Holding

The Companies (Accounting Standards) Rules, 2006 adopting AS 22 are intra‑vires, not ultra‑vires, and are not inconsistent with the Companies Act, 1956, including Schedule VI.

Summary

The Supreme Court examined whether the Companies (Accounting Standards) Rules, 2006 – which made Accounting Standard 22 (deferred tax) mandatory – exceeded the Central Government’s rule‑making power under s. 642 of the Companies Act, 1956 and conflicted with the Act’s provisions on true‑and‑fair accounts, Schedule VI and sections 209 and 211. The petitioners argued that AS 22 altered the statutory concepts of accrual accounting, created a notional liability (deferred tax liability) and was ultra‑vires, while the Union of India contended that the rule was a legitimate exercise of delegated legislation to fill in details. The Court held that the rule was a permissible, supplementary measure within the legislative policy of “true and fair” accounting, did not amend the essential features of the Companies Act, and therefore was intra‑vires and consistent with the Act. Consequently, the civil appeals were dismissed.

Issues considered

Whether the Companies (Accounting Standards) Rules, 2006 adopting AS 22 is ultra vires the powers conferred on the Central Government under s. 642(1) of the Companies Act, 1956
Whether AS 22 is inconsistent with or modifies the provisions of the Companies Act, 1956 – particularly sections 209, 211 and Schedule VI – relating to true‑and‑fair accounts and accrual basis of accounting
Whether the rule‑making power under s. 642 can be used to prescribe accounting standards that affect the presentation of profit‑and‑loss and balance‑sheet statements
Whether the provisions of AS 22, especially the treatment of deferred tax liability, violate Articles 14 and 19(1)(g) of the Constitution (not decided)

Legislation cited

Companies Act, 1956s. 209, s. 211(1), s. 211(3A), s. 211(3B), s. 211(3C), s. 641(1), s. 642(1)
Constitution of Indias. Article 14, s. Article 19(1)(g)
Income Tax Act, 1961

Subjects

deferred taxAccounting Standard 22Companies Act 1956ultra viresdelegated legislationtrue and fair viewSchedule VItax expensematching principlefinancial reporting

Judgment

A J.K. INDUSTRIES LTD. & ANR.
v.
UNION OF INDIA AND ORS.

NOVEMBER 19, 2007
B
(S.H. KAPADIA AND B. SUDERSHAN REDDY, JJ.)
~
.
Companies (Accounting Standards) Rules, 2006:

c Accounting for taxes on income-Accounting Standard 22 (AS
22)-Adoption of-By the Rules framed by Central Government-
Challenged as being ultra vires the provisions of Companies Act so
far as it related to 'deferred taxation; and as being in excess of the
powers conferred upon Central Government-Held: Rule is neither
ultra vires nor inconsistent with the provisions ofthe Companies Act-
D
Rules and the Act form part of the composite scheme-Rules are ;.

supplementary to the Act and constitute a legitimate aid to the
construction ofthe provisions ofthe Act-Rules also not suffering from
the vice of excessive delegation-Companies Act, 1956-ss. 209,
211 (3A) and (3C), 641, 642, Schedule VI Parts I and II.
E
Accounting Standard 22-Provisions relating to 'deferred
taxation '-Whether violative of Articles 14 and 19(J)(g) of the
Constitution-Question left open-Constitution of India, 1950-
Articles 14 and 19(1)(g).
F
Companies Act, 1956-s. 642(1)-Rule making power ofCentral
Government-Scope of

Delegated Legislation-Scope of-Held: Valid only when it is
confined to legislative policy and guidelines.
G
Doctrines/ Principles-Doctrine ofultra vires-Applicability of

Words and Phrases-- 'delegated legislation '-Meaning of 1-
~

Accounting Standard 22 (AS 22) titled as "Accounting for taxes
H 136
) J.K. INDUSTRIES LTD. v. UNION OF INDIA 137

on income", issued by Institute of Chartered Accountants in 2001 A
had been made mandatory for all companies listed in stock
Exchanges oflndia in preparation of their accounts for the fmancial
year 2001-02 onwards. Central Government by a Notification dated
7.12.2006 prescribed AS 22 u/s 211 (3Q of the Companies Act, 1956,
in consultation with National Advisory Committee on Accounting B
Standards, by enacting Companies (Accounting Standards) Rules,
2006.

In the present appeals AS 22 was challenged, alleging that it
was inconsistent with and ultra vires the provisions of Companies
Act, 1956, Income Tax Act, 1961 and the Constitution oflndia, 1950, C
insofar as it.relates to deferred taxation.

The questions for determination before this Courtwer_e:

1. Whether Companies (Accounting Standards) Rules, 2006,
-' adopting AS 22 was in excess of the powers conferred upon Central D
Government u/s 642 (1) of the Companies Act, 1956?
2. Whether AS 22 was inconsistent with the provisions of
Companies Act, 1956?
Dismissing the appeals, the Court E

HELD: 1.1. Notification dated 7.12.2006 or Companies
(Accounting Standards) Rules, 2006, does not suffer from the vice
of excessive delegation. [Para 56) (265-C)

1.2. On account of globalization and socio-economic problems, F
the power of delegation has become a consituent element of
legislative powers as a whole. 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 G
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
H
138 SUPREME COURT REPORTS [2007] 12 S.C.R.

A applicable on the same subject matter. Therefore, it has to yield to
plenary legislation. It can also be questioned on the ground that it is
lllanifestly 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
B 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
¢annot be said to be inconformity with the statute. It can also be
¢hallenged on the ground that it violates Article 14 of the
Constitution. Subordinate legislation cannot be questioned on the
C ground of violation of principles of natural justice on which
administrative action may be questioned. A distinction must,
bowevcr, 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
D 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,
fltilure to take relevant matters into consideration etc.
[Para 63) [267-E-H; 268-A-C]

E 1.3. 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
F 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 docs not make any substantial
difference as regards the jurisdiction of the Court to pronounce on
G its validity. [Para 63) [268-D-E)

1.4. 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
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 139

for which it is given. Before reaching the conclusion that the Rule is A
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 whatis 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 B
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.
[Para 64] [268-F-H; 269-A]

1.5. Ifthe impugned rule is a delegated legislation it would follow C
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. In the present case, abovementioned guideline D
is provided by Section 211(1), which has brought in a stand-alone
concept of "true and fair" accounting. The said concept is the
controlling consideration. [Paras 65 and 66] [269-B-C] -

TISCO v. The Workmen and Ors., AIR (1972) SC 1917, relied E
on.

1.6. What is permitted by the concept of "delegation" is
delegation of ancillary or subordinate legislative functions or what
is fictionally called as "power to fill up the details". Power to
supplement the existing law is not abdication of essential legislative F
function. Therefore, power to make subordinate legislation is derived
from the enabling Act and it is fundamental principle oflaw 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 G
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. [Para 68] [269-H; 270-A-C]
H
~
140 SUPREME COURT REPORTS [2007] 12 S.C.R.
'

,...
A Britnell v. Secretary a/State, (1991) 2 All ER 726, referred to.
1. 7. 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 Government. Sections 641
and 642 form part of the same scheme, hence, it cannot be said that
B
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. Section 642(1) begins with
the expression "in addition to the powers conferred by Section 641 ".
c Therefore, one has to read Section 642 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.
The Companies Act has been enacted to consolidate and amend the
law relating to companies and certain other associations. Under
D 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
E accounting standards referred to in Section 211(3)(c). Similarly,
under Section 211(1) the company accounts have to reflect "true and
fair" view of the state of affairs. [Para 71] [272-A-F]
Banarsi Das v. State ofMP., AIR (1958) SC 909, relied on.
F 1.8. The object behind insistence on compliance with the A.S. -I

and "true and fair" 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. The
provisions of the Companies Act together with the Rules framed by
G the Central Government, constitute a complete scheme. Without the
Rules, the Companies Act cannot be implemented. The impugned
t.
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,
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 141

net profit etc. cannot be put into operation without the rules. A
[Para 71) (272-F-H; 273-A)

1.9. In the present case also, even under the Rules impugned
herein viz. 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 B
' 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 ofits powers
under Section 642(1) of the Companies Act. The impugned Rule/ C
Notification is valid. It has nexus with the matters entrusted to the
Central Government to be covered by appropriate rules. 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 D
, manner and the power includes the power to prescribe conditions
under which business/profession can be carried on.
[Para 74) (276-B-E]

P. Kasilingam and Ors. v. P.S. G. College ofTechnology and Ors., E
(1995) Suppl 2 SCC 348 and TELCO v. Gram Panchayat, Pimpri
Waghere, (1976) 4SCC177, relied on.
Deepak Theatre, Dhuri v. State ofPunjab and Ors., AIR (1992)
SC 1519, referred to.
> F
2.1. The impugned Rule is neither ultra vires nor incongruous/
inconsistent with the provisions of the Companies Act, 1956. It does
not seek to modify the essential features of the Companies Act. Rules
m~de on matters permitted by the Act to supplement the Act, cannot
be held to be in violation of the Act. G
[Paras 126 and 133) [305-C]
Britnell v. Secretary ofState, (1991) 2 All ER 726, referred to.
2.2. The object behind enactment of A.S., which are now made
mandatory under section 211(3A) of the Companies Act, is to shift H
142 SUPREME COURT REPORTS [2007] 12 S.C.R.

A from historical method of accounting (Matching Principle) to fair
valuation principle. 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
B invoking the matching concept, which results in putting fictitious
assets on the balance-sheet. This is one reason why fair valuation
principles are accepted. [Para 60) [266-G-H; 267-AJ

2.3. When the power to make rules is limited to particular topics
C 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. 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 ifthe Act and the Rules
ate read together. In the present case, the impugned Rule constitutes
D a legitimate aid to construction of the provisions of the Companies
A~t. Further, the Central Government is the rule making authority
under Section 211(3C). As rule making authority, the Central
G(lvernment is empowered to enact accounting standards in
consultation with NAC which may be at variance with the Standards
E issued by the Institute. [Para 127] [299-B-DJ

2.4. Though the Central Government is vested with both the
powers, namely, to amend the Schedule and to fill in details, the
nafure of the rules framed under Section 641(2) continues to have
F the status of the rules despite the phraseology used in Section 641(2)
which, says that "any alteration notified under sub-section (1) of
Section 641 shall have effect as if enacted in the Companies Act".
[Para 94] [285-E-F)
Chief Inspector of Mines v. Karam Chand Thapar. AIR (1961)
G SC 838, relied on.

2.5. In the present case, measurement and recognition methods !-
arc not the items under the Companies Act. Methods ofrecognition
and measurements are talked about by the provisions of the
H Companies Act. Recognition and measurement of various items of
•

J J.K. INDUSTRIES LTD. v. UNION OF INDIA 143

revenue expenses etc. stand covered only by the accounting A
standards. Therefore, it cannot be said that the said standards are
contrary to the provisions of the Companies Act. It also cannot be
said that the impugned Rule does not touch upon maintenance of
books ofaccounts to be kept by the company. Under Section 209(3)(b)
every company is required to keep its books of accounts on accrual B
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. Books of accounts do not
include balance-sheet and P &L a/c. However, there is a difference C
between "true and correct" accrual and "true and fair" 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 "true and fair"
accrual concept. The said concept is wider than the concept of true D
and correct accrual. When Section 209(3) refers to maintenance of
books of accounts on accrual basis it means "true and fair" accrual,
which would include not only matching principles but also fair
valuation principles. These principles do not contravene accrual
system ofaccounting. [Para 128) [300-B-F)
E
Union ofIndia and Anr. v. Cynamide India Ltd. andAnr., [1987]
2 sec 720, referred to.
2.6. Para 9 and para 33 of AS 22 cannot be said to be
inconsistent with the provisions of the Companies Act including F
Schedule VI. Recognition and measurements bring in the concept
of fair value. When a financial instrument is measured at fair value
it brings transparency in financial reporting. Today, companies
undertake multifarious activities which warrants segment reporting.
AS 22 is mandatory; Therefore, it is the duty of the members of the
Institute to examine whether the accounting standard is complied G
with the said standard in the presentation of financial statement.
[Paras 116and118] [292-F, H;.293-A-C]
· 2. 7. With the introduction of the 'timing difference' concept, it
cannot be said that the accrual system of accounting is violated. It H
144 SUPREME COURT REPORTS [2007] 12 S.C.R.

A is the concept of'timing difference' 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, para 9 of
AS 22 is not inconsistent with the provisions of the Companies Act,
B including Schedule Vl [Para 128) (300-H; 301-A-B)
Bharat Hari Singhania and Ors. v. Commissioner a/Wealth-tax
(Central) and Ors., AIR (1994) SC 1355, relied on.
2.8. Para 9 of AS 22 merely represents gap-filling exercise,
C therefore, it is not correct 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
"true and fair" view in Section 211 (1) connotes the widest law making
powers and, thus the impugned Rule adopting AS 22 is intra vires as
D 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 "supplementary"
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
E th~t is required to implement what is there in the Act.
[Para 127) [298-F-H; 299-A)
Daymond v. South West Water Authority, (1976] 1 All ER 39,
referred to.
F 2.9. 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). The concept of"true and correct"
accrual is different from the concept of"true and fair'' accrual. Both
the ¢oncepts fall under accrual system of accounting. However, there
G is a difference. Under "true and correct" accrual, the matching
principle was always recognized. However, fair valuation principle
is the concept which brings out the real income of the company. Para
1-
9 has been enacted, to obliterate the difference between the
accounting income and taxable income. Para 9 aims to present the
H real income to the investors, shareholders and stake-holders in the
j J.K. INDUSTRIES LTD. v. UNION OF INDIA 145

• company. There is also a difference between accounting depreciation A
and tax depreciation. In order to harmonize these differences, para
9 has been enacted. 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. Para
9 of AS 22 merely provides for details in the matter of provision for B
liability for taxation. [Para 119] [293-D-G; 294-A]

