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 are specifically applicable to companies that are not required to comply with Indian Accounting Standards (Ind AS), commonly referred to as non-Ind AS companies.
The new rules came into effect for accounting periods commencing on or after April 1, 2021. These rules bring certain editorial updates to existing accounting standards and significantly revise the criteria for identifying Small and Medium-Sized Companies (SMCs). This revision involves increasing the turnover limit from Rs. 50 crores to Rs. 250 crores and raising the borrowing limit from Rs. 10 crores to Rs. 50 crores.
Understanding these revised criteria is important for companies to determine their classification as an SMC or otherwise, which in turn affects the accounting standards and exemptions applicable to them.
Background and Purpose of Revising the SMC Definition
The Companies Act, 2013 mandates companies to follow prescribed accounting standards to ensure transparency, consistency, and reliability of financial statements. However, recognizing the varied scale of businesses, the MCA introduced simplified accounting norms for smaller companies to ease their compliance burden.
With the evolving business environment and inflationary pressures, the limits defining small and medium-sized companies required revision. The Companies (Accounting Standard) Rules, 2021 aim to provide a more realistic and inclusive framework that reflects contemporary business scales, allowing a larger segment of companies to benefit from simpler accounting requirements.
By raising the turnover and borrowing thresholds, the rules also help companies to better align their financial reporting with their operational scale and risk profile.
Revised Definition of Small and Medium-Sized Companies
Criteria to Qualify as an SMC
Under the revised Companies (Accounting Standard) Rules, an entity qualifies as a Small and Medium-Sized Company if it fulfills all the following conditions:
- The company’s equity or debt securities are neither listed nor in the process of being listed on any stock exchange, whether within India or internationally. This ensures that publicly traded companies, which are subject to more rigorous reporting norms, are excluded from the SMC category.
- The company is not a bank, financial institution, or insurance company. These entities operate under distinct regulatory frameworks and are outside the scope of this classification.
- The company’s turnover, excluding other income, does not exceed Rs. 250 crores during the immediately preceding financial year. This increased turnover cap widens the applicability of simplified accounting standards.
- The company’s borrowings, including public deposits, have not exceeded Rs. 50 crores at any point during the immediately preceding financial year. The borrowing limit is evaluated based on peak borrowings during the year rather than the closing balance.
- The company is not a holding or subsidiary company of an entity that is not classified as an SMC. This holding/subsidiary test ensures that group companies are assessed consistently.
Understanding the Holding and Subsidiary Relationship in SMC Classification
A key aspect of the revised definition is the impact of holding and subsidiary relationships on SMC status. A company may meet turnover and borrowing thresholds independently but will be treated as a non-SMC if it is a holding or subsidiary company of a non-SMC.
This condition prevents companies in groups with large entities from circumventing accounting standards designed for larger companies by sheltering under the SMC classification.
The assessment of the holding or subsidiary status is made at the end of the relevant accounting period. This ensures that companies reflect their group position as it stands during the reporting period.
The criterion applies strictly to holding and subsidiary relationships and does not extend to other types of associations such as joint ventures or associate companies, differentiating it from the classification approach under Indian Accounting Standards.
Turnover Criteria and its Application
Definition and Components of Turnover for SMCs
For the purpose of determining whether a company qualifies as an SMC, turnover is defined as the total revenue earned from the company’s core business activities, excluding other income. The exclusion of other income ensures that the turnover reflects operational scale and does not include incidental or non-operating income streams.
Items classified as other income include profits or losses from the sale of fixed assets, investments, or other transactions not related to the primary business activities.
Examples Illustrating the Turnover Definition
To clarify the distinction between turnover and other income, consider the example of a manufacturing company. If this company sells scrap generated during the manufacturing process, the revenue from scrap sales would be included in turnover since it arises directly from the company’s operations.
In contrast, if the same company sells a piece of machinery or equipment, the resulting profit or loss from this sale would be recorded under other income because such sales do not constitute a part of the company’s regular business operations.
This classification is important because it affects the assessment of whether the company’s turnover exceeds the Rs. 250 crores threshold.
Assessing Turnover for SMC Status
Companies must evaluate their turnover based on the immediately preceding financial year. For example, to determine the SMC status for the financial year 2021-22, the turnover from the financial year 2020-21 should be used.
This retrospective assessment ensures consistency and helps companies plan their financial reporting requirements accordingly.
Borrowing Criteria for Small and Medium-Sized Companies
Definition of Borrowings under the Revised Rules
While the Companies (Accounting Standard) Rules, 2021 do not explicitly define “borrowings,” the term encompasses all forms of loans, debentures, bonds, and other debt instruments issued by the company, including public deposits.
