Demonetization now hits Financial Statement of Companies by Megha Saraf and Abhirup Ghosh

Background

Reserve Bank of India (“RBI”) on 8th November, 2016, has took a very bold move towards the currency market of India. Ministry of Finance (“MoF”) with effect from 9th November, 2016, has brought a serious revolution in the economy of the country by withdrawing Rs. 500 and Rs. 1000 as a legal tender. Due to this, people as well as corporates and Financial Institutions all over the country faced a serious glitch towards monetary transactions.

Further, MoF by its subsequent circulars brought stringent norms towards the monetary market. Several restrictions were imposed on cash and electronic transactions to curb the black market.

Now, Ministry of Corporate Affairs (“MCA”) vide its notification dated 30th March, 2017[1] (“the Notification”), has come up with a serious change in the preparation of financial statements that is required to be made as per Schedule III of the Companies Act, 2013 (“the Act”).

The Notification focuses on the disclosures to be made in the financial statements with regard to “Specified Bank Notes”.

The following Frequently Asked Questions (“FAQs”) are an attempt to provide an understanding in regard to the mentioned change.

  1. What is the scope of the Notification?

The Notification has been issued in line with the earlier notifications issued by the Government of India (“GOI”) in relation to demonetization of high value currency notes with effect from 8th November, 2016. There have been several measures implemented by the GOI in order to tackle the malpractices adopted to avoid the implications of the demonetization initiated by the GOI.

This time the intention of the GOI is to identify if the companies have been involved in any malpractices to bypass the effect of demonetization.

  1. On which companies the abovementioned Notification is applicable?

The abovementioned Notification is applicable on all companies required to prepare its Financial Statements as per Schedule III of the Act.

  1. Does entities other than companies also have to comply with the said Notification?

According to the explanation to Section 8(1) of the Ordinance, a company means “any body corporate and includes a firm, trust, a co-operative society and other association of individuals.” However, this Notification is issued by the MCA as an amendment to the Schedule III of the Companies Act, 2013. Therefore, the applicability of this Notification is limited only to companies.

  1. What is the scope of Schedule III of the Act?

Schedule III of the Act provided for the format for preparation of Financial Statements of a company. It is divided into two parts-

Division I- Financial Statements for a company whose Financial Statements are required to comply with the Companies (Accounting Standards) Rules, 2006.

Division II- Financial Statements for a company whose financial statements are drawn up in compliance of the Companies (Indian Accounting Standards) Rules, 2015.

Here it is important to note that this Notification is applicable to the companies falling under the purview of both the Divisions.

  1. What do you mean by “Specified Bank Notes”?

For understanding the meaning of this term, one has to make a reference to the notification issued by MoF (Department of Economic Affairs) on 8th November, 2016[2] which states that specified bank notes are those bank notes of denominations of the series of the value of five hundred rupees and one thousand rupees.

Further, Section 2(e) of the Specified Bank Notes (Cessation of Liabilities), Ordinance, 2016[3], defines Specified Bank Notes as “a bank note of the denominational value of five hundred rupees or one thousand rupees of the series existing on or before the 8th November, 2016.”

  1. What is the significance of “Held” and “Transacted”?

The Notification states that “every company shall disclose the details of Specified Bank Notes (SBN) held and transacted during the period from 8th November, 2016 to 30th December, 2016.”

Here the word “Held” refers to SBN held in hand on 8th November, 2016 and term “Transacted” refers to the SBN which were not held by the company as on the date of demonetisation but were dealt with during the period starting from 8th November, 2016 to 31st December, 2016.

Example: 

Company A had given a loan to Company B before the demonetization which was due to be repaid during the period starting from 8th November, 2016 to 30th December, 2016. Company B wanted to pay back in cash. Instead of receiving the repayment in cash, Company A authorized Company B to deposit the amount to the credit of the bank account held by Company A.

In the above example, Company A did not receive cash during the period however, it authorized Company B to deposit the cash to the credit of its bank account. Therefore, Company A transacted in cash during the period and must report the quantum of the cash deposited by Company B in the format provided by the MCA.

  1. What details are required to be stated in the Balance Sheet as per the Notification?

The Balance Sheet prepared in accordance with the format prescribed under Schedule III of the Act, shall include the following disclosure as tabulated below:

SBNs Other denomination notes Total
Closing cash in hand as on 08.11.2016
(+) Permitted receipts
(-) Permitted Payments
(-) Amount deposited in banks
Closing cash in hand as on 30.12.2016
  1. Are there any penal provisions if the disclosures are not made in the Financial Statements or inappropriate disclosures are made in the format?

The Notification does not provide for any specific penal provision in this regard. However, the penal provision under section 448 of the Companies Act, 2013 for making false statements in or omission of facts from financial statements shall continue to be applicable on the company.

  1. What do you mean by “Permitted Receipts”?

“Permitted Receipts” were referred to those receipts which were allowed to be taken by companies during the period 8th November, 2016 till 30th December, 2016 by the MoF.

  1. What do you mean by “Permitted Payments”?

Similarly, “Permitted Payments” were those payments which were allowed by the MoF to be made during 8th November, 2016 till 30th December, 2016.

  1. What happens if there is a mismatch in the cash balances reported in the given format and the balances as per the books of accounts?

By virtue of the notification dated 30th March, 2017, MCA has also brought Companies (Audit and Auditors) Amendment Rules, 2017.

The Rules provide for an additional disclosure by the auditors of the company in their Auditor’s Report mentioning whether the company had provided requisite disclosures in its financial statements as to holdings as well as dealings in SBN during the period from 8th November, 2016 to 30th December, 2016 and if so, whether those are in accordance with the books of accounts maintained by the company.

  1. What if the Company has dealt in SBNs for purposes other than permitted uses during the demonetization period? Was it illegal?

It is noteworthy to mention that none of the notifications issued by GOI or RBI after the demonetization termed that acceptance of payment through SBN to be invalid, until the notification of the Specified Bank Notes (Cessation of Liabilities) Ordinance, 2016[4], which stated that the following:

  1. On and from the appointed date, no person shall, knowingly or voluntarily, hold, transfer or receive any specified bank note;

In this regard, appointed date has been defined in the following manner:

“appointed day” means the 31st day of December, 2016.

Therefore, dealing in SBNs during the demonetisation was completely legal until 30th  December, 2016.

  1. What if a company has received SBN after 30th December, 2016?

Section 5 of the Ordinance treats receiving, holding and transferring SBNs illegal w.e.f. 31st December, 2016. The liabilities against the SBN have ceased w.e.f. from 31st December, 2016 such SBNs will not possess any value at all and therefore the same has been kept outside the purview of the disclosure requirements.

  1. MCA has made amendments in the Audit Rules as well, what is the implication of such amendment?

The abovementioned amendment refers to the additional duty of the auditors of the company to report about the holdings and dealings in SBNs during the period 8th November, 2016 till 30th December, 2016. They shall also disclose about its accuracy in accordance with books of accounts.

Thus, it can be said that with this move of MCA, companies are surely to have a tough time in maintaining their Financial Statements. The Notification shall not only act as a eye-catcher for companies but also have led them to think twice before making any move.

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[1] http://egazette.nic.in/WriteReadData/2017/175073.pdf

[2] http://www.finmin.nic.in/172521.pdf

[3] http://dea.gov.in/sites/default/files/Ordinance%2010%20of%202016%2030.12.2016.pdf

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