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Companies Act 2013 (‘the Act’), in terms of Section 129(3), establishes the requirement for consolidated financial statements for Indian companies and provides that where a company has one or more subsidiaries, it shall prepare a consolidated financial statements of the parent company and its subsidiaries, joint ventures and associates.
Such consolidated financial statements shall also be laid before the annual general meeting and the provisions of the Act applicable to the preparation, adoption and audit of the financial statements of a parent company also apply to the consolidated financial statements. The related Rules also provide that the consolidation of financial statements of the company shall be made in accordance with the provisions of Schedule III of the Act and the applicable accounting standards.
The relevant Indian accounting standard that deals with the guidance on preparation of consolidated financial statements is Accounting Standard (AS) 21, ‘Consolidated Financial Statements’. In addition, AS 23, ‘Accounting for Investments in Associates in Consolidated Financial Statements’ and AS 27, ‘Financial Reporting of Interests in Joint Ventures’ deal with accounting for investments in associates and joint ventures, respectively, in the consolidated financial statements.
The requirement for consolidated financial statements under the Act has been introduced for the first time; however, it is not new for listed companies. Previously, the listed companies were already required to prepare consolidated financial statements in terms of the listing agreements with stock exchanges. Thus, the new requirements more significantly affect the unlisted companies in India which practically might be doing this for the first time.
The accounting for subsidiaries, joint ventures and associates in the consolidated financial statements requires extensive financial information from those respective investees. For starters, for examples, the financial statements of the subsidiaries, associates and joint ventures must also be prepared following the Indian accounting standards and conform to the accounting policies of the parent company. Unlisted companies, since they were not required to gather this information in the past, may not have the ready ability to generate and gather this information.
This will specifically be the situation where such subsidiaries, associates and joint ventures are incorporated outside India as those entities will be preparing their financial statements only under the local requirements. This can also happen generally in case of associates and joint ventures as the parent company may not have the contractual rights in the present agreements and arrangement to get the necessary information.
Accordingly, to address the practical concerns in this regard, and also to specifically cover one of the aforesaid situations, the Ministry of Corporate Affairs (‘MCA’) had also issued a couple of amendments Companies (Accounts) Rules, 2014 to provide that preparation of consolidated financial statement shall not be required by:
More recently, on 16 January 2015, the MCA issued another amendment that provides that the requirements in respect of consolidation of financial statements shall not apply to a company having subsidiary or subsidiaries incorporated outside India only for the financial year commencing on or after 1 April 2014.
The amendment also aims to address the other of the aforesaid situations that is expected to result in implementation challenges. While it appears that the intention of this amendment is to provide a temporary relief, like the MCA earlier did in case of companies with no subsidiaries but only associates and joint ventures.
Apparently it seems that all unlisted companies with a foreign subsidiary are exempt from preparing consolidated financial statements for the financial year 2014-15. However, on a plain reading, it is not completely clear whether the exemption is available if a company has at least one foreign subsidiary along with Indian subsidiaries, or will be available if a company has only foreign subsidiaries but no Indian subsidiaries.
However, if it is the former case, this amendment can also be abused by creating an nonoperational subsidiary, say in Nepal or Sri Lanka, to avail this exemption. Nevertheless, the exemption seems to be only a transitional relaxation and can only benefit a company for so long.
While the amendments do not specify this but it appears that the use of the words ‘subsidiary or subsidiaries incorporated outside India’ in the amendment also refers and includes foreign associates and joint ventures following the explanation in section 129(3) of the Act.
That said, all unlisted companies required to prepare consolidated financial statements should start the process as early as possible. This will include evaluating their ability at present to generate and gather necessary information, the availability of financial information following the Indian accounting standards, alignment of policies of the investees to the parent company, additional resources in terms of accounting software and staff, increased scope of the engagement for the company’s auditors—and some of these requirements may require significant time and cost especially in case of large and mid-sized unlisted companies.
This article appeared in 'The Firm' on CNBC TV18 on 23rd January, 2015.