Small and Medium Companies (SMCs) often do not have the same level of resources, systems, or personnel as large enterprises. Recognising this, Indian Accounting Standards provide certain exemptions and relaxations to ease the financial reporting burden on these entities. These concessions are primarily offered to companies classified as SMCs under the Companies (Accounting Standards) Rules, and in some cases, similar relief is also provided to one-person companies, small companies, and dormant companies. We introduce two significant areas of exemption—cash flow statements under AS 3 and employee benefit accounting under AS 15.
Cash Flow Statement Exemption Under AS 3
According to the Companies Act, 2013, financial statements typically include a cash flow statement. However, for specific companies like one-person companies, small companies, and dormant companies, this requirement may be excluded. Accounting Standard 3 (AS 3) provides an exemption from the preparation of cash flow statements to these companies.
While this exemption is not directly tied to the definition of an SMC under the Rules, it is generally expected that most one-person companies, small companies, and dormant companies would also qualify as SMCs. Therefore, the exemption serves a broader purpose by accommodating smaller entities with limited resources for financial reporting.
Definition of a One-Person Company
Section 2(62) of the Companies Act, 2013,, defines a one-person company as a company that has only one person as its member. This structure allows a single individual to operate a corporate entity with limited liability, subject to certain conditions and regulatory requirements. One-person companies are eligible for several compliance relaxations, including the exemption from preparing a cash flow statement.
Definition and Thresholds for a Small Company
Section 2(85) of the Companies Act, 2013 defines a small company as a company, other than a public company, that meets both of the following criteria:
Paid-up share capital does not exceed two crore rupees
Turnover does not exceed twenty crore rupees as per the last profit and loss account.
The criteria are cumulative, meaning both the capital and turnover conditions must be satisfied. Certain types of companies are explicitly excluded from being classified as small companies, even if they meet the thresholds. These include holding and subsidiary companies, companies registered under Section 8, and companies governed by special Acts.
The Companies (Specification of Definitions Details) Rules, 2014, were amended with effect from April 1, 2021. Clause (t) of Rule 2, Sub-rule (1) confirms that the paid-up capital and turnover limits for a small company are now fixed at two crores and twenty crores respectively. These increased limits are intended to broaden the scope of companies that can benefit from the exemptions under this classification.
Definition and Regulatory Framework for Dormant Companies
Section 455 of the Companies Act, 2013, addresses the concept of dormant companies. A dormant company is formed for a future project or to hold an asset or intellectual property, and does not have significant accounting transactions. The Act also includes the term “inactive company” under this provision, referring to entities that have not carried on any business or filed financial statements or annual returns during the past two financial years.
Significant accounting transactions exclude basic compliance-related activities such as payment of fees to the Registrar, statutory payments, share allotments for regulatory purposes, and office maintenance expenses. Dormant companies can apply to the Registrar of Companies (ROC) for dormant status, and the ROC may issue a certificate upon approval.
Dormant companies must maintain a minimum number of directors, file prescribed documents, and pay annual fees to retain their dormant status. They can later apply to become active companies. However, failure to comply with regulatory requirements may result in their name being struck off the register of dormant companies.
Although AS 3 does not explicitly mention SMCs, it is presumed that most one-person companies, small companies, and dormant companies will fall under the SMC category and thus be eligible for the exemption from preparing a cash flow statement.
Overview of AS 15 on Employee Benefits
Accounting Standard 15 (AS 15) addresses the recognition, measurement, and disclosure of employee benefits. SMCs are granted certain relaxations under this standard, especially in complex areas involving actuarial valuations and detailed disclosures. The key areas of exemption or relief for SMCs under AS 15 include short-term compensated absences, defined contribution and defined benefit plans, other long-term employee benefits, offset and presentation rules, and certain disclosures.
Short-Term Compensated Absences
Companies often compensate employees for absence due to vacation, sickness, short-term disability, or parental leave. These compensated absences fall into two categories—accumulating and non-accumulating.