Cl T v. Duncan Brothers and Co. Ltd, [1996] 8 SCC 31; and P.
Kasilingam and Ors. v. P.S. G. College ofTechnology and Ors., [1995]
Suppl 2 SCC 348, relied on.
c
2.10. The word "tax expense" 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 "tax expense" now includes
both, current tax and deferred tax. This inclusion became necessary
because of developments not only in concepts but also in accounting D
practices. This inclusion becomes necessary if one has to go by
}
paratligm shift from historical costs accounting to fair value
principles. With the insertion of the words "true and fair" view in
Section 211, which is the requirement in the matter of presentation
of balance-sheet and P&L ale the rule making authority was entitled E
to include the concept of"deferred tax" 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. It is known F
as the balance-sheet date. One has to therefore consider matching
principle and fair valuation principles as important concepts in
Accrual Accounting. Further, 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 ale together with
recognition and measurements. Therefore, one has to read the G
provisions of the Companies Act along with the impugned Rule which
adopts AS 22 as recommended by the Institute.
[Para 120) (294-A-E)
2.11. The matching principle recognizes cost against revenue H
146 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
B 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
C 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. [Para 120) [294-E-H; 295-A)
2.12. For the purpose of determining accumulated deferred tax
D 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
E differences. Once it is 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.
[Paras 131and132) [304-C-D, G)
F 2.13. Deferred tax is nothing but accrual of tax due to
divergence between accounting profit and tax profit. This difference
arises on two counts, namely, different treatment of items ofrevenue/
expense as per profit and loss account and as per the tax law. It also
arises on account of the difference between the amount ofrevenue/
expense as per profit and loss account and the corresponding amount
G considered for tax purposes, e.g., depreciation.
[Para 134) [305-D)
Commissioner of Income-tax v. Indian Jute Mills Association,
(1982) 134 ITR 68 (Cal) and State Bank of Patiala v. CIT, (1996)
H 219 ITR 706, referred to.
/
j J.K. INDUSTRIES LTD. v. UNION OF INDIA 147
[KAPADIA,J.]
""' 3. The question that the provisions of AS 22 insofar as it relate A
to "deferred taxation" is violative of Articles 14 and 19(1 )(g) of the
Constitution oflndia is left open. [Para 135) (305-E-F)
CIVIL APPELLATE JURISDICTION: Civil Appeal No. 3761 of
2007.
B
From the Judgment and Order dated 19.04.2007 of the High Court
--\ of Calcutta in W.P. No. 10608 (W) of2002.
WITH
C.A. Nos. 3478-3480 and 3482 of 2007.
A. Sharan, ASG., Dr. Debiprosad Pal, S.K. Bagaria, J.P. Khaitan,
c
Arvind P. Datar and N.K. Poddar, Ananda Sen, R.K. Raghavan, K.V.
Mohan, K.V. Balakrishnan, Raj Shekhar Rao, N.P. Agarwalla, P.C.
Sharma, Amit Agarwalla, Dr. Anita Sumanth, V.S. Jay Kumar, Nikhil
Nayyar, Ankit Singhal, T.V.S.R. Sreyas, Gaurav Agrawal, Amit Anand
Tiwari, P. Parmeswaran, Pramod Dayal and Nikunj Dayal for the D
Appearing parties.
The Judgment of the Court was delivered by
KAPADIA, J. 1. A short question which arises for determination
in this batch of civil appeals is : E
"Whether Accounting Standard 22 (AS 22) entitled "accounting
for taxes on income" 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 (LT. F
Act) and the Constitution of India?"
2. Mis. 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 G
Accountants of India (for short, "Institute") 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 H
148 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 2006. Before that date, AS 22, when issued in 2001, was challenged in r-
writ petitions filed before Madras, Kamataka, Calcutta and Gujarat High
Cou1ts. 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
B 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
C 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 ("A.S."
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
D for paradigm shift from matching to fair value 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 oflndian companies with their joint venture partners abroad.
E 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 iPcome, Accounting Standards
F 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.
G
6. The core of Accountar1cy is Book-keeping. T11e 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
H is again an estimate, which can vary depending on the persons preparing
I

/
f J.K. INDUSTRIES LTD. v. UNION OF INDIA
[KAP ADIA,J.]
149

-\ the accounts as to when and at what stage he wants to record the A
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
standardiz.e the application of the fundamental rules to a variety of uncertain
situations like-retirement, contingencies, intangibles, consolidation, merger B
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. c
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 "accounting incoll.le" and
"taxable income". Accounting income is the real income. Tax laws lay
down rules for valuation of inventories, fixed assets, depreciation, bad D
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 E
at the fixed rate and higher than actual income for others where assets
erode faster. Accounting income is nonnally 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 F
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 "accounting income" is determined. The object behind the
Accounting Standards is to evolve methods by which accounting income G
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 Standards H
150 SUPREME COURT REPORTS [2007] 12 S.C.R. ~

A 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 cmnputed. Thus, if the rules by which inventories are to
be valued are laid down in the Accounting Standards artd are followed in.
the determination of accounting income, then tax laws do not need to lay
B 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
c 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 ''taxabl.e income" would avoid distortion of accounting income
which is the real ·income.
D
Reasons Joi- introducing AS 22: J..

9. In the ba1;kdrop 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
E developments in transport, communication and e-commerce. In this
backdrop, Conv ergence of Accounting Standards is aimed at removing
1

barriers in the flow of financial information and capital. Ba5ed on the above
developments in the global economy and the Indian economy, the
conceptual differences and consequent deviations in the National
F 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.
G
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.
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 151
[KAPADIA, J.]
Relevant provisions ofthe Companies Act, 1956 and Analysis thereof A
11. Before analyzing the provisions of the Companies Act, we quote
hereinbelow the following provisions from the Companies Act which read
as follow:
"PREAMBLE" B
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.
c
Be it enacted by Parliament in the 'Sixth Year of the Republic
oflndia as follows:-"
I

..--!
"PRELIMINARY D
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 Comi in consultation with The Tribunal, and as E
respect.;; 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;"
~
F
"ACCOUNTS
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-
G
j (a) all sums of money received and expended by the companJ
and the matters in respect of which the receipt and expenditure
take place;
(b) all sales and purchases of goods by the company;
H
'
.~
152 SUPREME COURT REPORTS [2007] 12 S.C.R. ~

r- ,,
A (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
B
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
c 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 :ompany has a branch office, whether in or outside
India, the company shall be deemed to have complied with the
D ._
provisions of sub-section (I), 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
E in sub-section (1 ).
(3) For the purposes of sub-sections (1) and (2), proper books
of account ~:hall not be deemed to be kept with respect to the
matters specified therein,- (a) if there are not kept such books as
are necessat)' to give a true and fair view of the state of the affairs ,,>
F
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.
G
(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
H
j

) J.K.INDUSTRIESLTD. v. UNION OF INDIA 153
[KAPADIA,J.]
'" together with the vouchers relevant to any entry in such books of A
account shall be preserved in good order :
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 B
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 c
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 D
,_,\

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 E
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 F
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;
G

Sect ion 210. Annual accounts and balance sheet
H
)
\

154 SUPREME COURT REPORTS [2007] 12 S.C.R. '\'
(1) At every annual general meeting of a company held in pursuance
A
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
(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
c 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".
D
(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
E by more than nine months; and
(b) in the case of any subsequent annual general meeting of the
company, to the period beginning with the day immediately after
the period for which the account was last submitted and ending
F 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.
G (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 : I.
Provided that it may extend to eighteen months where special
permission has been granted in that behalf by the Registrar.
H
f
t·
J.K. INDUSTRIES LTD. v. UNION OF INDIA 155
[KAPADIA, J.]
__, A
(5) If any person, being a director of a company, fails to take all A
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 B
-I
offence under this section, it shall be a defence to prove that a
competent and reliable person was charged with the duty of seeing
j
that the provisions of this section were complied with and was in
a position to discharge that duty :
c
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 D
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 exterid to ten thousand rupees, or with both :
Provided that no person shall be sentenced to imprisonment for E
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 F
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
G
::)
companies or class of companies under this Act.
(2) The Advisory Committee shall consist of the following
members, namely :-

- (a) a Chairperson who shall be a person of eminence well versed H
156 SUPREME COURT REPORTS [2007] 12 S.C.R.
..
A in accountancy, finance, business administration, business law,
economics or similar discipline;
(b) one member each nominated by the Institute of Chartered
Accountants oflndia constituted under the Chartered Accountants
Act, 1949, the Institute of Cost and Works Accountants of India
B 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
c 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
D 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;
E (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

F (i) one representative of the Securities and Exchange Board oflndia
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
G 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
H in the Committee shall be filled by the Central Government in the
I

f J.K. INDUSTRIES LTD. v. UNION OF INDIA 157
[KAPADIA,J.]
same manner as the member whose vacancy occurred was filled. A
(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.
B
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, C
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 D
balance sheet under 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 E
company for which a forn1 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 F
of Pm1 II of Schedule VI, so far as they m·e applicable thereto:
Provided that nothing contained in this sub-section shall apply to
any insurm1ce or banking company or any company engaged in
the generation or supply of electricity, or to any other class of G
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
H
\
/~
158 SUPREME COURT REPORTS [2007] 12 S.C.R.

.A 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.
B (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
c sheet, the following, namely:-
(a) the deviation from the accounting standards;
(b) the reasons for such deviation; and

D (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
E 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
F
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
G 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 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
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 159
[KAPADIA,J.]
shall not be treated as not disclosing a true and fair view of the A
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; B

(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 C
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 D
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 virttie of a notification issued under sub-section (3) or an E
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 F
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
G
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 H
160, SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
B 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
c
~-
(8) If any person, not being a person referred to in 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
D 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:
E
Provided that no person shall be sentenced to imprisonment for
any such offence, unless it was committed wilfully.

F SCHEDULE VI

(See section 21 I)

I [PART I

Form of Balance-sheet]
G
The balance sheet of a company shall be either in horizontal form or
vertical form
A. HORIZONTAL FORM]

H
Balance sheet of............ ..... .
[Here enter the name of the Company]
As at. ...... ...... .. .. .
[Here enter the date as at which the balance-sheet is made out.]

1nstructions LIABILITIES ASSETS Instructions in
in accordance Figures for Figures Figures for the Figures accordance with
with which the for previous year for which assets
liabilities previous the Rs. (b) the should be
should be year current current made out
made out Rs. (b) Rs. (b) Rs. (b)

*SHARE *FIXED ASSETS
CA PITAL
*Tenns of Authorised .... Distinguishing *Under eac h head the

.......
0\
red em ptro11or
conversion
... shares ot
Rs .... each.
as raras-
possible
ongma-i--rost, and the
additions thereto and
-
0\
N

(if any), or any between deductions therefrom
redeemable expenditure during the year, and
preference upon (a) total depreciation written
capital to be goodwill, (b) off or provided up to
stated, together land, (c) the end of the year to be
with earliest buildings, (d) stated.
date of leaseholds, (e)
redemption or railway
conversion. sidings, (f)
plant and
machinery, (g)
furniture and
fittings, (h)
development of
property, (i)
patents, trade
marks and
I designs, (j)
live-stock and (k)
vehicles, etc.
Where the original cost
atoresatct ano add1t1ons
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 pa1t 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.
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
\.J \,_ -- ~
/·
\~

thereafter and where, at
the date of issue of the
notification of the .......
Government of India, in ~
........
the Ministry oflndustrial z
0
Development and
c::::
Company Affairs [/J
-l
(Department of Company ~
........
Affairs), G.S.R. No. 129, ,........., trl
dated the 3rd day of
January, 1968,any
~~
>i::J -l
balance sheet, in relation, :i>o
o·
........ ;<:!
to which this paragraph
?> c::::
applies, has already been '.- z
...............
made out and laid before 0
the company in Annual z
General Meeting, the 0
'Tl
adjustment referred to in .......
this paragraph may be
z0
........
made in the first balance- >
sheet made out after the
issue of the said
notification.
O'\
Vi
\,
'

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's
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.] z
0
+Particulars +Issued Where sums have been ......
of any option (distinguishing written off on a reduction >
on un-issued between the of capital or a revaluation
share capital various of assets, every balance
to be specified. classes of sheet, (after the first
capital ana
stating the
oa1ance sneet)
subsequent to the
-
0\
00

particulars reduction or revaluation
specified shall show the reduced
below, in figures and with the date
respect of of the reduction in place
each class) of the original cost.
... shares of
Rs ..... each
+Particulars of +Subscribed Each balance sheet for the
the different (distinguishing first five years subsequent
classes of between the to the date of the reduction,
preference various shall show also the amount
shares to be · classes of of the reduction made.
given. Capital and
stating the
particulars ........,
specified N
0
below in 0
-..J
respect of ..........
each class.)
(c) ..... shares Similarly, where sums have
of Rs .... each. been added by writing up

/
/v
I'

,~'
I (
,'r'

the assets, every t>alance-
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 the
first five years subsequent
to the date of writing up
shall also show the amount
of increase made.
Rs ..... Explanation.- Nothing
called up. contained in the preceding
two paragraphs shall apply
to any adjustment made in
accordance with the
second paragraph.
Of the
above
shares
... shares
are
allotted as
,_.
fully paid- -..J
0
up pursuant
to a
contract
without
payments
being
received
in cash.
+Specify the Of the
source from above
which bonus shares
shares are ... shares
issued, e.g., are
capitalisation allotted as
of profits or fully paid-
Reserves or up by
from Share way of w
0
0
Premium bonus -..J
.......,
Account. shares+
+Any capital Less: calls
profit on unpaid:
reissue of

/r r
\ r

forfeited
shares
should be
transferred
to Capital
Reserve.
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 pnvate
company by
the directors
or members
of that
company.]
(ii) By
directors.
(iii) By
others.
+Add:
Forfeited
shares
(amount
originally
paid up)].
*Additions *RESERVES INVESTMENTS *Aggregate amount of ,......,
N
and deductions AND company's quoted 0
0
since last SURPLUS investment and also the -.J
..........
balance sheet market value thereof
to be shown shall be shown.
under each
!of the

~-----

I
spec1t1ed
heads.
The word (I) Capital Showing nature Aggregate amount of
"fund" in Reserves. of investments company's unquoted
relation to and mode of investments shall also
any valuation, for be shown.
"Reserve" example, cost
should be or market
used only value and
where such distinguishing
Reserve is between-
specifically
represented
by earmarked
investments.
(2) Capital *( 1) Investments All unutilised monies
Redemption in Government out of the issue must
Reserve. or Trust be separately
Securities. disclosed in the
Balance Sheet of the
company indicating
the form in which
such unutilised funds
have been invested.
(3) Share *(2) Investments
Premium in shares,
Account (cc). 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 ,.--,
N
companies. 0
0
(4) Other (3) Immovable -...J
..........
Reserves properties.
specifying
the nature
of each

T
) ...

Ke serve
and the
amount in
respect
thereof.
Less: Debit (4) Investments
balance in in the Capital
profit and of partnership
loss account firms.
(if any) (h).
(5) Surplus (5) Balance of
i.e., balance unutilised
in profit and monies raised
loss account by issue.
after
providing for
proposed
allocations,
namely:-
Dividend,
Bonus or
Reserves.
{ <>) Proposed
aamttons to
Reserves.
(7) Sinking
Funds.]
SECURED CURRENT ASSETS,
LOANS: LOANS AND
ADVANCES:
Loans from +(I) A.CURRENT +Mode of valuation of
Directors, Debentures ASSETS stock shall be stated
Manager ++ and the amount in
should be respect of raw
shown material shall also be
separately. stated separately
where practicable.
Interest +(2) Loans ( 1) Interest ++Mode of valuation
accrued and accrued on of works-in-progress
and due Advances Investments shall be stated. .......,
N
on Secured from Banks. 0
0
Loans -.....)
..........
should be
included
under the
appropriate

/ '
\.

sub-heads
under the
head
"SECURED
LOANS".
+The nature +(3) Loans +(2) Stores and @In regard to Sundry
of the and spare parts. Debtors particulars
security to Advances to be given separately
be specified from of- (a) debts
in each case. subsidiaries. considered
good and in respect of
which the company is
fully secured; and (b)
debts considered good
for which the company
holds no security other
than the debtor's
personal security; and
(c) debts considered
doubtful or bad.
When~ loans +(4) Other (3) Loose Debts due by directors
have been Loans and Tools. or other officers of the
guaranteed Advances. company or any of
I oy managers them enner severauy ........
-l
and/or or jointly with any 00

directors, a other person or debts
mention due by firms or private
thereof shall companies respectively
also be made in which any director
and the is a partner or a
aggregate director or a members
amount of to be separately
such loans stated.
under each
head
++Terms of +(4) Stock-in-trade. Debts due from other
redemption or companies under the
conversion same management
(if any) of within the meaning of
debentures sub-section (IB) of
,........,
issued to be section 370, to be N
0
stated disclosed with the 0
-l
together with names of the ..........
earliest date Companies.
of redemption
or conversion.

