The Institute of Chartered Accountants of India (ICAI) has recently released an exposure draft titled “Guidance Note on Transfer of Capital Reserve.” This draft aims to provide clarity and guidance on the transfer of capital reserve to free reserves or retained earnings. The ICAI has invited comments on this draft by April 20, 2023.
Capital Reserve and Indian Accounting Standards
Indian Accounting Standards (Ind AS), as notified under the Companies (Indian Accounting Standards) Rules, 2015 (as amended), necessitate the creation of a capital reserve for unrealized profits resulting from specific transactions or events. However, there is no clear guidance on transferring these reserves to retained earnings or other free reserves. The purpose of this Guidance Note is to address this issue and offer relevant guidance.
Scope and Purpose of the Guidance Note
The Guidance Note primarily focuses on the principles of transferring capital reserves to free reserves or retained earnings, including the appropriate timing for such transfers. It does not cover the utilization of the transferred amount for dividend payments, bonus share issuance, or any other purpose. These matters are considered legal issues and will continue to be governed by the requirements of the Companies Act, 2013 (as amended), and other applicable laws, if any.
Key Points of the Guidance Note
i) The Guidance Note addresses the lack of specific guidance on transferring capital reserves created due to unrealized profits from specific transactions or events, as required by certain Ind AS.
ii) It establishes principles for transferring capital reserves to free reserves, including when such transfers can be made.
iii) Reserves created as per the Companies Act or other applicable laws cannot be transferred to other reserves unless the relevant laws allow it. Certain reserves that are purely capital in nature, such as capital profit from the reissuance of forfeited shares, cannot be transferred to free reserves or retained earnings since the underlying transaction is complete.
iv) For capital reserves created following the requirements of Ind AS or previously applicable Accounting Standards, the amount can be transferred to retained earnings or other free reserves when two conditions are met:
(a) The company has realized the underlying amount, and
(b) The amount has become legally available for distribution.
v) The transfer of the amount may occur proportionately with each asset sale or at the end of the sale process.
vi) Specific disclosures must be made in the financial statements during the year of transfer.
vii) The Guidance Note will be applied retrospectively to capital reserves appearing in the books of accounts.
The exposure draft of the “Guidance Note on Transfer of Capital Reserve” released by ICAI aims to provide much-needed clarity on the principles and procedures involved in transferring capital reserves to free reserves or retained earnings. By following this guidance, companies can ensure compliance with Ind AS and maintain transparency in their financial reporting. It is essential for professionals and stakeholders to review the exposure draft and provide their feedback by April 20, 2023, to contribute to the development of robust guidance in this area.
Exposure Draft of the ICAI’s Guidance Note on Transfer of Capital Reserve (dt. 21/03/2023)