The Ministry of Corporate Affairs (MCA), in collaboration with the National Financial Reporting Authority (NFRA), has notified the Companies (Accounting Standard) Rules, 2021. These rules apply to companies that are not mandated to follow Indian Accounting Standards (Ind AS) as per the Companies (Indian Accounting Standards) Rules, 2015. Effective from April 1, 2021, the rules bring editorial modifications and a substantial revision in the definition of Small and Medium-Sized Companies (SMCs).
The turnover threshold for SMCs has been raised from Rs. 50 crores to Rs. 250 crores, and the borrowing limit has been enhanced from Rs. 10 crores to Rs. 50 crores. These changes aim to broaden the scope of companies that can avail exemptions and simplified reporting requirements under the Companies Act, 2013.
Applicability of Companies (Accounting Standard) Rules, 2021
The Companies (Accounting Standard) Rules, 2021 are applicable to all non-Ind AS companies. These entities will continue to follow the traditional Accounting Standards framework, albeit with specific amendments and revised criteria to determine SMC status. The enhanced thresholds ensure that more companies, especially those with moderate operations, can benefit from streamlined compliance.
Defining Small and Medium-Sized Companies (SMCs)
To qualify as an SMC, a company must meet several conditions concerning its listing status, business nature, turnover, borrowings, and corporate relationships. These criteria are designed to identify entities that operate on a smaller scale compared to large corporations but still need an appropriate financial reporting framework.
Listing Status
A company must ensure that neither its equity nor debt securities are listed on any stock exchange in India or abroad. Additionally, it should not be in the process of listing such securities. This condition is intended to exclude public companies from availing SMC exemptions, as their financial disclosures are critical for market transparency.
Nature of Business
Companies operating as banks, financial institutions, or insurance companies are categorically excluded from being classified as SMCs. This exclusion ensures that entities with significant financial complexity and regulatory oversight are not subject to simplified reporting standards.
Turnover Threshold
An essential criterion for SMC classification is the turnover limit. The revised rules specify that a company’s turnover should not exceed Rs. 250 crores during the immediately preceding financial year. Importantly, turnover for this purpose excludes other income, thereby focusing solely on revenue generated from primary business operations.
Borrowing Limit
A company’s total borrowings, including public deposits, must not exceed Rs. 50 crores at any time during the immediately preceding financial year. Unlike turnover, which is assessed based on year-end figures, the borrowing criterion considers the peak borrowing during the financial year. Even if the borrowings exceed Rs. 50 crores momentarily, the company loses its SMC status.
Corporate Relationship
A company cannot qualify as an SMC if it is a holding company or a subsidiary of a company that is not an SMC. This condition is strictly limited to holding and subsidiary relationships and does not extend to associate companies or joint ventures.
Understanding Turnover Calculation
The rules clarify that turnover should be computed by excluding other income. Differentiating between revenue and other income is crucial for accurate classification. Revenue pertains to earnings from core business activities, while other income encompasses gains from non-operational sources.
For instance, profit from the sale of Property, Plant, and Equipment (PPE), if not part of the company’s regular business operations, should be recorded as other income. Conversely, proceeds from the sale of manufacturing scrap by a manufacturing company should be classified as other operating revenue, as it directly relates to the company’s core activities.
The turnover criterion is evaluated based on the figures of the immediately preceding financial year. If a company is assessing its SMC status for the financial year 2021-22, it must refer to its turnover in the financial year 2020-21. This ensures that the classification reflects recent business performance and operational scale.
Borrowing Criteria and Peak Borrowings
The borrowing limit for SMC classification is a critical factor that companies must monitor meticulously. A company’s total borrowings, which include public deposits, should not exceed Rs. 50 crores at any point during the immediately preceding financial year. The term borrowings broadly covers loans, debentures, bonds, and other forms of debt instruments issued by the company.
Unlike turnover, which is a static year-end figure, borrowings are assessed based on their peak level during the year. This means that even a temporary spike in borrowings beyond Rs. 50 crores would render the company ineligible for SMC classification for the following financial year.
For example, if a company borrows Rs. 55 crores in October but repays Rs. 10 crores by the financial year-end, its peak borrowing remains above the prescribed threshold. Consequently, the company will not qualify as an SMC for the subsequent year.
