Exposure Draft Guidance Note on Financial Statements of Non-Corporate Entities (Comments to be received by March 8, 2023)
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
A financial reporting system supported by strong governance, high quality standards, and firm regulatory framework is the key to economic development. The sound financial reporting emphasises the trust that investors and other stakeholders like lenders, grantors, etc. place in financial reporting information. Thus, it is very essential that financial reporting of an entity should be comparable, transparent, complete and unbiased.
Accounting Standards contain wholesome principles of accounting and can be viewed as standardised language of business to communicate high quality information in financial statements based on principles of transparency, consistency and also comparability and reliability. Accounting standards are a set of principles which entities follow while preparing the financial statements providing a standardised way of describing the entity’s financial position and financial performance.
Financial information needs of Non-Corporate Entities
In case of corporate entities, the users or primary users of financial information are shareholders, regulators, potential investors, lenders, creditors and other stakeholders. These users need financial information of the reporting entities to make various economic decisions. Formats for financial statements of companies are specifically provided under Schedule III of the Companies Act, 2013.
In case of the Non-Corporate entities, considering the wide spectrum of role and responsibilities performed by them, undoubtedly there are wide users/stakeholders of the financial information of these Non-Corporate entities. The users could be present and potential investors, employees, lenders, suppliers, other trade creditors, customers.
Further, in case of some Non-Corporate entities the users of financial information are similar to the corporate sector, e.g., many statutory corporations or authorities raise substantial financial resources from capital and financial markets. Therefore, the investors or lenders of such Non-Corporate entities have similar financial information needs as that of corporate investors.
Extent or size of economic and financial activities of the Non-Corporate entities have grown over the period of time. In recent times, Indian government has initiated many steps to create or upgrade infrastructure for public services such as roads, bridges, tunnels, airports, hospitals, water distribution facilities, energy supply, telecommunication networks and educational institutions. While there is push for higher private participation through ‘Public-Private-Partnership’ model, it has also led to substantial increase in the number of Non-Corporate entities in private sector as well as in government sector and increase in size of financial activities of these Non-Corporate entities.
Financial Statements form the backbone for financial planning, analysis, benchmarking and decision making. If Non-Corporate entities follow high quality reporting framework, its financial statements faithfully represent its transactions and are more reliable, complete and comparable.
Applicability of Accounting Standards
In view of the above, Accounting Standards apply in respect of any entity engaged in commercial, industrial or business activities. Exclusion of an entity from the applicability of the Accounting Standards is permissible only if no part of the activity of such entity is commercial, industrial or business in nature. Even if where a very small proportion of the activities of an entity were considered to be commercial, industrial or business in nature, the Accounting Standards would apply to all its activities including those, which are not commercial, industrial or business in nature.
At present, there are three sets of Accounting Standards:
(i) Indian Accounting Standards (Ind AS) for specified class of companies;
(ii) Accounting Standards (AS) notified under Companies (Accounting Standards) Rules, 2021, for companies other than those following Ind AS;
(iii) Accounting Standards (AS) prescribed by ICAI for entities other than companies.
(i) Indian Accounting Standards (Ind AS) for Companies
In view of global developments and importance of integrating local Accounting Standards with global financial reporting standards, keeping in view the Indian legal and economic scenario, IFRS converged Ind AS have been notified and are applicable to all listed companies and Non-Banking Financial Companies (NBFCs) and to unlisted companies and unlisted NBFCs with networth of INR 250 crores or more. Ind AS are also applicable to holding/subsidiaries/joint ventures/associates of such companies.
(ii) Accounting Standards (AS) notified under Companies (Accounting Standards) Rules, 2021 for companies other than those following Ind AS
Companies that are not covered under Ind AS, as given in paragraph above, are required to apply Accounting Standards (AS) notified under the Companies Act as Companies (Accounting Standards) Rules, 2021. As on date, Accounting Standards (AS) 1 to 5, 7 and 9 to 29 are effective. As per the Companies (Accounting Standards) Rules, 2021, Small and Medium Companies (SMCs) are given certain exemptions/relaxations.