I
)-

++(5) Works-in- The maximum amount
Progress. 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 The provisions to be
debtors- 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
I
Surplus" (in the
liabilities side) under a
separate sub-head
"Reserve for Doubtful
or Bad Debts".
......
(a) Debts In regard to bank 00
0
outstanding for balances, particulars
a period to be given s.eparately
exceeding six of-
months.
(b) Other (a) the balances lying
debts. with Scheduled Banks
on current acc~unts,
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 ,......,
N
account the maximum 0
0
amount outstanding at -.)
..........
~ny time during .the ......
N
year from each such · Cl'J
, banker; and
\ '
n
(7A) Cash (c) the nature of the ?o

/
-i

t5a1ance interest, JI.any, or a11y
on hand. director or his relative
or the in each of the
bankers (other than
Scheduled Banks)
referred to in (b)
above.
(7B) Bank All unutilised monies
balances- 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
(b) with
others.
B.LOANS *The above ,_..
00
,_..
,_.
ANlJ mstrucuons regardmg 00
ADVANCES N
"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

·'"
I
•..
).
\

recervect, e.g.,
Rates, Taxes,
Insurance, etc.
(11)***]
(12) Balances
with Customs,
Port Trust,
etc. (where
payable on
demand).
UNSECURED MISCELLANEOUS
LOANS: EXPENDITURE
(to the extent not
written off or
adjusted):
+Loans from (I) Fixed (1) Preliminary
directors, Deposits. expenses.
manager
should be
shown
separately.
Interest
accrued -
00
w
ant ctue on
Unsecured
Loans
should be
included
under the
appropriate
sub-heads
under the
head
"Unsecured
Loans".]
+Where loans +(2) Loans (2) Expenses
have been and including
guaranteed Advances commission or
by managers from brokerage on
and/or subsidiaries. underwriting
directors, or subscription
a mention , bf shares or
thereof shall debentures.
be made and
also aggregate
amount of

/
·~'
"---
I'
.\
/
'
\'
\

such loans
under each
head.
*See note (d) +*(3) Short (3) Discount
at foot of Tenn Loans allowed on
Form and the issue of
Advances: shares or
debentures.
(a) From Banks. (4) Interest
paid out of
capital during
construction
(also stating the
rate or interest.)
(b) From (5) Development
others. expenditure not
adjusted.
(4) Other (6) Other items
Loans and . (specifying
Advances: nature).
(a) Froni
Banks. 00
V>
lbJ trom 00
0\
others.
CURRENT +PROFIT AND +Show here the debit
LIABILITIES LOSS ACCOUNT. balance of profit and
AND loss account carried
PROVISIONS: forward after
deduction of the
uncommitted reserves,
if any.
The name (s) A. CURRENT
of the small LIABILITIES
scale
industrial
undertaking (s)
to whom the
Company
owe a sum
exceeding
Rs. I lakh
which is
outstanding
for more
than 3 0 days,

/
)

are to oe
disclosed.
( 1) Acceptances.
(2) Sundry
creditors.
(i) Total
outstanding
dues of small
scale
industrial
undertaking( s);
and
(ii) Total
outstanding
dues of
creditors
other than
small scale
industrial
undertakings ( s ).
(3) Subsidiary
companies.
(4) Advance 00
payments 00

and un~xpired
discounts for
the portion for
which value
has still to be
given e.g., in
the case of the
follo\\'.ing
classes of
companies:-
Newspaper,
Fire Insurance,
Theatres, Clubs,
Banking,
Steamship
Companies, etc.
(5) Unclaimed
Dividends. ,

(6) Other
Liabilities (if any).
(7) Interest

'y 'r
\
>' l

a~crued but
not due on
loans.
B. PROVISIONS
(8) Provisions
for taxation.
(9) Proposed
dividends.
(10) For
contingencies.
(11) For
provident
fund
scheme.
(12) For.
insurance,
pension and
similar
staff
benefit
schemes.
( IJ) Other
provisions.
A foot-note
to the
balance-sheet
may be
added to
show
separately:
(1) Claims
against the
company not
acknowledged
as debts.
(2) Uncalled
liability on
shares
partly paid.
The period ++(3)
for which the
dividends are
Arrears of
fixed
.
in arrear of cumulative
if there is dividends.

r
y
/
t'

more than
one class
of shares, the '-
dividends on ~
.........
each such
class are in
zt:l
arrear, shall c:
r::/J
be stated. >-l
:::0
.........
The amount (4) Estimated .......... trl
shall be amount of
stated before contracts ~~
'"t) >-l
deduction of remaining >
t:l .t:l
income-tax, to be ....... ~

except that
in the case
executed
on capital
r c:
~z
........... .........
of tax-free account 0
dividends the and not z
provided 0
amount shall >-rj
.........
be shown
free of
for. z
t:l
.........
income-tax
and the
>
fact that it
is so
shown .....
'°
shall be
stated.
The amount +(5) Other
of any money for
guarantees which the
given by the company is
company on contingently
behalf of liable
Directors or I

other officers
of the
company
shall be
stated and ;

where
practicable,
the general
nature and
amount of
each such
contingent
liability, if
material,
shall also
be snecified.

,r r
J.K.INDUSTRIESLTD. v. UNION OF INDIA 193
[KAPADIA, J.]
General instructions for preparation of balance sheet.- A
(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
(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. C
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 D
utilisation.
(d) Short Tenn 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 E
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.
F
(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. G
(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 san1e management within the meaning
H
194
SUPREME COURT REPORTS (2007] 12 S.C.R.

A of sub-section (lB) of s~ction 370 should also be given with the
names of the companies the maximtun amount due from every one
of these at any time during the year must be shown.
G) Particulars of any redeemed debentures which the company has
power to issue should be given.
B
(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.
c (1) 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
D 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
E 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
F
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
G 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
H
J.K.INDUSTRIESLTD. v. UNIONOFINDIA 195
[KAPADIA,J.]
shown in the balance sheet shall be also given in the balance sheet A
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 servi~es rendered or B
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.
c
(q) A small scale industrial undertaking has the same meaning as
assigned to it under clause G) of section 3 of the Industries
(Development and Regulation) Act, 1951 .

B. VERTICAL FORM
D
Name of the Company ...... .... .
Balance Sheet as at... ............ .
Schedule Figures as Figures as
No. at the end at the end E
of current of previous
financial year financial year
,.,
1 2 .) 4 5
F
I. Sources of funds:
(1) Shareholder's funds
(a) Capital
(b) Reserves and Surplus G
(2) Loan funds
(a) Secured loans
(b) Unsecured loans
TOTAL:
H
196 SUPREME COURT REPORTS (2007] 12 S.C.R.

A II. Applications of funds:
(I) Fixed assets
(a) Gross block
(b) Less depreciation

B (c) Net block
(d) Capital work-in-progress
(2) Investments
(3) Current assets, loans, and advances:
(a) Inventories
c (b) Sundry debtors
(c) Cash and bank balances
(d) Other current assets
(e) Loans and advances
D Less:
Current liabilities and provisions:
(a) Liabilities
(b) Provisions
E Net current assets
(4) (a) Miscellaneous expenditure to the extent not written off
or adjusted
(b) Profit and Loss account
F TOTAL:
Notes.-
I . 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 Fonn read with notes
G containing general instructions for preparation of balance sheet.
2. The Schedules, referred to above, accounting policies and
explanatory notes that may be attached shall fonn an integral
part of the balance sheet. ·

H
) J.K.INDUSTRIESLTD. v. UNIONOFINDIA
[KAPADIA,J.]
197

3. The figures in the balance sheet may be rounded off to the A
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. B
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 c
of the Act, in like manner as they apply to a profit and loss account,
but subject to t~e 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 D
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. E

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:-
F
(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 G
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.
H
198 SUPREME COURT REPORTS [2007] 12 S.C.R. \

'\,
A (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
B 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
c 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.
(b) In the case of trading companies, the purchases made and the
D
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
E 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,
F 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.
G
Note 1.- The quantities of raw materials purchases, stocks, and
the turnover shall be express:ed 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
H items for which the company is holding separate industrial licences,
/ J.K. INDUSTRIES LTD. v. UNION OF INDIA 199
[KAPADIA, J.]
shall be treated as separate classes of goods, but where a company A
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 B
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 C
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,
D
(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 E
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 F
Act shall be disclosed by 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 G
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
H
200 SUPREME COURT REPORTS [2007] 12 S.C.R.
\'"-,
A 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 (b) repayment ofloans.
(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
c up.
(b) The aggregate, if material, of any amounts withdrawn from such
reserves.
(ixXa) The aggregate, if material, of the amounts to set aside to
D 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.
E (x) Expenditure incurred on each of the following items, separately
for each item:-
(a) Consumption of stores and spare parts.
(b) Power and fuel.
,......_
F (c) Rent.
(d) Repairs to buildings.
(e) Repairs to machinery.
(t) (1) Salaries, wages and bonus.
G (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 I-Information in respect of this item should also be given in
H the balance sheet under the relevant provision or reserve account.
'
~
/ J.K. INDUSTRIES LTD. v. UNION OF INDIA 201
[KAPADIA, J.]

Note 2. * * * A
(g) Insurance.
(h) Rates and taxes, excluding taxes on income.
(i) Miscellaneous expenses:
Provided that any item under which the expenses exceed one B
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". C
(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. D
(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 E
membership of a partnership firm to the extent not adjusted from
any previous provision or reserve.
Note.- Information in respect ofthis item should also be given in
the balance sheet under the relevant provision or reserve accow1t.
F
(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. G

(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. H
\

202 ~
SUPREME COURT REPORTS [2007] 12 S.C.R. \,

?--.
A (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
B
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
c or payable during the financial year to the directors (including
managing directors), manager, if any;
(ii)***;
(iii)***;

D (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);
E
(viii) pensions, etc.,-
(a) pensions,
(b) gratuities,
(c) payments from provident funds, in excess of own
F
subscriptions and interest thereon,
(d) compensation for loss of office,
(e) consideration in connection with retirement from office.

G 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).
H
J.K.INDUSTRIESLTD. v. UNIONOFINDIA 203
[KAPADIA, J.]
4B. The profit and loss account shall further contain or give A
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
-~ \ (b) as adviser, or in any other capacity, in respect of-

(i) taxation matters;
(ii) company law matters;

(rii) management services; and
c
(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 D
regard to the following, namely:-
(a) the licensed capacity (where licence is in force);
(b) the installed capacity; and
E
(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. F
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.
G
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 H
~\
204 SUPREME COURT REPORTS [2007] 12 S.C.R. \

>-
A by all such licences shall be treated as one class.
40. The profit and loss account shall also contain by way of a
note the following infonnation, namely:-
(a) value of imports calculated on C.I.F. basis by the company
B during the financial year in respect of:- ~
)...
(i) raw materials;
(ii) components and spare parts;
(iii) capital goods;
c
(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
D 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
E
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 /-,
F heads, namely:-
(i) export of goods calculated on F.O.B. basis;
(ii) royalty, know-how, professional and consultation fees;
(iii) interest and dividend;
G
(iv) other income, indicating the nature thereof. 1-:-~

5. The Central Government may direct that a company ~hall
not be obliged to show the amount set aside to provisions other
than those relating to depreciation, renewal or diminution in value
H
I

j J.K.INDUSTRIESLTD. v. UNIONOFINDIA 205
[KAPADIA, J.]
of assets, if the Central Government is satisfied that the infonnation A
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. B
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 C
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." D
"AUDIT

Section 227. Powers and duties of auditors
(1) Every auditor of a company shall have a right of access at all E
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
infonnation and explanations as the auditor may think necessary
for the perfonnance of his duties as auditor.
F
(IA) 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 tenns on
which they have been made are not prejudicial to the interest of G
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; H
' '·

206
SUPREME COURT REPORTS [2007] 12 S.C.R. ~ \

A (c) where the company is not an investment company within the r-
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;
B
(d) whether loans and advances made by the company have been
shown as deposits;
(e) whether personal expenses have been charged to revenue
account;
c (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
D 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
E 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
F the information required by this Act in the manner so required and I-_,
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

G (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-
y
(a) whether he has obtained all the information and explanations
H which to the best of his knowledge and belief were necessary for
) .._.<.,
J.K. INDUSTRIES LTD. v. UNION OF INDIA
[KAPADIA, J.]
the purposes of his audit;
207

A
(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
B
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 c
preparing the auditor's report;
(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
-( (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 E
company;
(f) whether any director is disqualified from being appointed as
director under clause (g) of sub-section (1) of section 274.
,..l
(g) whether the cess payable under section 441 A has been paid F
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 G
auditor's report shall state the reason for the answer.
f;_,,
(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
H
A
208 SUPREME COURT REPORTS [2007] 12 S.C.R.

