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Total Number of Subscribers: 426 |
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Date: 31 March 2008 |
Compiled by M. Sathya Kumar |
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NGOs ACCOUNTING
and LEGAL INTRICACIES In the absence of any legal authoritative pronouncement and
varied interpretation of certain terms under the related laws by the
judiciary, it has become a difficult task to follow a uniform line of action
in preparation and presentation of the financial statement of an NGO. The practices followed by an NGO on certain issues are varied
and diverse thereby making the financial statements incomparable and
difficult for users to understand. The
intricacies range from the accounting treatment of certain items of
income/expenditure, to the issues under legal laws in force at present. Nowadays, Non-Governmental Organisations play a vital role in
bringing the under-privileged and least-advantaged to the common stream of
the society. With the passage of time, there has been a big increase in their
physical as well as financial activities. Their presence has also increased
from the national to the international level and the source of funds has also
diversified from private donations to international funding agencies. Due to
this manifold increase, thereis a need for consensus on certain varied
accounting as well as legal issues so that a more meaningful financial
reporting and disclosure can be made. This would not only make the financial
statements of these organizations comparable, but would also provide the user
of these statements a bird’s eye view of the activities of such organisations. The succeeding paragraphs
deal with some such intricacies, which need consensus. Accounting of Grants NGOs receive grants from government as well as other national
and international agencies. Para 13 of the
Accounting Standards (AS) 12 - Accounting for Government Grants provides that
Government Grants should not be
recognised until there is reasonable assurance that (i) the enterprise
will comply with the conditions attached to them, and (ii) the grants will be
received. Even if Accounting
Standards are not applicable to an NGO, the principles of accounting laid
down in AS-12 should be followed. Grants may be of the nature of project
based grants, or comprehensive grants not related to a particular project but
for the general purposes of the ‘grantee’ organisation. At present three practices are widely followed in
recognition of grants: i. Grants recognised as income: Most of the NGOs recognise a grant as income in the yearin which
it is received. The amount expensed out of this amount is shown as
expenditure in the Income and Expenditure Account. While the total amount of
grant received is shown as income in the Income and Expenditure account, in a
strict sense grants are not income as they are given not to accumulate but to
spend for a particular project or the core activities of the organisation.
Sometimes these grants have to be returned to the funding agency and the overspent
balance can be charged from these agencies, if the agreement between the two
provides so. The main advantage of recognizing a grant as income is that the
whole income and the expenditure incurred out of this income is shown in
Income and Expenditure Account which can provide meaningful information to
the user of the financial statement about the activities and spending pattern
of the organisation. However, recognising a grant as income may result in
showing higher surplus for the year, which is actually unspent grant. It may further lead to an impression that the surplus is
available to the NGO for spending wherever it wants but that is not the case
as the surplus is the unspent grant which is usually project based or
earmarked. Further, adoption of this method understates liabilities as the
unspent balance of grant become surplus and showed as reserve. The other disadvantage of this method is that there may be
surplus in one year and deficit in another year due to effect of unspent and
overspent grant that makes figures incomparable. If this method is followed
the Income and Expenditure account and Balance Sheet will appear as shown on
the right. ii. Grants recognised as liability: This is another method of recognition of grants. In correct
sense, the grants are money of the donor agencies, which are given to an
organization to be spent in a particular manner. This is not the income of
the organisation, which is freely available for any use. That is why many
NGOs recognise grants as liabilities in their balance sheet. The expenditure is deducted directly from the balance of the
grant and does not form part of the Income and Expenditure account. The
unspent/overspent balance is shown as a liability or asset respectively in
the Balance Sheet. If this method is followed, assets and liabilities are
fairly shown in the balance sheet and the figures of Income and Expenditure
accounts are comparable from year to year as grants and the expenditure
incurred out of it does not form part of the Income and Expenditure account. The major disadvantage of using this method is that it results
in showing that the NGO is inactive, as the development expenses do not form
part of expenditure in Income andExpenditure account. The other disadvantage
is that overspent balance of a grant is shown as an asset item that
may not always be recoverable from the donor agencies. iii. Grants recognised as income only to the extent of the
expenditure incurred: Under thismethod, grants are recognised as income but only to
the extent of expenditure incurred out of it. The unspent or overspent
balance is shown as liability or assets in the Balance Sheet and in the
Income and Expenditure account the unspent balance is deducted from the grant
received. This matches the amount of the grant (income) and the expenditure
exactly. However, the unspent balance can be deducted from the total grant in
the Income and Expenditure account but if there is overspent balance it
cannot be added to the income. The concept of prudence should always be born
in mind whenever accounting for such issues is done. Preferably, it is better
not to recognise such income which has not been received or has not become
due to be received or until there is reasonable certainty of such receipt.