(iii) Accounting Standards (AS) prescribed by ICAI for entities other than companies.
ICAI, keeping in view the fact that the Accounting Standards (AS) notified under Companies Act will only be applicable to the companies, announced the scheme for applicability of Accounting Standards (AS) issued by ICAI to non-company entities. In this regard, the criteria for classification of non-company entities as decided by ICAI is given in Appendix A.
It may be noted that for the purpose of applicability of Accounting Standards (AS), entities are classified into four categories viz., Level I, Level II, Level III and Level IV non-company entities. Level I non-company entities are required to comply fully with all the AS. Level IV, Level III and Level II non-company entities are considered as Micro, Small and Medium Sized Entity (MSMEs) that have been granted certain exemptions/relaxations by the ICAI. The applicability of AS and exemptions/relaxations thereof for MSMEs are given in Appendix A.
Compliance with Accounting Standards
Apart from requirements to comply with AS, as may be prescribed in relevant standards, the ‘Preface to the Statements of Accounting Standards’, issued by the ICAI, lays down a few critical principles, which are reproduced below, regarding compliance with Accounting Standards:
“6.1 The Accounting Standards wil be mandatory from the respective date(s) mentioned in the Accounting Standard(s). The mandatory status of an Accounting Standard implies that while discharging their attest functions, it will be the duty of the members of the Institute to examine whether the Accounting Standard is complied with in the presentation of financial statements covered by their audit. In the event of any deviation from the Accounting Standard, it wil be their duty to make adequate disclosures in their audit reports so that the users of financial statements may be aware of such deviation.
6.2 Ensuring compliance with the Accounting Standards while preparing the financial statements is the responsibility of the management of the enterprise. Statutes governing certain enterprises require of the enterprises that the financial statements should be prepared in compliance with the Accounting Standards, e.g., the Companies Act, 19561 (section 211), and the Insurance Regulatory and Development Authority (Preparation of Financial Statements and Auditor’s Report of Insurance Companies) Regulations, 2000.
6.3 Financial Statements cannot be described as complying with the Accounting Standards unless they comply with all the requirements of each applicable Standard.”
In view of the above, the auditors are required to examine compliance with AS while discharging their attest function.
Audit of Financial Statements
For non-corporate entities, if audit of financial statements is required under a statute, the Auditor shall conduct the audit and issue the Auditors’ Report in accordance with the Standards on Auditing issued by the ICAI. For the purpose of tax audit, the auditor should issue a report taking into consideration the “Guidance Note on Tax Audit under Section 44AB of the Income-tax Act, 1961” issued by the ICAI.
In case of tax audit under section 44AB of the Income-tax Act, 1961, it is pertinent to note that the auditor is required to conduct audit of financial statements to give a true and fair view thereon and report the same in Form 3CB. Along with the Report in Form 3CB, they have to state true and correct view of particulars annexed in Form 3CD.
Objective and Scope of Guidance Note
Non-Corporate Entities – A wide spectrum of entities
All Business or Professional Entities, other than Companies incorporated under Companies Act and Limited Liability Partnerships incorporated under Limited Liability Partnership Act are considered to be Non-Corporate entities. Corporate or Company form of legal structure is the most commonly used one for commercial or business activities. Entities for business, commercial or other economic and social activities can be established under variety of structures and the most common structures are as follows:
(a) Sole proprietorship firms
(b) Hindu Undivided Family
(c) Partnership Firms
i) Registered Partnership Firms
ii) Unregistered Partnership Firms
(d) Association of Persons
i) Partnership firms not covered above
ii) Body of Individuals
iii) Resident welfare Association
(e) Society registered under any law for the time being in force
(f) Trust (private or public) registered or unregistered under any law for the time being in force.