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
B
and other ancillary matters proposed to be specified therein unless
ihe 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
c 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 i_n this or any other
D Act,' and ~

(b) those provisions are specified in the balance-sheet and profit ~

and loss account of the company."
(emphasis supplied)
E
"SCHEDULES, FORMS AND RULES
Section 641. Power to alter Schedules.
(1) Subject to the provisions of this section, the Central Government
F 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
G
the notification, unless the notification otherwise directs :
Provided that no such alteration in Table A of Schedule I shall apply /
0.
to any company registered before the date of such alteration.
(3) Every alteration made by the Central Government under sub-
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 209
[KAPADIA, J.]
section (1) shall be laid as soon as may be after it is made before A
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 follmving the session or the successive sessions
aforesaid, both Houses agree in making any modification in the B
alteration, or both Houses agree that the alteration should not be
made, the alteration ·shall thereafter have effect only in such
modified fonn or be of no effect, as the case may be, so, however,
that any such modification or annulment shall be without pr~judice
to the validi1y of anything previously done in pursuance of that c
alteration.
Section 642. Power of Central Government lo make rules.
(l) In additioa to the powers conferred by section 641, the Central
Government may, by notification in the Official Gazette, make rules- D
(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 E
contravention thereof shall be punishable with fine which may
extend to five thousand rupees and \Vhere the contravention is a
continuing one, with a further fine which may extend to five hundred
rupees for every day after the first dilling which such contravention
continues. F
(3) Every rnle made by the Central Government w1der sub-section
(I) 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 •>f thirty
days which may be comprised in one session or in two l'f more
successive sessions, and if, before the expiry of the session G
immediately following the session or the successive sessions
aforesaid, both Houses agree in making any modification in the rnle
or both Houses agree that the rule should not be made, the rule
shall thereafter have effect only in such modified fonn or be of no
H
210 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
B
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
c in the regulation or both Houses agree that the regulation should
not be made, the regulation shall thereafter have effect only in such
modified fonn or be of no effect, as the case may be; so however,
that any such modification or annuhnent shall be without prejudice
to t1e validity of anything previously done under that regulation."
D
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 ale for the financial year.
Section 210 of the Companies Act requires a company to place before
E AGM, a balance-sheet and a P&L ale for the relevant period. The function
of a balance-sheet is to show the share capital, reserves and liabilities of
the compariy 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 docunm1t. As a general rule it does
F not show the net worth of an undertaking at any particular date. It does
not show the present realizable value of goodwill, land, plant ~nd
machinery etc. It also does not show the realiz.able value of stock-in-trade,
except in cases where the realizable value of stock-in-trade is less than
cost. Therefore, it canrn it be said that the balance-sheet shows the true
G financial position.
13 . Section 210A was inse11ed 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 fo1mation and
H
- I
J.K. INDUSTRIES LTD. v. UNION OF INDIA
[KAPADIA,J.]
211

....;. laying down of accounting policies and Accounting Standards for adoption A
.,.-
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
21 OA was to make it obligatory on the part of the companies to comply
with the Accounting Standards. NAC was constituted vide Notification B
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 c
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 "or as near thereto as circumstances admit".
The said phrase "or as near thereto as circumstances admit" allows
adoption of improved techniques in the presentation of accounts to D
-1 shareholders. It is important to note that the information which is requited
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's affairs as also it must give a proper picture of the
company's profits(losses) for the relevant year. E

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 ale
and balance-sheet. By virtue of the said amendment, Accounting Standards
are required to be prescribed by the Central Government in consultation
F

with the 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
G
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
H
212 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
B 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
c 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
D the end of the financial year;
(ii) it must be in the form set out in Part I of Schedule VI or as r--
near thereto as circumstances admit; and
(iii) it must give regard to the general instructions for preparation
of balance-sheet under the heading "Notes".
E
17. Similarly, Section 211 (2) of the Companies Act requires that
every P&L ale 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 Paii II of Schedule VI so far as they are applicable thereto.
p 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 ale. Pait I of Schedule VI
prescribes a profom1a of balance-sheet. Pait II of Schedule VI only
prescribes the particulars which must be furnished in the P&L ale.
G Therefore, as far as possible, the P&L ale 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 ), imer alia, states that every balance-sheet of a company shall
H
subject to the provisions of that section, be in the fom1 set out in Paii I
j J.K. INDUSTRIES LTD. v. UNION OF INDIA
[KAPADIA, J.]
213

--1 of Schedule VI. The words ''subject to the provisions of this section" A
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 ale and balance-sheet shall comply with the
Accounting Standards. Therefore, implementation of the Accounting
Standards and their compliance are made compulsory and mandatory by B
the aforestated sub-sections (3A), (3B) and (3C). The insertion of the
concept of "true and fair view" in place of "true and correct" 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 "true and fair view" as c
regards the state of affairs. Therefore, the annual financial statements
should convey an overall fair view and should not give any misleading
infonnation or impression. All the relevant infonnation should be disclosed
in the balance-sheet and the P&L ale in such a manner that the financial
position and the working results are shown as they are. There should be D
neither an overstatement nor an understatement. Further, the infonnation
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
E
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. Severdl Accounting Standards prescribed
F
by the Institute have been made mandatory. The Institute has, however,
clarified that the expression "mandatory in nature" 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 G
noted that under Section 227(3)(d) it is the duty of the auditor, to state in
'""',;..i, his audit report whether the P&L ale 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.
H
I

214 SUPREME COURT REPORTS [2007] 12 S.C.R. ~""

A 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 ale and the balance-sheet have to comply with the . I

B Accounting Standards. For this purpose the expression "Accounting
Standards" shall mean the standards of accounting recommended by the
Institute as may be prescribed by the Central Gevernment in consultation
with NAC on Accounting Standards. Thus, the Accounting Standards are
prescribed by the Central Government. Thus, the Accounting Standards
c 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 "true and fair view".
18. Section 641 empowers the Central Government to alter any of
D 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.
E 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
F 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
G 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 21 OA( l ), the Central Government in consultation
with NAC on Accounting Standards has made the following Rules vide
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 215
[KAPADIA,J.]
the impugned notification dated 7.12.06. The said Rules are called as the A
Companies (Accounting Standards) Rules, 2006. We quote hereinbelow
the said impugned notification in entirety together with annexures:
"Ministry of Company Affairs
NOTIFICATION
B
New Delhi, the 7th December, 2006
ACCOUNTING STANDARDS

G.S.R. 739 (E). - In exercise of the powers conferred by clause
(a) of sub-section (1) of section 642 of the Companies Act, 1956 C
(1 of 1956), read with sub-section (3C) of section 211 and sub-
section (1) of section 2 lOA of the said Act, the Central
Government, in consultation with National Advisory Committee on
Accounting Standards, hereby makes the following mies, namely:-
1. Short title and commencement.- D

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. E
2. Definitions.- In these rules, unless the context otherwise
requires,-
a. "Accounting Standards" means the Accounting Standards
as specified in rule 3 of these rules; F
b. "Act" means the Companies Act, 1956 (1 of 1956);
c. "Annexure" means an Annexure to these rules;
d. "General Purpose Financial Statements" include balance G
sheet, statement of profit and loss, cash flow statement
(wherever applicable), and other statements and
explanatory notes which form part thereof.
e. "Enterprise" means a company as defined in section 3 of
H
216
~
SUPREME COURT REPORTS. [2007] 12 S.C.R. '\.

,._
A the Companies Act, 1956.
f "Small and Medium Sized Company" (SMC) means, a
company-
I. whose equity or debt securities are not listed or are not in
B 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;
c Ill. whose tum over (excluding other income) does not exceed
rupees fifty crore in the immediately preceding accounting
year;
iv. which does not have borro\vings (including public deposits)
in excess of rupees ten crore at any time during the
D 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.
E-cplanation: For the purposes of clause (f), a company shall qualify
E 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.
F
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
G 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.
H
/
f J.K. INDUSTRIES LTD. v. UNION OF INDIA 217
--i [KAPADIA,J.]
1. Obligation to comply with the Accounting Standards.- A
(1) Every company and its auditor( s)shall comply with the
Accounting Standards in the manner specified in Annexure to these
rules.
(2) The Accounting Standards shall be applied in the preparation B
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 C
remains an SMC for two consecutive accounting periods.
[No. 1/3/2006/CL-V]
JITESH KHOSLA, Jt. Secy.
-·. ANNEXURE D
(See rule 3)
ACCOUNTING STANDARDS
General Instructions
1. SMCs shall follow the following instructions while complying E
with Accounting Standards under these rules:-
1. l 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 F
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: "The Company is a Small and
Medium Sized Company (SMC) as defined in the General
Instructions in respect of Accounting Standards notified G
under the Companies Act, 1956. Accordingly, the
Company has complied with the Accounting Standards as
applicable to a Small and Medium Sized Company."
1.2 Where a company, being a SMC, has qualified for any
H
\
~
218 SUPREME COURT REPORTS [2007] 12 S.C.R. ."
~

-,-....-
A 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
B 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.
c 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.
D ~-
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.
E 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 '
,"--..,
F 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
G particular accounting standard is found to be not in conformity
with such law, the provisions of the said law will prevail and ,l:"'
the financial statements shall be prepared in conformity with
#
such law.
".) . Accounting Standards are intended to apply only to items
H
I'
)-
J.K.INDUSTRIESLTD. v. UNIONOFINDIA 219
[KAPADIA, J.]
--i .
which are material. A
4. The accounting standards include paragraphs set in bold italic
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 B
accordance with these General Instructions.
Accounting Standard (AS) 22
Accounting for Taxes on Income
c
(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
Accounting Standard should be read in the context of its
objective and the General Instructions contained in part A of D
the Annexure to the Notification.)
Objective
The objective of this Standard is to prescribe accounting treatment
for taxes on income. Taxes on income is one of the significant items E
in the statement of profit and loss of an enterprise. In accordarice
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 period poses special
problems arising from the fact that in a number of cases, taxable F
income may be significantly different from the accounting income.
This divergence between taxable income and accounting income
arises due to two main reasons. Firstly, there are differences
between items of revenue and expenses as appearing in the
statement of profit and loss and the items which are considered as
revenue, expenses or deductions for tax purposes. Secondly, there G
are differences between the amount in respect of a particular item
of revenue or expense as recognised in the statement of profit and
loss and

H
220 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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 ofsuch an amount in the
B
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
c 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
D used with the meanings specified: .

4.1 Accounting income (loss) is the net profit or loss for a period,
as reported in the statement ofprofit and loss, before deducting
income tax expense or adding income tax saving
E
4.2 Taxable income (tax loss) is the amount ofthe income (l,oss)
for a period, determined in accordance with the tax laws, based
upon which income tax payable (recoverable) is determined
4.3 Tax expense (tax saving) is the aggregate ofcurrent tax and
F deferred tax charged or credited to the statement ofprofit and
loss for the period.
4.4 Current tax is the amount of income tax determined to be
payable (recoverable) in respect of the taxable income (tax
loss) for a period .
G
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
H
/
t
/ J.K. INDUSTRIES LTD. v. UNION OF INDIA 221
.._...__ [KAPADIA, J.]
subsequent periods. A
4.7 Permanent differences are the differences between taxable
income and accounting income for a period that originate in
one period and do not reverse subsequently.
5. Taxable income is calculated in accordance with tax laws. In B
'~
some circumstances, the requirements of these laws to compute
taxable income differ from the accounting policies applied 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 c
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 reverse subsequently. For instance, if for the purpose of
\ computing taxable income, the tax laws allow only a part of an D
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 E
and are capable of reversal in one or.more subsequent periods.
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 and
"~ expenses are included or considered in arriving at accounting
F
income. For example, machinery purchased for scientific research
related to business is fully allowed as deduction in the first 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 accounting purposes·
.... G
--..-l and the amount allowed as deduction for tax purposes will
ultimately be the same, but periods over which the depreciation is
charged and the deduction is allowed will differ. Another example
of timing difference is a situation where, for the purpose of
computing taxable income, tax laws allow depreciation on the basis
H
·t
222 SUPREME COURT REPORTS [2007] 12 S.C.R.
'
~
A of the written down value method, whereas for accounting
purposes, straight line method is used. Some other examples of
timing differences arising under the Indian tax laws are given in
Illustration I.
8. Unabsorbed depreciation and carry forward of losses which can
B
be setoff against future taxable income are also considered as timing
differences and result in deferred tax assets, subject to consideration >--
of prudence (see paragraphs 15-18).
Recognition
c 9. Tax 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.
I 0. Taxes on income are considered to be an expense incurred by
D the enterprise in earning income and are accrued in the same period y
I
as the revenue and expenses to which they relate. Such matching
may result into timing differences. The tax effects of timing
differences are included in the tax expense in the statement of profit
and loss and as deferred tax assets (subject to the consideration
E of prudence as set out in paragraphs 15-18) or as deferred tax
liabilities, i!l 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 43B of the ).. '-4,
F Income-tax Act, 1961. This timing difference will reverse when the
deduction of that expense 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
allowable under the Income-tax Act, 1961, compared to the
G depreciation provided in the statement of profit and loss. In
subsequent years, the differential will reverse when comparatively
lower depreciation will be allowed for tax purposes.
v'
12. Permanent differences do not result in deferred tax assets or
deferred ta"< liabilities.
H
r J.K. INDUSTRIES LTD. v. UNION OF INDIA
[KAPADIA, J.]
223

--·r 13. Deferred tax should be recognised for all the timing differences, A
subject to the consideration 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 B
during the tax holiday period is not recognised to the extent the
enterprise's gross total income is subject to the deduction 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
'Act'). In case of sections lOA/lOB of the Act (covered under c
. Chapter III of the Act dealing with incomes which do not form
part of total income), the deferred tax in respect of timing
differences which reverse during the tax holiday period is not
recognised to the extent deduction from the total income of an
enterprise is allowed during the tax holiday period as per the D
-( 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 deferred tax assets
is subject to the consideration of prudence as laid down in E
paragraphs 15 to 18.
(c) For the above purposes, the timing differences which originate
first are considered to reverse first.
The application of the above explanation is illustrated in the F
' 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 G
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 recognised and carried forward only to the extent
that there is a reasonable certainty that sufficient future taxable
H
\
224 SUPREME COURT REPORTS [2007] 12 S.C.R. ~
A 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 extent
B that there is a reasonable certainty of their realisation. This
reasonable level of certainty would normally be achieved by
examining the past record of the enterprise and by making realistic
estimates of profits for the future.
r<
\.., 17. Where an enterprise has unabsorbed depreciation or carry
forward of losses under tax laws, 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.
D Explanation:
1. Determination of virtual certainty that sufficient future taxable
income will be available is a matter of judgement based on
convincing evidence and will have to be evaluated on a case to
E case basis. Virtual certainty refers to the extent of certainty, which,
for all practical purposes, can be considered certain. Virtual
certainty cannot be based merely on forecasts of perfonnance such
as business plans. Virtual certainty is not a matter of perception
and is to be supported by convincing evidence. Evidence is a
F
matter of fact. To be convincing, the evidence should be available )-_
at the reporting date in a concrete form, for example, a profitable
binding export order, cancellation 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 expenditures or future restructuring etc., submitted
G
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. r .