Impact of Holding and Subsidiary Relationships
A company’s relationship with its holding or subsidiary entities plays a pivotal role in determining its SMC status. Under the Companies (Accounting Standard) Rules, 2021, if a company is a holding or subsidiary of another entity that does not qualify as an SMC, it too will be categorized as a non-SMC. This provision is designed to prevent large corporate groups from segmenting operations to exploit SMC exemptions.
However, the scope of this restriction is confined to holding and subsidiary relationships. Unlike the Ind AS framework, associate companies and joint ventures are not considered for this classification criterion. The status of a company as a holding or subsidiary is determined based on its position as of the end of the relevant accounting period.
For example, if a company was a subsidiary of a non-SMC for part of the year but ceased to be a subsidiary by the financial year-end, it could potentially qualify as an SMC, provided all other conditions are met.
Determination Period for SMC Status
The Companies (Accounting Standard) Rules, 2021 specify that the assessment of SMC status should be based on the immediately preceding financial year. This ensures that the classification is reflective of the company’s most recent operational and financial scale. The rules are designed to provide a stable framework where companies consistently meeting SMC criteria over time can avail the associated exemptions and benefits.
Corporate Structure Considerations: Holding and Subsidiary Relationships
One of the critical factors in determining whether a company qualifies as a Small and Medium-Sized Company (SMC) under the Companies (Accounting Standard) Rules, 2021 is its relationship with other corporate entities. Specifically, a company will not be classified as an SMC if it is a holding or subsidiary company of another entity that does not meet the SMC criteria. This restriction ensures that large corporate groups cannot restructure operations to take undue advantage of exemptions intended for genuinely small and medium enterprises.
The relationship assessment focuses solely on holding and subsidiary connections. Unlike the Ind AS framework, associate companies and joint ventures are not included in this classification criterion. Therefore, a company that is an associate or joint venture of a non-SMC may still qualify as an SMC, provided it meets the other prescribed thresholds.
The determination of holding or subsidiary status is based on the company’s position at the end of the relevant financial period. If a company becomes a subsidiary of a non-SMC during the financial year but ceases to be a subsidiary by the year-end, it may still qualify as an SMC for that year.
Transition from Non-SMC to SMC: Waiting Period for Exemptions
The Companies (Accounting Standard) Rules, 2021 lay down specific guidelines for companies transitioning from non-SMC to SMC status. When a company, previously categorized as a non-SMC, meets all criteria to qualify as an SMC, it cannot immediately avail itself of the exemptions and relaxations provided to SMCs. Instead, it must consistently meet all SMC conditions for two consecutive accounting periods before becoming eligible for these benefits.
This provision is intended to prevent companies from making short-term structural adjustments to temporarily qualify for SMC exemptions. By enforcing a two-year compliance period, the rules ensure that only companies with a sustained scale of small or medium operations benefit from the simplified reporting framework.
For example, A Ltd., which was a non-SMC as of March 31, 2021, meets all SMC conditions by March 31, 2022. Despite this, A Ltd. is required to continue following full accounting standards for FY 2021-22. If the company maintains its SMC status through March 31, 2023, it will be eligible to apply SMC-specific exemptions and relaxations from FY 2022-23 onwards.
Transition from SMC to Non-SMC: Immediate Compliance with Full Standards
Conversely, if a company loses its SMC status, it must immediately comply with the full set of accounting standards applicable to non-SMCs from the current financial year. The transition from SMC to non-SMC is treated as an immediate change in compliance requirements, ensuring that companies with expanded scale or increased financial complexity are subject to comprehensive disclosure norms.
However, the Companies (Accounting Standard) Rules, 2021 provide relief concerning comparative figures. A company that ceases to qualify as an SMC is not required to restate or revise comparative figures of the previous financial year merely due to the change in classification. This provision mitigates the operational burden that could arise from retrospective adjustments.
For example, B Ltd., classified as an SMC as of March 31, 2021, fails to meet the SMC criteria by March 31, 2022. Consequently, B Ltd. must comply with the full accounting standards applicable to non-SMCs for FY 2021-22. However, it is not obligated to revise comparative figures of FY 2020-21. In its financial statements, B Ltd. must disclose that it was an SMC in the previous period and had availed exemptions accordingly.
Disclosure Requirements Following a Change in SMC Status
Transparency is a key principle in the Companies (Accounting Standard) Rules, 2021. When a company’s SMC status changes, it must provide specific disclosures in its financial statements. These disclosures ensure that stakeholders are informed about the basis of financial reporting applied during the reporting period.
