, that any such modification or  annulment shall be without prejudice to the validity  of anything previously done in pursuance of that  alteration.

Section 642. Power of Central Government to  make rules. (1) In addition to the powers conferred by section  641, the Central Government may, by notification in  the Official Gazette, make rules- (a) for all or any of the matters which by this  Act are to be, or may be, prescribed by the  Central Government; and   (b) generally to carry out the purposes of this  Act. (2) Any rule made under sub-section (1) may  provide that a contravention thereof shall be  punishable with fine which may extend to five  thousand rupees and where the contravention is a  continuing one, with a further fine which may  extend to five hundred rupees for every day after the  first during which such contravention continues.   (3) Every rule made by the Central Government  under sub-section (1) shall be laid as soon as may  be after it is made before each House of Parliament  while it is in session for a total period of thirty days  which may be comprised in one session or in two or  more successive sessions, and if, before the expiry  of the session immediately following the session or  the successive sessions aforesaid, both Houses  agree in making any modification in the rule or both  Houses agree that the rule should not be made, the  rule shall thereafter have effect only in such  modified form or be of no effect, as the case may be,  so, however, that any such modification or  annulment shall be without prejudice to the validity  of anything previously done under that rule.   (4) Every regulation made by the Securities and  Exchange Board of India under this Act shall be  laid, as soon as may be after it is made, before each  House of Parliament, while it is in session, for a  total period of thirty days which may be comprised  in one session or in two or more successive  sessions, and if, before the expiry of the session  immediately following the session or the successive

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sessions aforesaid, both Houses agree in making  any modification in the regulation or both Houses  agree that the regulation should not be made, the  regulation shall thereafter have effect only in such  modified form or be of no effect, as the case may be;  so however, that any such modification or  annulment shall be without prejudice to the validity  of anything previously done under that regulation.\024   12.     Analysing the above provisions of the Companies Act the  position is that at every AGM of a company the Board of Directors  is required to place before it a balance-sheet and a P&L a/c for  the financial year.  Section 210 of the Companies Act requires a  company to place before AGM, a balance-sheet and a P&L a/c for  the relevant period.  The function of a balance-sheet is to show  the share capital, reserves and liabilities of the company at the  date on which it is prepared and the manner in which the total  moneys representing them are distributed over several types of  assets.  A balance-sheet is a historical document.  As a general  rule it does not show the net worth of an undertaking at any  particular date.  It does not show the present realizable value of  goodwill, land, plant and machinery etc.  It also does not show  the realizable value of stock-in-trade, except in cases where the  realizable value of stock-in-trade is less than cost.  Therefore, it  cannot be said that the balance-sheet shows the true financial  position.

13.     Section 210A was inserted by Companies (Amendment) Act,  1999 with effect from 31.10.98 to provide for constitution of  National Advisory Committee (NAC) on Accounting Standards.   The said NAC was constituted to advice the Central Government  on the formation and laying down of accounting policies and  Accounting Standards for adoption by companies or class of  companies.  The accounting policies and Accounting Standards  were required to be prescribed by the Central Government as  contemplated by Section 2(33).  The object behind Section 210A  was to make it obligatory on the part of the companies to comply  with the Accounting Standards.  NAC was constituted vide  Notification dated 18.9.03.  Under Section 211(3C) it is provided,  that till such time the Accounting Standards are prescribed by  the Central Government in consultation with NAC on Accounting  Standards; the Accounting Standards prescribed by the Institute  shall be deemed to be the Accounting Standards to be complied  with by all the companies.  In all, the Institute has so far framed  29 Accounting Standards.

14.     Section 211(1) requires the balance-sheet to be in the form  set out in Part I of Schedule VI \023or as near thereto as  circumstances admit\024.  The said phrase \023or as near thereto as  circumstances admit\024 allows adoption of improved techniques in  the presentation of accounts to shareholders.  It is important to  note that the information which is required to be given to  shareholders pursuant to Schedule VI should be given in a  manner which they will understand and which must give a true  and fair view  of the company\022s affairs as also it must give a  proper picture of the company\022s profits(losses) for the relevant  year.

15.     By Companies (Amendment) Act, 1999, sub-sections (3A),  (3B) and (3C) as well as a proviso thereto stood inserted in  Section 211 of the Companies Act w.e.f. 31.10.98 in order to  provide for compliance of Accounting Standards by companies in  the preparation of P&L a/c and balance-sheet.  By virtue of the  said amendment, Accounting Standards are required to be  prescribed by the Central Government in consultation with the

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NAC established under Section 210A.  Until the NAC is  established and Accounting Standards are prescribed by the  Central Government, the Accounting Standards specified by the  Institute shall be followed by all the companies.  In the present  case, the NAC has been established.  In the present case, by the  impugned notification dated 7.12.06, the Accounting Standards  have been prescribed by the Central Government.  In the present  case, by the impugned notification, AS 22 earlier specified by the  Institute has been adopted by the Central Government in the  form of a Rule.  Therefore, vide the impugned notification, AS 22  stands prescribed by the Central Government in consultation  with NAC which has been established under Section 210A of the  Companies Act.  It is made clear that the Accounting Standards  prescribed by the Central Government in consultation with NAC  need not be identical with the Accounting Standards specified by  the Institute.  In the present case, the impugned notification  indicates that the Central Government has been given the  authority to enact a Rule and accordingly the rule-making  authority, namely, the Central Government has prescribed the  Accounting Standard No.22 in consultation with NAC by adopting  AS 22 originally specified by the Institute.    16.     Under Section 211(1) every balance-sheet of a company has  to comply with the following requirements: (i)     It must give true and fair view of the affairs of the  company at the end of the financial year; (ii)    it must be in the form set out in Part I of Schedule VI  or as near thereto as circumstances admit; and (iii)   it must give regard to the general instructions for  preparation of balance-sheet under the heading  \023Notes\024. 17.     Similarly, Section 211(2) of the Companies Act requires that  every P&L a/c of a company must give a true and fair view of the  profit or loss of the company for the financial year and comply  with the requirements of Part II of Schedule VI so far as they are  applicable thereto.  It may be noted that the balance-sheet  prescribed by Part I of Schedule VI has to be in the form of a  proforma.  However, the Companies Act does not prescribe a  proforma of P&L a/c.  Part I of Schedule VI prescribes a proforma  of balance-sheet.  Part II of Schedule VI only prescribes the  particulars which must be furnished in the P&L a/c.  Therefore,  as far as possible, the P&L a/c must be drawn up according to  the requirements of Part II of Schedule VI.  It is important to note  that Section 211 read with Part I and Part II of Schedule VI  prescribes the form and contents of balance-sheet and P&L a/c.   However, Section 211(1), inter alia, states that every balance- sheet of a company shall subject to the provisions of that section,  be in the form set out in Part I of Schedule VI.  The words  \023subject to the provisions of this section\024 would mean that every  sub-section following sub-section (1) including sub-sections (3A),  (3B) and (3C) shall have an overriding effect and consequently  every P&L a/c and balance-sheet shall comply with the  Accounting Standards.  Therefore, implementation of the  Accounting Standards and their compliance are made  compulsory and mandatory by the aforestated sub-sections (3A),  (3B) and (3C).  The insertion of the concept of \023true and fair view\024  in place of \023true and correct\024 has been made to do away with the  view that accounts should disclose arithmetically accuracy.   Adherence to the disclosure requirements as per Schedule VI is  subservient to the overriding requirement of \023true and fair view\024  as regards the state of affairs.  Therefore, the annual financial  statements should convey an overall fair view and should not give  any misleading information or impression.  All the relevant  information should be disclosed in the balance-sheet and the  P&L a/c in such a manner that the financial position and the

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working results are shown as they are.  There should be neither  an overstatement nor an understatement.  Further, the  information to be disclosed should be in consonance with the  fundamental accounting assumptions and commonly accepted  accounting policies.  Therefore, failure to make provision for  taxation would not disclose true and fair view of the state of  affairs.  Non-compliance for taxation would, therefore, amount to  contravention of Sections 209 and 211 of the Companies Act.   Accordingly, it is necessary for the auditor to qualify in his report,  and such qualification should bring out in what manner the  accounts do not disclose a true and fair view of the state of affairs  of the company as well as the profit/loss of the company.  Several  Accounting Standards prescribed by the Institute have been  made mandatory.  The Institute has, however, clarified that the  expression \023mandatory in nature\024 implies that while discharging  their functions, it will be the duty of the Chartered Accountants  who are members of the Institute to examine whether the said  Accounting Standard has been complied with in the presentation  of financial statements covered by their audit (See: Section  227(3)(d)).  In this regard it may be noted that under Section  227(3)(d) it is the duty of the auditor, to state in his audit report  whether the P&L a/c and the balance-sheet complies with the  Accounting Standards referred to in Section 211(3C).  Before  introduction of sub-sections (3A), (3B) and (3C) in Section 211  (w.e.f. 31.10.98), these Standards were not mandatory.   Therefore, the companies were then free to prepare their annual  financial statements, as per the specific requirements of Section  211 read with Schedule VI.  However, with the insertion of sub- sections (3A), (3B) and (3C) in Section 211 the P&L a/c and the  balance-sheet have to comply with the Accounting Standards.   For this purpose the expression \023Accounting Standards\024 shall  mean the standards of accounting recommended by the Institute  as may be prescribed by the Central Government in consultation  with NAC on Accounting Standards.  Thus, the Accounting  Standards are prescribed by the Central Government.  Thus, the  Accounting Standards prescribed by the Central Government are  now mandatory qua the companies and non-compliance with  these Standards would lead to violation of Section 211 inasmuch  as the annual accounts may then not be regarded as showing a  \023true and fair view\024.       18.     Section 641 empowers the Central Government to alter any  of the regulations, rules, tables, forms and other provisions  contained in Schedule VI to the Companies Act.  However, this  power can be used only for making simple alterations which will  not affect the legislative policies enshrined in the Companies Act.       19.     Section 642 refers to the powers of the Central Government  to make rules.  It states that in addition to the powers  conferred by Section 641, the Central Government may, by  notification in the official gazette, make rules for all or any of the  matters which by the Companies Act are to be prescribed by the  Central Government and to carry out the purposes of the  Companies Act.  Therefore, Section 641 and Section 642 form  part of the same scheme.  Under Section 642, the Central  Government exercises power of delegated legislation by  prescribing rules.  Under various provisions of the Act, Rules are  to be prescribed.  Rules can also be prescribed vide clause (b) to  Section 642(1) to carry out the purposes of the Act.       20.     In exercise of the powers conferred by clause (a) to sub- section (1) of Section 642 of the Companies Act read with sub- section (3C) of Section 211 and Section 210A(1), the Central  Government in consultation with NAC on Accounting Standards  has made the following Rules vide the impugned notification

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dated 7.12.06.  The said Rules are called as the Companies  (Accounting Standards) Rules, 2006.  We quote hereinbelow the  said impugned notification in entirety together with annexures:               \023Ministry of Company Affairs  NOTIFICATION New Delhi, the 7th December, 2006 ACCOUNTING STANDARDS G.S.R. 739 (E). \026 In exercise of the powers conferred by clause (a) of  sub-section (1) of section 642 of the Companies Act, 1956 (1 of 1956),  read with sub-section (3C) of section 211 and sub-section (1) of section  210A of the said Act, the Central Government, in consultation with  National Advisory Committee on Accounting Standards, hereby makes the  following rules, namely:- 1.      Short title and commencement.-  1.      These rules may be called the Companies (Accounting  Standards) Rules, 2006.  2.      They shall come into force on the date of their publication in  the Official Gazette.  2.      Definitions.- In these rules, unless the context otherwise  requires,-  a.      \023Accounting Standards\024 means the Accounting Standards as  specified in rule 3 of these rules;  b.      \023Act\024 means the Companies Act, 1956 (1 of 1956);  c.      \023Annexure\024 means an Annexure to these rules;  d.      \023General Purpose Financial Statements\024 include balance  sheet, statement of profit and loss, cash flow statement  (wherever applicable), and other statements and  explanatory notes which form part thereof.  e.      \023Enterprise\024 means a company as defined in section 3 of the  Companies Act, 1956.  f.      \023Small and Medium Sized Company\024 (SMC) means, a  company-  i.      whose equity or debt securities are not listed or are  not in the process of listing on any stock exchange,  whether in India or outside India;  ii.     which is not a bank, financial institution or an  insurance company;  iii.    whose turnover (excluding other income) does not  exceed rupees fifty crore in the immediately preceding  accounting year;  iv.     which does not have borrowings (including public  deposits) in excess of rupees ten crore at any time  during the immediately preceding accounting year;  and  v.      which is not a holding or subsidiary company of a  company which is not a small and medium-sized  company.  Explanation: For the purposes of clause (f), a company  shall qualify as a Small and Medium Sized Company, if the  conditions mentioned therein are satisfied as at the end of  the relevant accounting period.  (2) Words and expressions used herein and not defined in  these rules but defined in the Act shall have the same  meaning respectively assigned to them in the Act.  3.      Accounting Standards.-  (1) The Central Government hereby prescribes Accounting  Standards 1 to 7 and 9 to 29 as recommended by the  Institute of Chartered Accountants of India, which are  specified in the Annexure to these rules.  (2)     The Accounting Standards shall come into  effect in respect of accounting periods commencing on or  after the publication of these Accounting Standards.  1.      Obligation to comply with the Accounting Standards.-  (1) Every company and its auditor(s)shall comply with the  Accounting Standards in the manner specified in Annexure to

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these rules.  (2) The Accounting Standards shall be applied in the preparation  of General Purpose Financial Statements.  2.      An existing company, which was previously not a Small and  Medium Sized Company (SMC) and subsequently becomes an SMC,  shall not be qualified for exemption or relaxation in respect of  Accounting Standards available to an SMC until the company  remains an SMC for two consecutive accounting periods.  [No. 1/3/2006/CL-V]  JITESH KHOSLA, Jt. Secy. ANNEXURE  (See rule 3)  ACCOUNTING STANDARDS General Instructions 1.      SMCs shall follow the following instructions while complying  with Accounting Standards under these rules:-  1.1     the SMC which does not disclose certain information  pursuant to the exemptions or relaxations given to it  shall disclose (by way of a note to its financial  statements) the fact that it is an SMC and has complied  with the Accounting Standards insofar as they are  applicable to an SMC on the following lines:  \023The Company is a Small and Medium Sized Company  (SMC) as defined in the General Instructions in respect  of Accounting Standards notified under the Companies  Act, 1956. Accordingly, the Company has complied with  the Accounting Standards as applicable to a Small and  Medium Sized Company.\024  1.2     Where a company, being a SMC, has qualified for any  exemption or relaxation previously but no longer  qualifies for the relevant exemption or relaxation in the  current accounting period, the relevant standards or  requirements become applicable from the current period  and the figures for the corresponding period of the  previous accounting period need not be revised merely  by reason of its having ceased to be an SMC. The fact  that the company was an SMC in the previous period  and it had availed of the exemptions or relaxations  available to SMCs shall be disclosed in the notes to the  financial statements.  1.3     If an SMC opts not to avail of the exemptions or  relaxations available to an SMC in respect of any but not  all of the Accounting Standards, it shall disclose the  standard(s) in respect of which it has availed the  exemption or relaxation.  1.4     If an SMC desires to disclose the information not  required to be disclosed pursuant to the exemptions or  relaxations available to the SMCs, it shall disclose that  information in compliance with the relevant accounting  standard.  1.5     The SMC may opt for availing certain exemptions or  relaxations from compliance with the require ments  prescribed in an Accounting Standard:            Provided that such a partial exemption or  relaxation and disclosure shall not be permitted to  mislead any person or public.  2.      Accounting Standards, which are prescribed, are intended to be  in conformity with the provisions of applicable laws. However, if  due to subsequent amendments in the law, a particular  accounting standard is found to be not in conformity with such  law, the provisions of the said law will prevail and the financial  statements shall be prepared in conformity with such law.  3.      Accounting Standards are intended to apply only to items which  are material.  4.      The accounting standards include paragraphs set in bold italic

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type and plain type, which have equal authority. Paragraphs in  bold italic type indicate the main principles. An individual  accounting standard shall be read in the context of the  objective, if stated, in that accounting standard and in  accordance with these General Instructions.  

Accounting Standard (AS) 22

Accounting for Taxes on Income

(This Accounting Standard includes paragraphs set in bold italic type and plain type, which  have  equal authority. Paragraphs in bold italic type indicate the main principles. This Accountin g  Standard should be read in the context of its objective and the General Instructions contain ed in  part A of the Annexure to the Notification.)  

Objective The objective of this Standard is to prescribe accounting treatment for taxes on income. Tax es on  income is one of the significant items in the statement of profit and loss of an enterprise.  In  accordance with the matching concept, taxes on income are accrued in the same period as the  revenue and expenses to which they relate. Matching of such taxes against revenue for a peri od  poses special problems arising from the fact that in a number of cases, taxable income may b e  significantly different from the accounting income. This divergence between taxable income a nd  accounting income arises due to two main reasons. Firstly, there are differences between ite ms of  revenue and expenses as appearing in the statement of profit and loss and the items which ar e  considered as revenue, expenses or deductions for tax purposes. Secondly, there are differen ces  between the amount in respect of a particular item of revenue or expense as recognised in th e  statement of profit and loss and  

Scope

1. This Standard should be applied in accounting for taxes on income. This includes the  determination of the amount of the expense or savingrelated to taxes on income in respect of  an  accounting period and the disclosure of such an amount in the financial statements.

2. For the purposes of this Standard, taxes on income include all domestic and foreign taxes  which  are based on taxable income.

3. This Standard does not specify when, or how, an enterprise should account for taxes that  are  payable on distribution of dividends and other distributions made by the enterprise.

Definitions

4. For the purpose of this Standard, the following terms are used with the meanings specifie d:

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4.1 Accounting income (loss) is the net profit or loss for a period, as reported in the stat ement of  profit and loss, before deducting income tax expense or adding income tax saving.

4.2 Taxable income (tax loss) is the amount of the income (loss) for a period, determined in   accordance with the tax laws, based upon which income tax payable (recoverable) is determine d.

4.3 Tax expense (tax saving) is the aggregate of current tax and deferred tax charged or cre dited  to the statement of profit and loss for the period.

4.4 Current tax is the amount of income tax determined to be payable (recoverable) in respec t of  the taxable income (tax loss) for a period . 4.5 Deferred tax is the tax effect of timing differences.

4.6 Timing differences are the differences between taxable income and accounting income for  a  period that originate in one period and are capable of reversal in one or more subsequent  periods.

4.7 Permanent differences are the differences between taxable income and accounting income f or  a period that originate in one period and do not reverse subsequently.

5. Taxable income is calculated in accordance with tax laws. In some circumstances, the  requirements of these laws to compute taxable income differ from the accounting policies app lied  to determine accounting income. The effect of this difference is that the taxable income and   accounting income may not be the same.

6. The differences between taxable income and accounting income can be classified into  permanent differences and timing differences. Permanent differences are those differences  between taxable income and accounting income which originate in one period and do not revers e  subsequently. For instance, if for the purpose of computing taxable income, the tax laws all ow  only a part of an item of expenditure, the disallowed amount would result in a permanent  difference.

7. Timing differences are those differences between taxable income and accounting income for  a  period that originate in one period and are capable of reversal in one or more subsequent pe riods.  Timing differences arise because the period in which some items of revenue and expenses are  included in taxable income do not coincide with the period in which such items of revenue an d  expenses are included or considered in arriving at accounting income. For example, machinery   purchased for scientific research related to business is fully allowed as deduction in the f irst year  for tax purposes whereas the same would be charged to the statement of profit and loss as  depreciation over its useful life. The total depreciation charged on the machinery for accou nting  purposes and the amount allowed as deduction for tax purposes will ultimately be the same, b ut  periods over which the depreciation is charged and the deduction is allowed will differ. Ano ther  example of timing difference is a situation where, for the purpose of computing taxable inco

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me,  tax laws allow depreciation on the basis of the written down value method, whereas for accou nting  purposes, straight line method is used. Some other examples of timing differences arising un der  the Indian tax laws are given in Illustration I.

8. Unabsorbed depreciation and carry forward of losses which can be setoff against future ta xable  income are also considered as timing differences and result in deferred tax assets, subject  to  consideration of prudence (see paragraphs 15-18).

Recognition

9. Tax expense for the period, comprising current tax and deferred tax, should be included i n  the determination of the net profit or loss for the period.

10. Taxes on income are considered to be an expense incurred by the enterprise in earning in come  and are accrued in the same period as the revenue and expenses to which they relate. Such  matching may result into timing differences. The tax effects of timing differences are inclu ded in  the tax expense in the statement of profit and loss and as deferred tax assets (subject to t he  consideration of prudence as set out in paragraphs 15-18) or as deferred tax liabilities, in  the  balance sheet.

11. An example of tax effect of a timing difference that results in a deferred tax asset is  an expense  provided in the statement of profit and loss but not allowed as a deduction under Section 43 B of  the Income-tax Act, 1961. This timing difference will reverse when the deduction of that exp ense  is allowed under Section 43B in subsequent year(s). An example of tax effect of a timing  difference resulting in a deferred tax liability is the higher charge of depreciation allowa ble under  the Income-tax Act, 1961, compared to the depreciation provided in the statement of profit a nd  loss. In subsequent years, the differential will reverse when comparatively lower depreciati on will  be allowed for tax purposes.

12. Permanent differences do not result in deferred tax assets or deferred tax liabilities.

13. Deferred tax should be recognised for all the timing differences, subject to the conside ration of  prudence in respect of deferred tax assets as set out in paragraphs 15-18.

Explanation:

(a) The deferred tax in respect of timing differences which reverse during the tax holiday p eriod is  not recognised to the extent the enterprise\022s gross total income is subject to the deduct ion during  the tax holiday period as per the requirements of sections 80-IA/80 IB of the Income-tax Act ,  1961 (hereinafter referred to as the \021Act\022). In case of sections 10A/10B of the Act (c overed under  Chapter III of the Act dealing with incomes which do not form part of total income), the def erred  tax in respect of timing differences which reverse during the tax holiday period is not reco gnised

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to the extent deduction from the total income of an enterprise is allowed during the tax hol iday  period as per the provisions of the said sections.