Accumulating absences are those that can be carried forward if unused, and they may be either vesting or non-vesting. Vesting absences are payable in cash even if the employee leaves, while non-vesting absences are forfeited if unused. An obligation exists for both types, but measurement varies depending on whether the benefit is expected to result in a payment.
For accumulating compensated absences, companies must recognize a liability as employees render service that increases their entitlement. This recognition must account for expected usage patterns and the likelihood of leave being taken.
Non-accumulating compensated absences are recognized only when the leave is taken. This makes the accounting simpler but limits early liability recognition.
An SMC is not required to apply the recognition and measurement requirements of AS 15 for short-term accumulating compensated absences if the absences are non-vesting. In other words, if employees are not entitled to a cash payout for unused leave upon resignation or retirement, the SMC is exempt from accruing liability for these benefits in the current period.
If a company’s leave policy permits encashment of unavailed leave, the absences are considered vesting, and the exemption does not apply. The SMC would then be required to comply with full recognition and measurement under AS 15.
Defined Contribution Plan Obligations Extending Beyond Twelve Months
Examples of defined contribution plans include contributions to Employee Provident Fund, government plans, and certain insurance schemes. AS 15 requires that contributions not due within twelve months after the reporting period must be discounted to present value.
SMCs are exempt from this requirement and may recognize such obligations on a gross, undiscounted basis. This avoids the need for complex discounting calculations and actuarial inputs.
Defined Benefit Plan and Other Long-Term Employee Benefits
Defined benefit plans obligate a company to provide agreed-upon benefits to employees, such as gratuity or pensions. AS 15 mandates several steps for accounting for these obligations, including actuarial valuation, use of the Projected Unit Credit Method, discounting future benefits, determining plan asset values, and recognising actuarial gains or losses.
SMCs are not required to follow these comprehensive recognition and measurement requirements. However, they must still determine and provide for accrued liability through actuarial valuation using the Projected Unit Credit Method and a discount rate based on market yields on government bonds.
This partial exemption eases compliance while still ensuring that companies account for material liabilities using reliable methods.
Offset and Presentation Requirements
AS 15 permits offsetting of plan assets and liabilities only under specific conditions: a legally enforceable right to offset and an intention to settle on a net basis. It does not prescribe how to present individual cost components, such as service cost or interest cost, in the profit and loss statement.
SMCs are exempt from complying with these offset and presentation requirements for defined benefit plans. This allows greater flexibility in reporting and reduces disclosure complexity.
Disclosures for Defined Benefit Plans
AS 15 prescribes extensive disclosures for defined benefit obligations, including plan descriptions, accounting policies, actuarial assumptions, reconciliation of balances, and components of expenses.
SMCs are exempt from these disclosure requirements, with one exception. They must still disclose the actuarial assumptions used, as required by paragraph 120(l) of the Standard. This minimum disclosure ensures transparency without overwhelming smaller companies with compliance burdens.
Termination Benefits
Termination benefits include payments to employees resulting from voluntary retirement schemes or company-initiated terminations. AS 15 requires these benefits to be recognised as a liability and an expense when there is a present obligation, probable outflow of resources, and a reliable estimate can be made.
SMCs are permitted to avoid discounting termination benefit obligations due beyond twelve months, simplifying the accounting process.
Transitional Provisions for Defined Benefit Obligations
When a company first adopts AS 15 under the applicable Rules, it must determine its transitional liability. This is calculated as the present value of the obligation on the adoption date, minus the fair value of plan assets and any past service cost that should be recognised in later periods. If the resulting transitional liability is greater than what was recognised under the previous version of AS 15, the enterprise must choose one of two options:
Recognise the increase immediately as an adjustment to the opening balance of revenue reserves and surplus, adjusted for tax..
Recognise the increase as an expense over a maximum period of five years from the date of adoption.on
This choice, once made, is irrevocable.
If the transitional liability is lower than what was previously recognised, the difference must be adjusted immediately against the opening balance of revenue reserves and surplus.
