Case: Reliance Energy Limited  Vs. Maharashtra State Road Devt.Corp.Ld.&amp;Ors

current operating assets and liabilities. (See Stage II).Depreciation: This item of expense reduces the profit since it is a charge made against revenue for the use of tangible fixed assets. The likely journal entry to record the depreciation expense is:(i) Depreciation Account Dr.To Provision for Depreciation Account(or Accumulated Depreciation)AlternativelyDepreciation Account Dr.To Fixed Asset AccountIn either case the depreciation account would be closed be transfer to Profit and Loss Account. The net affect would be:EitherProfit and Loss Account Dr.To Provision for Depreciation AccountOrProfit and Loss Account Dr.To Fixed Asset AccountIt is clear that cash is not affected in the above journal entries. The depreciation does not require any expenditure in cash. Thus, the amount of depreciation charge must be added to be reported net income in order to arrive at the total increase in cash provided from the operations.Amortization of intangibles-goodwill, patents, etc.: The amortization of (i.e., writing off) goodwill, trade marks, patents copyrights, etc., has the same effect as the depreciation expense. The amount of amortization reduces the profit but does not involve any flow of cash as is evident from the following entry:Profit and Loss Account Dr.To Goodwill etc. AccountThere is no change in cash. Thus amount of intangibles so written off must also be added back to the reported net profit (income).”“12.20.Stage-2 : Adjustments in respect of current assets and current liabilities : The adjustments made in the net profit (income) figure as per profit and loss account as outlined in Stage-I above, gives As Operating Profit before Working Capital Changes. Several other adjustments are made in respect of current (Operating) assets (e.g., debtors, bills receivable, inventories, prepayments etc.) and current (Operating) liabilities (e.g., creditors bills payable, outstanding liabilities etc.) to obtain the final net cash from operating activities. There is an intimate relationship between the revenue and expense items of income statement and current assets and current liabilities items of the balance sheet. Since the income statement is prepared on the accrual basis, the resultant net income figure is affected by cash and non-cash items. But the net income on a cash basis considers only cash receipts as revenue and subtracts from cash receipts only cash spent for purchase of goods or raw materials) and expenses.The following general rules, as an aid to analysis of current assets and current liabilities affecting cash, may be noted :(i) An increase in an item of current asset causes a decrease in cash inflow because cash is blocked in current assets.(ii) A decrease in an item of current asset causes an increase in cash inflow because cash is released from the sale or recovery from current asset.(iii) An increase in an item of current liability causes a decrease in cash outflow because cash is saved.(iv) A decrease in an item of current liability causes increases in cash outflow because of payment of liability.Some of the adjustments are discussed below:(i) Debtors and Bills Receivable (Credit Sales) : It needs no explanation that the major source of cash from operations is cash sales. But it is not uncommon to find a significant amount of credit sales in the form of debtors and bills receivable representing current assets. This indicates that the sales were made both for cash and credit. Consequently the net income (or profit) figure does not disclose the cash from operations. The following adjustment, however, enables to overcome this difficulty:Cash from Operations = Operating Profit before Working Capital Changes + Net Decrease in Debtors and Bills Receivable.”(Emphasis supplied) 35. Taking into account the above principles, it is clear that there are two methods of “cash flow reporting” i.e. direct and indirect. Both give identical results in the matter of the final total. They differ only in presentation of the data. They differ only in presentation of the data contained in the cash flows from operational activities. No reason has been given by the Consultants of MSRDC for rejecting the indirect method invoked by KPMG, Chartered Accountants of REL/HDEC in their letter dated 12.8.2005. The said method is known as “reconciliation method”. In this case, as stated above, the only reason given by the Consultants of MSRDC to exclude REL/HDEC was the negative impact on the future cash flows on account of the provisioning for doubtful debts in the accounts of HDEC for the FY 2001. If future cash impact was the basis to exclude REL/HDEC, then the Consultants for MSRDC should have considered cash flow reporting methods, which includes Reconciliation Method. There is no question of difference of opinion or different views as far as the application of cash flow reporting, which also falls in AS 3. There is nothing to show whether indirect method has at all been considered by Crisil, particularly when KPMG had invoked that method. There is no reason given for rejecting it. Lastly, in the PQ document, the referral years were three years. The criteria was that there should be NCP of not less than Rs.200 crores. However, the opinion of the Consultants proceeds on the basis that if “add back” is allowed it may have future cash impact. In the evaluation process, the Consultants were entitled to take into account future cash impact but in order to do so they had to say why the indirect method of “cash flow reporting” should not be accepted and if at all the impact of the provisioning was to be seen then there was no reason for not examining the audited accounts of 2004. There is a mix-up of two concepts here. The concept of non-compliance of financial criteria and the impact in future years on cash flow. As stated above, the very purpose of “cash flow reporting” is to find out the ability of HDEC to generate cash flow in future and if an important method of cash flow reporting is kept out, without any reason, then the decision to exclude REL/HDEC, is arbitrary, whimsical and unreasonable. In our view, for non-consideration of the Reconciliation Method, under cash flow reporting system, the impugned decision-making process stood vitiated.