(b) Deferred tax in respect of timing differences which reverse after the tax holiday period  is  recognised in the year in which the timing differences originate. However, recognition of de ferred  tax assets is subject to the consideration of prudence as laid down in paragraphs 15 to 18.

(c) For the above purposes, the timing differences which originate first are considered to r everse  first.  

The application of the above explanation is illustrated in the Illustration attached to the  Standard.

14. This Standard requires recognition of deferred tax for all the timing differences. This  is based  on the principle that the financial statements for a period should recognise the tax effect,  whether  current or deferred, of all the transactions occurring in that period.

15. Except in the situations stated in paragraph 17, deferred tax assets should be recognise d and  carried forward only to the extent that there is a reasonable certainty that sufficient futu re taxable  income will be available against which such deferred tax assets can be realised.

16. While recognising the tax effect of timing differences, consideration of prudence cannot  be  ignored. Therefore, deferred tax assets are recognised and carried forward only to the exten t that  there is a reasonable certainty of their realisation. This reasonable level of certainty wou ld  normally be achieved by examining the past record of the enterprise and by making realistic  estimates of profits for the future.

17. Where an enterprise has unabsorbed depreciation or carry forward of losses under tax law s,  deferred tax assets should be recognised only to the extent that there is virtual certainty  supported  by convincing evidence that sufficient future taxable income will be available against which  such  deferred tax assets can be realised.

Explanation:

1. Determination of virtual certainty that sufficient future taxable income will be availabl e is a  matter of judgement based on convincing evidence and will have to be evaluated on a case to  case  basis. Virtual certainty refers to the extent of certainty, which, for all practical purpose s, can be  considered certain. Virtual certainty cannot be based merely on forecasts of performance suc h as  business plans. Virtual certainty is not a matter of perception and is to be supported by co nvincing  evidence. Evidence is a matter of fact. To be convincing, the evidence should be available a t the  reporting date in a concrete form, for example, a profitable binding export order, cancellat ion of  which will result in payment of heavy damages by the defaulting party. On the other hand, a  projection of the future profits made by an enterprise based on the future capital expenditu res or

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future restructuring etc., submitted even to an outside agency, e.g., to a credit agency for  obtaining  loans and accepted by that agency cannot, in isolation, be considered as convincing evidence .

2(a) Asper the relevant provisionsof the Income-taxAct, 1961 (hereinafter referred to as the  \021Act\022),  the \021loss\022 arising under the head \021Capital gains\022 can be carried forward and set -off in future years,  only against the income arising under that head as per the requirements of the Act.

(b) Where an enterprise\022s statement of profit and loss includes an item of \021loss\022wh ich can be set- off in future for taxation purposes, only against the income arising under the head \021Capi tal gains\022  as per the requirements of the Act, that item is a timing difference to the extent it is not  set-off in  the current year and is allowed to be set-off against the income arising under the head \021 Capital  gains\022 in subsequent years subject to the provisions of the Act. In respect of such \021l oss\022, deferred  tax asset is recognised and carried forward subject to the consideration of prudence. Accord ingly,  in respect of such \021loss\022, deferred tax asset is recognised and carried forward only t o the extent  that there is a virtual certainty, supported by convincing evidence, that sufficient future  taxable  income will be available under the head \021Capital gains\022 against which the loss can be  set-off as per  the provisions of the Act. Whether the test of virtual certainty is fulfilled or not would d epend on  the facts and circumstances of each case. The examples of situations in which the test of vi rtual  certainty, supported by convincing evidence, for the purposes of the recognition of deferred  tax  asset in respect of loss arising under the head \021Capital gains\022 is normally fulfilled,  are sale of an  asset giving rise to capital gain (eligible to set-off the capital loss as per the provision s of the Act)  after the balance sheet date but before the financial statements are approved, and binding s ale  agreement which will give rise to capital gain (eligible to set-off the capital loss as per  the  provisions of the Act).

(c) In cases where there is a difference between the amounts of \021loss\022 recognised for  accounting  purposes and tax purposes because of cost indexation under the Act in respect of long-term c apital  assets, the deferred tax asset is recognised and carried forward (subject to the considerati on of  prudence) on the amount which can be carried forward and set-off in future years as per the  provisions of the Act.

18. The existence of unabsorbed depreciation or carry forward of losses under tax laws is st rong  evidence that future taxable income may not be available. Therefore, when an enterprise has  a  history of recent losses, the enterprise recognises deferred tax assets only to the extent t hat it has  timing differences the reversal of which will result in sufficient income or there is other  convincing evidence that sufficient taxable income will be available against which such defe rred  tax assets can be realised. In such circumstances, the nature of the evidence supporting its  

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recognition is disclosed.

Re-assessment of Unrecognised Deferred Tax Assets

19. At each balance sheet date, an enterprise re-assesses unrecognised deferred tax assets.  The  enterprise recognises previously unrecognised deferred tax assets to the extent that it has  become  reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18), that  sufficient  future taxable income will be available against which such deferred tax assets can be realis ed. For  example, an improvement in trading conditions may make it reasonably certain that the enterp rise  will be able to generate sufficient taxable income in the future.

Measurement

20. Current tax should be measured at the amount expected to be paid to (recovered from) the   taxation authorities, using the applicable tax rates and tax laws.

21. Deferred tax assets and liabilities should be measured using the tax rates and tax laws  that  have been enacted or substantively enacted by the balance sheet date.

Explanation:

(a) The payment of tax under section 115JB of the Income-tax Act, 1961 (hereinafter referred  to  as the \021Act\022) is a current tax for the period.

(b) In a period in which a company pays tax under section 115JB of the Act, the deferred tax   assets and liabilities in respect of timing differences arising during the period, tax effec t of which  is required to be recognised under this Standard, is measured using the regular tax rates an d not  the tax rate under section 115JB of the Act.

(c) In case an enterprise expects that the timing differences arising in the current period  would  reverse in a period in which it may pay tax under section 115JB of the Act, the deferred tax  assets  and liabilities in respect of timing differences arising during the current period, tax effe ct of which  is required to be recognised under AS 22, is measured using the regular tax rates and not th e tax  rate under section 115JB of the Act.

22. Deferred tax assets and liabilities are usually measured using the tax rates and tax law s that  have been enacted. However, certain announcements of tax rates and tax laws by the governmen t  may have the substantive effect of actual enactment. In these circumstances, deferred tax as sets  and liabilities are measured using such announced tax rate and tax laws.  

23. When different tax rates apply to different levels of taxable income, deferred tax asset s and  liabilities are measured using average rates.  

24. Deferred tax assets and liabilities should not be discounted to their present value.  

25. The reliable determination of deferred tax assets and liabilities on a discounted basis

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requires  detailed scheduling of the timing of the reversal of each timing difference. In a number of  cases  such scheduling is impracticable or highly complex. Therefore, it is inappropriate to requir e  discounting of deferred tax assets and liabilities. To permit, but not to require, discounti ng would  result in deferred tax assets and liabilities which would not be comparable between enterpri ses.  Therefore, this Standard does not require or permit the discounting of deferred tax assets a nd  liabilities.  

Review of Deferred Tax Assets  

26. The carrying amount of deferred tax assets should be reviewed at each balance sheet date . An  enterprise should write-down the carrying amount of a deferred tax asset to the extent that  it is no  longer reasonably certain or virtually certain, as the case may be (see paragraphs 15 to 18) , that  sufficient future taxable income will be available against which deferred tax asset can be r ealised.  Any such write-down may be reversed to the extent that it becomes reasonably certain or virt ually  certain, as the case may be (see paragraphs 15 to 18), that sufficient future taxable income  will be  available.  

Presentation and Disclosure  

27. An enterprise should offset assets and liabilities representing current tax if the enter prise:  

      (a) has a legally enforceable right to set off the recognised amounts; and                 (b) intends to settle the asset and the liability on a net basis.          28. An enterprise will normally have a legally enforceable right to set off an asset and lia bility  representing current tax when they relate to income taxes levied under the same governing  taxation laws and the taxation laws permit the enterprise to make or receive a single net pa yment.  

29. An enterprise should offset deferred tax assets and deferred tax liabilities if:  

(a) the enterprise has a legally enforceable right to set off assets against liabilities  representing current tax; and  

(b) the deferred tax assets and the deferred tax liabilities relate to taxes on income levie d  by the same governing taxation laws.  

30. Deferred tax assets and liabilities should be distinguished from assets and liabilities  representing current tax for the period. Deferred tax assets and liabilities should be discl osed  under a separate heading in the balance sheet of the enterprise, separately from current ass ets and  current liabilities.  

Explanation:  

Deferred tax assets (net of the deferred tax liabilities, if any, in accordance with paragra ph 29) is  disclosed on the face of the balance sheet separately after the head \021Investments\022 and

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deferred tax  liabilities (net of the deferred tax assets, if any, in accordance with paragraph 29) is dis closed on  the face of the balance sheet separately after the head \021Unsecured Loans\022.  

31. The break-up of deferred tax assets and deferred tax liabilities into major components o f the  respective balances should be disclosed in the notes to accounts.  

32. The nature of the evidence supporting the recognition of deferred tax assets should be  disclosed, if an enterprise has unabsorbed depreciation or carry forward of losses under tax  laws.  

Transitional Provisions  

33. On the first occasion that the taxes on income are accounted for in accordance with this   Standard, the enterprise should recognise, in the financial statements, the deferred tax bal ance that  has accumulated prior to the adoption of this Standard as deferred tax asset/liability with  a  corresponding credit/charge to the revenue reserves, subject to the consideration of prudenc e in  case of deferred tax assets (see paragraphs 15-18). The amount so credited/charged to the re venue  reserves should be the same as that which would have resulted if this Standard had been in e ffect  from the beginning.  

34. For the purpose of determining accumulated deferred tax in the period in which this Stan dard  is applied for the first time, the opening balances of assets and liabilities for accounting  purposes  and for tax purposes are compared and the differences, if any, are determined. The tax effec ts of  these differences, if any, should be recognised as deferred tax assets or liabilities, if th ese  differences are timing differences. For example, in the year in which an enterprise adopts t his  Standard, the opening balance of a fixed asset is Rs. 100 for accounting purposes and Rs. 60  for  tax purposes. The difference is because the enterprise applies written down value method of  depreciation for calculating taxable income whereas for accounting purposes straight line me thod  is used. This difference will reverse in future when depreciation for tax purposes will be l ower as  compared to the depreciation for accounting purposes. In the above case, assuming that enact ed  tax rate for the year is 40% and that there are no other timing differences, deferred tax li ability of  Rs. 16 [(Rs. 100 - Rs. 60) x 40%] would be recognised. Another example is an expenditure tha t  has already been written off for accounting purposes in the year of its incurrance but is al lowable  for tax purposes over a period of time. In this case, the asset representing that expenditur e would  have a balance only for tax purposes but not for accounting purposes. The difference between   balance of the asset for tax purposes and the balance (which is nil) for accounting purposes  would  be a timing difference which will reverse in future when this expenditure would be allowed f or tax  purposes. Therefore, a deferred tax asset would be recognised in respect of this difference  subject  to the consideration of prudence (see paragraphs 15 - 18).

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Submissions 21.     Dr. D. Pal, learned senior counsel appearing on behalf of  M/s. Simplex Infrastructures Ltd. and Anr., submitted that  under para 9 of AS 22 tax expense for the period, comprising  current tax and deferred tax, is now required to be included in  the determination of net profit (loss) for that period.  That,  deferred tax is now defined under the said AS 22 to mean the tax  effect of timing differences.  Timing difference in turn is defined to  mean the difference between the taxable income and the  accounting income for a period that originates in one period and  is capable of reversal in one or more subsequent periods.   Therefore, DTL along with current tax liability (CTL) are now  required to be included in the determination of the net profit  (loss) for the period.  This inclusion of DTL along with CTL in the  determination of the net profit (loss), according to learned  counsel, is repugnant to Part II of clause 3(vi) of Schedule VI to  the Companies Act.  In this connection, learned counsel urged  that under the said Part II only the tax liability of the relevant  accounting year can be charged to P&L a/c.  Therefore, clause 9,  insofar as it provides for the inclusion of DTL in the  determination of the net profit (loss) is contrary to and  inconsistent with Part II of clause 3(vi) of Schedule VI.  According  to the learned counsel, DTL as an element of P&L a/c is not  mentioned in the form prescribed for the balance-sheet  or the  P&L a/c but it is made substantive provision by para 9 by  making it a charge on the P&L a/c and thus resulting in  enhancement of tax liability for the year.   

22.     Learned counsel further contended that Section 211(1) of  the Companies Act lays down that every balance-sheet of a  company shall give a true and fair view of the state of affairs of  the company at the end of the financial year and shall subject to  the provisions of the said section, be in the form set out in  Part I of Schedule VI or as near thereto as circumstances admit  or in such other form as may be approved by the Central  Government.  According to learned counsel, Section 211(1) of the  Companies Act should be read with the proviso which inter alia   provides that nothing contained in Section 211(1) shall apply to  insurance company, banking company, electricity company etc.  for which a separate balance-sheet has been specified in the  Companies Act.  Therefore, according to learned counsel, what is  contemplated by the expression \023subject to the provisions of  Section 211\024 is that where there is inconsistency or conflict  between the other provisions of Section 211, the other provision  will prevail as there are circumstances when insurance and  banking company or any company for which a form or balance- sheet has been specified under the Act.  Therefore, according to  learned counsel, because Section 211 is subject to the said  provision, the provision contained in the proviso shall apply  whenever there is any inconsistency or conflict between Section  211(1) and the proviso.

23.     Learned counsel next contended that the impugned rule has  been framed in exercise of power under Section 642 of the  Companies Act.  Therefore, Accounting Standard has been  prescribed by the rules framed under that Section.  The rules so  framed are placed before the Parliament.  However, Section  642(1) has not the effect as if it is enacted in the Act.  That, on  the other hand, under Section 641(1) the Central Government  has been given the power to alter any of the existing regulations,  rules, tables or forms or any of the schedules to the Act including  Schedule VI.  Therefore, any alteration notified in Section 641(1)  has the effect as if enacted in the Act and shall come into force on

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the date of the notification unless the notification otherwise  directs.  These rules are also required to be placed before the  Parliament.  Therefore, Schedule VI can be amended or altered by  a notification issued under Section 641(1) of the Companies Act.   If Schedule VI is not altered or amended in exercise of power  under Section 641(1) of the said Act, then, Schedule VI being part  of the Act, the rule adopting the AS under Section 642(1) of the  Act cannot modify or amend the provisions of Schedule VI to the  Companies Act.  In this connection, learned counsel urged that  AS 22 has now been prescribed by the rules framed under  Section 641(1) of the Companies Act.  That, it runs counter to or  inconsistent with Schedule VI to the Companies Act and  consequently it amounts to excessive exercise of the powers  conferred under Section 211 read with Section 642(1) of the  Companies Act as well as in excess of the provisions of Sections  209, 211 and Schedule VI to the Companies Act and is ultra vires  the said Act.  In other words, learned counsel submitted that  Section 641 empowers the Central Government to amend  Schedule VI but Section 642 does not confer any such power.   According to the learned counsel, if Schedule VI is amended  under Section 641 the amendment will have the effect as if  enacted in the Act and the schedule so amended under Section  641 of the Act becomes part of the Act but that is not the case  where AS is prescribed by the rules under Section 641(1) of the  Act.  Learned counsel, therefore, submitted that Accounting  Standard, as prescribed by the rules under Section 642(1) of the  Act run contrary to or being inconsistent with Schedule VI of the  Companies Act without any amendment being made under  Section 641(1) of the Act.  According to the learned counsel, rules  framed under Section 642(1) of the Act do not have any effect as  if enacted in the Companies Act;  that, the effect of amendment of  schedule under Section 641 is as if enacted in the Act but rules  framed under Section 642 do not have that effect.  Therefore, the  effect of the notifications under Section 641 on the one hand and  the notifications issued under Section 642 on the other hand is  entirely different.  According to learned counsel, so long as  Schedule VI to the Companies Act is not altered or amended by  exercising the power under Section 641(1) of the Act the AS  prescribed by the rules notified under Section 642(1) cannot alter  or amend Schedule VI and if the said rules are contrary to or  inconsistent with Schedule VI then the same are liable to be  struck down as inconsistent with the provisions of the  Companies Act.   

24.     Learned counsel further submitted that in any case the  requirement of maintaining accounts on accrual basis and on  double entry system of accounting as required under Section 209  of the Companies Act is mandatory and it is not subject to any  provisions of Section 211 of the Companies Act.  Therefore,  according to learned counsel, the rule prescribing AS 22 under  Section 642(1) is not only contrary to and inconsistent with  Section 209 but also with Schedule VI to the Companies Act  insofar as it requires the DTL to be included in the determination  of net profit (loss) for the current year. That, it is in excess of the  provisions of Section 209 and Schedule VI to the Companies Act.   According to the learned counsel, if the accounts are to be  maintained on accrual basis,  DTL cannot be considered as an  accrued liability.  That, the requirements of giving true and fair  view can be made only on accrual basis and on double entry  system of accounting.  However, if DTL is a notional and  contingent liability, it cannot be charged to the P&L a/c.  It can  only be disclosed by way of a Note in the balance-sheet and P&L  a/c which will give a true and fair view of the state of affairs of  the company.

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25.     Lastly, learned counsel submitted that clause 33 of AS 22  gives a retrospective effect to the transactions which have taken  place much earlier and in respect of which the DTL is to be  calculated as if the said AS 22 has been in effect from the  beginning and the entire amount of such DTL is now required to  be provided for in the opening balance of the year in which AS 22  has been given effect to i.e. in the year 2001.

26.     Mr. Arvind P. Datar, learned senior counsel appearing on  behalf of M/s. First Leasing Company of India Ltd., submitted  that AS 22 is a subordinate legislation.  It cannot be contrary to  the provisions of the parent Act, namely, Companies Act, 1956  and, in particular, Sections 205, 209, Schedule VI and Schedule  XIV thereof.  According to the learned counsel, AS 22 is ultra  vires the rule making power conferred by Section 642 to the  extent it seeks to create a fictional tax liability.  According to  learned counsel, AS 22 is also ultra vires as no subordinate  legislation can seek to reconcile divergent profits that are  arrived at by two independent enactments, namely, accounting or  book profits as per the Companies Act and taxable profits under  the I.T. Act.  In this connection, it was urged that all 29  Accounting Standards stood notified by Notification No.739(E)  dated 7.12.2006.  Accordingly, all 29 Accounting Standards are  now contained in the Companies (Accounting Standards) Rules,  2006.  They have, therefore, the status of subordinate legislation.   That, para 2 of the Annexure to the Accounting Standards has  expressly stated that the Standards are intended to be in  conformity with the provisions of applicable laws and, therefore,  according to learned counsel, the intention is not to treat the  Accounting Standards as part of the Companies Act but as a  subordinate legislation.  Therefore, AS 22 cannot be treated as  amending or altering Schedule VI which is part of the Companies  Act and which can only be done under Section 641(2) by way of  appropriate notification.  That, under Section 641(2), any  amendment to the schedules by way of notification is treated as if  it is enacted in the Act.  Such a provision is absent in Section  642.  That, as the Accounting Standards in the present case have  not been notified under Section 641, they cannot alter or amend  the Schedule VI to the Companies Act.  

27.     As regards matching principle, learned counsel submitted  that the said principle has to be applied in two ways: (i)     on revenue basis; and (ii)    on time basis That, the said principle can be applied for both the profits,  namely, accounting profits and taxable profits.  That, broadly  speaking, the matching principle can be applied by matching  expenditure against specific revenues as having been used in  generating those specific revenues or by matching expenses  against the revenues of a given period in general on the basis that  the expenditure pertains to that period.  The former is termed as  \023matching principle on revenue basis\024 and the latter is termed as  \023matching principle on time basis\024.  According to learned  counsel, the said principle applies only where the assessee has a  choice of debiting or crediting expenditure or income in a  particular financial year (time basis) or for correlating a  particular expenditure against particular revenue (revenue basis).   That, matching principle cannot be extrapolated to divergent  results that arise under two statues and, therefore, Accounting  Profits and Taxable Profits computed under the Companies Act  and the I.T. Act respectively cannot be reconciled by applying the  matching principle or on the basis of effect of Time Differences.   In this connection, learned counsel pointed out that in India the  timing difference arises mainly because different rates of  depreciation are statutorily prescribed by Schedule XIV to the

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Companies Act and by Rule 5, Appendix-I to the Income Tax  Rules.  It is submitted that 99% of DTL arises only on  account of difference in depreciation rates.  This position is  not disputed by the Institute.  Learned counsel, therefore, urged  that if the rates of depreciation are statutorily different, then the  Institute or the Central Government, as a rule making authority,  has no power to apply the matching principle or timing difference  and bring the \023accounting depreciation\024 in line with \023tax  depreciation\024.  Therefore, according to learned counsel, the  Institute as well as the Central Government has erred in  prescribing AS 22 as a mandatory rule to bring about a  reconciliation between tax depreciation and accounting  depreciation for which it has no such jurisdiction or power.   According to learned counsel, in India, unlike U.K., rates of  depreciation are statutorily prescribed.  They are separately  prescribed under I.T. Act and Companies Act.  Therefore, it is  only for the court/tax department to apply the matching principle  in a given case.  It would depend on the facts of a given case.  The  matching principle cannot be prescribed by a rule or an  Accounting Standard.  Learned counsel, therefore, submitted  that the Central Government as a rule making authority under  Section 642 or the Institute has no power to apply the matching  principle or timing difference across the board to bring the  accounting depreciation in line with tax depreciation.  The rates  of depreciation are not prescribed statutorily in U.K.  In U.K. the  assessee is at liberty to adopt any rate of depreciation he chooses  and, therefore, according to learned counsel, there could be  some justification for invoking the matching principle and  applying an accounting standard for deferred taxation.

28.     On the concept of \023true and fair\024 view, leaned counsel urged  that under Section 211(1), a balance-sheet has to present a true  and fair view.  Similarly, under Section 211(2), P&L a/c must  also be true and fair.  However, according to learned counsel, the  said concept does not mean that Accounting Standards can  alter Schedule VI or enable alteration of accounting profits  which have been computed as per Sections 205, 209 read with  Schedule VI and Schedule XIV to the Companies Act.  Learned  counsel further pointed out that in fact under Section 211(5)(v)  there is a stipulation that anything not disclosed as per Schedule  VI will not render the balance-sheet/P&L a/c as not disclosing  the true and fair view.