(g) Statutory Corporations, Autonomous bodies and Authorities
(h) Any form of organisation that is engaged fully or partially in any Business or Professional activities.
In June 2022, the Accounting Standards Board of ICAI has issued the Technical Guide on Financial Statements of Non-corporate Entities to deal with applicability of Accounting Standards to the non-corporate entities and recommending formats of the financial statements for the Non-Corporate entities.
The Accounting Standards Board has now prescribed the formats for the presentation of the financial statements of Non-corporate Entities in the form of Guidance Note, which were earlier issued as a part of Technical Guide. The objective is to standardise the formats of financial statements for these entities and to enhance the quality and comprehensiveness of the financial reporting by these entities.
This Guidance Note is relevant for the purpose of preparation of the financial statements of the above mentioned Non-Corporate Entities unless any formats/principles are specifically prescribed by the relevant Statute or Regulator or any Authority, e.g., formats have been prescribed for Trusts under Maharashtra Public Trust Rules, 1951, Guidance has been specifically given by ICAI (e.g., Educational Institutions, Political Parties, NPOs etc.).
It may be clarified that Limited Liability Partnerships (LLPs) form of entities are scoped out of this Guidance Note.
This Guidance Note shall be effective immediately from the date of its issuance. The Technical Guide on Financial Statements of Non-Corporate Entities shall be superseded by this Guidance Note.
What Are Financial Statements?
Financial statements form part of the process of financial reporting. A complete set of financial statements normally includes:
The notes also include significant accounting policies as required by applicable Accounting Standards. They may also include supplementary schedules and information based on or derived from, and expected to be read with, such statements. The objective of financial statements is to provide information about the financial position, performance and cash flows of an entity.
Few critical principles prescribed in the ‘Framework for the preparation and presentation of Financial Statements’, issued by the ICAI, are reproduced below:
Financial Position, Performance and Cash Flows
15. The economic decisions that are taken by users of financial statements require an evaluation of the ability of an entity to generate cash and cash equivalents and of the timing and certainty of their generation. This ability ultimately determines, for example, the capacity of an entity to pay its employees and suppliers, meet interest payments, repay loans, and make distributions to its owners. Users are better able to evaluate this ability to generate cash and cash equivalents if they are provided with information that focuses on the financial position, performance and cash flows of an entity.
16. The financial position of an entity is affected by the economic resources it controls, its financial structure, its liquidity and solvency, and its capacity to adapt to changes in the environment in which it operates. Information about the economic resources controled by the entity and its capacity in the past to alter these resources is useful in predicting the ability of the entity to generate cash and cash equivalents in the future. Information about financial structure is useful in predicting future borrowing needs and how future profits and cash flows wil be distributed among those with an interest in the entity; it is also useful in predicting how successful the entity is likely to be in raising further finance. Information about liquidity and solvency is useful in predicting the ability of the entity to meet its financial commitments as they fall due. Liquidity refers to the availability of cash in the near future to meet financial commitments over this period. Solvency refers to the availability of cash over the longer term to meet financial commitments as they fal due.
17. Information about the performance of an entity, in particular its profitability, is required in order to assess potential changes in the economic resources that it is likely to control in the future. Information about variability of performance is important in this respect. Information about performance is useful in predicting the capacity of the entity to generate cash flows from its existing resource base. It is also useful in forming judgements about the effectiveness with which the entity might employ additional resources.
18. Information concerning cash flows of an entity is useful in order to evaluate its investing, financing and operating activities during the reporting period. This information is useful in providing the users with a basis to assess the ability of the entity to generate cash and cash equivalents and the needs of the entity to utilise those cash flows.
19. Information about financial position is primarily provided in a balance sheet. Information about performance is primarily provided in a statement of profit and loss. Information about cash flows is provided in the financial statements by means of a cash flow statement.