Decision (1 = appeal accepted, 0 = rejected): 1

Explanation:
1[ds]At this stage, we need to clarify that HDEC had undertaken construction contracts in Iraq. That, large receivables had arisen prior to 1999 on account of war in Iraq. The Iraq contract receivables had nothing whatsoever to do with the three accounting years 2001, 2002 and 2003, therefore, there were no Iraq contract receivables nor was there anyas and by way of bad debt in any of the above three accounting years. Further, according to REL/HDEC, HDEC had incurredng to US $ 686.310 million in 2001, US $ 200.753 million in 2002 and US $ 199.084 million in 2003 which did not involve direct cash outflow and, therefore, the saidht to have been added back to NCP and if so added then the Consortium had NCP of Rs.2,000 million (Rs.200 crores) as mentioned in Clause 7.2.2.On 22.8.2005, a committee by the nameas constituted by MSRDC to review the draft evaluation report submitted by the consultants, M/s. Jean Muller Consortium, relating toof bidders to suggest process of evaluation and to provide recommendations to MSRDC. The said Committee met on 21.9.2005. The consultants M/s. Jean Muller Consortium and M/s. Crisil were both called to give clarifications. The said Committee was headed by Mr. Justice R.J. Kochar, Judge of Bombay High Court (retired), Shri A.K. Banerjee (Technical Member) in NHAI, Mr. R.S. Agarwal, Executive Director of IDBI (retired), Mr. V. Giriraj, Joint Managing Director of MSRDC etc. The Committee noted thatbids were received only from six Applicants, one of them was REL/HDEC. The Committee noted that while Indian companies could submit their audited accounts up to 31.3.2004 as their FY ended on 31st March the foreign companies could submit their audited accounts only up to 31.12.2003 as their FY ended on 31st December. The Committee further observed that although thedate was 10.1.2005, clarifications onsh expenses were sought from REL/HDEC up to 22.8.2005 and since in the mean time audited accounting statements were furnished by HDEC up to 31.12.2004, the same could be considered for evaluation. The Peer Committee did not agree with the opinion expressed bys that the loss incurred by HDEC for the financial year ending 31.12.2001 would have a cash impact in future. At this stage, we may reiterate that even according to the Consultants of MSRDC,provision for baddebt may not involve cash outflow in the year of incidence but it would have cash impact at a future date and, therefore, out of abundant caution they decided to exclude REL/HDEC. However, the Peer Committee did not concur with this accounting interpretation. According to the Peer Committee the majorprovision for baddebt was in the accounts for the year 2001 and it related to receivables from their contract in Iraq affected by war and since it was only aprovision for baddebt and not athe Committee came to the conclusion that there would be no cash impact in future. The Committee took the view that even without taking into account the audited accounts for the year 2004, REL/HDEC fulfilled the financial criteria in Clause 7.2.2. Accordingly, the Peer Committee opined that REL/HDEC should not be excluded from the second stage of the bidding process. At this stage, it may be noted that after receipt of the said report, made by the Peer Committee dated 1.10.2005, MSRDC placed the report of the Peer Committee before their Consultants. Needless to add that the Consultants of MSRDC retained their original position, namely, that since the audited accounts for the year ending 31.12.2004 could not have been submitted after 10.1.2005, the said accounts of HDEC could not have been taken into account as it would violate the tender conditions and, therefore, REL/HDEC should be excluded from the second stage of the bidding process.We find merit in this civil appeal. Standards applied by Courts in judicial review must be justified by constitutional principles which govern the proper exercise of public power in a democracy. Article 14 of the Constitution embodies the principle ofHowever, it is not aprovision. It has to be read in conjunction with rights conferred by other Articles like Article 21 of the Constitution. The said Article 21 refers toIt includesIn our view, as held in the latest judgment of the Constitution Bench ofin the case of I.R. Coelho (Dead) by Lrs. v. State of Tamil Nadu & Ors., I (2007) SLT 696=(2007) 2 SCC 1 , Article 21/14 is the heart of the chapter on fundamental rights. It covers various aspects of life.is an important concept while construing Article 19(1)(g) of the Constitution. It is this doctrine which is invoked by REL/HDEC in the present case. When Article 19(1)(g) confers fundamental right to carry on business to a company, it is entitled to invoke the said doctrine