29.     On the question of effect of AS 22, learned counsel urged  that the effect of implementation of AS 22 would result in drastic  reduction in profits of a company.  In this connection, learned  counsel urged that AS 22 provides for TOI.  That, the difference  between accounting profit (profit under the Companies Act after  providing for depreciation and taxation) and the taxable profit  (profit as per I.T. Act) are to be multiplied by the rate of income  tax.  This amount has to be reduced/deducted from the  accounting profit.  Therefore, the formula would be read as  under: (AP-TP) x rate of income tax = DTL In other words, if the accounting profit is Rs.50 crores and the  taxable profit is Rs.30 crores and the rate of income tax is 30%  then DTL will be Rs.6 crores (50-30 x 30/100).

30.     Similarly, (loss/unabsorbed depreciation) x rate of income  tax is = DTA.  If a company has a loss and carry forward  depreciation of Rs.40 crores and the rate of income tax is 30%  then DTA will be: 40 x 30/100 = Rs.12 crores         In such a case the loss of Rs.40 crores will be reduced to  Rs.28 crores (40-12).

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Relying upon the above illustrations, learned counsel submitted  that if a company is making accounting profits year after year the  said profits will stand reduced year after year by DTL if AS 22 is  implemented.  Similarly, according to learned counsel, the DTL of  each year will become accumulated and shown on the liability  side of the balance-sheet, below \023Unsecured Loans\024.  That, this  accumulated liability on account of DTL will reduce the net-worth  of a company.  On the other hand, DTA has to be shown on the  Asset side.  But DTA can be claimed as an asset only on the basis  of the concept of \023virtual certainty\024 (See: paras 17 and 18 of AS  22).  Accordingly, it is urged that profits available for distribution  as dividend shall also be reduced between 20% to 30% each year  if DTL is shown as accumulated liability.  According to learned  counsel, the Institute has not produced any evidence of any  company getting any benefit from implementation of AS 22.  In  this connection, learned counsel submitted that provision for  DTL unfortunately has not been treated as a reserve which can  be utilized in times of financial crisis.  That the Institute has not  given a single example of a situation where timing difference has  been reversed.  According to learned counsel, AS 22 does not in  any way help collection of higher taxes.  That, as long as a  company continues to be profitable, it is impossible for any  reversal by timing difference.  In this connection, learned counsel  urged that, in India, income tax depreciation is substantially  higher than accounting depreciation as per Schedule XIV and,  therefore, the accounting profits will always be more than the  book profits.  Therefore, every year, there would be DTL which  will keep on accumulating.  For example, according to learned  counsel, accumulated DTL of Reliance Industries Ltd. was  Rs.6982 crores as on 31.3.07 and this liability will keep on  accumulating.  According to learned counsel, except in the case  of companies which are likely to make loss in the near future,  reversal will never take place.  Therefore, the basic stipulation of  timing difference getting reversed will never happen.  Learned  counsel further submitted that DTL is made chargeable to the  P&L a/c even when it is a non-existent or fictional liability; that  the amount which is reduced from the profit is not even treated  as a reserve and, therefore, DTL cannot be utilized if the company  runs into financial difficulty.  

31.     According to learned counsel, under para 33 of AS 22  companies are required to rework the entire liability from the  beginning of the existing assets.  For example, in the case of  Indian Railway Finance Corporation Ltd., provision is required to  be made in respect DTL of Rs. 940.55 crores.  The transitional  provision took place for the year ended 2001-02.  The said  provision of Rs.940.55 crores has diminished Bond Redemption  Reserve.  Similarly, according to learned counsel, in the case of  M/s. First Leasing Company of India Ltd., application of para 33,  as transitional provision, has resulted in DTL of Rs.62 crores.       32.     On the question of legal status of AS 22, learned counsel  submitted that the said Standard is a subordinate legislation  and, therefore, it cannot create a tax liability.  DTL is neither a  liability nor a tax.  It is not a deferral.  That, the levy of tax can  either be by the Central Government or State Government under  List I or List II of Schedule VII to the Constitution.  That, under  Article 366(28), taxation includes imposition of any tax or impost.   Under Article 265, taxes can be levied only by authority of law.   DTL, according to learned counsel, is not a tax by definition or by  understanding.  It cannot be treated as a tax by any process of  interpretation.  If it is a tax, it has to be credited to the  Consolidated Fund of India/State.  DTL is also not a fee or a cess

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or any surcharge.  That, under para 3(vi) of Part II of Schedule VI  deduction of taxes on income has to be shown.  At present, the  taxes that can be deducted are Income Tax, Fringe Benefit Tax  (FBT), Minimum Alternate Tax (MAT).  Similarly, any surcharge  or cess levied by the Finance Act as a percentage of such taxes  will also be deductible.  According to learned counsel, gross  receipts of any company can be reduced by following items to  arrive at profits before taxation.  These items are expenses such  as salaries, raw materials and overheads; liability towards  gratuity, PF, etc..  A tax liability can be created only under an Act  of Parliament.  DTL can only be a liability by way of tax.  It is  not a liability of any other nature since it is not required to  be discharged in future.  It is not enforceable against the  company.  Thus, DTL creates a legal fiction with respect to the  concepts of taxation and liability which is contrary to the legal  meaning enunciated by several judgments of this Court (See:  State of Kerala v Madras Rubber Factory Ltd. \026 AIR 1998 SC  723 at 730 and Shree Digvijay Cement Co. Ltd. v. Union of  India (2003) 2 SCC 614 at 627, para 26 and 27).

33.     On the question of effect of Section 211(3A), (3B) and (3C),  learned counsel submitted that Section 211(3A) cannot be read to  imply that Accounting Standards have to be complied with even if  they are inconsistent with the Act or that they alter/amend any  provisions of the Companies Act.  As regards Section 211(3B),  learned counsel submitted that any deviation from the  Accounting Standards has to be qualified by the auditors which  may lead to adverse consequences for the company.  According to  learned counsel, unless the company is likely to make loss in  near future, timing difference can never arise.  According to  learned counsel, tax depreciation, in India, is higher than book  depreciation and, therefore, DTL will exist in the financial  statements indefinitely.  This is one more effect of AS 22 being  implemented in India.  On the other hand, according to learned  counsel, the very purpose of AS 22 of presenting true and fair  view can be easily achieved by making AS 22 a disclosure  requirement as Notes to the Accounts, rather than inserting it in  Schedule VI, Parts I and II to the Companies Act.

34.     Mr. S.K. Bagaria, learned counsel appearing on behalf of  J.K. Tyre & Industries Ltd. (formerly known as \023J.K. Industries  Ltd.\024), submitted that AS 22 requires charging  the P&L a/c for  an assumed liability on account of deferred tax which is not  payable according to the provisions of I.T. Act for the accounting  period nor does it represent any tax which would become payable  in future.  That, AS 22 requires provision to be made for alleged  tax liabilities and recognition of alleged tax assets which are not  at all accrued liabilities or assets.  According to learned counsel,  AS 22 requires provision for assumed tax liabilities and  recognition of assumed tax assets which are in reality non- existent, commercially or under the law.  According to the  learned counsel, notional and imaginary working is required to be  made for AS 22;  that, deferred tax is neither an asset nor a  liability; that, the accrual basis of accounting requires a provision  to be made for a known liability existing on the balance-sheet  date and that any  provision made on account of tax not payable  under I.T. Act for the accounting period is not a provision for any  known liability according to the accrual basis of accounting.   According to the learned counsel, any amount set aside on  account of tax for which there is no liability under the I.T. Act  cannot be considered as a \023tax expense\024 for the period of  account; that, statutory levy of tax has to be measured and  recognized as per the I.T. Act or the Companies Act or any other  applicable enactment and that if the I.T. Act does not create DTL,  such liability does not exist at all.  According to the learned

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counsel, under the \023accrual\024 basis of accounting, a company is  required to make provision only for a liability which has accrued  in the relevant accounting year; that,  in respect of contingent  liability, it is not required to make any provision but only a note  is required to be given in the accounts known as \023Disclosure  Note\024; that, DTL is not even a contingent liability; and that, on  the balance-sheet date several events such as the working of the  company in future years, whether the company will earned a  taxable profit (loss) in future are events which are totally  unknown at the end of the accounting period when the company  is required to recognize, measure and account for DTL.   According to the learned counsel, if there is no income in future,  there would be no liability for tax in future and if there is income  and additions to assets in future, the difference in depreciation  under the Companies Act and under the I.T. Act for the  accounting period will not result in any tax liability in future and  there would be no reversal of the DTL created in the accounting  period.  According to learned counsel, AS 22 requires  recognition of the tax effect, whether current or deferred, in  respect of individual transaction during the accounting  period as if in future the company would have to make  payment on account of deferred tax.  According to learned  counsel, the aforestated concept is merely an assumption.  Under  the I.T. Act, tax is determined with reference to the total  income and not with reference to any individual transaction.   The total income in future is uncertain.  The total statutory tax  liability in future is also uncertain.  The difference between the  current accounting income and the current taxable income, for  example, on account of depreciation, may or may not have any  impact on the computation of the total income of a future year or  it may or may not entail any tax liability.  Therefore, it cannot be  said with certainty that deferred tax in respect of an  individual transaction of the accounting period would result  in any cash outflow on account of tax in a future year.   According to learned counsel, AS 22 has been framed on the  fundamental accounting assumption of \023going concern\024.   However, it is one thing to assume that business would go on and  quite another to assume that it will produce profits.  If there is no  taxable income in future, the tax effect of the transactions of the  accounting period will not translate into any actual liability or  cash outflow.  According to learned counsel, AS 22 assumes that  there would be sufficient taxable income in future entailing tax  liability in future and that the tax effect of the transactions in the  accounting period would have a role to play in the determination  of future taxable income and liability.  According to learned  counsel, the above is also an assumption.  According to learned  counsel, the accrued liability for tax is the liability in respect of  the amount of tax statutorily payable on the taxable income  computed from the accounting income in accordance with the I.T.  Act after making appropriate deduction allowances and  disallowances.  Such liability for tax represents the provision for  taxation.  Any amount in excess of such liability would be a  reserve.  If the I.T. Act does not create any liability for tax, such  liability does not exist in fact or in law and, therefore, it would be  contrary to all norms of prudence to recognize or provide for a  non-existent liability.  According to learned counsel, liability for  tax must exist under I.T. Act for it to be called an accrued  liability; that the contention of the Institute that liability for tax  should be considered in the accounting sense and not in the  strict legal sense proceeds on the basis that deferred tax is not an  accrued liability in the legal sense; that, the tax liability in the  income is only to the extent the I.T. Act provides for such  liability; that real liability for income tax is only as computed  under the I.T. Act; that, merely because the difference between  the accounting income and taxable income is ascertainable and

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merely because tax effect on account of such difference can be  worked out on the basis of existing tax rates, it cannot be said  that such tax effect represents a real liability payable today  or tomorrow.  According to learned counsel, the difference  between accounting and taxable income in a given year may or  may not give rise to a liability or outflow of money in future.   According to learned counsel, this is an assumption.  This is  totally uncertain.  Therefore, according to learned counsel, to give  tax effect on such difference cannot be treated as an accrued  liability and in respect of such difference, no income tax is  payable under the I.T. Act for the accounting period.

35.     Mr. Bagaria, learned counsel, further submitted that  \023accrual\024 is a legal concept.  It has not been defined under I.T.  Act.  It has not defined under the Companies Act.  An accrued  liability arises only if that liability has arisen in the accounting  year concerned.  This position has been settled by various  decisions of this Court.  It has been further held in numerous  decisions by this Court that provision for taxation is the provision  for tax liability under the I.T. Act as on the last date of the  accounting year and that if anything is provided in excess of such  tax liability, it will not be a provision but it will be a reserve (See:  the judgment of this Court in Metal Box Company of India Ltd.  v. Their Workmen \026 AIR 1969 SC 612).  Therefore, according to  learned counsel, if the I.T. Act does not create any liability for  tax, there is no liability for tax either in fact or in law.  Learned  counsel, however, invited our attention to the difference between  contractual liability in case of cars sold with warranties and tax  liabilities which, according to learned counsel, stand on a totally  different footing as it is to be determined in accordance with the  principles laid down in various judgments of this Court under the  I.T. Act.   

36.     Learned counsel next contended that under Section  209(3)(b) of the Companies Act read with Section 209(1), income  and expenditure and assets and liabilities should be accounted  for in the books of account on \023accrual basis and according to the  double entry system of accounting\024; that, the concept of \023accrual\024  in Section 209(3)(b) is required to be understood in the same  manner as it is required to be understood judicially. According to  the learned counsel,  \023accrual\024 has been defined in AS 1, which  has also been prescribed by the impugned Notification dated  7.12.06, as revenues and costs recognized as they are earned or  incurred and recorded in the financial statements of the periods  to which they relate.  According to learned counsel, the definition  of the word \023accrual\024 in Notification dated 25.1.96 issued by the  Central Government under Section 145(2) of the I.T. Act also  referred to the word \023accrual\024 as an assumption, namely, that  revenues and costs are recognized as they are earned or incurred  and so recorded in the financial statements for the period(s) to  which they relate.  According to learned counsel, the Accounting  Standard notified under I.T. Act also requires the accounts to  give a true and fair view.  Therefore, according to learned  counsel, the definition of the word \023accrual\024 is the same both in  the Accounting Standard prescribed under Section 211(3C) and  that which is notified under Section 145(2) of the I.T. Act.   Therefore, according to learned counsel, the word \023accrual\024 for  the purposes of the Companies Act does not carry any meaning  different from that mentioned for the purposes of the I.T. Act.   That, only the amount of income tax actually payable under the  I.T. Act with reference to the taxable income for the period  covered by the account computed in accordance with the  provisions of that Act can constitute a charge for income tax and  is, therefore, an accrued liability.  Any amount in excess of such  tax is a reserve and not a provision for taxation.  According to

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learned counsel, therefore, for the above reasons AS 22 insofar as  it relates to deferred tax is contrary to the concept of \023accrual\024  which concept is recognized under Section 209(3)(b) read with  Section 209(1) of the Companies Act.           37.     On the question of matching principle, learned counsel  urged that the matching concept is fully complied with when a  provision is a made for tax computed in accordance with the  provisions of the I.T. Act with reference to the taxable income  derived from the accounting income after making appropriate  deductions, allowances and disallowances in accordance with the  statutory provisions.  According to learned counsel, matching  tax in respect of accounting income is only the tax computed  for the accounting period, according to the provisions of the  I.T. Act.  It is not any assumed future taxation dependent upon  any assumed future working of the company.  The object of  incurring expenses is to produce revenue.  In measuring the  income for a period, revenue is to be adjusted against  expenses incurred for producing that revenue.  This concept of  adjusting/offsetting the expenses against revenue is the  matching principle.  This concept is fully satisfied when  provision for taxation is made for tax liability in accordance with  the provisions of the I.T. Act and it is such tax alone which is the  tax liability incurred on the income earned during the period  concerned.       38.     As regards the question of the functional utility of  Accounting Standards under Section 211(3A), (3B) and (3C) is  concerned, learned counsel submitted that Section 209 provides  that every company keeping proper books of account with respect  to moneys received and expended and the matters in respect of  which the receipt and expenditure takes place as well as the  assets and liabilities of the company.  According to learned  counsel, therefore, Section 209(1) recognizes the receipt and  expenditure as well as assets and liabilities; that, prior to  substitution of Section 209(3) by the Companies Act  (Amendment) Act, 1988 w.e.f. 15.6.88, did not provide for keeping  the books of account on accrual basis.  However, based on the  report of Sachar Committee to the effect that \023true and fair\024 view  should be projected, Section 209 was suitably amended to make  it obligatory on all companies to maintain accounts on mercantile  system of accounting.  Based on the recommendation of the  Sachar Committee sub-section (3) was substituted.  Thus, from  Section 209, according to learned counsel, the following position  becomes clear, namely, that Section 209 recognises receipt and  expenditure as well as assets and liabilities on accrual basis and  on double entry system for accounting.  After the said  amendment, books of account are required to be kept on accrual  basis.  Therefore, according to learned counsel, the requirement  of \023true and fair view\024 stands incorporated in Section 209(3)(a),  Section 211(1), (2) and (5); Section 217(2AA)(ii); and Section  227(2).  According to learned counsel, on bare reading of Section  227 read with Section 209 it is clear that the auditor of the  company has to report that \023proper books of account\024 as required  by law has been kept by the company; that, \023proper books of  account\024 shall not be deemed to be kept unless they are kept on  accrual basis and double entry system of accounting;  that, the  auditor has to report that the balance-sheet and the P&L a/c are  in agreement with the books of account and that the auditor has  also to report whether profit and loss account as well as balance- sheet complies with the Accounting Standards referred to in  Section 211(3C).  According to learned counsel, sub-section (3A)  of Section 211 requires every P&L a/c and balance-sheet of the  company to comply with the Accounting Standards; that, sub- sections (3A), (3B) and (3C) do not refer to keeping of proper

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books of account; that this subject is covered by Section 209 only  which mandates that proper books of account shall not be  deemed to be kept unless the same are kept on accrual basis and  double entry system of accounting; that, the said mandate of  Section 209 cannot be altered by the Accounting Standards and  since the Accounting Standards as per sub-section (3A) can only  relate to the P&L a/c and balance-sheet and not to keeping  proper books of account which are basic primary records from  which the P&L a/c and balance sheet are prepared and since  P&L a/c and balance-sheet are not books of account but only  abstracts.

39.     AS 22 relating to deferred tax is directly in conflict with  Section 209 of the Companies Act and in excess of the powers  vested under sub-section (3A), (3B) and (3C) of Section 211.  In  this connection, learned submitted that the power conferred  upon the Central Government under sub-section (3C) of Section  211 for prescribing Accounting Standards by framing of rules is  in the nature of delegated legislation; that under the scheme of  sub-section (3A), (3B) and (3C) of Section 211, Accounting  Standards can be prescribed only in relation to P&L a/c and  balance-sheet; that a delegatee of power cannot assumed  jurisdiction in areas or over subjects which are not delegated;  that the power being limited to prescribing Accounting Standards  for P&L a/c and balance-sheet, cannot be exercised in relation to  maintenance of books of account and that too on a basis different  from accrual basis mandated in Section 209 and any such  exercise of power by prescribing any Accounting Standard  affecting the maintenance of proper books of account and that  too on a basis different from accrual basis will be in excess of the  powers vested in the Central Government under sub-section (3A),  (3B) and (3C) of Section 211 and will be directly in conflict with  Section 209 of the Companies Act.  In this connection, learned  counsel submitted that AS 22 requires a company to reduce or  increase its net profit by passing journal entries in its books of  account in respect of DTL or DTA; that it is only after these  entries are made in the books of account in respect of DTA or  DTL that the net profit in the P&L a/c can be increased or  reduced and DTA or DTL can be reflected in the balance-sheet  after the head \023Investments\024 in case of DTA and after the head  \023Unsecured Loans\024 in case of DTL and, therefore, according to  learned counsel, AS 22 exceeds the power conferred by sub- sections (3A), (3B) and (3C).  According to learned counsel, the  power under sub-sections (3A), (3B) and (3C) only relates to  prescribing Accounting Standards for presentation of P&L a/c  and balance-sheet whereas AS 22 directly and immediately  encroaches upon preparation of books of account and  maintenance and proper books of account on accrual basis and  in the process violates the mandate statutorily imposed by  Section 209(3).  That, there is no power conferred by sub-sections  (3A), (3B) and (3C) nor by any other sub-sections of 211 to  prescribe Accounting Standards relating to maintenance of  proper books of account.  In this connection, learned counsel  pointed out that the duty of the auditor is to report in terms of  Section 227(3)(d) about compliance with the Accounting  Standards referred to in sub-section (3C) of Section 211 which  applies only in respect of P&L a/c and balance-sheet; that, the  said provision makes it clear that compliance with the  Accounting Standards is to be made only in respect of the P&L  a/c and balance-sheet whereas keeping of books of account in  terms of Section 209 is required to be reported upon by the  auditor only in terms of Section 227(3)(d) and, therefore, AS 22  exceeds the power conferred by sub-sections (3A), (3B) and (3C)  of Section 211.  Learned counsel submitted that AS 22 is  confined to prescribing Accounting Standards for presentation of

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P&L a/c and balance-sheet.  It does not deal with preparation of  books of account.  That subject falls under Section 209(3).   Therefore, AS 22 prescribes Accounting Standards only for  P&L a/c and balance-sheet without directing that exercise to  be made in respect of preparation and maintenance and  proper books of account on accrual basis and, therefore, AS 22  brings about inconsistency between the provisions of Section  209(3) on one hand and sub-sections (3A), (3B) and (3C) of  Section 211.  According to learned counsel, Section 217(2AA)(i)  merely relates to \023preparation of annual accounts\024; it does not  deal at all with preparation and maintenance of books of account;  that annual accounts are not books of account (See: Section 210)  and, therefore, the said Section 217(2AA)(i) has nothing to do  with preparation and maintenance of proper books of account  which subject is independently dealt with in Section 209.   According to learned counsel, the provisions of AS 22 insofar as it  requires making of entries in the books of account reducing the  profit by accounting for DTL or increasing the profit by  accounting for DTA and to reflect such entries in the P&L a/c  and balance-sheet, are ultra vires sub-sections (3A), (3B) and (3C)  of Section 211 and Section 209 of the Companies Act.  That, by  AS 22, insofar as the same relates to \023deferred tax\024, the delegatee  of power (Central Government) has attempted to encroach upon  the areas far beyond those covered by the delegation.  