2(a) As per the relevant provisions of the Income-tax Act, 1961
H (hereinafter referred to as the 'Act'), the 'loss' arising under the
I
I

) J.K.INDUSTRIESLTD. v. UNION OF INDIA 225
/
[KAPADIA,J.]
head 'Capital gains' can be carried fotward and set-off in future A
years, only against the income arising under that head as per tlie
requirements of the Act.
(b) Where an enterprise's statement of profit and loss include$ an
item of' loss' which can be set-off in future for taxation purposes,
only against the income arising under the head 'Capital gains 1 as B
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 'Capital gains' in
subsequent years subject to the provisions of the Act. In respect
of such 'loss', deferred tax asset is recognised and carried fotward C
subject to the consideration of prudence. Accordingly, in respect
of such 'loss', deferred tax asset is recognised and carried forward
only to the extent that there is a virtual certainty, supported by
convincing evidence, that sufficient future taxable income will be
available under the head 'Capital gains' against which the loss can D
be set-off as per the provisions of the Act. Whether the test of
virtual certainty is fulfilled or not would depend on the facts and
circumstances of each case. The examples of situations in which
the test of virtual certainty, supported by convincing evidence, for
the purposes of the recognition of deferred tax asset in respect of E
loss arising under the head 'Capital gains' is normally fulfilled, are
sale of an asset giving rise to capital gain (eligible to set-off the
capital loss as per the provisions of the Act) after the balance sheet
date but before the financial statements are approved, and binding
sale agreement which will give rise to capital gain (eligible to set- F
off the capital loss as per the provisions of the Act).
(c) In cases where there is a difference between the amounts of
'loss' recognised for accounting purposes and tax purposes
because of cost indexation under the Act in respect of long-term
capital assets, the deferred tax asset is recognised and carried G
fotward (subject to the consideration 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_fotward H
226 SUPREME COURT REPORTS [2007] 12 S.C.R.
~
'-

A of losses under tax laws is strong evidence that future taxable .. <~

·f-""
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 that it has timing differences the reversal
of which will result in sufficient income or there is other convincing
B evidence that sufficient taxable income will be available against
which such deferred tax assets can be realised. In such
circumstances, the nature of the evidence supporting its recognition
is disclosed.
Re-assessment of Unrecognised Deferred Tax Assets
c
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
D (see paragraphs 15 to 18), that sufficient future taxable income will
be available against which such deferred tax assets can be realised.
For example, an improvement in trading conditions may make it
reasonably certain that the enterprise will be able to generate
sufficient taxable income in the future.
E 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.
F 21. Deferred tax assets and liabilities should be measured using
.J.-....,
the tax rates and tax laws that have been enacted or substantively
enacted by the balance sheet date.
bxplanation:
G (a) The payment of tax under section Jl 5JB of the Income-
tax Act, 1961 (hereinafter referred to as the 'Act') is a current
tax for the period.
v
(b) Jn a period in which a company pays tax under section
J 15JB of the Act, the deferred tax assets and liabilities in
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 227
[KAPADIA,J.]
respect of timing differences arising during the period, tax A
effect of which is required to be recognised under this Standard,
is measured using the regular tax rates and 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 B
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 effect of which is required to
be recognised under AS 22, is measured using the regular tax
rates and not the tax rate under section 115JB of the Act. C
22. Deferred tax assets and liabilities are usually measured using
the tax rates and tax laws that have been enacted. However, certain
announcements of tax rates and tax laws by the government may
have the substantive effect of actual enactment. In these D
circumstances, deferred tax assets 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 assets and liabilities are measured using
average rates. E

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 requires detailed scheduling of the timing of F
the reversal of each timing difference. In a number of cases such
scheduling is impracticable or highly complex. Therefore, it is
inappropriate to require discounting of deferred tax assets and
liabilities. To permit, but not to require, discounting would result in
deferred tax assets and liabilities which would not be comparable G
between enterprises. Therefore, this Standard does not require or
pem1it the discounting of defe1Ted tax assets and liabilities.
228 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
B
(see paragraphs 15 to 18), that sufficient future taxable income will
be available against which deferred tax asset can be realised. Any
such write-down may be reversed to the extent that it becomes
reasonably certain or virtually certain, as the case may be (see
paragraphs 15 to 18), that sufficient future taxable income will be
c available.
Presentation and Disclosure

27. An enterprise should offset assets and liabilities representing
current tax if the enterprise:
D
(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.
E 28. An enterprise will normally have a legally enforceable right to
set off an asset and liability 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 payment.
F 29. An enterprise should offset deferred tax assets and deferred
tax liabiliti'es if:
(a) the enterprise has a legally enforceable right to set off assets
against liabilities representing current tax; and
G (b) the deferred tax assets and the deferred tax liabilities relate to
taxes on income levied 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 tjlx assets and liabilities should be disclosed under c:
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 229
/
[KAPADIA, J.]
separate heading in the balance sheet of the enterprise, separately A
from current assets and current liabilities.
Explanation:
Deferred tax assets (net of the deferred tax liabilities, if any, in
accordance with paragraph 29) is disclosed on the face of the B
balance sheet separately after the head 'Investments' and deferred
tax liabilities (net of the deferred tax assets, if any, in accordance
with paragraph 29) is disclosed on the face of the balance sheet
separately after the head 'Unsecured Loans'.
31. The break-up of deferred tax assets and deferred tax liabilities C
into major components of 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 D
unabsorbed depreciation or carry forward oflosses 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 E
recognise, in the financial statements, the deferred tax balance 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 prudence in case of
deferred tax assets (see paragraphs 15-18). The amount so F
credited/charged to the revenue reserves should be the same as
that which would have resulted if this Standard had been in effect
from the begimung.
34. For the purpose of determining accumulated deferred tax in
the period in which this Standard is applied for the first time. the G
opening balances of assets and liabilities for accounting purposes
and for tax pUiposes are compared and the differences, if any, are
detennined. The tax effects of these differences, if any, should be
recognised as deferred tax assets or liabilities, if these differences
H
230 SUPREME COURT REPORTS [2007] 12 S.C.R.

A are timing differences. For example, in the year in which an
enterprise adopts this 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
B whereas for accounting purposes straight line method is used. This
difference will reverse in future when depreciation for tax purposes
will be lower as compared to the depreciation for accounting
purposes. In the above case, assuming that enacted tax rate for
the year is 40% and that there are no other timing differences,
c deferred tax liability of Rs. 16 [(Rs. 100 - Rs. 60) x 40%] would
be recognised. Another example is an expenditure that has already
been written off for accounting purposes in the year of its
incurrance but is allowable for tax purposes over a period of time.
In this case, the asset representing that expenditure would have a
D 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 for tax purposes. Therefore, a deferred tax asset would
be recognised in respect of this difference subject to the
E
consideration of prudence (see paragraphs 15 - 18).
Submissions

21. Dr. D. Pal, learned senior counsel appearing on behalf of Mis.
F Simplex Infrastructures Ltd. and Anr., submitted that under para 9 of AS J. •
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
G 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 ofDTL along with
CTL in the determination of the net profit (loss), according to learned
H
i f
/ J.K. iNDUSTRIES LTD. v. UNION OF INDIA 231
[KAPADIA,J.]
counsel, is repugnant to Part II of clause 3(vi) of Schedule VI to the A
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 ale. Therefore, clause 9, insofar as it provides for the
· inclusion ofDTL in the determination of the net profit (loss) is contrary
to and inconsistent with Part II of clause 3(vi) of Schedule VI. According B
to the learned counsel, DTL as an element of P&L ale is not mentioned
in the form prescribed for the balance-sheet or the P&L ale but it is made
substantive provision by para 9 by making it a charge on the P&L ale
and th\ls resulting in enhancement of tax liability for the year.
22. Learned counsel further contended that Section 211 ( 1) of the C
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 D
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 E
learned counsel, what is contemplated by the expression "subject to the
provisions of Section 211" 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 F
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 coun_sel next contended that the impugned rule has been G
fran1ed in exercise of power w1der 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.
H
232 SUPREME COURT REPORTS (2007] 12 S.C.R.

A That, on the other hand, under Sectior. 641(1) the Central Government ....,..."
has been given the power to alter any of the existing regulations, rules,
tables or fonns 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 the date of the notification
B 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,
c 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
D 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
E Govenunent 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,
F 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 t11e Companies Act without any amendment being made
under Section 641 (I) of the Act. According to the learned counsel, rules
framed under Section 642( 1) of the Act do not have any effect as if
G enacted in the Companies Act; that, the effect of an1endment 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
H
f-
/ J.K. INDUSTRIES LTD. v. UNION OF INDIA 2""
.) .)

[KAPADIA,].]
-+
counsel, so long as Schedule VI to the Companies Act is not altered or A
amended by exercising the power under Section 641 (I) 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. B
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 c
prescribing AS 22 under Section 642(1) is not only contrary to and
inconsistent with Section 209 but also "V.~th 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 D
the leamed cow1sel, 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 ale. It can only be E
disclosed by way of a Note in the balance-sheet and P&L ale which will
give a true and fair view of the state of affairs of the company.
25. Lastly, ieamed counsel submitted that clause 33 of AS 22 gives
a retrospective effect to the transactions which have taken place much
F
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 G
of M/s. First Leasing Company oflndia 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 H
\

234
~
SUPREME COURT REPORTS [2007] 12 S.C.R. "

A to the e:x.ient 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 ~ct
and taxable profits under the LT. Act. In this connection, it was urged
B 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
C 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
D 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
E 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

F (ii) on tin1e 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
G expenses against the revenues of a given period in general on the basis
that the expenditure pertains to thatperiod. The former is termed as ;.,..,..
"matching principle on revenue basis" and the latter is termed as "matching
p1inciple on time basis''. According to learned counsel, the said principle
applies only where the assessee has a choice of debiting or crediting
H
~
J.K. INDUSTRIES LTD. v. UNION OF INDIA 235
[KAPADIA,J.]
' ---)
expenditure or income in a particular financial year (time basis) or for A
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 LT. Act respectively
cannot be reconciled by applying the matching principle or on the basis B
--\ ofeffect 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
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 c
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 "accounting depreciation" in line with "tax D
depreciation". 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
E
are statutorily prescribed. They are separately prescribed under LT. 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 F
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 G
>---..._
~~
some justification for invoking the matching principle and applying
an accounting standard for deferred taxation.

28. On the concept of "true and fair" view, leaned counsel urged
that under Section 211 (1 ), a balance-sheet has to present a true and fair H
236 SUPREME COURT REPORTS (2007] 12 S.C.R.

A view. Similarly, t.!nder Section 211(2), P&L ale 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.
B 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 ale as not disclosing the true and fair
view.
29. On the question of effect of AS 22, learned counsel urged that
C 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 Cornpanies Act after providing for depreciation and taxation)
and the taxable profit (profit as per LT. Act) are to be multiplied by the
D 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
E 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 ofincome tax is
= DTA. If a company has a loss and carry forward depreciation of Rs.40
F 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 ofRs.40 crores will be reduced to Rs.28
crores (40-12).
G Relying upon the above illustrations, learned counsel submitted that if a
·~
company is making accounting profits year after year the said profits will I
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
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 237
[KAPADIA,J.]
"Unsecured Loans". That, this accumulated liability on account o( DTL A
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 "virtual certainty" (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 B
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 c
given a single example of a situation where timing difference has been
reversed. According to lea.med 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 D
\ 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
E
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 ale even when
it is a non-existent or fictional liability; that the amount which is reduced F
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 G
of the existing assets. For example, in the case oflndian 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 ofRs.940.55 crores has diminished Bond
Redemption Reserve. Similarly, according to learned counsel, in the case H
238 SUPREME COURT REPORTS [2007] 12 S.C.R.

;.,.- .
A of Mis. First Leasing Company oflndia Ltd., application of para 33, as
transitional provision, has resulted in DTL ofRs.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
B
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
C 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 oflndia/State. DTL is also not a fee or a cess 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
D Income Tax, Fringe Benefit Tax (FBI), 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
E 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
jl-. I
F 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., 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).
G
33. On the question of effect of Section 211(3A), (3B) and (3C),
learned counsel submitted that Section 211 (3 A) 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
H
( J.K. INDUSTRIES LTD. v. UNION OF INDIA 239
(
/
[KAPADIA,J.]

.. - -.A that any deviation from the Accounting Standards has to be qualified by A
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 B
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. c
34. Mr. S.K. Bagaria, learned counsel appearing on behalf of J.K.
Tyre & Industries Ltd. (formerly known as "J.K. Industries Ltd."),
submitted that AS 22 requires charging the P&L ale for an assumed
liability on account of deferred tax which is not payable according to
the provisions of LT. Act for the accounting period nor does it represent D
-4
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, E
commercially or under the law. According to the learned counsel, notional
and imaginary working is required to be made for AS 22; that, deferred
ta-x 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 F
payable under LT. 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 LT. Act cannot be considered as a "tax
expense " for the period of account; that, statutory levy of tax has to be G
........_
measured and recognized as per the I. T. Act or the Companies Act or
~ any other applicable enactment and that ifthe LT. Act does not create
DTL, such liability does not exist at all. According to the learned counsel,
under the "accrual" basis of accounting, a company is required to make
provision only for a liability which has accrued in the relevant accounting H
\

240
J
SUPREME COURT REPORTS [2007] 12 S.C.R. "

A 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 "Disclosure Note"; 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
B (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
c 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
D period as if in future the company would have to make payment on
account ofdeferred tax. According to learned counsel, the aforestated
concept is merely an assumption. Under the l 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
E 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 ofan individual transaction ofthe accounting
F 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 "going concern". 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
G 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 detennination of future
H
/
I
i J.K. INDUSTRIES LTD. v. UNION OF INDIA
[KAPADIA,J.]
241

taxable income and liability. According to learned counsel, the above is A
\ '--\
also an assumption. According to learned counsel, the accrued liability
for tax is the liability in respect of the amount of tax statutorily pay~ble
on the taxable income computed from the accounting income in
accordance with the l.T. Act after making appropriate deduction
allowances and disallowances. Such liability for tax represents the B
provision for taxation. Any amount in excess of such liability would be a
--~ reserve. If the LT. 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 LT. Act c
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 IT Act provides for such liability; that real
D
~ liability for income tax is only as computed under the LT. Act; that, merely
because the difference between the accounting income and taxable income
is ascertainable and 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
E
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
F
' ·" \ 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 cow1sel, further submitted that "accrual" is
a legal concept. It has not been defined under LT. Act. It has not defmed
under the Companies Act. An accrued liability arises only if that liability G
has arisen in the accounting year concerned. This position has been settled
\..
-'
by various decisions ofthis Court. It has been further held in numerous
decisions by this Collii 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 H
242 SUPREME COURT REPORTS [2007] 12 S.C.R.

A provision but it will be a reserve (See: the judgment of this Court in Metal
Box Company of India Ltd. v. Their Workmen, AIR (1969) SC 612.
1berefore, according to learned counsel, if the LT. 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
B 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 LT. Act.
36. Learned counsel next contended that under Section 209(3)(b)
C 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 "accrual basis and according to the double entry system of accounting";
that, the concept of "accrual" in Section 209(3 )(b) is required to be
understood in the same manner as it is required to be understood judicially.
D According to the learned counsel, "accrual" 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 "accrual" in
E Notification dated 25.1.96 issued by the Central Government under
Section 145(2) of the LT. Act also referred to the word "accrual" 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
F Accolinting Standard notified under LT. Act also requires the accounts
to give a true and fair view. Therefore, according to learned counsel, the
definition of the word "accrual" is the same both in the Accounting
Standard prescribed under Section 211 (3C) and that which is notified
under Section 145(2) of the LT. Act. Therefore, according to learned
G counsel, the word "accrual" for the purposes of the Companies Act does
not carry any meaning different from that mentioned for the purposes of
the LT. Act. That, only the amount of income tax actually payable under
the LT. Act with reference to the taxable income for the period covered
by the account computed in accordance with the provisions of that Act
H can constitute a charge for income tax and is, therefore, an accrued lial;>jlity.
./
j J.K. INDUSTRIES LTD. v. UNION OF INDIA
[KAPADIA, J.]
243