This method has advantages of both the earlier two methods. All assets,
liabilities, income and expenditure are fairly stated if this method is
followed. Besides, the inherent advantages of this method, it has also got
some legal sanctity. The ICAI has also recommended this method in its Technical Guide
on Accounting and Auditing in Not-for-Profit Organisations, issued in
February 2003. It has been provided that “Since not-for-profit organizations receive a large volume of
grants to meet certain revenue expenses, it is recommended that both the
grant (to the extent utilised during the period) and the relevant expense
should be disclosed separately in the income and expenditure account. Such a
disclosure would be useful in appreciating the operations undertaken by the
NGO during the period.” Applicability of Accounting Standards Regarding applicability of Accounting Standards to NGOs, the
Accounting Standard Board (ASB) has given an opinion in September 1995. The
relevant text of the opinion is reproduced below: “The Institute will issue Accounting Standards for use in the presentation of the general purpose financial statements
issued to the public by such commercial, industrial or business enterprises
as may be specified by the Institute from time to time and subject to the
attest function of its members” The reference to commercial, industrial or business enterprises
in the aforesaid paragraph is in the context of the nature of activities
carried on by an enterprise rather than with reference to its objects. It is
quite possible that an enterprise has charitable objects but it carries on,
either wholly or in part, activities of a commercial industrial or business
nature in furtherance of its objects. The Board believes that Accounting
Standards apply in respect of commercial, industrial or business activities
of any enterprise, irrespective of whether it is profit oriented or is
established for charitable or religious purpose. As, will not, however, apply
to those activities, which are not of a commercial, industrial or business
nature. E.g. an activity of
collecting donations and giving them to flood affected people). It is also
clarified that exclusion of an entityfrom the applicability of Accounting
Standards would be permissible only if no part of the activity of such entity
was commercial, industrial or business in nature. For the removal of
doubts, it is clarified that even if a very small proportion of the
activities of an entity was considered to be commercial, industrial or
business in nature, then it could not claim exemption from the application of
Accounting Standard. The Accounting standards would apply to all its
activities including those which were not commercial, industrial or business
in nature. It is clear from the above that the Accounting Standards are
applicable to NGOs whose some, or more, of the activities are commercial or
business in nature. However, it is very difficult to determine what is the
exact meaning of commercial or business activities with reference to NGOs.
NGOs are not meant for earning profit out of their activities. Even if profit
is derived from some of the activities the profit is ploughed back or
returned to the beneficiaries. For example, if one of the objects of an NGO is to grant loans
to micro credit institutions or self-help groups and some interest income is
derived from the loans granted, will the activity be constituted as
commercial in nature? Similarly, if an NGO provides its training or
conference hall to some other organizations or institutions and charges rent
from such organisations, which is
utilised for other objects of the NGO, will it be constituted as commercial
activity? Should Accounting Standards be applicable to such NGOs who derive
income from such small income generating activities, which are not purely
commercial in nature? Intricacies Under Income Tax Act, 1961 There have always been some issues underthe Income Tax law,
which have been subjected to different interpretations by the taxation as
well as judicial authorities. Some of them are discussed below— 1. Depreciation: Tax authorities are reluctant to allow depreciation as deduction
from the income of NGOs on the grounds that when capital expenditure is
itself allowed as ‘application’ of income for the
purposes of section 11 then allowing depreciation will amount to a double
deduction. However, in Director of Income Tax
(Exemption) v. Franjee Cawasjee Institute (1993)109 CTR (Bom) 463 it was held that even if the capital
expenditure on acquisition of asset is treated as application for the
purposes of section 11, depreciation is allowed as deduction. Similarly, in Eight ITO v. Trustees of Marathi Mission(1982) 1 ITD 539, the Bombay Tribunal held that depreciation
claim is allowable even if the assessee trust does not carry on any business
and the entire cost of assets has been allowed full deduction. However, for
deriving ‘income’ for the purpose
of section 11 of the Act, depreciation is treated as ‘application’. It was held in CIT v. Society of Sister of St. Anne (1984) 146 ITR 28 (Kar) that it is not right to contend that the
depreciation, being a notional expenditure, cannot be allowed to be debited
to the expenditure account of the trust. ‘Income’ for
the purposes of section 11 is to be arrived
on normal commercial principles and in popular or general sense. In CIT v. Sheth Manilal Ranchhoddas Vishram Bhavan Trust (1992) 198 ITR 598 (Guj), it was held that though the income of
the assessee trust was assessable under the head house property, depreciation
debited to the accounts was allowable. In CIT
v. Raipur
Pallotine Society (1989) 180 ITR 579 (MP),
it was held that depreciation has to be allowed as a deduction to preserve
the corpus of the trust. 2. Income: What constitutes income for the Income tax purposes has been a