40.     According to the learned counsel, Section 211(1) starts with  the mandate that \023every balance-sheet of a company shall give a  \021true and fair\022 view at the end of the financial year\024.  This  mandate is, according to learned counsel, not subject to  anything.  It is not qualified by the expression \023subject to the  provisions of this section\024.  Similar is the position in sub-section  (2) of Section 211 with regard to the P&L a/c.  Therefore,  according to learned counsel, \023true and fair view\024 requirement is  the primary requirement of Section 211(1) and Section 211(2)  which requirement stands satisfied only if the accrual basis is  followed as mandated in Section 209(3).  According to learned  counsel, the expression \023subject to the provisions of this  section\024 in Section 211(1) obviously includes the provision of  sub-section (1).  Therefore, according to learned counsel, even in  terms of the specific language of Section 211(1) the requirement  of \023true and fair view\024 in that sub-section is a stand-alone  concept and it is not subject to anything.  According to  learned counsel, accrual basis in Section 209(3) is a necessary  component of \023true and fair\024 view as a requirement and,  therefore, the said requirement in Section 211 and in Section 209  would have the same meaning. However, according to learned  counsel, the expression \023subject to the provisions of this section\024  in Section 211(1) only qualifies the requirement of balance-sheet  being in the form set out in Part I of Schedule VI; that, similarly  the expression \023subject as aforesaid\024 in sub-section (2) of Section  211 only qualifies the requirement of Part II of Schedule VI in  respect of P&L a/c; that, sub-section (3A) of Section 211 inter alia   provides that every P&L a/c and balance-sheet of the company  shall comply with the Accounting Standards and, therefore,  according to learned counsel in the entire scheme relating to  accounts and audit in Part VI, Chapter I, Section 209 to Section  233B of the Companies Act, the statutory mandate of keeping  proper books of account on accrual basis is not allowed to be  altered or encroached upon by any Accounting Standards.   According to learned counsel, it is the statutory mandate that  P&L a/c and balance-sheet shall be in consonance with the  books of account.  Therefore, sub-sections (3A), (3B) and (3C) can  only relate to presentation of and disclosures in P&L a/c and  balance-sheet, keeping intact the statutory mandate of  maintaining proper books of account on accrual basis.  

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Therefore, if the format of a balance-sheet or the requirements of  P&L a/c is allowed to be altered by any Accounting Standards it  would amount to encroachment upon the statutory mandate of  keeping proper books of account on accrual basis.  Therefore,  according to learned counsel, Accounting Standards can provide  in relation to presentation of and disclosures in P&L a/c and  balance-sheet without touching upon the basic requirement of  maintaining proper books of account on accrual basis and only  thereby one can comply with the concept of \023true and fair view\024.   Any other interpretation would mean that AS 22 far exceeds the  power conferred by sub-sections (3A), (3B) and (3C) of Section  211 and it would amount to creating inconsistencies between  various sections of the Companies Act.         41.     Learned counsel next contended that accrual basis of  accounting does not recognize DTA or DTL; that, accounting for  any DTA or DTL would be contrary to the accrual basis of  accounting and would not result in keeping of proper books of  account in terms of Section 209.  Neither the books of account  nor the P&L a/c or balance-sheet which are required to be in  agreement with the books of account will give a true and fair view  if accounting has to be made in respect of DTA or DTL; that, AS  22 does not result in a true and fair measurement of the P&L a/c  or the state of affairs of a company and if any provision is made  on account of \023deferred tax\024 with reference to the difference  between accounting and taxable incomes for which no liability  exists under the I.T. Act, such provision would distort the books  of account and financial statements and would not give a true  and fair view.  That, similarly creation of a deferred tax asset  because of current losses would distort the books of account and  financial statements and would not give a true and fair view.   According to learned counsel, accrual basis is a necessary  component of true and fair view requirement.  The provision  contrary to the accrual basis cannot satisfy the said requirement.   Lastly, according to learned counsel, the only way out of the  above inconsistencies is to harmoniously construe Sections 209,  211 and AS 22 by reading down the said Standard so that the  company is only required to make a disclosure in the P&L a/c  and balance-sheet as regards DTA or DTL without requiring the  company to make any entry in the books of account or without  making any company to reduce or increase its net profit.

42.     Lastly, learned counsel submitted that vide para 33 of AS  22 DTL is sought to be created in respect of individual  transactions since the inception of the company which may be  long before the AS 22 came into effect resulting in reduction of  the revenue reserve by the amount of such DTL.  That, the  working required to be made in terms of para 33 of AS 22 is  complicated.  In this connection, learned counsel pointed out  that under para 34 of AS 22, not only opening balances of assets  but also opening balances of liabilities for accounting purposes  and for tax purposes have got to be compared; that, para 33  requires a working to be made in respect of individual  transactions since the inception of the company in order to  ascertain DTAs or DTLs.  That, in case of DTL, the revenue  reserve has to be reduced and conversely in case of a DTA, the  revenue reserve has to be increased.  This is, according to  learned counsel, indicates that para 33 which is termed as  \023transitional provision\024 is clearly retrospective in its operation.   Therefore, according to learned counsel, para 33 of AS 22 would  result in reduction of the company\022s revenue reserves.  It will  erode the company\022s net worth.  It will alter the company\022s debt- equity ratio.  It will adversely effect the company\022s borrowing  capacity.  Therefore, according to learned counsel, the High Court  had erred in dismissing the writ petitions filed by the appellants.  

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According to learned counsel, Section 211(3C) does not enable  the Central Government to give any retrospective operation to the  Accounting Standards.  The rule-making power under Section  642 of the Companies Act also does not permit the making of any  rules with retrospective effect and, therefore, according to learned  counsel, para 33 deserves to be set aside.  For the above reasons,  learned counsel submitted that AS 22 far exceeds the power and  jurisdiction conferred by sub-sections (3A), (3B) and (3C) of  Section 211 and that it brings about inconsistencies between  various sections of the Companies Act and, therefore, the said AS  22 deserves to be struck down or in the alternative AS 22  deserves to be read down so that at best the company is required  to make a disclosure in the P&L a/c and balance-sheet as  regards any DTA or DTL without requiring it to make any entry in  the books of account and without requiring any company to  increase or reduce its net profit (loss).         43.     Mr. A Sharan, learned Additional Solicitor General  appearing for Union of India, submitted that validity of a  legislation could be challenged on grounds of incompetence of the  legislation or same being violative of Part III of the Constitution.   That, a subordinate legislation can be challenged additionally on  the grounds that the same is beyond the authority of delegate or  that it is violative of provisions of the enactment.  According to  learned counsel, in the present case, appellants have not  challenged the competence of the Central Government to notify or  provide for Accounting Standards, they have restricted their  challenge only on the ground that AS 22 contravenes the  provisions of Companies Act by stating that the same violates  Sections 205, 209, 211 and Schedule VI of the Companies Act.   According to learned counsel, even in that regard no details have  been given by the appellants in their original writ petition as to  how the impugned Accounting Standard contravenes the  provisions of the Companies Act.  Therefore, according to learned  counsel, the entire original writ petition filed by the appellant is  misplaced, misconceived and not maintainable for want of  details.  Learned counsel urged that AS-22 provides for a  different manner than Schedule VI in which account of a  company required to be prepared.  It is submitted that Schedule  VI is the form set out under the Companies Act in which a  company is required to submit its balance-sheet and profit and  loss account.  Section 211(1) requires the companies to prepare  their balance-sheet in the form set out in Part-I of Schedule VI.  A  plain reading of Section 211 reveals that the requirement of  submission of balance-sheet in the said form is subject to the  other sub-sections of Section 211 and hence the format of the  said balance shall necessarily be guided by the Accounting  Standards provided under sub-section (3A) as same is having  overriding effect on Part I of Schedule VI.  According to learned  counsel, when any provision made is subject to other provisions  of that section, then the said provision (Part I of Schedule VI) has  to give way the other provisions (AS-22 as provided by Section  221(3A)).  In this connection, reliance is placed on the judgment  of this Court in the case of South India Corporation (P) Ltd. v.  Board of Revenue, Trivandrum and Anr. \026 AIR 1964 SC 207 at  p.215, in which this Court has held that the expression \023subject  to\024 conveys the idea of a provision yielding place to another  provision or other provision(s) to which it is subject to.  Reliance  was also placed by the learned counsel on the judgment of this  Court in the cases: The State of Bihar and Anr. v. Sir Kameshwan Singh and  Anr. \026 AIR 1952 SC 252;  

K.R.C.S. Balakrishna Chetty and Sons & Co. v. The State  of Madras \026 AIR 1961 SC 1152; and

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Heggade Janardhan Subbaraya v. The State of Mysore  and Ors. \026 AIR 1963 SC 702.    

In the alternative, learned counsel submitted that in any event  Section 641 empowers the Central Government to amend  Schedule VI whereas Section 642 confers powers on the Central  Government to formulate rules.  That, Part I of Schedule VI  prescribes the form in which the balance-sheet and P&L a/c is  required to be prepared.  According to learned counsel, AS 22 is  prescribed by the Central Government with respect to  computation of tax liability; that, AS 22 lays down the manner in  which the said computation of tax liability in the balance-sheet is  required to be prepared and, therefore, in pith and substance AS  22, according to learned counsel, prescribes additional mode in  which tax liability of a company is required to be calculated.   Thus, according to learned counsel, exercise of power by the  Central Government under Section 642 providing for AS 22 is  exercise of power for same purpose which is required to be  exercised under Section 641 to amend Schedule VI and,  therefore, in pith and substance, according to learned counsel,  exercise of power by the Central Government under Section 642  will be deemed to be exercise of power by the Central Government  under Section 641 and accordingly Part I of Schedule VI will  stand modified/amended to the extent it contravenes AS 22.   This is particularly because Part I of Schedule VI is subject to  Section 211(3A) of the Companies Act.  According to learned  counsel, under Section 211 every company is required to prepare  its balance-sheet and P&L a/c in the manner provided therein.   Sub-section (3A) of that Section makes it mandatory to comply  with Accounting Standards.  While preparing P&L a/c and  balance-sheet (See: Section 211(3C)).  According to learned  counsel, since AS 22 is an Accounting Standard prescribed under  sub-section (3C) it has a statutory status, required to be followed  while preparing the books of account in terms of Section 211 of  the Companies Act.  Lastly, learned counsel urged that the  Companies Act is a special statute; that, Section 211 is a special  provision aimed at providing the form and content of P&L a/c  and balance-sheet required to be prepared by the company; that,  a special provision like Section 211 ordinarily overrides the  general provision; that, if a special provision is made on a  particular subject then that subject is excluded from the general  provision and since AS 22 is a special provision notified under  Section 211(3C) with respect to form and content of accounts of  the company, the same will override other provisions of the  Companies Act as well as any other statute to the extent provided  therein.  In this connection, learned counsel placed reliance on  the judgment of this Court in the cases: Gadde Venkateswara Rao v. Government of Andhra  Pradesh and Ors. \026 AIR 1966 SC 828;

State of Bihar v. Dr. Yogendra Singh GOL (Retired) and  Ors. \026 (1982) 1 SCC 664

Maharashtra State Board of Sec. and High. Sec.  Education and Anr. etc. v. Paritosh Bhupeshkumar  Sheth and Ors. etc. \026 (1984) 4 SCC 27

State of Gujarat and Anr. etc. v. Patel Ramjibhai  Danabhai and Ors. etc. \026 (1979) 3 SCC 347

44. In view of the aforestated submissions learned counsel  submitted that AS 22 is intra vires the Companies Act and,  therefore, the appeals deserve to be dismissed with costs.

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     45.     Mr. N.K. Poddar, learned senior counsel appearing for the  Institute, submitted that corporate accounts are required to  disclose a \023true and fair view\024.  It is a requirement.  That  requirement has to be ensured by the auditors who have to  certify that the accounts are prepared so as to provide \023true and  fair view\024 of the state of affairs of the company.  This  responsibility is undertaken by accountants and auditors who  are members of the Institute.  If Accounting Standards are not  followed, financial accounts would not be \023true and fair\024 and in  that case, the statutory requirement in Section 211 for preparing  true and fair accounts would not be satisfied.  According to  learned counsel, prior to 1988 the requirement contemplated by  the Companies Act was disclosure of \023true and correct view\024.   This requirement was deliberately changed by the Legislature to  \023true and fair view\024.  When it was a question of disclosing a true  and correct view, it was permissible to look into the legal liability  for tax, and make a provision accordingly; but when the  requirement in law is to disclose \023true and fair\024 accounts, a wider  perspective is warranted.  That is why, the Institute states that  the I.T. provision should be based not only on the strict legal  liability to be discharged immediately, but also on the legal  liability based on book profits (real profits) which are earned  and reflected in the corporate accounts of the company.   Therefore, the Institute insists that there should be a reasonable  matching of cost and benefit, if the accounts are to disclose a  \023true and fair view\024.  The Institute has legal obligation of ensuring  disclosure of \023true and fair view\024 in the corporate accounts.   However, in the absence of a statutory definition of \023true and  fair\024, it is the Institute\022s function to determine the basic rules for  ensuring disclosure of a \023true and fair view\024.  According to  learned counsel, \023true and fair view\024 is a concept which requires  the Auditor to look at the substance rather than pure legal form  and that is why all its Accounting Standards emphasize the  importance of Substance over Form.  The said view of the  Institute is duly affirmed by Parliament when Parliament decreed  that corporate accounts shall comply with the proper Accounting  Standards (See: sub-sections (3A) and (3B) of Section 211 of the  Companies Act).  The basic reason for issuing AS 1 through  Notification dated 25.1.96 of Government of India, to be followed  by all assessee\022s following mercantile system of accounting, was  to lay down that accounting policies adopted by an assessee  should represent a \023true and fair\024 view of the state of affairs of  the business in the financial statements prepared and presented  based on such accounting policies.  Therefore, the requirement  \023true and fair\024 view overrides all other statutory  requirements as to the matters to be included in the  corporate accounts.  In order to give a \023true and fair view\024 it is  not necessary to provide information, additional to the one  needed to comply with all other statutory requirements or even to  depart from compliance with one or the other requirements.  Any  departure has to be disclosed in a Note to the Financial  Statements giving reasons for such departure and its effects.   Moreover, the concept of \023true and fair\024 is not static.  It is  dynamic in nature.  It continues to evolve in accordance with the  changes in the requirements of economy.         46.     It is the function of the Institute to regulate the profession of  Chartered Accountants.  By formulating Accounting Standards,  Institute is fulfilling its statutory function.  It is furthering  Legislative intent of Parliament, which requires that accounts  should be \023true and fair\024.  Therefore, by laying down Accounting  Standards, which explains what is \023true and fair\024, the Institute is  merely fulfilling its statutory duty and function.        

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47.     Learned counsel submitted that conceptually, the  justification for Accounting Standards lies in the compelling logic  and conceptual validity of each Standard.  Those who prepare  Accounting Standards are not framing the Standards without any  basis.  The framers review accounting policies already adopted  and select those policies which are most appropriate in the  presentation of accounts based on the requirement of \023true and  fair view\024.  The Standard represents the most appropriate  accounting policies out of various accounting policies adopted by  different companies over last several years.  This is what is called  as conceptual validity.  The acceptance in such cases is not only  recognized by statutory provisions but it is recognized by a wider  degree of acceptance in the corporate world.  That is why, almost  all the major public companies, in India, have recognized and  accepted the validity of the Standards.  Even, this Court has  expressed confirmation of commercial accounting Principles,  Practices & Standards recommended by the Institute (See:  Challapalli Sugars Ltd. v. Commissioner of Income Tax (1975)  98 ITR 167 at 172; Commissioner of Central Excise v. Dai Ichi  Karkaria Ltd. & Ors. (1999) 7 SCC 448 at 461.       48.     On the topic of \023accrual\024 learned counsel submitted that  under Section 209(3)(b) all books of account are required to be  kept on accrual basis and according to the double entry system  of accounting.  According to learned counsel, the expressions  \023accrual\024, \023accrual basis of accounting\024, \023accrued asset\024,  \023accrued expense\024, \023accrued liability\024, \023accrued revenue\024,  \023current assets\024, \023current liabilities\024, \023deferred expenditure\024,  \023depreciation\024, \023provision\024, \023prudence\024 etc. are explained and  defined in the Guidance Note on Terms Used in Financial  Statements issued by the Institute.  Learned counsel submitted  that the matching principle is the most important concept in  \023accrual accounting\024.  The matching principle indicates as to  when expenses should be recorded against the revenue.  The  Institute had issued Guidance Note on Accrual Basis of  Accounting in 1988, since after the amendment of Section 209,  requiring all companies to maintain their accounts on accrual  basis of accounting.  All relevant above mentioned expressions  relating to accrual basis of accounting including recognition of  revenue and expenses, assets and liabilities have been explained  in the said Guidance Note on Accrual Basis of Accounting which  inter alia  lays down the matching principle of recognizing costs  against revenue or against the relevant time period to determine  the periodic income.  According to learned counsel, in order to  understand the relevance of Accounting Standards issued by the  Institute for preparation and presentation of financial statements  vis-‘-vis the accrual system of accounting and vis-‘-vis the  matching principle it is necessary to refer to the concepts that  underline the preparation and presentation of such statements.   The main purpose of Accounting Standards is, therefore, to assist  the Accountants to prepare financial statements and to deal with  topics that have yet to form the subject of an Accounting  Standard.  The entire object is to promote harmonization of  Regulations, Accounting Standards and Procedures relating to  the preparation of financial statements by providing a basis for  reducing a number of alternative accounting treatments  permitted by Accounting Standards.  According to learned  counsel, \023accrual basis\024, \023going concern\024 and \023consistency\024 are  underlying assumptions in preparation of financial statements.   Prudence is important in the preparation of financial statements.   It is a degree of caution in the exercise of judgments needed in  making the estimates required under conditions of uncertainty so  that assets or income are not overstated and liabilities or  expenses are not understated.  That, the principles to be followed  in the recognition of \023assets\024, \023liabilities\024, \023income\024 and

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\023expenses\024 require application of the matching concept i.e.  matching of costs with revenue, which principle involves  combined recognition simultaneous recognition of revenues and  expenses that result directly from the same transactions or other  events.  According to learned counsel, this Court has always  recognized the need for estimation in accrual system of  accounting.  This Court, according to learned counsel, has  recognized the accounting concept of matching costs with  revenue in preparation of financial statements.  In this  connection, learned counsel placed reliance on the judgment of  this Court in Calcutta Company Ltd. v. Commissioner of  Income Tax \026 (1959) 37 ITR 1; Madras Industrial Investment  Corporation Ltd. v. Commissioner of Income Tax - (1997) 225  ITR 802.  According to learned counsel, at one point of time in  the past strict legal concept of \023accrual\024 was laid down in the  case of Commissioner of Income Tax v. Tungabhadra  Industries Ltd. \026 (1994) 207 ITR 553 (Cal.).  However, according  to learned counsel, that strict legal concept is no longer accepted  by the Courts and for that purpose learned counsel places  reliance on the judgment of this Court on the same issue in the  case of Madras Industrial Investment Corporation Ltd.  (supra).  In short, learned counsel submitted that with  globalization and with new concepts coming in, the law is no  more confined to the strict legal concept of \023accrual\024 which does  not recognize the matching principle.   

49.     Learned counsel urged that the requirement for \023accrual  basis of accounting\024 was introduced in the Companies Act in  1988 through Section 209.  Under Section 209(1) every company  is required to maintain proper books of account with respect to  receipts and expenses, sales and purchases of goods, assets and  liabilities of the company, utilization of material or labour and  such other items of costs incurred in production, process,  manufacturing etc.  Under Section 209(3) proper books of  account shall not be deemed to be kept if such books of account  do not give true and fair accounts and if such books fail to  explain its transactions further if such books are not kept on  accrual basis they have to be rejected for not giving a true and  fair view of the state of affairs of the company.  This position is  also reflected in Section 211.  Therefore, according to learned  counsel, under the scheme of Companies Act, two requirements  have to be satisfied, namely, \023accrual\024 system of accounting and  \023true and fair\024 view.  Both must read together with each other.   According to learned counsel, the accrual basis of accounting  must be applied so that \023true and fair\024 accounts are  presented.  Indeed, the requirement to present a \023true and fair\024  view precedes the requirement for accrual accounting.  The  requirement to present true and fair accounts is wider than  the requirement of accrual accounting.  Therefore, in a given  case it is possible that accounts prepared on accrual basis  may not present true and fair view because of certain  deficiencies, however, it is not possible for accounts to be  \023true and fair\024 unless they are prepared on accrual basis.   According to learned counsel, while Section 209(3)(b) mandates  the accrual basis of accounting, it does not indicate the  amount which should be recognized (accrued) in respect of  specific matters.  This is left to the judgment of the Accountant.   According to learned counsel, accrual basis is a fundamental  accounting assumption which means that all Accounting  Standards including AS 22 are framed on the basis of accrual  system of accounting and, therefore, the question of conflict of an  Accounting Standard with the accrual basis of accounting does  not arise.  That, all Accounting Standards are framed in order to  present a \023true and fair\024 view; that, the primary consideration in  the selection of accounting policies is to disclose a \023true and fair\024

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view and, therefore, the purpose of all Accounting Standards  including AS 22 is to adopt the accrual basis of accounting in the  context of disclosing a \023true and fair\024 view and if this principle is  kept in mind then there would be no conflict between AS 22 with  accrual basis of accounting.  In fact, according to learned  counsel, it is significant to note that while auditors are required  to certify that accounts are true and fair, they are not required to  certify that they are prepared on the accrual basis for the simple  reason that accounts cannot be true and fair unless the accrual  basis is adopted.  For example, a particular liability is not  provided for, because it is not legally imminent, it could still be  argued that accrual basis bas been adopted in a legalistic sense,  but the accounts would nevertheless not represent true and fair  view.  According to learned counsel, for the aforestated reasons  Accounting Standards require that the accrual basis should be  adopted in the context of presenting/disclosing a \023true and fair\024  view.  Therefore, the need to disclose a true and fair view is  wider then the need for accrual accounts since it  automatically includes accrual method of accounting.   Learned counsel urged that there is overriding importance  for the disclosure of a \023true and fair\024 view, since the entire  structure of corporate credibility is built on this foundation.   Therefore, if any rules for technical disclosure are not  consistent with the true and fair view requirement, then the  company has to depart from the technical provisions, to the  extent necessary, to give a \023true and fair\024 view.  That, the  disclosure requirements are subservient to the overriding  requirement of presenting a \023true and fair\024 view.  Therefore, in  other words, the need to present a \023true and fair\024 view should  override technical compliance of the law on the basis of true  and correct accrual.  Therefore, according to the learned  counsel, AS 22 goes far beyond technical compliance in order to  ensure a \023true and fair presentation\024.  Therefore, according to  learned counsel, since Section 211(1) requires true and fair  presentation, AS 22, is not beyond the mandate of the Companies  Act.   