ofWe may clarify that this doctrine is, however, subject to public interest. In the world of globalization, competition is an important factor to be kept in mind. The doctrine ofis an important doctrine which is embodied in Article 19(1)(g) of the Constitution. This is because the said doctrine provides space within whichcompetitors are allowed to bid so as to subserve the larger public interest.in essence, is liberalization of trade. Today India has dismantledThe economic reforms introduced after 1992 have brought in the concept ofDecisions or acts which results in unequal and discriminatory treatment, would violate the doctrine ofembodied in Article 19(1)(g). Time has come, therefore, to say that Article 14 which refers to the principle ofshould not be read as a stand alone item but it should be read in conjunction with Article 21 which embodies several aspects of life. There is one more aspect which needs to be mentioned in the matter of implementation of the aforestated doctrine ofAccording to Lord Goldsmith — commitment tois the heart of parliamentary democracy. One of the important elements of theis legal certainty. Article 14 applies to Government policies and if the policy or act of the Government, even in contractual matters, fails to satisfy the test ofthen such an act or decision would be unconstitutional.is a matter of estimation. ASs are policy documents. Accounting interpretation depends on application of several ASs simultaneously. The concept ofis not restricted only to AS 26. Similarly, the concept ofis not restricted to AS 3. Therefore, different methods are prescribed for estimating net profits and/or net cash profits. There are no two views on this point. Provisioning for doubtful debts cannot be equated toIn the case of provisioning there is no. This proposition is undisputed. What is being argued is that once there isdoes not get routed through the P&L account and, therefore, there will be cash impact in future. This argument amounts to begging the question. If this argument is to be accepted then we are obliterating the difference betweenThe question ofin future is a separate question. It has to be answered in terms ofwhich falls in AS 3 which has been invoked by the chartered accountants of REL/HDEC.Applying the tests laid down in the aforesaid two judgments [Jwala Prasad (supra) and Metal Box (supra)] it is clear that the concept ofis different from the concept ofThe effect of the two is quite different. Provisions made against anticipated losses are charges against profits and, therefore, to be taken into account against gross receipts in the P&L account and there usually shown in theby way of deduction from the assets whereasare shown as part of the interest of the proprietor. In the present case, there is no dispute regarding the aforestated concepts. However, according to the consultants for MSRDC though provision for doubtful debt is aexpense it has to be treated as a cash expense because once a provisionhas been made, thecannot be routed through P&L account and, therefore, what is conceptually aexpense is being treated as a cash expense. As stated above, this is begging the question. If the aforestated argument is to be accepted it would obliterate the conceptual difference betweenThe above reasoning shows that the only reason for excluding REL/HDEC is the future cash impact of the provision made in the accounts of HDEC for the FY 2001. This aspect has been discussed by us in the following paragraphs.32.On the second question of future cash impact it may be reiterated that KPMG, the chartered accountants for REL/HDEC has invoked the principle ofwhich also finds place in AS 3.According to the said principle ofwhen P&L accounts andare prepared on accrual basis, revenues and expenses are recognized on accrual basis, i.e., when the transaction or event occurs. However, timing of cash flow is not reckoned in such system of accounting. Similarly, in cases where accounts are based on accrual system of accounting, recognition of assets and liabilities is not dependent on the actual timing of cash spent on capital expenditure and cash inflow on account of capital receipt. Thus the financial statements prepared on accrual basis do not reflect the timing of the cash flow and amount of cash flow. The object of the cash flow statement is to assess theability to generate the cash flow in future and to assess reasons for difference betweent cashing cashcan be derived by eitherin which cash items of cash inflow are listed like cash received from customers, payment of interest etc. asws like payment to supplier, payment for taxes etc. or bych is also known asin which theis derived by adding to the net profititems like provision for taxes, provision for doubtful debts, loss on sale of fixed