For example, assume an enterprise has recognised a pension liability of 100 under the old standard. Under the new standard, the present value of the obligation is 1300, and plan assets are worth 1000. If a cost of 160 for non-vested benefits is to be recognised over ten years, the transitional liability would be 236. The increase in liability is 136. The company may choose to recognise this amount immediately or amortise it over five years.
If the company chooses amortisation, it must monitor and disclose unrecognised amounts and limit the recognition of actuarial gains only when the net cumulative unrecognised actuarial gains exceed the unrecognised transitional liability.
At the end of the first year post-adoption, assume the net unrecognised actuarial gain is 120 and the unrecognised transitional liability is 109. Only 11 can be recognised as an actuarial gain due to the imposed limit. This ensures a gradual transition to full compliance with the updated accounting standards.
Transition Provision for Other Employee Benefit Obligations
For employee benefits other than defined benefit plans and termination benefits, AS 15 requires that any difference in liability due to the adoption of the standard be adjusted against the opening balance of revenue reserves and surplus, adjusted by any related tax effects. This applies when a company first adopts AS 15 and experiences a change in accounting treatment that leads to an increase or decrease in the recognised liability.
This transition provision simplifies the adoption process and allows companies to avoid restating comparative periods or building complex reconciliations.
Accounting Standard 17 – Segment Reporting
AS 17 requires enterprises to disclose information about their operating segments. This includes identifying primary and secondary segments, reporting segment revenue, assets, liabilities, and other relevant data. The purpose is to enable stakeholders to evaluate the performance and risk profile of different parts of the business.
However, AS 17 is not mandatory for SMCs. While such companies are encouraged to comply voluntarily, they are not required to report segment information unless they choose to do so. This exemption recognises the operational and financial limitations faced by SMCs, which may not maintain detailed internal reporting systems that support segment analysis.
Accounting Standard 19 – Leases
AS 19 guides how lessees and lessors should account for finance and operating leases. It includes requirements for recognition, measurement, and disclosure. SMCs are granted several disclosure exemptions under this standard.
Lessee Disclosures in Case of Finance Lease
SMCs are exempted from certain disclosures typically required from lessees in finance lease arrangements. These exemptions include:
Reconciliation between total minimum lease payments and their present value
Disclosure of minimum lease payments and their present value for periods not later than one year, between one and five years, and later than five years
Disclosure of total future minimum sublease payments expected to be received under non-cancellable subleases
General description of significant leasing arrangements, including the basis for determining contingent rent, renewal or purchase options, escalation clauses, and restrictions imposed by the lease
These exemptions aim to reduce the reporting burden on SMCs, particularly those that may not have large or complex leasing arrangements.
Lessee Disclosures in Case of Operating Lease
SMCs are also exempt from certain disclosures related to operating leases. The specific disclosure exemptions include:
Total future minimum lease payments under non-cancellable leases broken down into periods
Total future minimum sublease payments expected to be received under non-cancellable subleases
General description of the lessee’s significant leasing arrangements, such as the basis for contingent rent payments, terms of renewal or purchase options, escalation clauses, and any restrictions imposed by the lease
These reliefs are especially beneficial for smaller businesses that rely on operating leases for office space or equipment, reducing the need for complex reporting.
Lessor Disclosures in Case of Finance Lease
In finance leases where the SMC is the lessor, the standard requires disclosure of investment in the lease and reconciliation between gross investment and the present value of lease payments receivable.
However, SMCs are exempt from these disclosure requirements. The specific exemptions are:
Reconciliation between total gross investment and the present value of minimum lease payments receivable
Disclosure of gross investment and present value of lease payments receivable for periods not later than one year, between one and five years, and later than five years
General description of significant leasing arrangements, including key terms and conditions
These exemptions recognise the limited reporting capacity of smaller lessors, especially those engaged in low-volume or short-term leasing activities.
Purpose of Lease Disclosures and Justification for Exemptions
In larger enterprises, lease disclosures play an important role in understanding off-balance sheet obligations and financial risk. However, for SMCs with limited exposure to leasing activities or with simple leasing terms, the effort and cost involved in preparing detailed lease disclosures may not be justified by the benefit to stakeholders.