20. The component parts of the financial statements are interrelated because they reflect different aspects of the same transactions or other events. Although each statement provides information that is different from the others, none is likely to serve only a single purpose nor to provide al the information necessary for particular needs of users.
Notes and Supplementary Schedules
21. The financial statements also contain notes and supplementary schedules and other information. For example, they may contain additional information that is relevant to the needs of users about the items in the balance sheet and statement of profit and loss. They may include disclosures about the risks and uncertainties affecting the entity and any resources and obligations not recognised in the balance sheet (such as mineral reserves).
Information about business and geographical segments and the effect of changing prices on the entity may also be provided in the form of supplementary information.
Information about financial position is provided through balance sheet. The elements directly related to the measurement of financial position in the balance sheet are assets, liabilities and equity.
Items Included in the Balance Sheet
As per the Framework for the Preparation and Presentation of Financial Statements, issued by the ICAI:
49. The elements directly related to the measurement of financial position are assets, liabilities and equity. These are defined as folows:
(a) An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.
(b) A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.
(c) Equity is the residual interest in the assets of the enterprise after deducting all its liabilities.
The definitions of an asset and a liability identify their essential features but do not attempt to specify the criteria that need to be met before they are recognised in the balance sheet. Thus, the items are recognised as assets or liabilities in the balance sheet if they satisfy the criteria for recognition as specified in the relevant Accounting Standards and, if there is no specific Accounting Standard, as specified in the said Framework.
Statement of Profit and Loss
Statement of Profit and Loss is one of the three important elements of the financial statements used for reporting an entity’s financial performance over a specific accounting period. It is also known as the ‘Income Statement’ or ‘Profit & Loss Account’. The Statement of Profit and Loss primarily focuses on an entity’s income and expenses during a particular period.
As per the Framework for the Preparation and Presentation of Financial Statements, issued by the ICAI:
68. Profit is frequently used as a measure of performance or as the basis for other measures, such as return on investment or earnings per share. The elements directly related to the measurement of profit are income and expenses. The recognition and measurement of income and expenses, and hence profit, depends in part on the concepts of capital and capital maintenance used by the enterprise in preparing its financial statements.
69. Income and expenses are defined in the Framework as folows:
(a) Income is increase in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants.
(b) Expenses are decreases in economic benefits during the accounting period in the form of outflows or depletions of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants.
The definitions of income and expenses identify their essential features but do not attempt to specify the criteria that need to be met before they are recognised in the statement of profit and loss. Criteria for recognition of income and expenses are prescribed in relevant Accounting Standards and, if there is no specific Accounting Standard dealing with the item, the recognition criteria prescribed in the Framework may be referred.
Cash Flow Statements
As per Accounting Standard (AS) 3, Cash Flow Statements, a cash flow statement, when used in conjunction with the other financial statements, provides information that enables users to evaluate the changes in net assets of an enterprise, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Cash flow information is useful in assessing the ability of the enterprise to generate cash and cash equivalents and enables users to develop models to assess and compare the present value of the future cash flows of different enterprises. It also enhances the comparability of the reporting of operating performance by different enterprises because it eliminates the effects of using different accounting treatments for the same transactions and events.
For non-company entities, AS 3 provides that financial statements of Micro, Small and Medium Sized Enterprises (Level IV, Level III and Level II non-company entities), may not include cash flow statements, i.e., preparation of cash flow statement is not mandatory. Such entities are, however, encouraged to comply with this standard.
The cash flow statement reconciles the income statement with the balance sheet in three major business activities. The three components of the cash flow statement are listed below.
a) Operating Activities
Operating activities are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. The operating activities in the Cash Flow Statement include any sources and uses of cash from running the business and selling its products or services. Cash flow from operations includes any changes made in cash, accounts receivable, depreciation, inventory, and accounts payable. These transactions also include wages, income tax payments, interest payments, rent, and cash receipts from the sale of a product or service.
b) Investing Activities
Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Investing activities include any sources and uses of cash from an entity’s investments into the long-term future of the entity. Cash payments to acquire assets or cash receipts from disposal of assets, cash advances and loans made to third parties or cash receipts from repayment of advances and loans made to third parties are included in this category.
c) Financing Activities
Financing activities are activities that result in changes in the size and composition of the owners’ capital and borrowings of the enterprise. Cash flow from financing activities include the sources of cash from investors or banks, as well as the uses of cash paid to shareholders. Financing activities include debt issuance, loans and repayment of debt.