When a company transitions from SMC to non-SMC, it must disclose that it had availed SMC-specific exemptions in the previous period. This disclosure is necessary to explain differences in the financial statement presentation and reporting compared to prior years. The rules mandate that such disclosure should be included in the notes to accounts section of the financial statements.
Similarly, companies transitioning from non-SMC to SMC status must also disclose their status and the timeline regarding eligibility for exemptions. For instance, a company that has met SMC criteria for the first time but is yet to complete the mandatory two-year compliance period should disclose that it is classified as an SMC but is not yet eligible to apply the associated exemptions.
Practical Scenarios of Status Change
Understanding practical scenarios where a company’s SMC status may change helps in comprehending the impact of these transitions. Here are two typical examples:
Example 1: Non-SMC to SMC Transition
Consider A Ltd., which was a non-SMC as of March 31, 2021. By March 31, 2022, A Ltd. meets all criteria for SMC classification. However, for FY 2021-22, A Ltd. is not permitted to avail SMC exemptions. If it continues to qualify as an SMC on March 31, 2023, it will become eligible for exemptions from FY 2022-23 onwards.
This two-year waiting period ensures that companies maintain a consistent scale before benefitting from simplified reporting.
Example 2: SMC to Non-SMC Transition
B Ltd., which was classified as an SMC as of March 31, 2021, fails to meet the SMC criteria by March 31, 2022. As a result, B Ltd. must follow full accounting standards for FY 2021-22. However, comparative figures for FY 2020-21 need not be restated. In its financial statements, B Ltd. should disclose that it was an SMC in the preceding year and had availed exemptions accordingly.
These scenarios underscore the importance of maintaining consistent compliance with SMC criteria to ensure seamless reporting and disclosure practices.
Impact of Borrowing and Turnover Fluctuations on Status
Borrowing and turnover levels play a crucial role in a company’s SMC classification. Companies must closely monitor these financial metrics throughout the financial year, as even temporary breaches of thresholds can affect their eligibility.
For borrowings, the rules stipulate that the Rs. 50 crores limit applies to the peak borrowing at any point during the year. This means a short-term borrowing spike, even for a day, can disqualify a company from being an SMC. Companies must therefore manage their financing activities carefully to avoid unintended status changes.
Turnover assessments are based on the immediately preceding financial year’s figures, which provide a more stable basis for classification. However, companies with seasonal or cyclical business models need to be particularly vigilant, as fluctuations in turnover can lead to status transitions that affect their reporting obligations.
Corporate Structure Realignment and SMC Status
Changes in a company’s corporate structure, particularly in its holding and subsidiary relationships, can have a direct impact on its SMC status. Companies engaged in mergers, demergers, or acquisitions must evaluate the resultant structure to determine their eligibility under the revised SMC criteria.
For instance, a company that becomes a subsidiary of a large corporate group during a financial year might lose its SMC status if the parent company does not qualify as an SMC. Conversely, a company that undergoes a demerger and operates independently by the financial year-end could regain SMC classification, provided other criteria are met.
Companies planning structural changes must conduct a thorough assessment of how these changes impact their SMC status. Early identification of potential implications allows companies to align their financial reporting strategies accordingly.
Broader Implications of the Revised SMC Definition
The revised criteria for Small and Medium-Sized Companies (SMCs) under the Companies (Accounting Standard) Rules, 2021 bring significant implications for the corporate landscape. By increasing the turnover threshold from Rs. 50 crores to Rs. 250 crores and the borrowing limit from Rs. 10 crores to Rs. 50 crores, the Ministry of Corporate Affairs (MCA) has effectively broadened the scope of companies eligible for simplified financial reporting requirements.
This change is a recognition of the evolving scale of Indian businesses. Companies that previously operated on the fringes of the SMC thresholds but were still relatively small in their operations can now benefit from the regulatory relaxations and reduced compliance burden that SMC classification offers. The revised criteria aim to foster ease of doing business by aligning financial reporting obligations with a company’s operational complexity.
Benefits of Being Classified as an SMC
The advantages of qualifying as an SMC are multi-fold. Companies that meet the SMC criteria under the Companies (Accounting Standard) Rules, 2021 are entitled to a range of exemptions and relaxations in accounting standards, which can significantly reduce the cost and complexity of financial reporting.