50.     Coming to the concept of \023prudence\024, learned counsel  submitted that when financial statements are prepared,  sometimes, the accountant comes across uncertainties that  surround many events and in such case caution in exercise of  the judgments is required while making estimates, so that assets  or income are not overstated and liabilities or expenses are not  understated.  This is the principle of prudence.  The said  principle applies in view of uncertainties attached to future  events.  Profits are not anticipated, but they are recognized  only when they are realized.  Similarly, Provision is made for  all known liabilities and losses, even though the amount  cannot be determined with certainty and, therefore,  Provision represents only an estimate in the light of available  information.  The principle of prudence has also been recognized  in the Accounting Standard issued by the Central Government  under Section 145(2) of the I.T. Act through its notification dated  25.2.96 which is required to be followed by all assessees following  mercantile system of accounting.  In this connection, reliance  was placed by learned counsel on the judgment of this Court in  the case of Chainrup Sampatram v. Commissioner of Income  Tax \026 (1953) 24 ITR 481 at 485 in which this Court has also  underlined the effect that even for income tax purposes profits  are to be computed in conformity with ordinary principles of  commercial accounting unless such principles stand modified by  specific legislative enactments/provisions contained in the  Income Tax Law.  Similarly, in the case of Commissioner of  Income Tax v. Duncan Brothers & Co. Ltd. \026 (1996) 8 SCC 31  at 35, this Court has observed that the terms used in the

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Companies Act should be read in the manner as understood in  accounting parlance.

51.     On the question of alleged conflict between AS 22 and  Schedule VI of Companies Act, learned counsel submitted that  Accounting Standards, issued by the Institute, deal with  recognition, measurement and disclosure and certain  elements in financial accounts of every enterprise.  That,  Schedule VI deals with manner of presentation of financial  data in the annual financial statements, namely, the balance- sheet and P&L a/c to be drawn by a corporate enterprise at the  end of each financial year.  That, Part I of Schedule VI lays down  the form of balance-sheet whereas Part II lays down the  requirements as to the presentation of various financial data in  the P&L a/c.  Part II deals with interpretation of some of the  expressions, namely, \023provisions\024, \023reserve\024, \023capital reserve\024,  \023liability\024, \023investment\024 etc.  According to learned counsel, except  in the case of Depreciation which is provided by every corporate  enterprise in accordance with the rates laid down in Schedule  XIV of the Companies Act, having regard to the provisions  contained in Sections 205, 350 of the said Act, the said Act does  not lay down the procedure for recognition and measurement  of either the income or expenses and or the assets and  liabilities.  For example, Schedule VI nowhere lays down as to  which assets should be recognized as \023Investments\024 and also the  method of valuing \023Investments\024.  Similarly, AS 6 deals with  \023Depreciation Accounting\024, however, except the statutorily fixed  rate of depreciation as laid down in Schedule XIV of the  Companies Act, all other aspects relating to recognition and  measurement of depreciation are dealt with only in AS 6.  They  are not dealt with in the Companies Act.  Similarly, under Part II  of Schedule VI to the Companies Act the manner of presentation  of various items of income and expenses in the P&L a/c has been  laid down.  However, the said Act nowhere lays down as to  how and when income or expenditure should be measured  and/or recognized.  This aspect is dealt with by AS 9 alone and  not by the provisions of the Companies Act.  According to learned  counsel, events and contingencies occurring after the balance- sheet date mentioned in AS 4, net profit or loss for a given period,  prior period items and changes in accounting policies mentioned  in AS 5, Accounting for Construction Contracts in AS 7,  Accounting for Fixed Assets in AS 10, the Effect of changes in  Foreign Exchange Rates as mentioned in AS 11, Accounting for  Intangible Assets contained in AS 26, Accounting for Impairment  of Assets in AS 28 are various aspects dealt with only under  Accounting Standards and not under the Companies Act.   According to learned counsel, since the Companies Act  nowhere deals with recognition and measurement of various  items of income and expenses, assets and liabilities, and  since it deals with only presentation, there can never be any  conflict between the provisions of the said Act and the  Accounting Standards issued by the Institute in discharge of  its statutory obligations under the Chartered Accountants  Act, 1949 read with the Companies Act, 1956 which requires  that every corporate enterprise must maintain such books as  are necessary to give a \023true and fair\024 view of its state of  affairs and to explain its transactions (See: Section 209(3)),  and that every balance-sheet of a company shall give a \023true  and fair\024 view of the State of affairs of the company at the  end of the financial year, and that every P&L a/c of a  company shall also give \023true and fair\024 view of the P&L a/c  of a company for the financial year (See: Section 211(1)(ii)).   It is in this context of true and fair view requirement that the  Institute has framed Accounting Standards so as to enable  proper recognition and measurement of all income and expenses,

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assets and liabilities etc. as laid down in Section 209(1) read with  Section 211(3A), (3B) and (3C).       52.     Coming to the question of true scope and AS 22, learned  counsel submitted that AS 22 deals with accounting for taxes  on income.  According to learned counsel, as far back as in  1991, the Institute had issued the Guidance Note on Accounting  for Taxes on Income.  This Note recommended deferred tax  adjustments.  It also explained the taxes payable method.  It  also explained the tax effect accounting method.  It also  explained the method for calculating deferred tax adjustments  under \023deferred method\024 and under \023liability method\024.  It  recommended that till the tax effect accounting method stood  developed, it would be permissible for an enterprise to follow the  taxes payable method as an alternative.  After 10 years, AS 22  was finally issued by the Institute in 2001 in order to ensure a  \023true and fair\024 view of the profits earned during a financial year,  and the taxes payable with reference thereto, to be presented in  the corporate accounts.  That is the reason why, AS 22 leaves out  of account differences between book profits and taxable profits  which are of permanent nature.  But AS 22 requires that  DTL/DTA arising on account of timing differences should be  reflected in the corporate accounts through what is called as  \023deferred tax account\024.  According to learned counsel, deferred  tax accounting ensures that profits are measured in a real and  factual manner.  It also ensures that the benefit obtained in  one year, which could be reversed in a subsequent year, is  duly recognized as a liability.  Therefore, according to learned  counsel, AS 22 not only complies with the requirement for  accrual accounting, but it applies the need for accrual  accounting, in the context of presenting a \023true and fair\024 view,  rather than purely on the basis of a true and correct view.   Accounting treatments contained in various Accounting  Standards issued by the Institute are based on accrual  accounting and, therefore, these Standards adopt the accounting  treatments mentioned therein to ensure that a company has  followed the accrual basis of accounting.  According to learned  counsel, AS 22, therefore, fulfills, the need for accrual accounting  in the context of the true and fair view requirement.  According to  learned counsel, there is a difference between accrual accounting  on the basis of true and correct view vis-‘-vis accrual accounting  on the basis of true and fair view.  In the case of former, the  profits are likely to be overstated and in which event the investors  would be misled.  That, the purpose of true and fair accounts is  to protect investors and, therefore, the purpose of AS 22 is to  ensure that accrual is made on a true and fair basis, by reference  to the Substance rather than the Form.  Learned counsel urged  that the very object behind issuance of AS 22 is that in  accordance with the matching concept, taxes on income are  recognized (accrued) in the same period as the revenue and  expenses to which they relate.  Matching of such taxes against  income/revenue for a period raises problems as taxable income  may be different from accounting income significantly.  According  to learned counsel, para 4 of AS 22 lays down the definitions of  various terms used in AS 22.  One such term is \023current tax\024  which has been defined to mean the amount of income tax  determined as payable in respect of taxable income (loss) for a  particular period.  Similarly, in para 4 the expression \023deferred  tax\024 has been defined to mean what is called as \023timing  differences\024 which in turn has been defined to mean the  differences between taxable income and accounting income for a  period.  Such \023timing differences\024 originates in one period and are  capable of reversal in one or more subsequent periods.  \023Timing  differences\024 arises because the period in which some items  of revenue and expenses are included in taxable income

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which items do not coincide with the period in which such  items are included or considered in arriving at accounting  income.  This difference between taxable income and accounting  income arises for two reasons.  Firstly, there are differences  between items of revenue and expenses, as appearing in the P&L  a/c, and the items which are considered as revenue, expenses or  deductions for tax purposes.  Secondly, there are differences  between the amount in respect of a particular item of revenue or  expense, as recognized in the P&L a/c, and the corresponding  amount, which is recognized for the computation of taxable  income.  This happens in the case of depreciation.  The tax laws  allow \023incentive depreciation\024 on increased rate, as prescribed in  Rule 5 read with the percentages mentioned in second column of  the table in appendix I to the I.T. Rules, 1962 on the written  down value of the block of assets, as are used by the assessee for  the purpose of the business at any time during the relevant  previous year.  Depreciation includes amortization of assets  whose useful life is predetermined.  The commercial accounting  principle requires that the original cost of an asset should written  off in the accounts by way of charge against income of each year  in such a manner that its entire cost is debited against the  income arising therefrom during life time of such asset.  However,  the I.T. Act lays down incentive rates of depreciation.  While for  accounting purposes, depreciation is provided for on straight line  method, the Income Tax Act allows depreciation by way of  incentive at much higher rate with reference to its written down  value.  The total depreciation charged on the plant and  machinery for accounting purposes and the amount allowed as  deduction for tax purposes ultimately remains constant, but  period over which depreciation is charged in the accounts as  compared to the period during which the deduction is allowed  under I.T. Act, will differ.  This is a case of timing difference.  For  example, machinery purchased for scientific research is fully  allowed as deduction in the very first year for tax purposes,  whereas the same would charged in the P&L a/c, as depreciation,  over its useful life of, let us say, 15 years.  Unabsorbed  depreciation and carry forward of losses, which can be set off  against future taxable income, are also examples of timing  differences.  Such timing differences result in DTAs.  According to  learned counsel, for the above reasons para 9 of AS 22 lays down  that tax expense for a given period, shall, therefore, consists of  current taxation and deferred tax which included in the  determination of the net profit or loss for the period.  Similarly,  para 10 of AS 22 further provides that tax effects of timing  differences should be included in the tax expense in the P&L a/c  and as deferred tax assets or as deferred tax liabilities in the  balance-sheet.         53.     Learned counsel for the Institute next submitted that para  33 of AS 22 is Transitional Provisions.  According to the learned  counsel, it is not retrospective as alleged by the appellants.   According to learned counsel, under Section 209(3)(b) of the  Companies Act, books of account must be kept on accrual basis  and according to the double entry system of accounting.  In other  words, if a company was maintaining its accounts on cash basis  prior to 1988 when the present section came into existence, the  said company is required to change the system of accounting  from cash to mercantile w.e.f. 15.6.88.  However, this would not  mean that without maintaining accounts on mercantile basis, the  company would not record the opening balances of its assets and  liabilities merely because Section 209(3)(b) does not refer to  retrospective application.  Learned counsel submitted that,  therefore, there is no merit in the submissions made on behalf of  the appellants that para 33 of AS 22 is ultra vires  the provisions  of the Companies Act.  For the above reasons, learned counsel

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submitted that AS 22 is in no way contradictory to and/or in  conflict of Schedule VI to the Companies Act having regard to the  statutory requirement/consideration of presenting the financial  statements in \023true and fair\024 manner as laid down in Section  211(1)(ii) of the Companies Act.  That, clause (vi) under para 3 of  Part II of Schedule VI to the Companies Act reference is made  only to presentation of income liability in the P&L a/c.  It does  not refer to the method of its recognition and/or measurement  which aspects are considered and dealt with only by AS 22.   Therefore, the portion of income tax expenses deferred to future  tax returns is required to be credited to a Liability Account called  as Deferred Income Tax Account.       54.     On behalf of the appellants it was vehemently submitted  that the DTL is a notional and contingent liability and, therefore,  it is not required to be charged to the P&L a/c as per the  requirements of the Companies Act.  According to the appellants  DTL is a future liability and, therefore, it does not exist on the  balance-sheet.  Appellants have also argued that DTL is a  contingent liability because it may or may not arise in future.   They have argued that DTL is not in accordance with the  requirement of Section 209(3)(b) of the Companies Act as it does  not amount to keeping books of account on accrual basis.  In  reply, Mr. Poddar, submitted that DTL is not a notional tax  liability, but a real liability as it results in future cash outflow in  the form of tax payment to the Income Tax Department.   According to learned counsel, DTL arises in the current year in  which the timing difference originates i.e. during the year the  difference in the tax depreciation and accounting  depreciation arises.  Therefore, according to learned counsel,  DTL exists on the balance-sheet date for the financial year in  which it originates and, therefore, it is a real liability.  According  to learned counsel, the liability which arises in the current year  (i.e. the year in which timing difference arises) and is payable in a  future year is not a future liability.  According to learned counsel,  DTL arises, therefore, in the current financial year in which  timing difference arises but is payable in a future financial year.   According to learned counsel, the aforestated concept is the  essence of the accrual basis of accounting which has been  defined in AS 1.  Learned counsel further submitted that for the  above reasons DTL is not a contingent liability as it actually  arises in the financial year in which the timing difference  originates.  According to learned counsel, a contingent liability  becomes a liability on happening or not happening of an  uncertain event in future.  That DTL is not contingent.  It does  not arise in future on happening or not happening of future  event.  That, there is a difference in the liability arising in future  or contingent on a future event taking place and a liability, which  exists today, but payment in respect of which is to be made in  future.  That, any existing liability payable in future is not a  future or contingent liability.  According to learned counsel, DTL  is an existing liability on the balance-sheet date.  According to  learned counsel, reversal of timing difference in respect of an  asset is definite during the life of an asset.  Therefore, there is no  uncertainty with regard to the reversal of timing difference in  future over the life of the asset.  The accounts of a company are  prepared under the fundamental accounting assumption of  \023going concern\024 which is defined in AS 1 under which the  enterprise is normally looked upon as a \023going concern\024, i.e.,  continuing in operation for the foreseeable future.  Under that  assumption it is assumed that the enterprise has neither the  intention nor the necessity of liquidation or to reduce the scale of  its operations.  Therefore, according to learned counsel, the  examples, given on behalf of the appellants, of liquidation or fall  in the scale of operations are not apposite illustrations for

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treating DTL as a notional liability.  According to learned  counsel, DTL is a liability for the current period i.e. for the  period in which the timing difference originates, on the basis  of matching principle also, which is a part of accrual basis of  accounting.  In the light of the said submissions, learned  counsel contended that the charge in the P&L a/c for  deferred tax expense is in respect of a known liability  payable in future; and, therefore, it is covered by the definition  of the word \023Provision\024 as contained in Part II of Schedule VI to  the Companies Act.       55.     On the question of ultra vires learned counsel for the  Institute had adopted the contentions advanced by learned  Additional Solicitor General on behalf of Union of India.                      Finding:

        56.     For the following reasons we hold that the impugned  Rule which adopts AS 22 neither suffers from the vice of  excessive delegation nor is the said Rule  incongruous/inconsistent with the provisions of the  Companies Act, 1956. Reasons: (i)     Preface: 57.     India is an emerging economy. Globalization  has helped  India to achieve the GDP rate of around 8 to 9 per cent.  However, with globalization, India is required to face  challenges in various forms. Corporate India has been  acquiring companies in India and abroad. Indian companies  are partners in joint ventures. They are part of international  consortium. Therefore, Indian Accounting Standards (IAS)  have to harmonize and integrate with International Accounting  Standards by which harmonization of various accounting  policies, practices and principles could take place.

58.     In its origin, an accounting standard is the policy  document. In matters of recognition of various items of  income, expenditure, assets and liabilities, the aim is to  achieve standards/norms which would help to reflect \023true  and fair\024 view of the accounts of a company. Every Indian and  foreign investor/partner before entering into joint venture  agreement(s) with its counterpart examines the financial  statements and tries to ascertain the real income of the Indian  company.       59.     With globalization, we have conventional/orthodox  system of accounting (recognition, measurement and  disclosure) vis-a-vis modern system of advanced accountancy.  Therefore, the role of accounting has undergone a  revolutionary change with the passage of time. Traditionally,  accounting was considered solely a historical description of  financial activities. That view is no longer acceptable.  Accounting is now considered as a service activity. Its function  is to provide quantitative information, primarily of financial  nature about the economic entities. Accounting today includes  several branches, e.g., Financial Accounting, Management  Accounting and Government Accounting. The primary role of  accounting is to provide an effective measurement and  reporting system. This is possible only when accounting is  based on certain coherent set of logical principles that  constitute the general frame of reference for evaluation and  development of sound accounting practices. That is why, we  have different accounting concepts and fundamental  accounting assumptions, such as, separate entity concept,

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going concern concept, accrual concept, matching concept  etc.. Therefore,  Accounting Standards are based on a number  of accounting principles. For example, the Matching Principle  and Fair Valuation principle. Historically, matching principles  ensured that costs incurred matched with  revenues they  generated, though they resulted in assets and liabilities in the  balance-sheet at other than fair values. Similarly, they  resulted in assets, which were not assets in the real sense,  e.g., deferred revenue expenditure. However, the matching  principles ensured purity of the profit and loss statement.  Therefore, matching principles ensure ascertainment of  true income. Today under Advanced Accountancy, matching  principles recognizes not only costs against revenue but also  against the relevant time period to determine the Periodic  Income. Therefore, matching principle today forms an  important component of Accrual Basis of Accounting.        60.     On the other hand, Fair Valuation principles are  important in the context of valuing derivatives and other  investments. If one were to describe one single change in  accounting practice over the last few years, it would be the use  of Fair Valuation principles. Today, the object behind  enactment of A.S., which are now made mandatory under  section 211(3A) of the Companies Act, is to shift from  historical method of accounting to fair valuation. In the case of  mergers and acquisitions, which is common today in the world  of globalization,  fair valuation principles have important role  to play. Mergers and acquisitions are sometimes  undertaken to defer revenue expenditure over future years  by invoking the matching concept, which results in  putting fictitious assets on the balance-sheet. This is one  reason why fair valuation principles are accepted.       61.     A.S. are established rules relating to recognition,  measurement and disclosures thereby ensuring that all  enterprises that follow them are comparable and that their  financial statements are \023true and fair\024. Measurements and  disclosures based on fair value are becoming increasingly  important. Fair valuation is generally used in valuation and  disclosure of financial instruments, derivatives, conversions,  auctions in a bond, business combinations, impairment of  assets, retirement obligations, transactions involving exchange  of assets without monetary consideration, transfer pricing,   etc..        62.     In conclusion, the importance of the Preface is to show a  paradigm shift in the thinking of Accountants all over the  world, particularly with the coming-in of the abovementioned  new concepts.

(ii)    Doctrine of Ultra Vires 63.     At the outset, we may state that on account of globalization  and socio-economic problems (including income disparities in our  economy) the power of Delegation has become a constituent  element of legislative power as a whole. However, as held in the  case of Indian Express Newspaper  v.  Union of India reported  in (1985) 1 SCC 641 at page 689, subordinate legislation does not  carry the same degree of immunity which is enjoyed by a statute  passed by a competent Legislature. Subordinate legislation may  be questioned on any of the grounds on which plenary legislation  is questioned. In addition, it may also be questioned on the  ground that it does not conform to the statute under which it is  made. It may further be questioned on the ground that it is  inconsistent with the provisions of the Act or that it is  contrary to some other statute applicable on the same subject

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matter. Therefore, it has to yield to plenary legislation. It can also  be questioned on the ground that it is manifestly arbitrary and  unjust. That, any inquiry into its vires must be confined to the  grounds on which plenary legislation may be questioned, to the  grounds that it is contrary to the statute under which it is made,  to the grounds that it is contrary to other statutory provisions or  on the ground that it is so patently arbitrary that it cannot be  said to be inconformity with the statute. It can also be challenged  on the ground that it violates Article 14 of the Constitution.  Subordinate legislation cannot be questioned on the ground of  violation of principles of natural justice on which administrative  action may be questioned. A distinction must, however, be made  between delegation of a legislative function in which case the  question of reasonableness  cannot be gone into and the  investment by the statute to exercise a particular discretionary  power. In the latter case, the question may be considered on all  grounds on which administrative action may be questioned, such  as, non-application of mind, taking irrelevant matters into  consideration, failure to take relevant matters into consideration  etc.. A subordinate legislation may be struck down as arbitrary or  contrary to statute if it fails to take into account vital facts which  expressly or by necessary implication are required to be taken  into account by the statute or the Constitution. This can be done  on the ground that the subordinate legislation does not conform  to the statutory or constitutional requirements or that it offends  Article 14 or Article 19 of the Constitution. However, it may be  noted that, a notification issued under a section of the statute  which requires it to be laid before Parliament does not make any  substantial difference as regards the jurisdiction of the Court to  pronounce on its validity.

64.     Apart from the grounds referred to by this Court in the  above judgment in the case of Indian Express Newspaper,  it  is important to bear in mind that where the validity of  subordinate legislation is challenged, the question to be asked  is whether the power given to the rule making authority (in the  present case the Central Government under section 642(1) of  the Companies Act)  is exercised for the purpose for which it is  given. Before reaching the conclusion that the Rule is intra  vires (we have to begin with the presumption that the Rule is  intra vires), the court has to examine the nature, object and  the scheme of the legislation as a whole and in that context,  the court has to consider what is the Area over which powers  are given by the section under which the Rule Making  Authority is to act. However, the court has to start with the  presumption that the impugned Rule is intra vires. This  approach means that, the Rule has to be read down only to  save it from being declared ultra vires if the court finds in a  given case that the above presumption stands rebutted.        65.     If the impugned rule is a delegated legislation it would  follow that the said rule is made in exercise of the power  conferred by the statute. Legislature has wide powers of  delegation. This, however, is subject to one limitation, namely,  it cannot delegate uncontrolled power. Delegation is valid only  when it is confined to legislative policy and guidelines.       66.     In the present case, abovementioned guideline is  provided by section 211(1), which has brought in a stand- alone concept of \023true and fair\024 accounting. The said  concept is the controlling consideration. As stated above,  delegation is valid when it is confined to Legislative Policy and  Guidelines which are adequately laid down and the delegate is  only empowered to implement such Policy within the  Guidelines laid down by the Legislature (see TISCO  v.  The

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Workmen & ors. reported in AIR 1972 SC 1917)

67.     In the present case, we are required to consider  the  scope of section 642(1), which refers to the power of Central  Government (rule making authority) to make rules vis a vis  section 641, which states that subject to the provision of the  section, the Central Government may, by Notification in the  Official Gazette, alter any of the regulations, rules, forms,  tables and other provisions contained in any of the Schedules  to the Companies Act (including Schedule VI). This aspect is of  some importance. Section 642 is in addition to the powers  conferred by section 641, therefore, the two sections form part  of the same scheme. However, the scope of section 641 is  different from the scope of section 642. Power to alter any  provision of the Schedules and the power to carry out gap- filling exercise are both entrusted to the Central Government.  The expression \023in addition\024 to in section 642 indicates that  both the above sections constitute one scheme. However,  section 642 enables Central Government to provide details  and, therefore, under section 642 the rules contemplated  refers to gap-filling exercise.