-~-\ Any amount in excess of such tax is a reserve and not a provision for A
taxation. According to learned counsel, therefore, for the above reasons
AS 22 insofar as it relates to deferred tax is contrary to the concept of
''accrual'' which concept is recognized under Section 209(3 Xb) read with
Section 209(1) of the Companies Act
37. On the question of matching principle, learned counsel urged that B
4 \
the matching concept is fully complied with when a provision is a made
for tax computed in accordance with the provisions of the LT. 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, c
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 D
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
LT. Act and it is such tax alone which is the tax liability incurred on the E
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
F
' 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 G
--.:;-'I provide for keeping the books of account on accrual basis. However,
\
based on the report of Sachar Committee to the effect that ''true and
fair" view should be projected, Section 209 was suitably amended to
make it obligatory on all companies to maintain accounts on mercantile
H
244 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
B the said amendment, books of account are required to be kept on accrual
basis. Therefore, according to learned counsel, the requirement of' 'true
and fair view" 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
c is clear that the auditor of the company has to report that ''proper books
of account" as required by law has been kept by the company; that,
"proper books of account" 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 ale are in
D 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 al
c and balance-sheet of the company to comply with the Accounting
E Standards; that, sub-sections (3A), (3B) and (3C) do not refer to keeping
of proper 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
F altered by the Accounting Standards and since the Accounting Standards
as per sub-section (3A) can only relate to the P&L ale and balance-sheet
and not to keeping proper books of account which are basic primary
records from which the P&L ale and balance sheet are prepared and since
P&L ale and balance-sheet are not books of account but only abstracts.
G 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 Centrm Government under
sub-section (3C) of Section 211 for prescribing Accounting Standards
H by framing of rules is in the nature of delegated legislation; that under the
,-
} J.K. INDUSTRIES LTD. v. UNION OF INDIA 245
[KAPADIA,J.]
scheme of sub-section (3A), (3B) and (3C) ofSection21 l, Accounting A
Standards can be prescribed only in relation to P&L ale 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 ale and balance-sheet, cannot
be exercised in relation to maintenance of books of account and that too B
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 C
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 p
the net profit in the P&L ale can be increased or reduced and DTA or
DTL can be reflected in the balance-sheet after the head ''Investments''
in case ofDTA and after the head "Unsecured Loans" in case ofDTL
and, therefore, according to learned counsel, AS 22 exceeds the power
conferred by sub-sections (3A), (3B) and (3C). According to learned E
counsel, the power under sub-sections (3A), (3B) and (3C) only relates
to prescribing Accounting Standards for presentation of P&L ale 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- F
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 G
211 which applies only in respect of P&L ale 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 ale and balance-
sheet whereas keeping of books of account in terms of Section 209 is
H
246 SUPREME COURT REPORTS [2007] 12 S.C.R. \
\

A 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 P&L ale and balance-sheet. It does not deal with
B preparation of books of account. That subject falls under Section 209(3).
Therefore, AS 22 prescribes Accounting Standards only for P&L ale
and balance-sheet without directing that exercise to be made in
respect ofpreparation and maintenance and proper books of account
on accrual basis and, therefore, AS 22 brings about inconsistency
c 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 2 l 7(2AA)(i) merely relates to "preparation of annual accounts";
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)
D and_, ther~fore, ~he_said Section 217(2,~A)(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
E profit ~y ac~ounting for DTA and to reflec~ such entries in the P&L ale
and balance-sheet, are ultra vires sub-sections (3A), (3B) and (3C) of
Sectio.n 211 and Section _209 of the Companies Act. That, by AS 22,
insofar as the same relates to ''deferred tax'', the de legatee of power
(C~ntral Government).has attempted to encroach upon the areas far
beyond those covered by the delegation.
F
40. According to the learned counsel, Section 211(1) starts with the
mandate that ''every balance-sheet of a company shall give a 'true and
fair' view at the end of the financial year". This mandate is, according to
learned counsel, not subject to anything. It is·not qualified by the expression
G "subject to the provisions ofthis section". Similar is the position in sub-
section (2) of Section 211 with regard to the P&L ale. Therefore,
according to learned counsel, ''true and fair view'' 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
H mandated in Section 209(3). According to learned counsel, the expression
; J.K. INDUSTRIES LTD. v. UNION OF INDIA 247
/
[KAPADIA,J.]
"subject to the provisions of this section" in Section 211 (1) obviously A
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 ''true and fair view'' 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 B
"true and fair" 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 "subject
to the provisions of this section" in Section 211(1) only qualifies the
requirement of balance-sheet being in the form set out in Part I of c
Schedule VI; that, similarly the expression "subject as aforesaid" 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 D
learned counsel in the entire scheme relating to accounts and audit in Pait
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 E
P&L ale 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 ale and balance-sheet, keeping
intact the statutory mandate of maintaining proper books of account on
accrual basis. Therefore, if the format of a balance-sheet or the
requirements of P&L ale is allowed to be altered by any Accounting F
Standards it would amount to encroachment upon the statutory mai1date
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 ale and balance-sheet
without touching upon the basic requirement of maintaining proper books G
of account on accrual basis and only thereby one can comply with the
concept of' 'true and fair view''. 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
H
248 SUPREME COURT REPORTS . (2007] 12 S.C.R.

A 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/or any DTA or DTL
would be contrary to the accrual basis of accounting and would not
B result in keeping of proper books of account in terms of Section 209.
Neither the books of account nor the P&L ale 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 ofDTA orDTL;
that, AS 22 does not result in a true and fair measurement of the P&L al
c or the state of affairs of a company and if any provision is made on
C account of "deferred tax" 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
D of account and financial stateme:its 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 oniy way out of the above inconsistencies is to
E 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 ale 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.
F
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
G such DTL. That, the working required to be made in terms of para 33 of
AS 22 is complicated. In this comection, learned counsel pointed out that
under para 34 of AS 22, not only opening balances of assets but also
opening balances ofliabilities for accounting purposes and fortax purposes
have got to be compared; that, para 33requires a working to be made
in respect of individual transactions since the inception of the company in
H
) J.K. INDUSTRIES LTD. v. UNION OF INDIA 249
[KAPADIA,J.]
order to ascertain DTAs or DTLs. That, in case of DTL, the revenue A
reserve has to be reduced and conversely in case of a OTA; the revenue
reserve has to be increased. This is, according to learned counsel,
indicate<; that para 33 which is tenned as "transitional provision" is dearly
retrospective in its operation. Therefore, according to learned counsel,
para 33 of AS 22 would result in reduction of the company's revenue B
-' reserves. It will erode the company's net worth. It will alterthe company's
debt-equity ratio. It will adversely effect the company's borrowing
capacity. Therefore, according to learned counsel, the High Court had
erred in dismissing the writ petitions filed by the appellants. According to
learned counsel, Section 211 (3C) does not enable the Central C
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 D
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 ale and balance-sheet as regards any OTA or DTL without E
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 F
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 G
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 H
\

250
~,
SUPREME COURT REPORTS [2007] 12 S.C.R. \

A 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
B 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
C 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
D 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., AIR (1964) SC 207 at p.215, in
E which this Court has held that the expression "subject to" 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 ofthis Court in the cases:
I-
F The State of Bihar and Anr. v. Sir Kameshwan Singh and Anr.,
AIR (1952) SC 252;
KR.CS. Balakrishna Chetty and Sons & Co. v. The State of
Jovfadras, AIR (1961) SC 1152; and

G Heggade .Janardhan Subbaraya v. The State of Mysore and Ors.,
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 fom1ulate rules.
H
) J.K.INDUSTRIESLTD. v. UNION OF INDIA 251
~. ,.....,._...1i,
[KAPADIA,J.]
That, Part I of Schedule VI prescribes the form in which the balance- A
sheet and P&L ale 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 B
-\ 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 c
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
D
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 ale in the manner provided therein. Sub-section
(3A) of that Section makes it mandatory to comply with Accounting
Standards. While preparing P&L ale and balance-sheet (See: Section
E
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 ale and balance-sheet F
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 pmiicular 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 G
- :.. -A
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:
H
252 SUPREME COURT REPORTS [2007] 12 S.C.R.

A Gadde Venkateswara Rao v. Government of Andhra Pradesh
and Ors., AIR (1966) SC 828;
State of Bihar v. Dr. Yogendra Singh GOL (Retired) and Ors.,
[1982] 1 sec 664
B Maharashtra State Board ofSec. and High. Sec. Education and
Anr. etc. v. Paritosh Bhupeshkumar Sheth and Ors. etc., [1984] 4 SCC >c-
27
State of Gujarat and Anr. etc. v. Patel Ramjibhai Danabhai and
C Ors. etc., [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.
D 45. Mr. N.K. Poddar, learned senior counsel appearing for the
Institute, submitted that corporate accounts are required to disclose a ''true
and fair view''. 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 "true and fair view" of the state of affairs of the company.
TI1is responsibility is undertaken by accountants and auditors who are
E members of the Institute. If Accounting Standards are not followed,
financial accounts would not be "true and fair" 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' 'true
F and correct view''. This requirement was deliberately changed by the
Legislature to ''true and fair view''. 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 ''true and fair'' accounts, a wider perspective is
G warranted. That is why, the Institute states that the LT. 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 (l·eal profits) which
are earned and reflected in the corporate accounts of the company.
Therefore, the Institute insists that there should be a reasonable matching
H
) J.K. INDUSTRIES LTD. v. UNION OF INDIA
I 253
[KAPADIA,J.]
of cost and benefit, if the accounts are to disclose a ''true and fair view''. A
The Institute has legal obligation of ensuring disclosure of' 'true and fair
view" in the corporate accounts. However, in the absence of a statutory
definition of "true andfair", it is the Institute' s function to detennine the
basic rules for ensuring disclosure of a ''true and fair view''. According
to learned counsel, "true and fair view" is a concept which requires the B
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 C
211 of the Companies Act). The basic reason for issuing AS 1 through
Notification dated 25.1.96 of Government oflndia, to be followed by all
assessee's following mercantile system of accounting, was to lay down
that accounting policies adopted by an assessee should represent a ''true
and fair'' view of the state of affairs of the business in the financial
D
statements prepared and presented based on such accounting policies.
Therefore, the requirement ''true and fair'' view overrides all other
statutory requirements as to the matters to be included in the
corporate accounts. In order to give a "true and fair view" it is not
necessary to provide information, additional to the one needed to comply E
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' 'true and fair'' is not static. It is
'
\ dynamic in nature. It continues to evolve in accordance with the changes
in the requirements of economy. F
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 fu11hering Legislative intent of
Parliament, which requires that accounts should be ''true and fair''. G
Therefore, by laying down Accounting Standards, which explains what is
"true and fair", the Institute is merely fulfilling its statutory duty and
function.
47. Learned counsel submitted that conceptually, the justification for
H
254 SUPREME COURT REPORTS [2007] 12 S.C.R. \

A AC'.:ounting 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
B ''true and fair view''. The Standard represents the most appropriate
accounting policies out of various accounting policies adopted by different
y.-
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 1'y a wider degree of acceptance in the
C 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
D 172 and Commissioner of Central Excise v. Dai Jchi Karkaria Ltd.
& Ors., [1999] 7 SCC 448 at 461. .f

48. On the topic of "accrual" 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
E to learned counsel, the expressions "accrual", "accrual basis of
accounting'', ''accrued asset'', ''accrued expense'', ''accrued liability'',
' 'accrued revenue'', ''current assets'', ' 'current liabilities' ', ' 'deferred
expenditure'', ''depreciation'', ''provision'', ''prudence'' etc. are
explained and defined in the Guidance Note on Terms Used in Financial
F Statements issued by the Institute. Learned counsel submitted that the
matching principle is the most important concept in "accrual
accounting". 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
G 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
H matching principle of recognizing costs against revenue or against the
) J.K. INDUSTRIES LTD~ v. UNION OF INDIA 255
I [KAPADIA,J.]
~----\
relevant time period to determine the periodic income. According to A
learned counsel, in order to understand the relevance of Accounting
Standards issued by the Institute for preparation and presentation of
financial statements vis-a-vis the accrual system of accounting and vis-
a-vis the matching principle it is necessary to refer to the concepts that
underline the preparation and presentation of such statements. The main B
purpose of Accounting Standards is, therefore, to assist the Actountants
-\ to prepare financial statements and to deal with topics that have yet to
fom1 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 c
a basis for reducing a number of alternative accounting treatments
permitted by Accounting Standards. According to learned counsel,
"accrual basis", "going concern" and "consistency" 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
D
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"assets", "liabilities'', "income" and
''expenses'' require application of the matching concept i.e. matching of
E
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
Comt has always recognized the need for estimation in accrual system of
\
accounting. 111.is Court, according to learned counsel, has recognized the
accounting concept of matching costs with revenue in preparation of F
financial statements. In this c01mection, learned counsel placed reliance
on the judgment of this Court in Calcutta Company Ltd. v.
Commissioner ofIncome Tax, (1959) 37 ITR 1; and 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 G
- ~-__.1, past strict legal concept of "accrual" was laid down in the case of
Commissioner of Income Tax v. Tungabhadra Industries Ltd., (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
H
- . - --- -
256 SUPREME COURT REPORTS [2007] 12 S.C.R. \

A 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"accrual" which does not recognize the matching principle.
B 49. Learned counsel urged that the requirement for "accrual basis
of accounting" 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
C material or labour and such other items of costs incurred in productio0;
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
D rejected for not giving a true and fair view of the state of affairs of the f

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, ''accrual'' system of accounting
and "true and fair" view. Both must read together with each other.
E According to learned counsel, the accrual basis of accounting must
be applied so that ' 'true and fair ' ' accounts are presented. Indeed,
the requirement to present a "true and fair" view precedes the requirement
for accrual accounting. The requirement to present true and fair
accounts is wider than the requirement of accrual accounting.
F Therefore, in a given case it is possible that accounts prepared on I
accrual basis may not present true and fair view because of certain
deficiencies, however, it is not possible for accounts to be ''true and
fair'' unless they are prepared on accrual basis. According to learned
counsel, while Section 209(3)(b) mandates the accrual basis of accounting,
G 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,
H therefore, the question of conflict of an Accounting Standard with the
) J.K. INDUSTRIES LTD. v. UNION OF INDIA 257
I [KAPADIA,].]
t >'·~-'I accrual basis of accounting does not arise. That, all Accounting Standards A
are framed in order to present a "true and fair" view; that, the primary
consideration in the selection of accounting policies is to disclose a ''true
and fair" 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 ''true and fair'' view and if this principle is kept in mind B
-,, then there would be no conflict between AS 22 with accrual basis of
accounting. In fact, according to learned counsel, it is significant to not~
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 c
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
D
the accrual basis should be adopted in the context of presenting/disclosing
a "true anci fair" view. Therefore, the need to disclose a true andfair
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
E
of a ''true and fair'' 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 "true and/air" view.
'\
That, the disclosure requirements are subservient to the overriding F
requirement of presenting a ''true and fair'' view. Therefore, in other
words, the need to present a ''true and fair'' 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 ''true and fair presentation 1 ' . G
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.

H
258 SUPREME COURT REPORTS [2007] 12 S.C.R.
\.

A 50. Coming to the concept of "prudence", 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
B 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,
C 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 LT. Act through its notification dated 25.2.96
which is required to be followed by all assessees following mercantile
D 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, (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
E 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 vfIncome Tax v. Duncan
Brothers & Co. Ltd., [1996] 8 SCC 31 at 35, this Court has observed
that the terms used in the Companies Act should be read in the manner
as understood in accounting parlance.
F I
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
G enterprise. That, Schedule VI deals with manner of presentation of
financial data in the annual financial statements, namely, the balance-
sheet and P&L ale 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
H presentation of various financial data in the P&L a.Jc. Part II deals with
j
/ J.K. INDUSTRIES LTD. v. UNION OF INDIA 259
[KAPADIA,J.]
,.-~-\

interpretation of some of the expressions, namely, "provisions'', A
"reserve", "capital reserve", "liability'', "investment" 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 B
---\ 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 "Investments" and also the method of valuing "Investments".
Similarly, AS 6 deals with "Depreciation Accounting", however, except c
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
D
income and expenses in the P&L ale 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 E
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 Exchaage 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 F
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 G
~ > ~,
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
H
260 SUPREME COURT REPORTS [2007] 12 S.C.R.