matter of controversy since the inception of the definition of ‘income’ under the
Income Tax Act. Section 2(24)(iia) of the Income Tax Act, 1961 defines ‘income’. It provides that ‘income’
includes voluntary contributions received by
charitable or religious trusts or such institutions, scientific research
associations or sports associations. Voluntary contribution received by funds
or trusts or institutions is exempted under section 10(23C)(iv) and
10(23C)(v) also constitutes income of such fund or trust or institution. Thus, income of NGOs may be in the form of donations, voluntary
contributions from members, subscription fees, capital gains, profit and
gains from business carried on by the organisation, income from property held
under trust and corpus donations. Corpus donations do constitute income for
the purposes of section 2(24)(iia) but this section has to be read with
section 12 which provides that contributions made with specific directions
that they shall form part of corpus of the trust are not included in income
of the trust or institution. It was held in CIT v. Rao Bahadur Calavala Cuna
Chetty Charities (1982) 135 ITR 485 that
the word ‘income’ used in section 11 is to be understood in general commercial or popular sense. The word ‘income’ under section 11(1)(a)
and the word ‘total income’ defined under
sec-tion 2(45) have different meanings vide
CBDT’s Circular No. 5P (LXX-6) dated Similar was decision in CIT v. Birla Janahit Trust (1990) 208 ITR 372 ( Issues Under Foreign Contribution Regulation Act, 1976 The FCRA 1976 was originally focused on political parties and
the involvement of foreign funds in Indian elections. It was much later that
the focus shifted towards the NGOs. Currently, it is the basic law that
governs the foreign funding and its utilisation. However, there have always
been some issues of controversies under the present FCRA. These issues range
from what is foreign source to how recoveries under foreign funds are to be
accounted for under the financial statement of the NGOs. 1. Foreign Source (i) Section 2(e) of the FCRA, 1976 defines the term ‘foreign source’. This is an
inclusive definition but not an exhaustive one. There have always been
divergent views regarding contributions from certain kind of individuals and
agencies. l Indian citizens
living abroad: Clause (x) of sec. 2(e) provides that donations from a citizen
of foreign country is deemed to be a ‘foreign
source‘. This means that although a
person may be living in a foreign country, but his donations to Non-Resident
Indians (NRIs): An Indian can become Non-Resident due to his period of stay
abroad yet he doesn’t become a foreign citizen by
becoming an NRI as Non-Resident and foreign
citizenship are two separate and distinct concepts. Thus, contributions from NRIs
are not treated as a ‘foreign source’ until they become
foreign citizens. Subsidiaries of foreign companies formed in India Contributions from companies of foreign countries are treated as
a ‘foreign source’.
Similarly, contributions from their subsidiaries formed outside l International
agencies: By virtue of sub-clause (ii) of clause (e) of section 2 of the
Act, all international agencies are treated as foreign source except United
Nations Organizations,UN Specialized Agencies, The World Bank and
International Monetary Fund. Besides these, the Central Government has power
to exempt any international agency from being treated as ‘foreign source’ by
notifying such agency in the Official Gazette. Similarly a foreign
institution, which has been permitted by the Central Government by its
notification in the Official Gazette to carry on its activities in 2. Recoveries under
foreign funds: Sometimes, NGOs recover some nominal amount from the individual
beneficiaries who are provided certain services, items etc., at a subsidised
rate. The reporting of receipt of such money mainly depends upon the funding
of the related expenditure on such items, services etc. If the related
payment to purchase such items or hire such services is from foreign funds,
then such recoveries should be reported as foreign contribution money only
and must be reported in FC-3. If the related expenditure has been made out of
both Indian and foreign funds then the recoveries should also be bifurcated
into Indian and foreign on the basis of related incurrence of expenditure. 3. Overhead Cost
Charged on Projects: An NGO may many times charge certain overhead costs like rent of
premises hire charges of vehicles, etc., from certain projects according to
the project terms and conditions and may get the reimbursement of such costs
from the project itself. Accounting of reimbursement of such funds under FCRA
depends on where the related asset is situated. If the asset is shown in
foreign Balance Sheet then the related recovery must be shown in foreign
account only. Thus the reporting of the income from such assets depends upon
the initial funding and accounting of such assets, in Indian or foreign
Balance Sheet. The general rule is that if there is any income from the
assets acquired out of foreign contribution or its funds the same goes to
foreign contribution accounts only. Conclusion Because of diverse practices being followed by NGOs for
preparation of financial statements, there is an immediate need for
consolidating the entire gamut of issues under one umbrella, either, in the
form of a Guidance Note or a Financial and Reporting Standard, so that the
goal of uniform accounting practices and better presentation of financial
statements can be achieved. The State
shall also bring out some clarifications or explanations regarding the
disputable issues under different laws so that a consensus can be achieved
and preserved. Courtesy : Mr.
CA. Anand Pagaria, The author is the member of the ICAI |
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