68.     It is well settled that, what is permitted by the concept of  \023delegation\024 is delegation of ancillary or subordinate legislative  functions or what is fictionally called as \023power to fill up  the details\024. The judgments of this Court have laid down that  the Legislature may, after laying down the legislative policy,  confer discretion on administrative or executive agency like  Central Government to work out details within the  framework of the legislative policy laid down in the  plenary enactment. Therefore, power to supplement the  existing law is not abdication of essential legislative function.  Therefore, power to make subordinate legislation is derived  from the enabling Act and it is fundamental principle of law  which is self-evident that the delegate on whom such  power is conferred has to act within the limitations of the  authority conferred by the Act. It is equally well settled that,  Rules made on matters permitted by the Act in order to  supplement the Act and not to supplant the Act, cannot be  held to be in violation of the Act. A delegate cannot override  the Act either by exceeding the authority or by making  provisions inconsistent with the Act. (See Britnell  v.   Secretary of State 1991 (2) AllER 726 at 730)            69.     The issue before us in the present batch of civil appeals  is whether the Central Government, which is the rule making  authority, has overridden the Companies Act, 1956 either by  exceeding its authority in adopting AS 22 or by making  provisions inconsistent with sections 209 and 211 read with  Part I and Part II of Schedule VI to the Companies Act as  alleged by the appellants.

70.     Since the said issue has two parts, for the sake of  convenience, the first point which needs to be decided is as  follows:

(a)     Whether the impugned Rule adopting  AS 22 is in excess of the powers  conferred upon Central Government  under section 642(1) of the Companies  Act, 1956 ?

71.     In the case of Banarsi Das  v.  State of M.P. reported in  AIR 1958 SC 909 the State had issued a Notification under

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section 6(2) of the Central Provinces and Berar Sales Act, 1947  amending Item 33 in Schedule II by substituting for the words  \023goods sold to or by the State Government\024 by the words  \023goods sold by the State Government\024. As a result of the said  Notification, amending the schedule, the assessee who was  entitled for exemption from payment of sales tax in respect of  goods sold to the State Government could no longer claim  such exemption by reason of the said Notification. That  Notification was challenged on the ground that it was not open  to the Government in exercise of the authority delegated to it  under section 6(2) to modify or alter what the Legislature had  enacted and, therefore, the said Notification was bad as being  unconstitutional delegation of legislative authority. It was  argued on behalf of the assessee that earlier they had been  granted exemption under section 6(1) of the Act which  subsisted when the impugned Notification came to be issued  and that in consequences, while an exemption under section  6(1) existed any amendment to the Schedule under section  6(2) was bad as it had the effect of deletion of the exemption  which had been granted. Section 6(1) of the Act contemplated  exemption to be given by the State Government on certain  types of transactions whereas section 6(2) empowered the  State Government to amend the schedule. It is in this context  that the question arose as to whether the impugned  Notification was bad as being an unconstitutional delegation of  legislative authority. The said contention was rejected by this  Court stating that the two sub-sections together constituted  integral part of a single enactment. We quote hereinbelow para  11 of the said judgment, which reads as follows: \02311. The contention of the appellant that the  notification in question is ultra vires must, in  our opinion, fail on another ground. The basic  assumption on which the argument of the  appellant proceeds is that the power to amend  the schedule conferred on the Government  under section 6(2) is wholly independent of  the grant of exemption under section 6(1) of  the Act, and that, in consequence, while an  exemption under section 6(1) would stand, an  amendment thereof by a notification under  section 6(2) might be bad. But that, in our  opinion, is not the correct interpretation of  the section. The two sub-sections together  form integral parts of a single enactment, the  object of which is to grant exemption from  taxation in respect of such goods and to such  extent as may from time to time be  determined by the State Government. Section  6(1), therefore, cannot have an operation  independent of section 6(2), and an exemption  granted thereunder is conditional and subject  to any modification that might be issued  under section 6(2). In this view, the impugned  notification is intra vires and not open to  challenge.\024       (emphasis supplied)

Applying the tests laid down in the aforestated judgment to the  present case, it may be noted that, in this case, we are  concerned only with the existence and the extent of the powers  given to the Central Government to make rules, both for  altering the Schedules to the Companies Act as well as to fill in  details. Power to alter the Schedule as well as power to fill in  details are two distinct powers. However, both the powers are  entrusted to the same delegate, namely, the Central

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Government. Further, as stated above, sections 641 and 642  form part of the same scheme, hence, it cannot be said that  merely because the impugned Notification has been issued  under section 642 and not under section 641 the said  Notification is exhaustive of the powers given to the Central  Government to frame rules under the aforestated two sections.  Moreover, in the present case, section 642(1) begins with the  expression \023in addition to the powers conferred by section  641\024, therefore, one has to read section 641 as an additional  power given to the Central Government to make Rules, in  addition to its power to alter the schedule by making  appropriate Rules under section 641. There is one more way of  looking at the arguments. The Companies Act has been  enacted to consolidate and amend the law relating to  companies and certain other associations. Under section  211(3A) Accounting Standards framed by National Advisory  Committee on Accounting Standards constituted under  section 210A are now made mandatory. Every company has to  comply with the said standards. Similarly, under section  227(3)(d), every auditor has to certify whether the P&L a/c and  balance-sheet comply with the accounting standards referred  to in section 211(3)(c). Similarly, under section 211(1) the  company accounts have to reflect \023true and fair\024 view of the  state of affairs. Therefore, the object behind insistence on  compliance with the A.S. and \023true and fair\024 accrual is the  presentation of accounts in a manner which would reflect the  true income/profit. One has, therefore, to look at the entire  scheme of the Companies Act. In our view, the provisions of  the Companies Act together with the Rules framed by the  Central Government constitute a complete scheme. Without  the Rules, the Companies Act cannot be implemented. The  impugned Rules framed under section 642 are a legitimate aid  to construction of the Companies Act as contemporanea  expositio. Many of the provisions of the Companies Act, like  computation of book profit, net profit etc. cannot be put into  operation without the rules.  

72.     In the case of P. Kasilingam and ors.  v.  P.S.G. College  of Technology and ors. 1995 Suppl(2) SCC 348 vide para 20  this Court ruled as follows: \02320. The Rules have been made in exercise of  the power conferred by Section 53 of the Act.  Under Section 54(2) of the Act every rule made  under the Act is required to be placed on the  table of both Houses of the Legislature as soon  as possible after it is made. It is accepted  principle of statutory construction that \023rules  made under a statute are a legitimate aid to  construction of the statute as contemporanea  expositio \024 (See : Craies on Statute Law , 7th  Edn., pp. 157-158; Tata Engineering and  Locomotive Co. Ltd. v. Gram Panchayat,  Pimpri Waghere (1976) 4 SCC 177.) Rule 2(b)  and Rule 2(d) defining the expression \021College\022  and \021Director\022 can, therefore, be taken into  consideration as contemporanea expositio for  construing the expression \023private college\024 in  Section 2(8) of the Act. Moreover, the Act and  the Rules form part of a composite scheme.  Many of the provisions of the Act can be put  into operation only after the relevant provision  or form is prescribed in the Rules. In the  absence of the Rules the Act cannot be  enforced. If it is held that Rules do not apply to  technical educational institutions the

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provisions of the Act cannot be enforced in  respect of such institutions. There is,  therefore, no escape from the conclusion that  professional and technical educational  institutions are excluded from the ambit of the  Act and the High Court has rightly taken the  said view. Since we agree with the view of the  High Court that professional and technical  educational institutions are not covered by the  Act and the Rules, we do not consider it  necessary to go into the question whether the  provisions of the Act fall within the ambit of  Entry 25 of List III and do not relate to Entry  66 of List I.\024                       (emphasis supplied)     73.     To the same effect is the judgment of this Court in the  case of TELCO  v.  Gram Panchayat, Pimpri Waghere  reported in (1976) 4 SCC 177 in which the Court was required  to consider the definition of the word \023house\024 under the Rules  framed in 1934. It was held that the rules provided internal  legitimate aid for the interpretation of the words and phrases  used in the main enactment.

74.     In the present case also even under the Rules impugned  herein AS 22, which is made mandatory, provides an internal  legitimate aid to the meaning of the words in the Companies  Act, including Schedule VI, namely, liability, provision for  taxes on income, book profit, net profit, depreciation,  amortization etc.. Therefore, it cannot be said that the  impugned Rules framed under section 642(1) constitute an act  on the part of the rule making authority, namely, the Central  Government, in excess of its powers under section 642(1) of  the Companies Act. In our view, the impugned  Rule/Notification is valid. It has nexus with the matters  entrusted to the Central Government to be covered by  appropriate rules. Therefore, in our view, the impugned Rule is  valid as it has nexus with statutory functions entrusted to  Central Government which is the rule making authority under  the Act. It is important to bear in mind that the power to  regulate a business or profession implies the power to  prescribe and enforce all such proper reasonable rules as may  be deemed necessary to conduct business/profession in a  proper and orderly manner and the power includes the power  to prescribe conditions under which business/profession can  be carried on. (See Deepak Theatre, Dhuri  v.  State of  Punjab and ors. AIR 1992 SC 1519 at page 1521). The  Scheme of the Companies Act indicates that Accounting  Standards are made mandatory. They have to be followed by  the auditors. They have to be followed by the companies. The  Accounting Standards provide discipline. They provide  harmonization of concepts. They provide harmonization of  accounting principles. In the past, when Accounting  Standards were not mandatory, various companies used to  follow alternate system of accounting. This led to  overstatement of profits. Therefore, the said Standards have  now been made mandatory. In our view, it is the statutory  function given to the Central Government to frame Accounting  Standards in consultation with the National Advisory  Committee on Accounting Standards (NAC) under section  211(3C). It is not necessary for the Central Government to  adopt in every case the Accounting Standards issued by the  Institute. Nothing prevents the Central Government from  enacting its own Accounting Standards which may not be in  consonance with the Standards prescribed by the Institute.

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Similarly, nothing prevents the Central Government from  adopting the Standards issued by that Institute as is the case  in the present matter. Therefore, in our view, the impugned  Rule is valid as it has nexus with the statutory functions  entrusted to the Rule making authority, namely, the Central  Government. (b)     Whether the impugned Rule is  incongruous/contrary to sections 209  and 211 read with the provisions of Part I  and Part II of Schedule VI to the  Companies Act, 1956 and whether the  said Rule seeks to modify the essential  features of the Companies Act ?

(A)     Concepts 75.     To answer the above question, we need to examine the  following concepts prevalent in Accounting.

Accrual System of Accounting 76.     In the conventional sense, amounts which become  receivables/recoverable are shown as income actually received  and the liabilities incurred are shown as amounts actually  disbursed in a given year. Therefore, under the aforestated  system of accounting, entries are posted in the books of  accounts on the date of the transaction, i.e., on the date on  which rights accrue or liabilities are incurred, irrespective of  the date of payment. In such cases, a company has to  account for its income or loss as per the above system and not  otherwise, if that company has adopted mercantile system of  accounting which is also known as accrual system of  accounting. However, accrual does not mean confinement of  items of revenue/expenditure to a given year. As stated  above, mergers and acquisitions are undertaken to defer  revenue expenditure over future years by invoking  matching principles. Therefore, the said principle forms an  important part of accrual accounting.

Taxes on Income (TOI)

77.     It is an important item of P&L a/c. Taxes on income are  considered as expenses incurred by a company in earning  revenues. It is an expense which is recognized in the same  period as revenue and expense to which they relate. This is  called as matching principle. Such matching, results in what  is called as Timing Differences. Tax effects of Timing  Differences are included as tax expense in the statement  of profit and loss and as deferred tax asset (DTA) or as  deferred tax liability (DTL) in the balance-sheet. In short,  deferred tax should be recognized for timing differences.  This is the basic mandate of AS 22. This mandate is based on  an important principle of accounting, namely, that every  transaction has a tax effect. However, DTA is subject to the  principle of prudence and certainty that in future the company  will have adequate income. This principle of prudence states  that DTAs are recognized and carried forward only to the  extent of their being a reasonable certainty of their realization,  i.e., in future there would be taxable income. Therefore, under  the rule of prudence, DTAs are to be recognized only to the  extent of their being timing differences, the reversal whereof  will result in sufficient taxable income in future against which  they can be realized. On the other hand, DTL is to be  recognized as liability under the said standard as it results in  future cash outflow in the form of payments to the Income tax  Department in the case of TOIs.

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Current Tax 78.     Current tax has to be measured by using the applicable  tax rates. This is because current tax has to be measured at  the amount expected to be paid to the Income tax Department  by way of tax. Not only the tax rates, but also tax laws  constitute the basis for measuring the amount of tax expected  to be paid to the Income tax Department. It is important to  note that while measuring current tax, companies have to go  by the balance-sheet date. The company has to examine the  tax rates and the tax laws on that date.

Timing Differences 79.     They are differences which arises because the period  in which some items of revenue and expenses are included  in the taxable income do not tally with the period in  which items are considered to compute the Accounting  Income. In other words, it recognizes expenses against the  relevant time period to determine the periodic income. This  concept has been brought in after the amendment to section  211(1) of the Companies Act which emphasizes that after 2001  the companies shall prepare their accounts so as to reflect  \023true and fair\024 view of the State of Affairs and to obliterate  the difference between Accounting and Taxable Income.  This concept bridges the gap between accounting income and  taxable income. Deferred tax is the tax effect of such  differences which are now required to be accounted for. As  stated above, Accounting Standards today constitute a  paradigm shift from the conventional system of accounting  based on Historical Costs Method towards Fair Valuation  Principles. Similarly, in the past, companies used to follow  alternate system of accounting. The Accounting Standards  today are trying to harmonize different accounting concepts  and principles and, therefore, timing differences play an  important role in harmonizing the matching principle under  accrual system of accounting with the Fair Valuation  Principles. The object is to achieve proper presentation of  balance-sheet and P&L a/c. The object is to present before the  investors, shareholders and other stake-holders the book  profits (real income) of the company. The tax effect of timing  difference under AS 22 has to be included in the tax  expenses in the P&L a/c as DTA or DTL in the balance- sheet. Therefore, timing difference is the tax effect which  forms part of tax expense in the P&L a/c. The primary  object of AS 22 adopted by the impugned Rule is to prescribe  an accounting treatment for TOI. In accordance with the  matching concept, TOIs are recognized in the same period as  revenue and expenses to which they relate. Matching of TOI  against revenue for a period poses problems due to the effect  that in a number of cases, taxable income is different from  accounting income. This difference arises for two reasons.  Firstly, there are differences between items of revenue and  expenses in the P&L a/c and items considered as revenue  expenses or taken for tax purposes. Secondly, there are  differences between the amount in respect of a particular item  of revenue or expenses as recognized in the P&L a/c and the  corresponding amount which is recognized for computing  taxable income.

Tax Expense 80.     As stated above, current tax is the amount of income tax  determined to be payable in respect of taxable income for a  period. On the other hand, deferred tax is the tax effect of  Timing Differences. As stated above, Timing Differences are  differences between taxable income and accounting income for  a given period. Timing Difference originates in one period,

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but it is capable of reversal in one or more subsequent  period(s). As stated above, every transaction has a tax  effect, therefore, tax expense is the sum total of current  tax + deferred tax charged or credited to the statement of  profit and loss for the given period. Therefore, tax expense  for that period has to be included in the Net Profit. Therefore,  we see no inconsistency between liability as understood in the  conventional sense and DTL as submitted on behalf of the  appellants.

Assets 81.     Assets represent expenditure. When an expenditure is  written off for accounting purposes in the year in which it is  incurred but is admissible as deduction for tax purposes over  a period of time then in such cases, the asset representing  expenditure would have a balance only for tax purposes but  not for accounting purposes. The difference between the  balance of the assets for tax purposes and the balance for  accounting purposes would be a timing difference which  will reverse in future when the expenditure would be  allowed for tax purposes. In such a case, DTA would be  recognized in respect of the timing difference, subject to the  principle of prudence. This concept is important while deciding  the question as to whether para 33 of AS 22 (transitional  provision) is or is not inconsistent with the provisions of  Schedule VI to the Companies Act.

Matching Principle 82.     Matching Concept is based on the accounting period  concept. The paramount object of running a business is to  earn profit. In order to ascertain the profit made by the  business during a period, it is necessary that \023revenues\024 of the  period should be matched with the costs (expenses) of that  period. In other words, income made by the business during a  period can be measured only with the  revenue earned during  a period is compared with the expenditure incurred for earning  that revenue. However, in cases of mergers and acquisitions,  companies sometimes undertake to defer revenue expenditure  over future years which brings in the concept of Deferred Tax  Accounting. Therefore, today it cannot be said that the concept  of accrual is limited to one year.  

83.     It is a principle of recognizing costs (expenses) against  revenues or against the relevant time period in order to  determine the periodic income. This principle is an important  component  of accrual basis of accounting. As stated above,  the object of AS 22 is to reconcile the matching principle with  the Fair Valuation Principles. It may be noted that  recognition, measurement and disclosure of various items  of income, expenses, assets and liabilities is done only by  Accounting Standards and not by provisions of the  Companies Act.

Depreciation 84.     As stated above, timing difference is the difference  between taxable income and accounting income for a period.  Depreciation is one of the important items in computation of  income, be it taxable income or accounting income. According  to Pickles Accountancy, fourth edn., at page 0518, depreciation  is the inherent decline in the value of an asset from any cause  whatsoever. The wearing out of a machine is a simple example  of depreciation. In double-entry system of accounting, there  has to be complete double-entry for depreciation adjustment.  The required entry under that system of Depreciation

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Adjustment is debit Trading and Profit & Loss account and  credit the asset in respect of which depreciation is being  recorded. Such an entry conforms with the principles  enunciated, namely, that, the debit to Trading and Profit &  Loss account is necessary because the amount written-off  represents an expense and the credit to the asset is  required, as the asset has, pro tanto, reduced in value.  Therefore, from the above point of view in the principles of  accountancy, even distribution in certain cases is treated as  expenditure paid out over the years. The object of providing for  such distribution is to spread the expenditure incurred in  acquiring the assets over its effective lifetime. The amount of  provision to be made in respect of the accounting period is  intended to represent the portion of such expenditure which  has expired during the period. Therefore, in that sense, it is  money expended which is spread out over the effective life of  an asset. Even under the Income tax Act, Parliament has used  the expression \023allowances and depreciation\024 in several  sections in Chapter IV within which section 44A appears. In  this connection, reference may be made to section 37 which  enjoins that, any expenditure not falling in sections 30 to 36  expended wholly and exclusively or laid out for business  purposes should be allowed in computing the business  income. Therefore, depreciation and allowances have been  dealt with in section 32 and the expression \023any expenditure\024  in section 37 covers both, allowances and depreciation. [See  Commissioner of Income-tax  v.  Indian Jute Mills  Association (1982) 134 ITR 68 (Cal)]. Depreciation under  Income tax Act is an incentive/allowance. However, in  commercial accountancy, it is reduction/deduction from  the value of an asset on the balance-sheet.

Reserves & Provisions 85.     In State Bank of Patiala  v.  CIT  reported in (1996) 219  ITR 706 substantial amounts were set apart by the assessee- bank as reserves. No amount of bad debt was actually written  off or adjusted against the amounts claimed as reserves. No  claim for any deduction by way of bad debts was made during  the relevant assessment years. The assessee never  appropriated any amount against any \023bad and doubtful\024  debts. The amount remained in the account of the assessee by  way of capital and the assessee treated the said amount as  \023reserves\024 and not as \023provisions\024 designed to meet any  liability, contingency, commitment or diminution in the value  of assets known to exist on the date of the balance-sheet.

86.     The question which arose for consideration by this Court  was whether amounts set apart in the balance-sheet are  \023provisions\024 or \023reserves\024. The matter arose under the  provisions of Companies (Profits) Surtax Act, 1964 which  levied a charge on every company for every assessment year  called as surtax, insofar as the chargeable profits of the  previous year exceeded the statutory deduction at the rates  mentioned in the Third Schedule. Rule (1) of Schedule II  stipulated mandatory that the capital of the company shall be  the total of the amounts including reserves. The assessee  contended that the amounts set apart in the balance-sheet are  reserves. The Department contended that the said amounts  were provisions. The assessee succeeded. However, the  reasoning given in the judgment is important. It was held by  this Court, after referring to the relevant provisions of the  Companies Act regarding the form of balance-sheet wherein  the words \023reserves and surplus\024 and \023current liabilities and  provisions\024 are dealt with, that if any retention or  appropriation falls within the definition of \023provision\024 it can

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never be a reserve but it does not follow that if the retention or  appropriation is not a provision it is automatically a reserve.  That question has to be decided having regard to the true  nature and character of the sum so retained depending on  several factors including the intention with which and the  purpose for which such retention has been made because the  substance of the matter is to be recorded. In the said  judgment, it has been further held that if any retention is  made to meet depreciation, renewal or diminution in value of  asset, the same is not a reserve.        87.     In that case, one of the other questions which arose for  determination was whether a fund created or a sum of money  set apart by assessee-bank to meet any liability which the  assessee-bank can reasonably anticipate on the balance-sheet  date is equivalent to the case where the liability has actually  arisen. The High Court took the view that since the assessee is  the banking company, it would be reasonable and legitimate to  assume that the bank was in a position to anticipate any  liability by way of bad debt on the balance-sheet date. This  Court held that the aforestated assumption made by the High  Court was unjustified. According to this Court, the question  to be asked in such cases is whether the liability was  known or anticipated on the date when the balance-sheet  was prepared and not whether the assessee can anticipate on  the balance-sheet date the debt and doubtful debts.