Formats of Financial Statements for Non-corporate Entities
The financial statements should give true and fair view of the state of affairs of the entity, comply with the applicable Accounting Standards and shall be in the form as provided hereafter.
GENERAL INSTRUCTIONS FOR PREPARATION OF BALANCE SHEET AND STATEMENT OF PROFIT AND LOSS OF A NON-CORPORATE ENTITY
1. (a) These formats shall apply for preparation of Balance Sheet and Statement of Profit and Loss of a non-corporate entity. Where compliance with the requirements of the relevant statute including Accounting Standards as applicable to the Non-Corporate entity require any change in treatment or disclosure including addition, amendment, substitution or deletion in the head or sub-head or any changes, inter se, in the financial statements or statements forming part thereof, the same shall be made and the formats shall be modified accordingly.
(b) This Guidance Note uses terminology that is suitable considering the nature and business of non-corporate entities in general. However, certain non-corporate entities may need to amend the descriptions used for particular line items in the formats of financial statements and for the financial statements themselves, e.g., Association of Persons may need to use terminology “members’ funds” instead of “owners’ funds”.
2. The disclosure requirements specified in the formats are in addition to and not in substitution of the disclosure requirements specified in the Accounting Standards issued by the Institute of Chartered Accountants of India. Additional disclosures specified in the Accounting Standards shall be made in the notes to accounts or by way of additional statement unless required to be disclosed on the face of the Financial Statements. Similarly, all other disclosures as required by the relevant statute shall be made in the notes to accounts in addition to the requirements set out in these formats.
3. (i) Notes to accounts shall contain information in addition to that presented in the Financial Statements and shall provide where required (a) narrative descriptions or disaggregations of items recognised in those statements; and (b) information about items that do not qualify for recognition in those statements.
(ii) Each item on the face of the Balance Sheet and Statement of Profit and Loss shall be cross-referenced to any related information in the notes to accounts. In preparing the Financial Statements including the notes to accounts, a balance shall be maintained between providing excessive detail that may not assist users of financial statements and not providing important information as a result of too much aggregation.
4. (i) Depending upon the Total Income of the Non-Corporate entity, the figures appearing in the Financial Statements may be rounded off as given below:—
|(a) less than one hundred crore rupees||To the nearest hundreds, thousands, lakhs or millions, or decimals thereof.|
|(b) one hundred crore rupees or more||To the nearest lakhs, millions or crores, or decimals thereof.|
5. Except in the case of the first Financial Statements prepared by the Non-Corporate entity (after its incorporation) the corresponding amounts (comparatives) for the immediately preceding reporting period for all items shown in the Financial Statements including notes shall also be given.
6. For the purpose of this format, the terms used herein shall be as per the applicable Accounting Standards.
Note:—This part recommends the minimum requirements for disclosure on the face of the Balance Sheet, and the Statement of Profit and Loss (hereinafter referred to as “Financial Statements” for the purpose of the Format) and Notes. Line items, sub-line items and sub-totals shall be presented as an addition or substitution on the face of the Financial Statements when such presentation is relevant to an understanding of the Non-Corporate entity’s financial position or performance or to cater to industry/sector-specific disclosure requirements or when required for compliance with the amendments to the relevant statutes or under the Accounting Standards.
Downloads Form, Appendices & Annexure in Below:-
1 With regard to the reference to Companies Act, 1956, relevant section of Companies Act, 2013, shall be referred.