Simplified Disclosure Requirements
One of the primary benefits of SMC classification is the reduction in disclosure requirements. SMCs are permitted to furnish fewer disclosures in their financial statements compared to larger entities. This not only reduces the administrative burden but also makes the financial statements more concise and focused on material information relevant to stakeholders.
Exemptions from Specific Accounting Standards
Certain accounting standards provide exemptions or simplified treatments exclusively for SMCs. For example, SMCs may be exempt from the detailed requirements of segment reporting, simplified disclosure obligations concerning related party transactions, and may not be required to present cash flow statements. These exemptions are designed to ensure that the cost of compliance does not outweigh the benefits of disclosure for smaller entities.
Lower Compliance Costs
Comprehensive compliance with all accounting standards can be a costly affair, particularly for small and medium-sized enterprises with limited resources. SMC classification helps alleviate this burden by streamlining reporting obligations. The reduced complexity in financial reporting translates to lower audit fees, fewer hours dedicated to financial statement preparation, and overall savings in compliance-related expenses.
Flexibility in Adoption of Accounting Policies
SMCs enjoy greater flexibility in the adoption of certain accounting policies. For example, they may opt for simplified recognition and measurement criteria in areas like lease accounting, deferred taxes, and financial instruments. This flexibility aligns the accounting practices of SMCs with the scale and nature of their business operations.
Challenges in Applying the Revised SMC Criteria
While the revised SMC definition offers several benefits, companies may face practical challenges in maintaining compliance. The process of determining and preserving SMC status requires continuous monitoring and robust internal controls.
Monitoring Borrowing Limits Throughout the Year
One of the significant challenges is the assessment of the borrowing threshold. Unlike turnover, which is evaluated based on year-end figures, borrowings are assessed based on peak levels during the financial year. A temporary breach of the Rs. 50 crores limit, even for a single day, can disqualify a company from SMC classification.
Companies must implement rigorous tracking mechanisms to monitor borrowing levels on a real-time basis. This may necessitate changes in treasury operations, financing strategies, and debt management policies to ensure that the borrowing threshold is not inadvertently breached.
Complexity in Distinguishing Revenue from Other Income
The revised rules stipulate that turnover should be computed excluding other income. For companies with diverse business models, accurately distinguishing between revenue from core operations and other income can be challenging. Misclassification can lead to erroneous assessments of SMC eligibility, resulting in non-compliance.
Companies need to establish clear accounting policies and internal guidelines to ensure the accurate classification of income streams. Regular reviews of accounting treatments and consultation with auditors can help mitigate the risk of misclassification.
Corporate Restructuring and SMC Status Implications
Corporate restructuring activities such as mergers, acquisitions, or demergers can have direct implications on a company’s SMC status. If a company becomes a holding or subsidiary of a non-SMC as a result of restructuring, it will lose its SMC classification.
Companies planning such transactions must conduct a thorough assessment of the resultant corporate structure and its impact on SMC eligibility. Early identification of these implications allows companies to plan their reporting strategies accordingly and avoid unexpected compliance requirements.
Transition Period Constraints
The two-year waiting period for companies transitioning from non-SMC to SMC status before they can avail exemptions poses a challenge for businesses seeking immediate relief. Companies must sustain compliance with SMC criteria for two consecutive financial years before they can benefit from the simplified reporting framework.
This provision necessitates strategic planning and disciplined financial management to ensure consistent qualification. Companies must align their long-term operational strategies with the objective of maintaining SMC status.
Strategic Considerations for Maintaining SMC Status
Given the operational and compliance benefits of SMC classification, companies must adopt proactive strategies to preserve their SMC status. This involves meticulous financial planning, vigilant monitoring of compliance parameters, and strategic decision-making.
Financial Planning and Debt Management
To avoid inadvertent breaches of the borrowing threshold, companies need to adopt conservative financing strategies. This could involve diversifying funding sources, optimizing working capital cycles, and avoiding short-term spikes in borrowings that could jeopardize SMC eligibility.
Treasury teams must coordinate closely with finance and compliance functions to monitor borrowings in real-time. Implementing automated tracking tools and setting internal borrowing caps below the regulatory threshold can serve as effective risk mitigation measures.
Revenue Management and Classification Policies
Clear guidelines for revenue recognition and classification are essential to ensure compliance with the turnover criterion. Companies should establish robust internal controls to differentiate between core revenue and other income, especially in cases where ancillary activities contribute significantly to overall earnings.