88.     Applying this test to the facts of the present case, the tax  effect of the timing difference was known on the date when the  balance-sheet was prepared and, therefore, AS 22 is right in  stipulating that the tax effect of such timing differences  should be included in the tax expense in the statement of  profit and loss as DTA/DTL in the balance-sheet.       89.     Depreciation in accounting sense is similar to bad and  doubtful debts. Provision for bad and doubtful debt like  depreciation is not a provision for liability but it is a  provision for diminution in value of assets. Where such  provision is made and if that provision is not excessive or  unreasonable, it is not a reserve, however, any amount in  excess of the requirement can be considered to be a  reserve. Thus, provision can be made for depreciation,  renewal, diminution in the value of an asset or for any known  liability. In this case, we are concerned with depreciation  mainly because in 99 per cent of the cases the difference  between tax depreciation and accounting depreciation results  in timing differences.        90.     The provision for bad and doubtful debt is always made  with reference to debt receivable where there is doubt about  full realization of debt. The provision is made in order to cover  up the probable diminution in the value of an asset, i.e., debt  which is amount receivable. For example, if the receivable is  Rs. 1 crore and the assessee is of the opinion that Rs. One  crore might not be realized and that only 90 per cent of the  debt would be realized and, therefore, he makes a provision for  Rs. 10 lacs for bad debts. By making the provision, the  assessee is valuing his asset, namely, debt, which is the  amount receivable,  at  Rs. 90 lacs as against the book figure  of Rs. 1 crore. Thus, the provision for bad and doubtful debt is  the provision for diminution in the value of asset, i.e., debt.  Such provision is not a provision for liability, because even if a  debt is not recovered, no liability would be fastened upon the  assessee. The debt is the amount receivable by the assessee. It  is not any liability payable by the assessee. Therefore, any

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provision towards irrecoverability of debt cannot be said to be  provision for liability. It is the provision for diminution in the  value of assets. The expression \023reserve\024 has been defined in a  negative manner by clause 7(1)(b) of Part III of Schedule VI to  the Companies Act and it only says that the reserve shall not  include any amount written off or retained by way of provision  for depreciation, renewal, diminution in value of asset or by  way of provision for any known liability. Thus, if the provision  made by the assessee for depreciation, (diminution in value of  the asset) is in excess of the amount which is reasonably  necessary for the purpose for which the provision is made, the  excess shall be treated as a reserve and not a provision. This  aspect is important because the question as to whether the  provision made is in excess of the  requirement would depend  on the facts of each case. This aspect is important also  because it has been vehemently argued on behalf of the  assessee that AS 22 requires the assessee to make provision  for DTL which, in fact, should have been treated as a reserve  and not as a provision. Reserve is not a charge to be deducted  before arriving at the profit for the period under review. It is  appropriation of profit. The \023reserve account\024 is credited as a  result of a debit to the appropriation account and not to the  P&L a/c or revenue account. In a broad sense, all allocations  to reserve represent additions to capital. In the case of a  provision, unlike reserves, the charge is created as a result of  debit to the P&L a/c and not a debit to the appropriation  account.

Tax Base 91.     The tax base of an asset or liability is the amount  attributed to that asset or liability for tax purpose. As  stated above, deferred tax has to be recognized for all  timing differences. This is based on the principle that  financial statements for a given period should recognize the  tax effect, whether current or deferred, of all transactions  occurring in a given period. One more principle needs to be  noted that assets represent expenditure. Concept of DTL/DTA

92.     DTL/DTA is recognized for all timing differences. AS  22 requires the companies to make a provision for Deferred  Tax Accounting with reference to the difference between  accounting income and taxable income. In our view, matching  principle is an important component of Accrual Accounting.  The said principle is not in conflict with accrual accounting as  vehemently submitted on behalf of the appellants. Accrual  Accounting is the concept recognized by sections 205, 209,  211 and Schedule VI to the Companies Act. However, the said  provisions of the Companies Act nowhere lays down as to  which asset should be recognized as an investment and the  method of valuing investments. That exercise is left to the  accounting standards. Similarly, the Companies Act nowhere  lays down as to how and when income or expenditure should  be measured/recognized. That exercise is left to the  accounting standards. AS 22 proceeds on the basis that a  benefit obtained in one year could be reversed in the  subsequent year and, therefore, it has to be recognized as a  liability. One more concept needs to be mentioned. Deferred  tax is the same as timing difference. It arises on account of the  difference between taxable and accounting incomes. This  difference arises between items of revenue and expenses as  comparing in P & L a/c vis-‘-vis items considered as revenue,  expenses or deduction for tax purposes. Secondly, difference  also arises between the amount in respect of an item of

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revenue or expenses as recognized in the P & L a/c and the  corresponding amount required in the computation of taxable  income. It is the tax effect of time difference which is  required to be included in Tax Expense in the P & L a/c and  as DTA/DTL in the balance-sheet. Timing difference originates  in the year in which difference arises between the tax  depreciation and accounting depreciation. Therefore, it is a  known liability for the current year, though payable in future  period(s). Therefore, tax effect of timing difference is a real  liability for which a provision is required to be made in the P &  L a/c as well as DTL in the balance-sheet. As stated above,  deferred tax is the tax effect of timing difference. It has been  vehemently submitted that a provision for Matching Tax is  required to be made in respect of accounting income only for  accounting period. The emphasis is on the words \023only for  accounting period\024. In our view, even under accrual system of  accounting, the accounting period need not be confined to one  year alone. As stated hereinabove, mergers and acquisitions  today are sometimes undertaken by companies to defer  revenue expenditure over future period(s) by invoking the  matching concept. Historically, it may also be stated that prior  to the introduction of AS 22, the companies used to follow  what is called as Tax Payable Method. They were put to  notice by the Institute that in future the companies shall have  to follow what is called as Tax Effect Accounting method. AS  22 introduces tax effect accounting method.

93.     Before us, it has been vehemently urged on behalf of the  appellants that, unlike U.K., in India, rates of depreciation are  statutorily prescribed under the Companies Act and under the  Income-tax Act, 1961. According to the appellants, rates of  depreciation are not prescribed statutorily in U.K.. Therefore,  in U.K. the tax payer is at liberty to adopt any rate of  depreciation and, therefore, there could be justification for  invoking the matching principle and for applying AS 22 for  deferred taxation. We find no merit in this argument. In our  view, on the contrary, since in India we have two separate  rates of depreciation statutorily prescribed under two different  Acts, introduction of matching principle becomes relevant.  Ultimately, AS 22 is for deferred taxation. It brings out for  the information of shareholders, investors and stake-holders  the hidden liability which earlier could not be brought out.  Today, we are living in the world of globalization in which,  apart from merger, acquisitions play an important role. The  buyer wants to know the income and liabilities of a company.  He wants to know the real income of the company, which he  proposes to buy. Because of the difference in the rates of  depreciation statutorily prescribed under the Income-tax Act  and the Companies Act, the concept of deferred taxation has  been introduced in order to obliterate the difference between  accounting depreciation and tax depreciation.  

(B)     Application of above Concepts: 94.     As stated above, the power to alter the Schedule is  distinct and separate from the power to fill in the details,  though both together form part of the same scheme. In the  present case, under section 641, the Central Government is  empowered vide the Notification to alter any of the  Regulations, Rules, Forms and other provisions contained in  any of the Schedules except Schedules XI and XII. Under  section 641(2), any alteration notified under sub-section (1)  has the effect as if the notified alteration stood enacted in the  parent Act and shall come into force on the date of the  Notification, unless the Notification directs otherwise. In the  present case, we are concerned with the provision of section

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641(2) which is not there in section 642. However, as stated  above, section 642 begins with the expression \023in addition to  the powers conferred by section 641\024. The point which we  would like to stress is that though the Central Government is  vested with both the powers, namely, to amend the Schedule  and to fill in details, the nature of the rules framed under  section 641(2) continuous to have the status of the rules  despite the phraseology used in section 641(2) which, as  stated above, says that \023any alteration notified under sub- section (1) of section 641 shall have effect as if enacted in the  Companies Act\024. To this extent, we are in agreement with the  submission made on behalf of the appellants. Our view is  supported by the judgment of this Court in the case of Chief  Inspector of Mines  v.  Karam Chand Thapar AIR 1961 SC  838. We quote hereinbelow para 20 of the said judgment,  which read as follows:   \02420. The true position appears to be that the  Rules and Regulations do not lose their  character as rules and regulations, even  though they are to be of the same effect as if  contained in the Act. They continue to be rules  subordinate to the Act, and though for certain  purposes, including the purpose of  construction, they are to be treated as if  contained in the Act, their true nature as  subordinate rule is not lost. Therefore, with  regard to the effect of a repeal of the Act, they  continue to be subject to the operation of  Section 24 of the General Clauses Act.\024  

Therefore, in our view, Rules framed under section 641  followed by Rules framed under section 642(1) shall continue  to be Rules subordinate to the Companies Act though for the  purposes of construction, they are to be treated as forming  part of the same scheme.

95.     In the present case, the most important question, which  we have to decide is whether the impugned Rule adopted AS  22 is contrary to or inconsistent with the provisions of the  Companies Act and in that connection our judgment proceeds  on the basis that the impugned Rule is an example of  subordinate legislation.

96.     As stated above, tax expense or tax income represents  total amount included in the determination of net profit or loss  for the period in respect of current tax and deferred tax.          97.     DTL is a tax payable in future period(s) which arises out  of taxable temporary differences.          98.     DTA is the tax recoverable in future period(s) which  arises out of deductible temporary difference, carry forward of  unused tax losses and carry forward of unused tax credits.

99.     Temporary difference is the difference between the  carrying amount of an asset or liability in the balance-sheet  and its tax base, which is an amount attributable for tax  purpose.

100.    Taxable temporary difference will result in future  period(s) when carrying amount of the asset or liability is  recovered. It will arise when the tax base of an asset/liability  is lower than the balance-sheet amount. Tax base of an asset  gets reduced by over-charge of depreciation as per the tax law.

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The tax base of a liability gets reduced by over-charge of a  liability which is to be written back as income in the future  period(s). This analyses can be explained by the following  examples:

Example-1 101.    A Plant costs Rs. 100 lacs. Accelerated depreciation is  charged on the Plant to the extent of Rs. 70 lacs as per the  Income tax Rules. Therefore, the tax base of the Plant is (100 \026  70) Rs. 30 lacs. On the other hand, Accounting Depreciation  charged as per the Accounting Standard is Rs. 25 lacs. In  such a case, the balance-sheet value or what is called as  depreciated book value of the Plant would be (100 \026 25) Rs. 75  lacs.          102.    Therefore, a timing difference has arisen, in the above  example, between the depreciated book value (balance-sheet  value of the Plant) and its tax base.       103.    The principle which emerges from the above example is  that when tax base is lower than the balance-sheet value of  the asset (depreciated book value of the Plant) a deferred tax  liability emerges.          104.    Similarly, the following example will show as to when  DTA emerges. Example-2 105.    Preliminary expenses of Rs. 10 lacs are allowed to be  written off over a period of 10 years on a straight-line basis,  which are charged to the income statement over a period of 5  years. Therefore, after 3 years from the date the expenses are  incurred, book value (the balance-sheet value) of such  preliminary expenses would be  Rs. 4 lacs (10\0266) and the tax  base will be Rs. 7 lacs (10-3).  

106.    In the above example, the tax base of the Plant (asset) at  Rs. 7 lacs is higher than the balance-sheet value of  preliminary expenses at Rs. 4 lacs. There will, therefore, arise  deductible timing difference which gives rise to deferred tax  asset (DTA). However, a DTA, as stated above, should be  recognized for all deductible temporary difference to the extent  it is probable that taxable profit will be available against which  the deductible timing difference can be utilized. A DTA should  also be recognized for carrying forward the unused tax losses  and unused tax credits to the extent that it is probable that  future taxable profit will be available against which the  unused tax losses and unused tax credits can be utilized. It is,  therefore, necessary to review DTA at each balance-sheet date.

107.    We would also like to give few more examples of DTA and  DTL as follows:

Example-3 108.    Cost of a Plant is Rs. 100 lacs, its carrying amount is Rs.  80 lacs whereas its tax base is Rs. 20 lacs. Therefore, the  Taxable Timing Difference is (Rs. 80 \026 20) Rs. 60 lacs. In case  the tax rate is 25 per cent then the DTL shall be computed as  follows: DTL = (Taxable Timing Difference) Rs. 60 lacs x (Tax Rate) 25% DTL     = 60 x 25/100 = Rs. 15 lacs 109.    Similarly, if a company recognizes its liability for  Provident Fund in its accounts at Rs. 30 lacs which is not  allowed by the Income tax Department unless actually paid  and if the tax rate is 30 per cent then the DTA will be Rs. 30  lacs x 30/100 = Rs. 9 lacs as in such a case the tax base is Nil

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whereas the carrying amount is Rs. 30 lacs.

Example-4 (Matching Concept) 110.    A leasing company deducts an amount of lease  equalization charges from lease rental income. For that  purpose, the company makes a provision for the said charges  in accordance with the guidelines issued by the Institute on  \023Accounting of income, depreciation and other aspects for  leasing company\024. This charge is created to equalize the  imbalance between lease rentals and depreciation charges   over the period of lease. It is based on the rationale of  matching costs with revenues so that the periodic net income  from a finance lease is true and fair. Such matching is  achieved by showing the lease rentals received under finance  lease separately under Gross Income in the P&L a/c of the  relevant period and against such lease rental income, a  matching lease annual charge is made to the P&L a/c. This  annual lease charge represents recovery of the net  investment/ fair value of the leased asset over the lease period  and is calculated by deducting the finance income for the  period from the lease rent for that period. Accordingly, where  the annual lease charge is more than the statutory  depreciation under the Income tax Act, lease equalization  charge account would be debited to that extent; whereas when  annual lease charge is less than statutory depreciation under  the Income tax Act, a lease equalization would emerge.  Therefore, lease equalization charge is created as a result of  debit to the P&L a/c. It is a charge which has to be deducted  to arrive at the true and correct profit of the leasing business  and is neither an appropriation of profit nor a reserve. This  example indicates applicability of matching concept.

(C)     Whether AS 22 is contrary to or inconsistent with  the         provisions  of the  Companies Act.  

111.    In the case of C.I.T.  v.  Duncan Brothers & Co. Ltd.  reported in (1996) 8 SCC 31 the assessee company submitted  that provision for taxation made by it for assessment years  1963-64 and 1964-65 should be treated as a fund and,  therefore, it should be deducted from the cost of asset required  to be excluded under Rule 1(ii) of Schedule II to the Super Tax  Act, 1963 and Rule 2(ii) of Schedule II to the Companies  (Profits) Super Tax Act, 1964 respectively. This contention was  rejected. This Court held that since Schedule II to both the  Acts pertained to computation of capital, the terms used in  Schedule II should be interpreted in the context of the  balance-sheet of a company and its P&L a/c which will have to  be looked at to ascertain the company\022s capital and its profits.  It was held that a provision for taxation of the kind in question  was not a fund etymologically in accounting parlance. It was  observed that words of accounting language should be  interpreted as understood in accounting practice.       112.    Applying the above test to the present case, we are now  required to interpret the words \023the amount of charge for  Indian Income tax on profits\024 in clause 3(vi) in Part II of  Schedule VI to the Companies Act. Similarly, we are required  to interpret the words \023current liabilities and provisions\024 in the  form of balance-sheet in Part I of Schedule VI to the  Companies Act. Part III of the said Schedule defines the words  \023provision\024 as well as \023reserve\024.       113.    As stated above, the form of balance-sheet is prescribed  by Part I of Schedule VI. The Act does not prescribe a proforma

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of P&L a/c. However, Part II of Schedule VI prescribes the  particulars which must be furnished in a P&L a/c. As far as  possible, the P&L a/c must be drawn up according to the  requirements of Part II of Schedule VI. As stated above, section  211(1) emphasizes \023true and fair\024 view in place of \023true and  correct\024 view of accounting. As stated above, the legislative  policy is to obliterate the difference between the accounting  income and the taxable income. As stated above, the  accounting income/book profit is the real income. Therefore,  section 211(1) emphasizes the concept of \023true and fair\024 view.  As stated above, it is a stand-alone consideration. It is the  controlling element underlying the scheme of sections 209,  211 and 227. However, as stated above, the Companies Ac  does not deal with Recognition, Measurement and Disclosure.  As stated above, how much amount should be recognized in  respect of a specific matter is not covered by section 209(3)(b).  Recognition, measurement and disclosure are the three items  which can only be done by way of Accounting Standards and  not by the provisions of the Companies Act. This aspect is  important because under section 642(1) the Central  Government is empowered to carry out ancillary/subordinate  legislative functions which is also fictionally called as power to  fill-up the details. Under section 211(1) Parliament has laid  down the controlling consideration in presentation of balance- sheet and P&L a/c by companies and it has thereafter  conferred discretion on Central Government to work out  details within the framework of that Policy. Presentation of  balance-sheet and P&L a/c is different from recognition,  measurement and disclosure of various items of revenue,  expenses, assets, liabilities etc.. That part has been left to the  Central Government which is empowered to enact Accounting  Standards in consultation with National Advisory Committee  on Accounting Standards (NAC), which committee is to be  established and which has been established under section  210A(1). As stated above, the Central Government is the rule  making authority. As stated above, it is not bound to go by the  recommendations of the Institute in the matter of framing of  accounting standards. Generally, it follows such  recommendations. However, in law nothing prevents the  Central Government from enacting accounting standards in  consultation with NAC which are in variance from the  Standards prescribed by the Institute. In the present case, we  are concerned  with the accounting standards prescribed by  Central Government in consultation with NAC under section  642(1) of the Companies Act.       114.    In the present case, the main objection of the appellants  is against paragraphs 9 and 33 of AS 22. Para 9 reads as  under:      \023Tax expense for the period,  comprising current tax and deferred tax,  should be included in the determination of  the net profit or loss for the period.\024       115.    Para 33 of AS 22 reads as under:      \023On the first occasion that the taxes on  income are accounted for in accordance with  this Statement, the enterprise should  recognise, in the financial statements, the  deferred tax balance that has accumulated  prior to the adoption of this Statement as  deferred tax asset/liability with a  corresponding credit/charge to the revenue  reserves, subject to the consideration of  prudence in case of deferred tax assets (see

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paragraphs 15-18). The amount so  credited/charged to the revenue reserves  should be the same as that which would have  resulted if this Statement had been in effect  from the beginning.\024       116.    As regards para 9, the appellants had no objection to the  disclosure of DTL/DTA in their financial statements. They  object to a charge being created qua P&L a/c for DTL mainly  because it results in reduction of reserves and net profits.  Therefore, the main contention is that the DTL is a notional  concept. According to the appellants, DTL is not a liability.  Therefore, according to the appellants, there cannot be a  charge for DTL to the P&L a/c of the company. According to  the appellants, DTL distorts their financial statements.  According to the appellants, Schedule VI forms part of the  Companies Act. According to the appellants Part II of Schedule  VI contains clause 3(vi). According to the appellants, the said  clause 3(vi) refers to the amount of charge for income tax on  the profits. According to the appellants when AS 22 states that  tax expense for the period shall consist of current tax and  deferred tax and that such tax expense should be included in  the determination of net profit or loss, it amounts to alteration  of clause 3(vi) of Schedule VI to the Companies Act which is  the part thereof. According to the appellants, Rules framed by  the Central Government as a delegate under section 642  cannot alter the provisions of the Companies Act including  Schedule VI. We have dealt with this aspect in the earlier  paragraphs. However, the appellants have further contended  that para 9 of AS 22 is inconsistent with the provisions of the  Companies Act including Schedule VI and, therefore, void. It is  also contended on behalf of the appellants that section 211  deals with P&L a/c and balance-sheet. That, para 9 only refers  to filling in the details qua items in P&L a/c and balance- sheet. According to the appellants, P&L a/c and balance-sheet  do not constitute primary books of accounts. According to the  appellants, deferred taxation do not form part of accrual  system of accounting. According to the appellants para 9 of AS  22 requires the company to make provision for liability for  taxation in the balance-sheet and P&L a/c, further, according  to the appellants P&L a/c and balance-sheet do not constitute  books of accounts and, therefore, according to the appellants,  such a standard brings about inconsistency between  maintenance of books of accounts which are primary  documents on one hand and balance-sheet an P&L a/c on the  other hand. According to the appellants, para 9 of AS 22 does  not touch the subject \023maintenance of books of accounts\024.  That, it only touches the presentation of balance-sheet and  P&L a/c. According to the appellants, books of accounts  constitute primary documents and if para  9 does not apply to  the maintenance of books of accounts, para 9 cannot be made  applicable only to balance-sheet and P&L a/c because if it is  so permitted it would bring about inconsistency between  \023maintenance of books of accounts\024 under section 209 vis-‘- vis presentation of financial statements under section 211. In  short, according to the appellants para 9 and para 33 of AS 22  are inconsistent with the provisions of the Companies Act  including Schedule VI.

117.    We do not find any merit in the arguments of the  appellants on the point of inconsistency.  

118.    As stated above, recognition and measurements bring in  the concept of fair value. When a financial instrument is  measured at fair value it brings transparency in financial

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reporting. Today, companies undertake multifarious activities  which warrants segment reporting. For example in RIL we  have three segments, namely, refining, industry and  infrastructure. Similarly, in the case of Sterlite Industries  (India) Ltd., it has different segments. Each segment earns its  own revenue. For example, revenue from copper, revenue from  aluminium and revenue from others. Under clause 3(vi) of Part  II non-provision for taxation would amount to contravention of  the provisions of sections 209 and 211 of the Companies Act.  Accordingly, it is necessary for the auditor to say in what  manner the accounts do not disclose a \023true and fair\024 view of  the state of affairs of the company and the P&L a/c of the  company. AS 22 is mandatory. Therefore, it is the duty of the  members of the Institute to examine whether the accounting  standard is complied with the said standard in the  presentation of financial statement. [see also section 227(3)(d)]

119.    In our view, para 9 only provides for details which are  necessary for giving effect to the concept of true and fair  accrual of accounts contemplated by section 211(1). As stated  above, the concept of \023true and correct\024 accrual is different  from the concept of \023true and fair\024 accrual. Both the concepts  fall under accrual system of accounting. However, there is a  difference. Under \023true and correct\024 accrual, the matching  principle was always recognized. However, fair valuation  principle is the concept which brings out the real income of  the company. Para  9 has been enacted, as stated above, to  obliterate the difference between the accounting income and  taxable income. Para 9 aims to present the real income to the  investors, shareholders and stake-holders in the company. As  stated above, there is also a difference between accounting  depreciation and tax depreciation. In order to harmonize these  differences, para 9 has been enacted. As stated above, true  and fair view is the basic requirement in the matter of  presentation of balance-sheet and P&L a/c. Therefore, in order  to bring out the true income of a company, one has to read the  provisions of the Companies Act with the accounting  standards adopted by the impugned Notification. As held in  the judgment of P. Kasilingam (supra) there are statute under  which the rules provide an internal aid to the construction of  the words used in the parent Act. The Companies Act uses the  words like, provision, reserve, liability etc. in the accounting  sense and as held in the case of Duncan Brothers (supra) the  words of accounting language should be interpreted as  understood in accounting practice. Therefore, in our view,  para 9 of AS 22 merely provides for details in the matter of  provision for liability for taxation.