A as are necessary to give a ' 'true and fair '' view of its state ofaffairs
and to explain its transactions (See: Section 209(3)), and 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
that every P&L ale ofa company shall also give ''true andfair'' view
· B of the P&L ale of a company for the financial year (See: Section
21 I (J)(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, assets and.
liabilities etc. as laid down in Section 209(1) read with Section211(3A),
C (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
D recommended deferred tax adjustments. It also explained the taxes
payable method. It also explained the tax effect accounting method.
It also explained the methodfor calculating deferred tax adjustments
under ''deferred method'' and under "liability method". It recommended
l-
that till the tax effect accounting method stood developed, it would be
E. permissible for an enterprise to follow the taxes payable method as an-
altemative. After I 0 years, AS 22 was finally issued by the Institute in
200 I in order to ensure a ''true and fair'' view of the profits earned during
a financial year, and the taxes payable with reference thereto, to be
presented in the c0rporate accow1ts. That is the reason why, AS 22 leaves ) ,
F out of account differences between book profits and taxable profits which
are of permanent nature. But AS 22 requires that DTLIDTA arising on
account of timing differences should be reflected in the corporate
accounts through what is called as ''deferred tax account''. According
to learned counsel, deferred tax accounting ensures that profits are
G 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
H ''true and fair'' view, rather than purely on the basis of a true and correct
.1 J.K.INDUSTRIESLTD. v. UNIONOFINDIA 261
[KAPADIA, J.]
view. Accounting treatments contained in various Accounting Standards A
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. B
According to learned counsel, there is a difference between accrual
accounting on the basis of true and correct view vis-a-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 C
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 D
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 "current tax" which has been defined to
mean the.amount of income tax determined as payable in respect oftaxable E
income (loss) for a particular period. Similarly, in para 4 the expression
"deferred tax" has been defined to mean what is called as "timing
differences " which in turn has been defined to mean the differences
between taxable income and accounting income for a period. Such ''timing
differences'' originates in one period and are capable of reversal in one F
or more subsequent periods. "Timing differences" arises because the
period in which some items of revenue and expenses are included in
taxable income 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 G
arises for two reasons. Firstly, there are differences between items of
revenue and expenses, as appearing inthe.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
H
262 SUPREME COURT REPORTS [2007] 12 S.C.R. \

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. "incen~ive depreciation" on increased rate, as prescribed in Rule
5 read with.the percentages mentioned in second column of the table in .
B . appe~dix 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 as..c;et should written
C off ill 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 .
ra~es of depre~iation. While for accounting purposes, depreciation is
provided for on straight line method, the Income Tax Act allows
D depreciation by way of in~entive ,at much higher rat~ with reference to itS
written down value. The tot~l depreciation charged on the plant and
machipery for accounting purposes and the amount allowed as deduction
for tax purposes ultimately remains constant, but period over which
deprecfation is charged in the accounts as compared to the period during
which the deductiol\iS allowed under LT. Act, will differ. this is a case
E. of timing differenc~: For example, machinery purchased for scientific
research is fully allowed as deduction in the very first year for tax pwposes,
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 oflosses, which can be set off against future taxable income, are J
F also examples of timing differences. Such timing differences result in DTAs.
According to learned counsel, for the above reasons para 9 of AS 2;2
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
G 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
H AS 22 is Transitional Provisions. According to the learned counsel, it is
i
j J.K. INDUSTRIES LTD. v. UNION OF INDIA 263
/ [KAPADIA,].]
·~-\ not retrospective as alleged by the appellants. According to learned A
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 B
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 me1it in the submissions made c
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
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 ''true
D
and fair" manner as laid down in Section 21 l(l)(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 ale. 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 E
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 tliat the
' DTL is a notional and contingent liability and, tlierefore, it is not required F
'
to be charged to the P&L ale 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 G
Section 209(3)(b) of the Companies Act as it does not an10unt 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 tlie Income Tax Department.
According to learned counsel, DTL arises in the current year in which H
264 SUPREME COURT REPORTS [2007] 12 S.C.R. i
A 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
B (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
c has been defined in AS I . 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.
D 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
E 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 ''going concern" which is defined in AS 1
F under which the enterprise is normally looked upon as a "going concern", >

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
G of the appellants. of liquidation or fall in the scale of operations are not
apposite illustrations for treating DTL as a notional liability. According to
learned counsel. DTL is a liability for the cun·ent 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
H
f
J.K. INDUSTRIES LTD. v. UNION OF INDIA 265
/
[KAPADIA, J.]
............ ~
accounting. In the light of the said submissions, learned counsel A
contended that the charge in the P&L ale for deferred tax expense
is in respect ofa known liability payable in future; and, therefore, it is
covered by the definition of the word "Provision" as contained in Part II
of Schedule VI to the Companies Act.
55. On the question of ultra vires learned counsel for the Institute B
had adopted the contentions advanced by learned Additional Solicitor
General on behalf of Union oflndia.
Finding:
56. For the follow..ng reasons we hold that the impugned Rule which c
adopts AS 22 neither suffers from the vice of excessive delegation nor is
the said Rule incongruous/inconsistent with the provisions ofthe Companies
Act, 1956.
Reasons: D
(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. E
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 F
take place.
58. In its 01igin, 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
"true and fair" view of the accounts of a company. Every Indian and G

<
. -~
foreign investor/partner before entering into joint venture agreement(s) with
its counterpait exainines the financial statements and tries to asce1tain the
real income of the Indian company.
59. With globalization, we have conventional/orthodox system of H
266 SUPREME COURT REPORTS [2007] 12 S.C.R.
'
A accounting (recognition. measurement and disclosure) vis-a-vis modem
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
B 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
C possible only when accounting is based on certain coherent set oflogical
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. going concern concept, accrual concept, matching
D 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 ..
E 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 dete1mine the Periodic
F Income. Therefore, matching principle today forms an important
component of Accmal 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
G describe one single change in accounting practice over the last few years,
it would be the use of Fair Valuation p1inciples. Today. the object behind
enactment of A.S .. which are now made mandatory under section
2l1(3A) of the Companies Act, is to shift from historical method of
accoLmting to fair valuation. In the case of mergers and acquisitions, which
11 is common today in the world of globalization. fair valuation principles
J.K. INDUSTRIES LTD. v. UNION OF INDIA 267
/
[KAP ADIA,J.]
·~ --1 have important role to play. Mergers and acquisitions are sometimes A
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.
B
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 "true and fair".
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, C
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 D
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 globaliz.ation and E
socio-economic problems (including income disparities in our economy)
the power of Delegation has become a constituent element oflegislative
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 F
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 confonn to the statute under which it is
made. it may further be questioned on the ground that it is G
inconsistent with the provisions ofthe Act or that it is contrary to some
other statute applicable on the same subject matter. Therefore, it has to
yield to plenary legislation. It can also be questioned on the ground that it
is manifestly arbitrary and unjust. T11at, any inquiry into its vires must be
confined to the grounds on which plenary legislation may be questioned, H
268 SUPREME COURT REPORTS (2007] 12 S.'C.R.

A 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
B 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 discretiomuy power. In the latter case, the question
C 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
D 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 w1der a section of the statute which
E 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
F 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 tmder 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
G begin with the presumption that the Rule is intra vires), the comt has to
examine the nature, object and the scheme of the legislation as a whole
and in that context, the cornt 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 stait with the presumption that the
H impugned Rule is intra i·ires. This approach means that, the Rule has to
J.K. INDUSTRIES LTD. v. UNION OF INDIA 269
/ [KAPADIA, J.]
- ..._ --' be read down only to save it from being declared ultra vires ifthe court A
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 B
one limitation, namely, it cannot delegate uncontrolled power. Delegation
"'J. 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 ''true
and fair'' accounting. The said concept is the controlling C
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 TlSCO v. The Workmen &
Ors., reported in AIR (1972) SC 1917) D
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 Gaz.ette, alter any of the regulations, rules, fom1s, E
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 F
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 "in addition" 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 se,ction 642 the rules G
contemplated refers to gap-filling exercise.
68. It is well settled that, what is permitted by the concept of
''delegation'' is delegation of ancillary or subordinate legislative fi.mctions
or what is fictionally called as "power to fill up the details". The H
270
SUPREME COURT REPORTS [2007] 12 S.C.R. 4

A judgments of this Court have laid down that the Legislature may, after laying
duwn 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
B 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
ofthe authority conferred by the Act. It is equally well settled that, Rules
c 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 hy making provisions inconsistent with the Act. (See Britnell v.
Secretary a/State, (1991) 2 AllER 726 at 730
D 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 \Vith sections 209 and 211
read with Part I and Part II of Schedule VI to the Companies Act as
E 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
F 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 MP. reported in AIR
1958 SC 909 the State had issued a Notification under section 6(2) of
G the Central Provinces and Berar Sales Act, 1947 amending Item 33 in
Schedule II by substituting for the words "goods sold to or by the State
Government" by the words "goods sold by the State Government". 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
H
/ J.K. INDUSTRIES LTD. v. UNION OF INDIA 271
............. ~
[KAP AD IA,J.]
reason of the said Notification. That Notification was challenged on the A
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 oflegislative authority. It was argued on behalf
of the assessee that earlier they had been granted exemption under section B
l _J
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 c
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- D
sections together constituted integral part of a single enactment. We quote
hereinbelow para 11 of the said judgment, which reads as follows:
"11. Th~ contention of the appellant that the notification in question
is ultra vires must, in our opinion, fail on another ground. TI1e basic
assumption on which the argument of the appellant proceeds is that E
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( I) would stand, an amendment thereof
by a notification under section 6(2) might be bad. But that, in our F
opinion, is not the correct interpretation of the section. The two
sub-sections together form integral parts ofa 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, G
... _.--'. 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."
(emphasis supplied) H
272 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
B fill in details are two distinct powers. However, both the powers are
entrusted to the same delegate, namely, the Central Government. Furthei, ' '
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
C Notification is exhaustive of the powers given to the Central Government
to frame rules under the aforestated two sections. Moreover, in the present
cas¢, section 642(1) begins with the expression "in addition to the powers
conferred by section 641 ", therefore, one has to read section 641 as an
additional power given to the Central Government to make Rules, in
D 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
E on Accounting Standards constituted under section 21 OA 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
F company accounts have to reflect "true and fair" view of the state of
affairs. Therefore, the object behind insistence on compliance with the AS.
and ''true and fair'' accrual is the presentation of accounts in a manner
which would reflect the tme income/profit. One has, therefore, to look at
the entire scheme of the Companies Act. In our view, the provisions of
G 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
H
/
,· J.K. INDUSTRIES LTD. v. UNION OF INDIA 273
[KAPADIA,].]
without the rules. A
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:
"20. The Rules have been made in exercise of the power conferred B
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 "rules made
under a statute are a legitimate aid to construction of the statute C
as contemporanea expositio '' (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 'College' and 'Director'
can, therefore, be taken into consideration as contemporanea D
expositio for construing the expression "private college" 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 E
cannot be enforced. If it is held that Rules do not apply to technical
educational institutions the 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 F
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 G
Entry 66 of List I."
(emphasis supplied)
73. To the same effect is the judgment of this Comi in the case of
TELCO v. Gram Panchayat, Pimpri Waghere, reported in [1976] 4 H
274 SUPREME COURT REPORTS [2007] 12 S.C.R.

A SCC 177 in which the Court was required to consider the definition of
the word "house" 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
B 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
C 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
D 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
E 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
F followed by the companies. ·n1e Accounting Standards provide discipline.
They provide hannonization of concepts. They provide ham10nization 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
G 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.
H Nothing prevents the Central Government from enacting its own
(
J.K. INDUSTRIES LTD. v. UNION OF INDIA 275
[KAPADIA,].]
Accounting Standards which may not be in consonance with the Standards A
prescribed by the Institute. 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
(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 ? C
(A) Concepts

75. To answer the above question, we need to examine the following
concepts prevalent in Accounting.
D
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 E
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 ofthe date
ofpayment. 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 F
system of accounting. However, accrual cioes 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. G
Taxes on Income (TOI)

77. It is an important item of P&L ale. 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 H
276 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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
ofprofit and loss and as deferred tax asset (DTA) or as deferred tax
liability (DTL) in the balance-sheet. In short, deferred tax should be
B 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
C 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
D 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 fonn of payments
to the Income tax Department in the case ofTOis.
Current Tax
E 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
F to note that while measuring current tax, corr.panies have to go by the
balance-sheet date. The company has to examine the tax rates and the
tax laws on that date.
Timing D!lfi:rences
G 79. They are differences which arises because the period in which
some items of revenue and expenses are included in the tawble
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 detennine the periodic income. This
H concept has been brought in after the amendment to section 211 ( 1) of
{

J.K.INDUSTRIESLTD. v. UNION OF INDIA 277
[KAPADIA, J.]
the Companies Act which emphasizes that after 2001 the companies shall A
prepare their accounts so as to reflect "true and fair" 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, B
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, c
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 ale. The object is to present before the investors,
shareholders and other stake-holders the book profits (real income) of D
the company. The tax effect of timing difference under AS 22 has to
be included in the tax expenses in the P&L ale 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 ale. The primary object of AS
22 adopted by the impugned Rule is to prescribe an accounting treatment E
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
F
between items of revenue and expenses in the P&L ale 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 ale and the corresponding
amount which is recognized for computing taxable income.
G
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. H
278 SUPREME COURT REPORTS [2007] 12 S.C.R.

A As stated above, Timing Differences are differences between taxable ~ .. ·
income and accounting income for a given period. Timing Difference
originates in one period, 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 +
B deferred tax charged or credited to the statement ofprofit 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.
c 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
D 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
E purposes. In such a case, DIA 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.
F 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
G that ""revenues" 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
H defer revenue expenditure over future years which brings in the concept
f
.i
/ J.K. INDUSTRIES LTD. v. UNION OF INDIA 279
[KAP ADIA,J.]
of Deferred Tax Accounting. Therefore, today it cannot be said that the A
concept of accrual is limited to one year.
83. It is a principle ofrecognizing 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 B
I .l
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.
c
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 D
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 Adjustment is debit Trading and E
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. F
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 G
.... -1 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 "allowances and depreciation"
in several sections in Chapter IV within which section 44A appears. In H
280 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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 "any expenditure"
B in section 37 covers both, allowances and depreciation. [See
Commissioner ofIncome-lax 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.
c 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
D 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 "bad and doubtful" debts. The
amount remained in the account of the assessee by way of capital and
the assessee treated the said amount as "reserves" and not as
E "provisions" 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 ''provisions'' or
F "reserves". TI1e 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 (I) of Schedule II stipulated mandatory that the
G 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
H relevant provisions of the Companies Act regarding the form of balance-
/
J.K.INDUSTRIESLTD. v. UNION OF INDIA 281
[KAP ADIA,J.]
sheet wherein the words "reserves and surplus'; and "current liabilities A
and provisions'' are dealt with, that if any retention or appropriation falls
within the definition of "provision" it can 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 B
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. C

. 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 D
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 E
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 F
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 ofprofit and loss as DT A/DTL in the balance-sheet.