assets and investments, depreciation, amortization of intangibles etc. because these items do not. Similarly, profit on the sale of fixed assets and investments are deducted from the net income figure as these items also do not. Similarly, adjustments in respect of current assets and liabilities are also required to make to net income (loss) figure to arrives. Both the methods give the same results in respect of the finalof the major items of information in the cash flow statement is theow provided by (or used in) operating activities. In fact it is the regular source of cash in any enterprise that determines whether or not an enterprise will continue to exist in the long run. The logic for determining theflow from operating activities is to understand why net profit (loss) as reported in the profit and loss account must be converted. As we know that financial statements are generally prepared on accrual basis of accounting which requires that revenues be recorded when earned and the expenses be recorded when incurred. Earned revenues more often include credit sales that have not been collected in cash and expenses incurred that may not have been paid in cash during the accounting period. Thus under accrual basis of accounting net income will not indicate thecash provided byoperating activities or net loss will not indicate theed in operating activities. In order to calculate thecash provided by(or used in) operating activities, it is necessary to replace revenues and expenses on accrual basis with actual receipts and actual payments in cash. This is done by eliminating theash expenses from the given earned revenues and incurred expenses in the profit and loss account. In addition to regularash expense items, the profit and loss account is also debited and credited with purelyitems which reduce and increase the profits respectively but do not affect the cash at all e.g. depreciation, loss (or profit) on the sale of fixed assets, amortization of intangible assets like goodwill, patents trademarks etc. deferred revenue expenditures like preliminary expenses, discount on the issue of shares and debentures and so on. Sincecash provided byoperations is to be calculated, certainitems like rent income, interest income, dividend income, refund of tax etc. should also be adjusted although these items may have been recorded on cash basis. Such items are analysed separately in the cash flow statement as operating, investing and investing activities.Taking into account the above principles, it is clear that there are two methods ofi.e. direct and indirect. Both give identical results in the matter of the final total. They differ only in presentation of the data. They differ only in presentation of the data contained in the cash flows from operational activities. No reason has been given by the Consultants of MSRDC for rejecting the indirect method invoked by KPMG, Chartered Accountants of REL/HDEC in their letter dated 12.8.2005. The said method is known as. In this case, as stated above, the only reason given by the Consultants of MSRDC to exclude REL/HDEC was the negative impact on the future cash flows on account of the provisioning for doubtful debts in the accounts of HDEC for the FY 2001. If future cash impact was the basis to exclude REL/HDEC, then the Consultants for MSRDC should have considered cash flow reporting methods, which includes Reconciliation Method. There is no question of difference of opinion or different views as far as the application of cash flow reporting, which also falls in AS 3. There is nothing to show whether indirect method has at all been considered by Crisil, particularly when KPMG had invoked that method. There is no reason given for rejecting it. Lastly, in the PQ document, the referral years were three years. The criteria was that there should be NCP of not less than Rs.200 crores. However, the opinion of the Consultants proceeds on the basis that ifis allowed it may have future cash impact. In the evaluation process, the Consultants were entitled to take into account future cash impact but in order to do so they had to say why the indirect method ofshould not be accepted and if at all the impact of the provisioning was to be seen then there was no reason for not examining the audited accounts of 2004. There is aof two concepts here. The concept ofof financial criteria and the impact in future years on cash flow. As stated above, the very purpose ofis to find out the ability of HDEC to generate cash flow in future and if an important method of cash flow reporting is kept out, without any reason, then the decision to exclude REL/HDEC, is arbitrary, whimsical and unreasonable. In our view, forof the Reconciliation Method, under cash flow reporting system, the impugnedprocess stood vitiated.