Periodic internal audits focusing on revenue classification and consistency in accounting treatments can help ensure accurate reporting. Engaging with external auditors to validate the classification approach further strengthens compliance.
Corporate Structure Alignment
Companies must evaluate their corporate structure periodically to assess its impact on SMC classification. In cases where a company is part of a larger group, careful consideration should be given to the holding and subsidiary relationships to ensure continued eligibility as an SMC.
Strategic decisions such as restructuring, spin-offs, or operational independence initiatives must factor in their implications on SMC status. Legal and compliance teams should collaborate to assess the potential impact of such changes and advise management accordingly.
Regulatory Trends and Future Outlook
The revision of SMC criteria reflects the regulatory intent to align compliance obligations with the operational realities of businesses. As the Indian economy evolves, further refinements in financial reporting frameworks are anticipated to support the growth of small and medium enterprises.
Regulators are likely to continue focusing on simplifying compliance requirements for businesses with moderate operational scales. Future amendments may involve further revisions in thresholds, introduction of sector-specific criteria, or enhanced clarity on accounting treatments.
Companies must stay abreast of regulatory developments and proactively adapt their compliance strategies to leverage available exemptions while ensuring adherence to reporting obligations.
Impact on Financial Reporting Ecosystem
The expanded SMC criteria have a cascading impact on the broader financial reporting ecosystem. Auditors, financial advisors, and regulatory bodies must align their methodologies to accommodate the increased number of entities falling within the SMC bracket.
Auditors will need to recalibrate their audit plans, focusing on the simplified disclosure requirements applicable to SMCs. Financial advisors must assist companies in interpreting the nuances of SMC criteria and optimizing their compliance frameworks.
From a regulatory perspective, the challenge lies in ensuring that the relaxations do not compromise the quality and reliability of financial disclosures. Continuous engagement between regulators and industry stakeholders is essential to balance the dual objectives of simplifying compliance and maintaining robust financial reporting standards.
Conclusion
The revision of the Small and Medium-Sized Companies (SMCs) criteria under the Companies (Accounting Standard) Rules, 2021 marks a pivotal step towards simplifying financial reporting obligations for a broader spectrum of Indian businesses. By expanding the turnover threshold to Rs. 250 crores and the borrowing limit to Rs. 50 crores, the Ministry of Corporate Affairs has addressed the long-standing concerns of businesses operating at a moderate scale, enabling them to benefit from exemptions and relaxed reporting standards that were previously out of reach.
This regulatory shift not only eases the compliance burden but also promotes operational efficiency, allowing SMCs to channel their resources into business growth rather than navigating complex accounting requirements. The exemptions from detailed disclosures, simplified accounting treatments, and reduced compliance costs create an environment that fosters entrepreneurship and supports the financial reporting needs of businesses aligned with their scale of operations.
However, the pathway to achieving and maintaining SMC status demands rigorous internal governance. Companies must actively monitor their turnover and borrowings, ensuring adherence to the prescribed thresholds throughout the financial year. The nuances of peak borrowing assessment, correct revenue classification, and careful corporate structuring require strategic foresight and disciplined financial management.
Moreover, the transition rules, particularly the mandatory two-year compliance period before availing SMC exemptions, necessitate long-term planning. Companies must align their financial strategies with these regulatory timelines to effectively leverage the benefits of SMC classification. Simultaneously, transparent disclosures during status transitions uphold the integrity of financial statements and maintain stakeholder trust.
From a broader perspective, these revisions align with India’s vision of enhancing the ease of doing business. By reducing the compliance complexity for genuine small and medium enterprises, the revised rules empower a critical segment of the economy, enabling them to operate with greater agility while maintaining financial transparency.
As the business landscape continues to evolve, it is essential for companies, auditors, and regulatory bodies to maintain a collaborative approach. Companies must stay informed of regulatory updates, auditors must adapt their methodologies to reflect the revised compliance framework, and regulators must ensure a balance between simplification and robustness of financial reporting.
In essence, the revised SMC criteria under the Companies (Accounting Standard) Rules, 2021 not only simplify the compliance landscape but also encourage businesses to pursue growth with confidence. The success of this regulatory framework will depend on proactive compliance, strategic financial planning, and a collective commitment to upholding the quality of financial reporting in India’s dynamic corporate environment.