Exempting SMCs from these requirements allows them to focus on key financial metrics while avoiding unnecessary complexity. At the same time, if an SMC has material lease arrangements, it is encouraged to voluntarily disclose the most relevant information to ensure transparency for stakeholders.
AS-13: Accounting for Investments
In AS-13, SMCs are exempt from disclosing the market value of current investments if it is different from the carrying amount. This exemption simplifies reporting obligations for SMCs that may not have access to regular market valuations or may consider the cost of such disclosures burdensome. The objective behind this relaxation is to reduce the effort of measuring and disclosing frequent fair value changes, which may not significantly impact the users of SMCs’ financial statements.
AS-15: Employee Benefits
SMCs are given significant relief under AS-15, particularly concerning defined benefit plans and long-term employee benefits. They are not required to use actuarial valuation methods such as the Projected Unit Credit Method, which can be both costly and complex. Instead, SMCs may apply simplified methods of measurement for estimating liabilities. Moreover, detailed disclosures regarding assumptions, plan descriptions, and reconciliation statements are not mandatory. This exemption is crucial for entities that do not have access to actuarial expertise or wish to avoid additional compliance costs.
AS-17: Segment Reporting
AS-17 requires entities to disclose financial information by business and geographical segments. However, SMCs are fully exempted from this requirement. The rationale is that segment reporting is primarily useful for listed companies and large enterprises whose stakeholders require such information to make informed decisions. For SMCs, especially those with a narrow product or geographic focus, the benefit of segment reporting does not justify the added effort and cost.
AS-18: Related Party Disclosures
Under AS-18, SMCs are exempt from disclosing details of transactions with related parties in some cases, especially if such disclosures would result in unwarranted detail or breach of confidentiality. However, material related party transactions still need to be disclosed if they are likely to influence decisions of users of the financial statements. This exemption balances the need for transparency with the confidentiality needs of closely held companies.
AS-19: Leases
SMCs are not required to make detailed disclosures prescribed under AS-19 for finance leases and operating leases. They are only expected to provide minimal information sufficient to understand lease obligations. This is particularly helpful for smaller businesses with limited leasing activities or basic lease arrangements.
AS-20: Earnings Per Share (EPS)
AS-20 mandates the presentation of basic and diluted EPS. However, SMCs are exempt from disclosing EPS, given that many of them are not listed entities or do not have complex capital structures. Since EPS is primarily a performance metric for investors, it is less relevant for private or closely held companies. The relaxation removes unnecessary complexity from their financial reporting.
AS-22: Accounting for Taxes on Income
While AS-22 applies to all entities, SMCs receive partial relief in disclosure requirements. They are not required to present a detailed reconciliation of tax expenses and accounting profits. This simplifies tax reporting and helps reduce compliance costs for smaller entities that do not engage in complex tax planning or international operations.
AS-28: Impairment of Assets
Although SMCs must recognize impairment losses, they are exempt from making elaborate disclosures related to assumptions, discount rates, and recoverable amounts used in impairment tests. This exemption acknowledges the practical challenges SMCs face in performing rigorous impairment assessments that are typically more relevant to larger, asset-heavy companies.
AS-29: Provisions, Contingent Liabilities, and Contingent Assets
SMCs are not required to provide detailed disclosures such as expected reimbursements or detailed movement of provisions during the period. They only need to disclose material provisions and contingencies. This simplification helps in focusing on significant financial risks without overloading the financial statements with technical details that may not be useful for general-purpose users.
Impact of Exemptions and Relaxations on Financial Reporting
The exemptions and relaxations provided to SMCs are designed to ease their financial reporting burden without compromising the quality of information that stakeholders need. These measures directly impact how financial statements are prepared, the level of disclosure, and the extent of professional judgment required. For example, the relaxation in disclosure requirements under AS 15 enables SMCs to omit complex actuarial valuation disclosures, reducing reliance on external consultants and thus lowering costs. Similarly, simplified requirements in AS 19 relieve SMCs from certain detailed lease-related calculations that may be burdensome without material benefit.
