ICAI issues Exposure Draft of the ‘Guidance Note on Transfer of Capital Reserve’

Certain Indian Accounting Standards (Ind AS) notified under the Companies (Indian Accounting Standards) Rules, 2015 require capital reserves to be created toward unrealised profits arising from certain transactions or other events. However, currently, there is no specific guidance on their subsequent transfer to retained earnings or other free reserves. The Guidance Note sets out principles for the transfer of capital reserve to free reserve, including the timing when such a transfer can be made.

‘Capital Reserve’ is defined as a reserve of a corporate enterprise which is not available for distribution as a dividend (Glossary of Terms Used in Financial Statements issued by the Institute of Chartered Accountants of India (ICAI)). Neither Ind AS nor the Companies Act contains any specific requirement on how such reserves once created should be used. Any reserve created as per the requirements of the Act or other applicable law cannot be transferred to any other reserve except as per the requirements of the applicable law. Regarding capital reserve created pursuant to Ind AS the following two views are possible:

a) Capital reserve once created is in the nature of permanent capital for the Company. Hence, companies cannot utilise or transfer capital reserve to another reserve

b) Ind AS/other applicable guidance require amount to be credited to capital reserve because they are unrealised and cannot be used for dividend distribution at this stage. However, except for few reserves, the amount can be transferred to the retained earnings or other free reserves when the following two conditions are met:

• • The company has realised the underlying amount or
  • The amount has become available for distribution as dividend or issue of bonus shares under the Act or other applicable laws

Till both these conditions are met, the amount should continue to be reflected as capital reserve.

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