Query No. 5

Subject: Disclosure of items exceeding the quantitative threshold in the Notes toAccounts.1

A. Facts of the Case

1. The querist is a defence public sector undertaking (hereinafter referred to as ‘thecompany’) under the Ministry of Defence and is engaged mainly in the construction ofwarships and submarines for Indian Navy.

2. The company has been outsourcing some of the production processes ofshipbuilding and has been accounting the expenses under line item ‘Sub-contract’.Various outsourcing activities, such as, cleaning, insulation, machining, fittings andmachine seats, pipe fitting / bending etc., are considered under natural head ‘Sub-contractExpenses’. At times, out of these aforesaid activities, one or two activities may exceedone per cent of the revenue from the operations or Rs.1,00,000, whichever is higher.

3 The company is following the practice of disclosing few categories of expensestowards sub-contracting/outsourcing, though the amount is more than one per cent ofrevenue from the operations, on the grounds of homogeneity and is clubbing the same as‘Sub-contract charge’ and a separate line item has been inserted in the statement of profitand loss.

4. The Govt. Audit, while quoting the provisions of the Revised Schedule VI to theCompanies Act, 1956, stated that any item of income or expenditure which exceeds oneper cent of the revenue from operations or Rs.1,00,000, whichever is higher, needs to bedisclosed separately in the Notes to Accounts.

5. In reply to the observation of the Govt. Audit, the company has stated that thedisclosure in respect of line items under Revised Schedule VI is by nature of expenditure.The value of individual sub-contract activity may not be relevant for the readers of thefinancial statements. Therefore, the disclosure of activity-wise expenditure under suchcategory is not intended by the Revised Schedule VI.

B. Query

6. The querist has sought the opinion of the Expert Advisory Committee as towhether the disclosure of expenses towards sub-contracting/outsourcing on ahomogenous group and reporting as sub-contracting expenses is appropriate.

C. Points considered by the Committee

7. The Committee notes that the basic issues raised by the querist relate to disclosureof expenses towards various sub-contracting/outsourcing activities as single separate line

1Opinion finalised by the Committee on 5.4.2013 and 6.4.2013

item, ‘sub-contracting expenses’ in the statement of profit and loss and separatedisclosure of expenses in the Notes to Accounts, if the amounts of such expensesindividually exceed the quantitative threshold prescribed in the Revised Schedule VI tothe Companies Act, 1956. The Committee has, therefore, considered only this issue andhas not examined any other issue that may be contained in the Facts of the Case. Further,the Committee presumes that the relationship between the company and the sub-contractors is neither a principal-agent relationship nor a employer-employeerelationship.

8. The Committee notes that the Form of the Statement of Profit and Loss prescribedunder the Revised Schedule VI contains minimum line items, which include some itemsof expenditure (classified by nature). The Revised Schedule VI also requires disclosure ofsome items of income and expenditure in the Notes to Accounts. The Instructionsappearing above Part I of the Revised Schedule VI require that “line items, sub-line itemsand sub-totals shall be presented as an addition or substitution on the face of the FinancialStatements when such presentation is relevant to an understanding of the company’sfinancial position or performance”. The Committee notes that in the extant case, thecompany has been outsourcing some of the production processes of ship-building and isclubbing expenses on various outsourcing activities, such as, cleaning, insulation,machining, fittings and machine seats, pipe fitting / bending etc., and disclosing the sameunder the head ‘Sub-contract Expenses’, though, at times, expenditure on one or moreactivities may individually exceed one per cent of revenue from the operations orRs.1,00,000, whichever is higher. This, as per the querist, is done on the grounds ofhomogeneity. The Committee further notes Clause (c) of Note 5(i) of the ‘GeneralInstructions for Preparation of Statement of Profit and Loss’, which is reproduced asbelow:

“5. Additional Information

A Company shall disclose by way of notes additional informationregarding aggregate expenditure and income on the following items:-

(i) (a) …

(c) Any item of income or expenditure which exceeds one percent of the revenue from operations or Rs.1,00,000,whichever is higher;”

The Committee also notes the Note appearing after the ‘General Instructions forPreparation of Statement of Profit and Loss’ to the Revised Schedule VI to theCompanies Act, 1956, which states as follows:

“Note:- Broad heads shall be decided taking into account the concept ofmateriality and presentation of true and fair view of Financial Statements.”

The question that arises is whether, for the purposes of above disclosure, variousexpenses which pertain to an item should be considered as separate items or can beaggregated as a single item even if such expenses individually exceed 1% of revenue or

Rs. 1,00,000, whichever is higher. The Committee is of the view that various expensespertaining to an item can be aggregated as a single item, only if the expenses aggregatedare of homogeneous/similar nature and the nature of the expenses covered by the item areclearly represented by the nomenclature used. In the extant case, the matter relates to‘sub-contracting expenses’. The Committee is of the view that the expenses aggregatedunder this head should relate to only ‘sub-contracting’ charges paid by the company forsub-contracting a part of the production process. If it includes any expense which is not inthe nature of sub-contracting charges, such as, cost of raw material supplied to the sub-contractor to be machined by it then it cannot be included under the said head. Such rawmaterials are to be included under ‘raw materials consumed’ or any other appropriatehead. The Committee is further of the view that the term ‘sub-contracting expenses’ doesnot clearly explain the nature of expenses aggregated under this head and therefore, is notan appropriate nomenclature. Thus, if the nature of sub-contracting expense can also beindicated by the nomenclature, viz., sub-contracting machining charges, sub-contractingcleaning charges, etc., it would be an appropriate presentation of such expenses.

As regards the separate disclosure of expenses so included if they individually exceed Rs.1,00,000 or 1% of revenue, whichever is higher, the Committee is of the view that if thenature of all the charges included under the single head are being appropriately explainedby the nomenclature used, these need not be disclosed as separate items in the statementof profit and loss or in the Notes to Accounts.

D. Opinion

9. On the basis of the above, the Committee is of the opinion on the issue raised bythe querist in paragraph 6 above that the disclosure of expenses towards sub-contracting/outsourcing activities pertaining to a homogenous group and reporting as asingle item would be appropriate, provided the expenses aggregated under this headrelate to only sub-contracting charges paid by the company for sub-contracting a part ofthe production process. A proper nomenclature should be used for the head to explainclearly the nature of items aggregated under a particular head. The term ‘sub-contractingexpenses’ is not an appropriate nomenclature as it does not clearly explain the nature ofexpenses aggregated. The Committee is also of the opinion that if the nomenclature usedappropriately represents the nature of expenses clubbed therein, there would be no needfor separate disclosure of various sub-contracting expenses even if they individuallyexceed the threshold limit as prescribed under the Revised Schedule VI to the CompaniesAct, 1956.

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