Moreover, these exemptions promote the timeliness and relevance of financial reporting by allowing SMCs to concentrate on the essentials. A streamlined approach can help small entities focus on the primary objective of financial statements—providing a true and fair view of the financial position and performance—without getting lost in technical complexities that have little bearing on their operational scale. However, stakeholders such as banks, investors, or regulators must be aware of these exemptions so they can properly interpret the scope and depth of the information provided.
Auditor’s Perspective on SMC Exemptions
From the auditor’s perspective, the application of exemptions and relaxations by SMCs changes the scope of audit procedures. Auditors must first confirm the entity’s classification as an SMC by the Companies (Accounting Standards) Rules, 2021. This classification directly affects which standards are fully applicable and which are not. Once classification is confirmed, auditors need to document the exemptions availed and assess the appropriateness of such applications during the audit.
The auditor must also ensure that the entity has made adequate disclosures in its financial statements about the application of the SMC classification and any consequential non-application of specific accounting standard provisions. Any misclassification or misapplication of exemptions can lead to a qualified or adverse opinion in the audit report. Therefore, despite reduced compliance requirements, an SMC must maintain proper documentation to support its accounting treatments and justifications for availing the exemptions.
Benefits of the SMC Framework
The framework for SMCs provides several clear advantages. Most significantly, it reduces the overall cost of compliance, making financial reporting more affordable and accessible for smaller entities. Many SMCs lack dedicated finance teams or in-house accounting expertise, so simplifying accounting requirements supports timely and accurate reporting with limited resources. Additionally, it promotes entrepreneurship by removing regulatory roadblocks that might otherwise discourage formal financial reporting or discourage business incorporation.
From a regulatory perspective, it enables the authorities to achieve a proportionate level of oversight by focusing on full accounting standard compliance on larger entities where the stakes and impact are more significant. The SMC framework also aligns with global trends where similar relief is provided to small and medium-sized entities under IFRS for SMEs or regional equivalents.
Limitations and Areas for Caution
Despite the benefits, certain limitations must be acknowledged. First, excessive reliance on exemptions could lead to inconsistency in financial statements across companies, making comparative analysis difficult. Secondly, certain stakeholders—particularly banks or investors—may prefer or require full disclosures regardless of the SMC classification, meaning SMCs might need to maintain parallel systems or voluntarily disclose more than what’s mandated.
There is also the risk of misuse, where companies may structure themselves artificially to qualify as SMCs and avoid full compliance. This calls for careful monitoring and robust enforcement by regulatory bodies such as the Ministry of Corporate Affairs (MCA) and the Institute of Chartered Accountants of India (ICAI). Additionally, users of financial statements must remain aware of the exempted disclosures to correctly interpret the information presented.
Regulatory Evolution and Future Outlook
The regulatory framework for SMCs continues to evolve, with ICAI and MCA periodically reviewing the thresholds and exemptions to keep them in line with economic realities. As Indian businesses grow and diversify, and as the country further integrates into the global financial system, the balance between simplification and transparency becomes crucial. Regulatory bodies are also exploring the adoption of Ind AS for SMEs voluntarily in the future, which would further harmonize Indian accounting practices with international norms.
There is also a possibility that technology-enabled accounting platforms could reduce the cost burden of compliance, potentially allowing for more rigorous financial reporting even among SMCs. However, until such efficiencies are universally accessible, the existing exemptions continue to provide necessary relief to small and medium enterprises.
Conclusion
The introduction and implementation of exemptions and relaxations in accounting standards for Small and Medium Companies represent a pragmatic approach to financial reporting. It offers relief to smaller businesses while maintaining sufficient standards to ensure accountability and transparency. By tailoring compliance requirements to the scale of operations, this framework allows businesses to focus on growth while upholding fundamental principles of sound financial reporting. However, it also requires careful application, transparent disclosure, and responsible oversight to ensure that the intent of the framework is preserved and not misused.