89. Depreciation in accounting sense is similar to bad and doubtful G
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, H
282 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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.
B 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 a~set, 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.
C 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
D 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 provision towards irrecoverabi!ity of debt
E cannot be said to be provision for liability. It is the provision for diminution
in the value ofassets. The expression "reserve" has been defined in a
negative manner by clause 7( ! )(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,
F renewal, diminution in value of asset or by way of provision for any known
liability. Thus, ifthe 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
G 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 asscssee 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
H provision. Reserve is not a charge to be deducted before arriving at the
I
~
/
J.K. INDUSTRIES LTD. v. UNION OF INDIA 283
[KAPADIA, J.j
profit for the period under review. It is appropriation of profit. The A
"reserve account" is credited as a result of a debit to the appropriation
account and not to the P&L ale 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 ale and not a debit to the appropriation account. B
) ~'
Tax Base
91. The tax base ofan asset or liability is the amount attributed
to that asset or liability for tax purpose. As stated above, deferred
tax has to be recognized/or all timing differences. This is based on C
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 DTLIDTA D

92. DTLIDTA 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 E
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 F
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 G
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 ale vis-a-vis items H
284 SUPREME COURT REPORTS [2007] 12 S.C.R.

' .. -
A considered as revenue, expenses or deduction for tax purposes. Secondly,
difference also arises between the amount in respect of an item of revenue
or expenses as recognized in the P & L ale and the corresponding amount
required in the computation of taxable income. It is the tax effect oftime
difference which is required to be included in Tax Expense in the P & L
B ale and as DTNDTL in the balance-sheet. Timing difference originates in
the year in which difference arises between the tax depreciation and ' '
accounting depreciation. TI1erefore, 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
c in the P & L ale 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 "only for accounting period". In our view, even under
D 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
E 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
F 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
statut01ily 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
G 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
H out for the information of shareholders, investors and stake-holders the
J.K.INDUSTRIESLTD.v. UNIONOFINDIA 285
(KAPADIA,].]
hidden liability which earlier could not be brought out. Today, we are living A
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, B
the concept of deferred taxation has been introduced in order to obliterate
the difforence between accounting depreciation and tax depreciation.
(B) Application of above Concepts:
94. As stated above, the power to alter the Schedule is distinct and C
separate from the power to fill in the details, though both together fonn
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 D
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 641 (2)
which is not there in section 642. However, as stated above, section 642 E
begins with the expression "in addition to the powers conferred by section
641 ''. 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) continues to have the status of the rules despite the phraseology F
used in section 641 (2) which, as stated above, says that "any alteration
notified under sub-section (1) of section 641 shall have effect as if
enacted in the Companies Act''. 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 ChiefInspector ofMines v. G
Karam Chand Thapar, AIR ( 1961) SC 83 8. We quote hereinbelow para
20 of the said judgment, which read as follows:
"20. The true position appears to be that the Rules and Regulations
do rrot lose their character as rules and regulations, even though
they are to be of the same effect as if contained in the Act. They H
286 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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 Jost. Therefore, with regard to the effect of a repeal of
the Act, they continue to be subject to the operation of Section
B 24 of the General Clauses Act."

Therefore, in our view, Rules framed under section 64 l followed by Rules
framed under section 642( I) shall continue to be Rules subordinate to
the Companies Act though for the purposes of construction, they are to
C 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
D 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.
E 97. DTL is a tax payable in future period(s) which arises out of
taxable temporary differences.
98. OTA 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.
F
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
G 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 ta"X law. 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
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 287
[KAPADIA,J.]
analyses can be explained by the following examples: A
Example-]
10 I. A Plant costs Rs. I 00 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 - 70) Rs. 30 lacs. On the B
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 (I 00--25) Rs.
75 lacs.
I 02. Therefore, a timing difference has arisen, in the above example,
c
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 D
(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 E
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 (10-6) and the F
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 G
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 H
288 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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.

B l 07. We would also like to give few more examples of DTA and
DTL as follows:
Example-3
108. Cost of a Plant is Rs. I 00 lacs, its carrying amount is Rs. 80
C lacs whereas its tax base is Rs. 20 lacs. Therefore, the Taxable Timing
Difference is (Rs. 80-20) 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
D
I 09. 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/ I 00 = Rs. 9 lacs as in such a case the tax
E base is Nil 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
F a provision for the said charges in accordance with the guidelines issued
by the Institute on ''Accounting of income, depreciation and other aspects
for leasing company". 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
G 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 ale of the relevant period and
against such lease rental income, a matching lease annual charge is made
to the P&L ale. This annual lease charge represents recovery of the net
H investment/ fair value of the leased asset over the lease period and is
J.K. INDUSTRIES LTD. v. UNION OF INDIA 289
[KAPADIA,J.]
calculated by deducting the finance income for the period from the lease A
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 B
is created as a result of debit to the P&L ale. 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 C
provisions of the Companies Act.
111. In the case of Cl T v. Duncan Brothers & Co. Ltd., reported
in [ 1996] 8 sec 31 the assessee company submitted that provision for
taxation made by it for assessment years 1963-64 and 1964-65 should D
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 E
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's 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 F
of accounting language should be interpreted as undersrood in
accounting practice.
112. Applying the above test to the present case, we are now
required to interpret the words ''the amount of charge for Indian Income
tax on profits" in clause 3(vi) in Part II of Schedule VI to the Companies G
Act. Similarly, we are required to interpret the words "current liabilities
and provisions'' 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
"provision" as well as "reserve".
H
290 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 113. As stated above, the form of balance-sheet is prescribed by
Part I of Schedule VI. The Act does not prescribe a proforma of P&L
a/c. However, Part II of Schedule VI prescribes the particulars which must
be furnished in a P&L ale. As far as possible, the P&L ale must be drawn
up according to the requirements of Part II of Schedule VI. As stated
B above, section 211 (I) emphasizes "true and fair" view in place of "true
and correct" 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 "true
C and fair" 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 docs 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
D 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 Govenunent is empowered to
carry out ancillary/subordinate legislative functions which is also fictionally
E 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 ale 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 ale is different from
F 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 21 OA(l ). As stated above, the Central
G Government is the mle 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
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 291
[KAPADIA,J.]
the Standards prescribed by the Institute. In the present case, we are A
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 B
against paragraphs 9 and 33 of AS 22. Para 9 reads as under:
. "Tax expense for the period, comprising current tax and
deferred tax, should be included in the determination of !he
net profit or loss for the period. "
115. Para 33 of AS 22 reads as under:
c
"On 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 o
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 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 E
from the beginning."

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 F
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 ale 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 G
the appellants Pait 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 appel lai1ts 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 detem1ination of H
292 SUPREME COURT REPORTS [2007] 12 S.C.R.

A net profit or loss, it amoill1ts 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.
B 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 ale and balance-sheet. That, para 9 only
refers to filling in the details qua items in P&L ale and balance-sheet.
c According to the appellants, P&L ale 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 ale, further, according
D to the appellants P&L ale 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 accoill1ts which are
primary documents on one hand and balance-sheet and P&L ale on the
other hand. According to the appellants, para 9 of AS 22 does not touch
E the subject " maintenance of books of accounts". 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 docs not apply to the maintenance of books of accounts, para 9 cannot
be made applicable only to balance-sheet and P&L ale because if it is
F so pennitted it would bring about inconsistency between "maintenance
of books of accounts" under section 209 vis-a-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.
G 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 reporting. Today, companies undertake
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 293
[KAPADIA,J.]
multifarious activities which warrant~ segment reporting. For example in A
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 IT non-provision for taxation would amount to contravention B
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 ''true and fair'' view of the state of affairs of
the company and the P&L ale of the company. AS 22 is mandatory.
Therefore, it is the duty ofthe members of the Institute to examine whether c
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 D
of ' 'true and correct'' accrual is different from the concept of' 'true and
fair' ' accrual. Both the concepts fall under accrual system of accounting.
However, there is a difference. Under "true and correct" 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 E
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 st<ik:e-holders in the
company. As stated above, there is also a difference between accounting
depreciation and tax depreciation. In order to harmonize these differences, F
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 ale.
Therefore, in order to bring out the tme 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. G
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 H
294 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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 ·'tax expense" 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 "tax expense" now includes both, current
B 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 "true and fair" view in section 211, which is the
C requirement in the matter of presentation of balance-sheet and P&L ale
the rule making authority was entitled to include the concept of '' deferred
tax'' 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
D merely provides for a liability which arises on account of timing difference
as explained hereinabove. As stated above, 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
E provisions of the Companies Act, therefore, one has to read the
presentation of balance-sheet and P&L ale 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 [nstitute. The matching principle recognizes cost against revenue
F or against the relevant time period to determi.11e 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. DTUDTA arises out of timing
differences. Therefore, such differences have got to be reflected in
G Defe1Ted 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
H accounting depreciation is based on the useful life of the asset. Thus, an
,J J,K. INDUSTRIES LTD. v. UNION OF INDIA
[KAP ADIA,J.]
295

asset under Income tax Act would be charged over a much shorter period A
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 B
amount of depreciation, Le., 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 c
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. D

Illustration 1
122, A company, ABC Ltd., prepares its accounts annually on
31st March. On 1st April, 20x 1, it purchases a machine at a
cost of Rs.1,50,000. The machine has a useful life of three E
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 F
corporate tax rate is 40 per cent each year.
The purchase of machine at a cost of RsJ ,50,000 in 20x I
gives rise to a tax saving of Rs,60,000. If the cost of the
machine is spread over three years of its life for accounting
purposes, the amount of the tax saving should also be spread G
over the same period as shown below:

H
296 SUPREME COURT REPORTS [2007] 12 S.C.R. 1
,_
A Statement of Profit and Loss
(for the three years ending 31st March, 20xl, 20x2, 20x3)
(Rupees in thousands)
20xl 20x2 20x3
B
Profit before depreciation and taxes
Less: Depreciation for accounting Purposes 50
200 200
50
200
50
• ..
Profit before taxes 150 150 150
c Less: Tax expense
Current tax
0.40 (200-150) 20
0.40(200) 80 80
D
Deferred tax
Tax effect of timing differences originating during the year
0.40( 150-50) 40
E
Tax eflect of timing differences reversing during the year
0.40 (0-50) (20) (20)

Tax expense 60 60 60
F Profit after tax 90 90 90
Net timing differences 100 50 Q
Deferred tax liability 40 20 Q

G In 20x 1, 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
ofRs.40,000. In 20x2 and 20x3, accounting income is lower than
H taxable income because the amount of depreciation charged for
f
t J.K. INDUSTRIES LTD. v. UNION OF INDIA 297
[KAPADIA, J.]
accounting purposes exceeds the amount of depreciation allowed A
for tax purposes by Rs.50,000 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.
B
In 20xl, the profit and loss account is debited and deferred tax
liability account is credited with the amount of tax on the originating
timing difference ofRs.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 ofRs.50,000. C

Illustration-2 (Application of "Fair Value Principles")
123. A convertible debenture is normally presented in the financial
statements as a liability, while it has two components; a liability and an
'· D
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 E
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 F
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 G
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
tin1ing differences.
124. A company has an option to designate a financial asset at fair H
298 SUPREME COURT REPORTS (2007] 12 S.C.R.

A 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
B 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
c 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 oflong term investment.
D 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. I001- in the year it makes 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
E 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
F 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
G every transaction has a tax effect. The words "true and fair" 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
H power is given to fill-in details. The word "supplementary" means
J.K. INDUSTRIES LTD. v. UNION OF INDIA 299
[KAPADIA, J.]
something added to what is there in the Act, to fill-in details for which A
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 B
• \ matters permitted by the Act to supplement the Act cannot be held to be
in violation of the Act. [See Britnell v. Secretary ofState (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 c
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 D
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 E
Ltd. and Anr., reported in [1987] 2 SCC 720 one of the arguments
advanced on behalf of the company was that, in calculating the "net worth"
the cost of works·· in-progress and the amount invested outside business
were excluded from "free reserves" and that such exclusion could not
be justified on any known principle of commercial accountancy (See para F
33). The matter related to price fixation. In the Control Order vide para
2(g) the word "free reserve" 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 G
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 under the Income tax Act in allowing expenses H
300 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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,
B 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
C 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
D 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 ale. However. as stated above, there is a difference between
E "true and correct" accrual and "true and fair" 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 "true and fair" accrual concept. The said concept
is wider than the concept of true and correct accrual. When section
F 209(3) refers lo mainlenance of books of accounts on accrual basis
it means ·'true andfi1ir ''accrual. \Vhich 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 ale. These are financial
G 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 ofliability. In the
past, when timing difference concept was not there, in many cases, profits
were overstated, particularly because provision for DTL (deferred
ta"Xation) was not recognized. With the introduction of the timing difference
H
JX. INDUSTRIES LTD. v. UNION OF INDIA 301
[KAPADIA,J.]
concept, it cannot be said that the accrual system of accounting is violated. A
As stated above, it is the concept of "timing difference" 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, B
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 C
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 D
method of valuation out of several methods of valuing an asset. And since
the break-up method adopted by the rule-making authority was a known
method in the relevant circles, it cannot be said that the method adopted
was an impe1missible method. Paras 13, 14 and 21 read as under:
E
"13. 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 F
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 G
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
H
3~ SUPREME COURT REPORTS (2007] 12 S.C.R. '\

A 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
B 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
c 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,
D 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.
E 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
F the correct market value. We do not see any basis for this
assumption. No empirical data is 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
G 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.
H
J.K. INDUSTRIES LTD. v. UNION OF INDIA 303
[KAPADIA, J.]
xxx A

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 B
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 C
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 D
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 E
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 F
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 G
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 yield method may be more H
304 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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."

Validity of Para 33 of AS 22
B
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
C para is retrospective.
131. To decide the said question, we have to analyse the scope of
para 33. For the purpose of detennining 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
D purposes are to be compared and the differences, if any, are to be
detennined. The tax effect ofthese differences have got to be recognized
as OTA 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's say, Rs. 100 for accounting purposes and Rs. 60 for
E 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
F example, let's assume that the tax rate is 40 per cent and that there are
no other timing differences then, DTL would be [Rs. l 00\- Rs. 60] x 40/
100 =Rs. 16
132. Once we are required to take into account the concept of
G 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's 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
H representing expenditure would have a Balance only for tax purposes and
J.K. INDUSTRIES LTD. v. UNION OF INDIA 305
[KAPADIA,J.]
not for accounting purposes. Therefore, the difference between the Balance A
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,
OTA would be recognized in respect of difference, subject to the principle
of prudence. In the circumstances, it cannot be said that para 33 is B
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 C
provisions of the Companies Act, including Schedule VI.
134. To sum up, deferred tax is nothing but accrual of tax due 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 D
account of the difference between the amount of revenue/expense as per
profit and loss account and the coITesponding amount considered for tax
purposes, e.g., depreciation.
135. However, we need to comment on one aspect. Before the E
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 ' 'deferred taxation' ' is violative of Articles 14 and 19( 1)(g) of the
Constitution oflndia. In this connection, it was pleaded that by making
AS 22 mandatory, the appellants' companies will suffer erosion ofits net F
worth. That, as a result, the debt equity ratio will also increase and that
the lenders may recall the loans and thereby the appellants' rights to carry
on business in future would be violated. Although, the aforestated
challenge was pleaded in the writ petition, when the matter can1e for hearing
before the High Com1, it appears that the said grounds were not argued. G
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 cany on business under Article 19( l )(g) or whether the said H
306 SUPREME COURT REPORTS [2007] 12 S.C.R.

A 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.
B
136. For the aforestated reasons, we find no infinnity 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.
K.K.T. Appeals dismissed.