120.    The word \023tax expense\024 in para 9 under conservative  system of accounting was confined to current tax. However,  with para 9 of AS 22 coming into force, the word \023tax expense\024  now includes both, current tax and deferred tax. This  inclusion became necessary because of developments not only  in concepts but also in accounting practices. This inclusion  becomes necessary if one has to go by paradigm shift from  historical costs accounting to fair value principles. In our view,  with the insertion of the words \023true and fair\024 view in section  211, which is the requirement in the matter of presentation of  balance-sheet and P&L a/c the rule making authority was  entitled to include the concept of \023deferred tax\024 in tax expense.  It may be stated that under clause 3(vi) of Part II, Schedule VI  the charge for tax on profit is contemplated. Provision for  liability for taxation is contemplated by the said clause. Para 9  of AS 22 merely provides for a liability which arises on account  of timing difference as explained hereinabove. As stated above,

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it is known on the balance-sheet date. One has to therefore  consider matching principle and fair valuation principles as  important concepts in Accrual Accounting. Further, as stated  above, recognition and measurement is not covered by the  provisions of the Companies Act, therefore, one has to read the  presentation of balance-sheet and P&L a/c together with  recognition and measurements. Therefore, one has to read the  provisions of the Companies Act along with the impugned Rule  which adopts AS 22 as recommended by the Institute. The  matching principle recognizes cost against revenue or against  the relevant time period to determine the periodic income.  Therefore, the said principle constitutes an important  component of the accrual basis of accounting. The concept of  accrual, in case of mergers and acquisition, is not limited to  one year. DTL/DTA arises out of timing differences. Therefore,  such differences have got to be reflected in Deferred Tax  Accounting. DTL in most cases arises on account of the  difference between tax depreciation and accounting  depreciation. When on account of over-charging of  depreciation under the Income-tax Rules, the taxable income  falls below the accounting income, DTL emerges. This is  because the rates of tax depreciation are incentive rates  whereas accounting depreciation is based on the useful life of  the asset. Thus, an asset under Income tax Act would be  charged over a much shorter period as compared to the useful  life of the asset. If the useful life of the asset is 10 years, for  tax purposes it should be written off fully in 4 years. Thus, in  the first year in which tax depreciation is higher than the  accounting depreciation, the taxable income would be less  than the accounting income, which would give rise to DTL on  account of the difference between the amount of depreciation,  i.e., the timing difference, which arises as it relates to the  depreciation amounts for that particular year. It would become  payable in future years when the timing difference reverses,  i.e., when the taxable income becomes higher than the  accounting income. Therefore, it is called as DTL. It is so  called because it results in future cash outflow on account of  the timing difference.

121.    Hereinbelow, we are required to give two illustrations to  indicate as to how the DTL emerges out of timing differences  and, secondly, the application of Fair Valuation principles in  advanced accounting. Illustration 1

122.    A company, ABC Ltd., prepares its  accounts annually on 31st March.  On 1st  April, 20x1, it purchases a machine at  a cost of Rs.1,50,000.  The machine  has a useful life of three years and  an expected scrap value of zero.   Although it is eligible for a 100%  first year depreciation allowance for  tax purposes, the straight-line method  is considered appropriate for  accounting purposes.  ABC Ltd. has  profits before depreciation and taxes  of Rs.2,00,000 each year and the  corporate tax rate is 40 per cent each  year.

The purchase of machine at a cost of  Rs.1,50,000 in 20x1 gives rise to a  tax saving of Rs.60,000.  If the cost  of the machine is spread over three

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years of its life for accounting  purposes, the amount of the tax saving  should also be spread over the same  period as shown below:

Statement of Profit and Loss (for the three years ending 31st March, 20x1, 20x2,  20x3)

(Rupees in thousands)

                                                20x1    20x2    20x3

Profit before depreciation  and taxes       200     200     200

Less: Depreciation for accounting Purposes        50      50      50

Profit before taxes     150     150     150

Less: Tax expense

       Current tax                          0.40 (200-150)  20

       0.40(200)               80      80

              Deferred tax

       Tax effect of timing differences         originating during the year

       0.40(150-50)    40

       Tax effect of timing differences         reversing during the year

       0.40 (0-50)     ___     (20)    (20)

Tax expense     60      60      60

Profit after tax        90      90      90

Net timing differences  100     50      0

Deferred tax liability  40      20      0

In 20x1, the amount of depreciation allowed for tax  purposes exceeds the amount of depreciation charged  for accounting purposes by Rs.1,00,000 and,  therefore, taxable income is lower than the  accounting income.  This gives rise to a deferred  tax liability of Rs.40,000.  In 20x2 and 20x3,  accounting income is lower than taxable income  because the amount of depreciation charged for  accounting purposes exceeds the amount of  depreciation allowed for tax purposes by Rs.50,000

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each year.  Accordingly, deferred tax liability is  reduced by Rs.20,000 each in both the years.  As  may be seen, tax expense is based on the accounting  income of each period.

In 20x1, the profit and loss account is debited and  deferred tax liability account is credited with the  amount of tax on the originating timing difference  of Rs.1,00,000 while in each of the following two  years, deferred tax liability account is debited  and profit and loss account is credited with the  amount of tax on the reversing timing difference of  Rs.50,000.

Illustration-2 (Application of \023Fair Value Principles\024)          123.    A convertible debenture is normally presented in the  financial statements as a liability, while it has two  components; a liability and an option to convert loan into  equity. Appropriate accounting principle requires separate  accounting for rights and obligations. Each component has to  be separately accounted for. In the past, many of those rights  and obligations were shown as off-balance-sheet items. Only  recently, on account of accounting standards, the number of  such items stand reduced. The issuer of a financial  instrument is required to classify convertible debentures  (financial instrument) as liability or as equity depending on the  terms of the contract. A convertible debenture is a compound  instrument. In case of such instrument, having different  components, one has to present such components in financial  statements either as equity or as liability based on the terms  of the contract. As a general principle, a contract that will be  settled by an entity receiving a fixed number of its own shares  is an equity instrument. For example, when an enterprise  issues shares in consideration of cash or some other  asset/service, the transaction does not result in any cash  outflow. For example, a redeemable preference share should  be classified as liability and not as equity because it gives rise  to an obligation to deliver cash. This example is given to show  that DTL is a liability because it results in cash outflow in  future on account of timing differences.       124.    A company has an option to designate a financial asset at  fair value through profit or loss. A financial asset held for  trading should be classified as an asset at fair value through  profit or loss. The difference in the fair value of financial asset  at the beginning of the period and at the end of the period is  generally recognized as profit or loss in the P&L a/c. Similarly,  loans and receivables are carried at amortized cost unless the  company intends to sell the same immediately. Similarly, there  are certain assets like Held-to-maturity-investments which are  required to be carried in the balance-sheet at the amortized  cost. In all such cases, the company will now have to classify  such assets or liabilities at fair value through profit or loss.  Therefore, fair value under the new A.S. has become the basis  for measurement of financial assets. Application of new  standards will require a change in the mind-set. At present,  non-financial companies carry current investments at cost or  market value, whichever is lower. However, they carry long  term investments at cost. They provide for permanent  diminution in value of long term investment.       125.    Similarly, in case the company pays customs duty under  section 43B of Rs. 100. For tax purpose, that company is  entitled to deduction of Rs. 100/- in the year it makes

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payment. But for accounting purpose, it can divide Rs. 100/-  into Rs. 80/- + Rs. 20/- (embedded in the closing stock). The  company can show Rs. 20/- as pre-paid expense, in the  balance-sheet.       126.    The above examples indicate that measurement and  recognition of timing differences and financial instruments at  fair value brings transparency in presentation of financial  statements. Lastly, valuation is an important element of the  Method of Accounting. 127.    In our view, para 9 of AS 22 merely represents gap-filling  exercise, therefore, there is no merit in the contention  advanced on behalf of the appellants that AS 22 is  inconsistent with the provisions of the Companies Act  including Schedule VI. It proceeds on the principle that every  transaction has a tax effect. The words \023true and fair\024 view in  section 211(1) connotes the widest law making powers and, in  that context, we hold that that impugned Rule adopting AS 22  is intra vires as the said Rule is incidental and/or  supplementary to the specific powers given to the Central  Government to make Rules, particularly when such power is  given to fill-in details. The word \023supplementary\024 means  something added to what is there in the Act, to fill-in details  for which the Act itself does not provide. It is something in the  sense that is required to implement what is there in the Act.  [See Daymond  v.  South West Water Authority (1976) 1 All  ER 39]. There is no merit in the contention advanced on behalf  of the appellants that the impugned Rule seeks to modify the  essential features of the Companies Act. Rules made on  matters permitted by the Act to supplement the Act cannot be  held to be in violation of the Act. [See Britnell  v. Secretary of  State (supra)]. When the power to make rules is limited to  particular topics and if that rule falls within the ambit of that  topic, namely, taxes on income in the present case, it cannot  be said that the rule is inconsistent with the provisions of the  Act. As stated above, the Act and the Rules form part of the  composite scheme. The provisions of sections 205, 209 and  211 can be put into operation only if the Act and the Rules are  read together. In the present case, in our view, the impugned  Rule constitutes a legitimate aid to construction of the  provisions of the Companies Act. Further, as stated above, the  Central Government is the rule making authority under  section 211(3C). As rule making authority, the Central  Government is empowered to enact accounting standards in  consultation with NAC which may be at variance with the  Standards issued by the Institute.       128.    In the case of Union of India and anr. v.  Cynamide  India Ltd. and anr. reported in (1987) 2 SCC 720 one of the  arguments advanced on behalf of the company was that, in  calculating the \023net worth\024 the cost of works-in-progress and  the amount invested outside business were excluded from  \023free reserves\024 and that such exclusion could not be justified  on any known principle of commercial accountancy (See para  33). The matter related to price fixation. In the Control Order  vide para 2(g) the word \023free reserve\024 was defined. Similarly, in  the Form prescribed in the Fourth Schedule, several items like  bonus, bad debts and provisions, loss/gain on sale of assets  etc. were required to be excluded from the cost of production.  Therefore, it was argued that such exclusion was not  warranted by principles of commercial accountancy. This  argument was rejected by this Court on the ground that it was  open to the subordinate body to prescribe and adopt its own  mode of ascertaining the cost of production. That the said  body was under no obligation to adopt the method indicated

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under the Income tax Act in allowing expenses for the  purposes of ascertaining income. It was further held that so  long as the method prescribed and adopted by the subordinate  legislating body is not opposite to the principle statutory  provisions and so long as the method prescribed is ancillary to  the provisions of the parent Act, it cannot be legitimately  questioned. In the present case, as stated above, measurement  and recognition methods are not the items under the  Companies Act. Methods of recognition and measurements are  talked about by the provisions of the Companies Act.  Recognition and measurement of various items of revenue  expenses etc. stand covered only by the accounting standards.  Therefore, it cannot be said that the said standards are  contrary to the provisions of the Companies Act. We also do  not find any merit in the argument advanced on behalf of the  appellants that the impugned Rule does not touch upon  maintenance of books of accounts to be kept by the company.  Under section 209(3)(b) every company is required to keep its  books of accounts on accrual basis and according to double- entry system of accounting. Under section 209(3)(a) every  company is required to maintain books of accounts necessary  to provide a true and fair view of the state of affairs of the  company and its accounts. In our view, books of accounts do  not include balance-sheet and P&L a/c. However, as stated  above, there is a difference between \023true and correct\024 accrual  and \023true and fair\024 accrual. In the past, what prevailed was  true and correct accrual. At that time, it was noticed in several  cases that profits were overstated and, therefore, the  Legislature inserted what is called as \023true and fair\024 accrual  concept. The said concept is wider than the concept of true  and correct accrual. When section 209(3) refers to  maintenance of books of accounts on accrual basis it  means \023true and fair\024 accrual, which would include not only  matching principles but also fair valuation principles. These  principles do not contravene accrual system of accounting.  Moreover, we are concerned with presentation of balance-sheet  and P&L a/c. These are financial statements. An investor,  shareholder or stake-holder is entitled to know the real income  which the company has earned during the year. Provision for  diminution in value of an asset results in emergence of  liability. In the past, when timing difference concept was not  there, in many cases, profits were overstated, particularly  because provision for DTL (deferred taxation) was not  recognized. With the introduction of the timing difference  concept, it cannot be said that the accrual system of  accounting is violated. As stated above, it is the concept of  \023timing difference\024 which obliterates the difference between  accounting and tax incomes. Ultimately, the object is to  obliterate the difference between accounting income and  taxable income. Accounting income is the real income,  therefore, in our view, para 9 of AS 22 is not inconsistent with  the provisions of the Companies Act, including Schedule VI.       129.    In the case of Bharat Hari Singhania and ors.  V.   Commissioner of Wealth-tax (Central) and ors. reported in  AIR 1994 SC 1355 valuation of unquoted equity shares based  on the break-up method was challenged. That challenge was  rejected on the ground that the break-up method leads to  appropriate market value and, therefore, the said method  adopted by Rule 1-D of Wealth-tax Rules was neither ultra  vires nor inconsistent with section 7 of the Wealth tax Act. We  quote hereinbelow paras 13, 14 and 21 of the said judgment  which held that it is always open to the rule-making authority  to prescribe an appropriate method of valuation out of several  methods of valuing an asset. And since the break-up method

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adopted by the rule-making authority was a known method in  the relevant circles, it cannot be said that the method adopted  was an impermissible method. Paras 13, 14 and 21 read as  under: \02313. We may first take up the question  whether Rule 1-D is void for being inconsistent  with the Act or for the reason that it is beyond  the rule-making authority conferred by the  Act. Section 7(1) indeed defines the expression  "value of an asset." It is "the price which in the  opinion of the Wealth Tax Officer it would fetch  if sold in the open market on the valuation  date", but this is made expressly subject to the  Rule made in that behalf. No. guidance is  furnished by the Act to the rule-making  authority except to say that the Rule made  must lead to ascertainment of the value of the  asset (unquoted equity share) as defined in  Section 7. It is thus left to the rule-making  authority to prescribe an appropriate method  for the purpose. Now, there may be several  method of valuing an asset or for that method  an unquoted equity share. The rule-making  authority cannot obviously prescribe all of  them together. It has to choose one of them  which according to it is more appropriate. The  rule-making authority has in this case chosen  the break-up method, which is undoubtedly  one of the recognised methods of valuing  unquoted equity shares. Even if it is assumed  that there was another method available which  was more appropriate, still the method chosen  cannot be faulted so long as the method  chosen is one of the recognised methods,  though less popular. One probable reason why  yield method or dividend method was not  adopted in the case of unquoted equity shares  was that bulk of these companies are private  limited companies where the divided declared  does not represent the correct state of affairs  and to estimate the probable yield is no simple  exercise. The dividends in these companies is  declared to suit the purposes of the persons  controlling the companies. Maintainable profits  rather than the dividends declared represent  the correct index of the value of their shares.  The break-up method based upon the balance- sheet of the company, incorporated in Rule 1- D, is a fairly simple one. Indeed, no serious  objection can also be taken to this course  since the basis of the Rule is the balance-sheet  of the company prepared by the company itself  - subject, of course, to certain modifications  provided in Explanation-II.   14. We are not satisfied that the break-up  method adopted by Rule 1-D does not lead to  proper determination of the market value of  the unquoted shares. The argument to this  effect, advanced by the learned Counsel for the  assessees, is based upon the  assumption/premise that the value  determined by applying the yield method is the  correct market value. We do not see any basis  for this assumption. No empirical data is

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placed before us in support of this submission  or assumption. It may be more advantageous  to the assessees but that is not saying the  same thing that it alone represents the true  market value. It cannot be stated as a principle  that only the method that leads to lesser value  is the correct method. The idea is to find out  the true market value and not the value more  favourable to the assessee. Accordingly, the  contention that rule 1-D is inconsistent with  Section 7(1) or that it travels beyond that  purview of Section 7 is rejected.  

               xxx

21. The statement of law in the decision would  thus establish that it does not purport to "lay  down any hard and fast rule." It recognises  that various factors in each case will have to  be taken into account to determine the method  of valuation to be applied in that case. The  dividend yield method is not the only method  indicated in the case of a going concern; there  is the ’earning method’ and then a  combination of both methods. The several  qualifications added to the above rules, as  already stated, make them highly cumbersome  and time-consuming. The Wealth Tax Officer  has to examine the facts and circumstances of  each case including the nature of the  business, prospects of profitability and similar  other considerations before finally determining  whether to apply the dividend method, yield  method or whether the break-up method  should be followed. There may be cases where  an assessee may be holding shares of a large  number of private companies or other public  limited companies whose shares are not  quoted. Compared to them, the break-up  method incorporated in Rule 1-D is far simpler  and far less time-consuming. It prescribes a  simple uniform method to be followed in all  cases. All that the Wealth Tax Officer has to do  is to take the balance-sheet, delete some items  from the columns relating to assets and  liabilities as directed by Explanation-II, and  then apply the formula contained in the Rule.  He need not have to look into the profitability,  the earning capacity and the various other  factors mentioned in propositions (2), (3) and  (4) of the decision. The decision, it bears  repetition, recognises that break-up method  "nonetheless is one of the methods." In the  circumstances, it is difficult to agree with the  learned Counsel for the assessees either that  break-up method is not a recognised method  or that yield method is the only permissible  method for valuing the unquoted equity  shares. It is not as if the rule-making authority  has adopted a method unknown in the  relevant circles or has devised an  impermissible method. There is no empirical  data produced before us to show that break-up  method does not lead to the determination of  market value of the shares. Merely because

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yield method may be more advantageous from  the assessee’s point of view, it does not follow  that it alone leads to the ascertainment of true  market value and that all other methods are  erroneous or misleading. This aspect we have  emphasised hereinbefore too.\024

Validity of Para 33 of AS 22

130.    We have already quoted hereinabove para 33. The said  para is challenged on the ground that a subordinate legislation  cannot be retrospective unless there is provision to that effect  in the parent Act. Therefore, the short question which we have  to decide is whether the said para is retrospective.

131.    To decide the said question, we have to analyse the scope  of para 33. For the purpose of determining accumulated  deferred tax in the period in which the Standard is applied for  the first time, the opening balances of assets and liabilities for  accounting purposes and for tax purposes are to be compared  and the differences, if any, are to be determined. The tax effect  of these differences have got to be recognized as DTA or DTL, if  such differences are timing differences. For example, in the  year in which a company adopts AS 22, the opening balance of  a fixed asset is, let\022s say, Rs. 100 for accounting purposes and  Rs. 60 for tax purposes. This difference is because the  company applied written down value method of depreciation  for calculating taxable income, whereas for calculating  accounting income it adopts straight-line method. This  difference will reverse in future when depreciation for tax  purposes will be allowed as compared to depreciation for  accounting purposes. In this example, let\022s assume that the  tax rate is 40 per cent and that there are no other timing  differences then, DTL would be  [Rs. 100 \026 Rs. 60] x 40/100 =  Rs. 16

132.    Once we are required to take into account the concept of  opening balance of a fixed asset in para 33, it cannot be said  that the said para is retrospective. In fact, it is a transitional  provision. Let\022s say that there is an expenditure which is  written off for accounting purposes in the year in which it is  incurred but is admissible for deduction under Income-tax Act  over a period of time. In such a case, the asset representing  expenditure would have a Balance only for tax purposes and  not for accounting purposes. Therefore, the difference between  the Balance of the asset for tax purposes and balance for  accounting purposes, which is nil, would give rise to a timing  difference which will reverse in future when expenditure would  be allowed for tax purposes. In such a case, DTA would be  recognized in respect of difference, subject to the principle of  prudence. In the circumstances, it cannot be said that para 33  is retrospective.

Conclusion: 133.    For the aforestated reasons, we are of the view that the  impugned Notification/Rule is neither ultra vires nor  inconsistent with the provisions of the Companies Act,  including Schedule VI.  

134.    To sum up, deferred tax is nothing but accrual of tax due

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to divergence between accounting profit and tax profit. This  difference arises on two counts, namely, different treatment of  items of revenue/expense as per profit and loss account and  as per the tax law. It also arises on account of the difference  between the amount of revenue/expense as per profit and loss  account and the corresponding amount considered for tax  purposes, e.g., depreciation.

135.    However, we need to comment on one aspect. Before the  Calcutta High Court, the impugned Notification adopting AS  22 was also challenged on the ground that the provisions of  AS 22 insofar as it relate to \023deferred taxation\024 is violative of  Articles 14 and 19(1)(g) of the Constitution of India. In this  connection, it was pleaded that by making AS 22 mandatory,  the appellants\022 companies will suffer erosion of its net worth.  That, as a result, the debt equity ratio will also increase and  that the lenders may recall the loans and thereby the  appellants\022 rights to carry on business in future would be  violated. Although, the aforestated challenge was pleaded in  the writ petition, when the matter came for hearing before the  High Court, it appears that the said grounds were not argued.  According to the appellants, implementation of AS 22 would  result in reduction of profits and reserves. In the  circumstances, we do not wish to express any opinion on the  constitutional validity of the said AS 22. Whether the said  Standard constitutes a restriction on the rights of the  appellants to carry on business under Article 19(1)(g) or  whether the said Standard is violative of Article 14 are  questions on which we express no opinion. We keep those  questions open. Suffice it to state that, in the present case, we  are of the view that the said AS 22 is neither ultra vires nor  inconsistent with the provisions of the Companies Act,  including Schedule VI.       136.    For the aforestated reasons, we find no infirmity in the  impugned judgment of the High Court and, accordingly, the  civil appeals filed by the various companies stand dismissed  with no order as to costs.