Measurement of Borrowings for SMC Classification
The borrowing limit of Rs. 50 crores applies to the maximum amount of borrowings outstanding at any point during the immediately preceding financial year. This differs from turnover, which is measured cumulatively.
For instance, if a company borrowed Rs. 60 crores temporarily during the year but repaid Rs. 20 crores before the financial year-end, its peak borrowing was Rs. 60 crores, exceeding the threshold. Hence, the company would be classified as a non-SMC for that year, regardless of the year-end borrowing balance.
Implications of Borrowing Limits on SMC Status
The borrowing threshold serves as a mechanism to identify companies that have limited reliance on external debt. Companies exceeding the Rs. 50 crores borrowing limit are required to follow the full set of accounting standards without any relaxations intended for smaller companies.
This borrowing criterion aims to reflect the risk profile of companies more accurately, as higher borrowing levels often imply greater financial complexity and scrutiny.
Key Criteria for SMC Classification
To summarize, a company must satisfy all the following conditions to qualify as an SMC under the Companies (Accounting Standard) Rules, 2021:
- Unlisted equity or debt securities
- Not a bank, financial institution, or insurance company
- Turnover (excluding other income) not exceeding Rs. 250 crores in the immediately preceding financial year
- Borrowings including public deposits not exceeding Rs. 50 crores at any time during the immediately preceding financial year
- Not a holding or subsidiary of a non-SMC company
Meeting these criteria allows companies to avail specified relaxations and exemptions in accounting standards applicable to SMCs.
Practical Considerations for Companies
Companies must carefully analyze their financial data, ownership structures, and group relationships annually to determine their classification status. This assessment directly influences their compliance requirements, the complexity of financial statements, and disclosures.
Proper documentation of turnover and borrowing calculations is essential, especially given that borrowings are assessed on a maximum point-in-time basis rather than a closing balance. Group companies should also review their holding and subsidiary relationships to understand their impact on SMC classification.
Detailed Borrowing Criteria for Small and Medium-Sized Companies
Definition and Scope of Borrowings
Although the Companies (Accounting Standard) Rules, 2021 do not explicitly define “borrowings,” the term is generally understood to encompass all types of debt instruments and loans raised by a company. This includes:
- Loans taken from banks, financial institutions, or other entities.
- Debentures issued by the company.
- Bonds and other debt securities.
- Public deposits accepted by the company.
These sources collectively determine the total borrowings of the company at any point during the financial year.
Importance of Borrowing Limits in SMC Classification
The borrowing limit is a key criterion that helps to distinguish companies with limited external financial exposure from those with substantial debt obligations. The revised threshold under the 2021 Rules has been increased from Rs. 10 crores to Rs. 50 crores, reflecting current economic realities and business sizes.
This limit serves as a safeguard ensuring that companies with higher risk profiles due to substantial borrowings adhere to stricter accounting standards, while smaller companies with limited borrowings enjoy simplified compliance.
Measurement of Borrowings: Point-in-Time Assessment
Unlike turnover, which is measured cumulatively over the financial year, borrowings are assessed based on the highest amount outstanding at any time during the immediately preceding financial year.
For example, if a company borrowed Rs. 45 crores in April but increased its borrowings to Rs. 55 crores in September and then repaid Rs. 10 crores by the year-end, its maximum borrowing at any time was Rs. 55 crores. This exceeds the Rs. 50 crores threshold, classifying the company as a non-SMC for that year.
Implications of Peak Borrowing Measurement
This method of measurement prevents companies from temporarily reducing borrowings at year-end to artificially qualify as an SMC. It encourages transparent financial management throughout the year.
However, companies need to maintain proper records and monitoring systems to track peak borrowings accurately during the year. This ensures timely compliance with accounting standards and prevents inadvertent misclassification.
Examples Illustrating Borrowing Criteria Application
Consider Company X which had borrowings fluctuating between Rs. 30 crores and Rs. 48 crores during the financial year 2020-21. Since its borrowings never exceeded Rs. 50 crores, it qualifies as an SMC based on borrowing criteria.
On the other hand, Company Y borrowed Rs. 60 crores in August 2020 and repaid Rs. 15 crores by March 2021, leaving Rs. 45 crores as the closing balance. Despite the lower year-end balance, Company Y’s peak borrowing exceeded the Rs. 50 crores threshold, disqualifying it from SMC status for 2020-21.
These examples illustrate the importance of evaluating borrowing levels throughout the year rather than relying solely on year-end figures.
Holding and Subsidiary Relationship Criterion for SMC Classification
Overview of Holding and Subsidiary Impact
One of the key additions in the Companies (Accounting Standard) Rules, 2021 is the emphasis on the holding and subsidiary relationship when determining SMC status. A company that is a holding or subsidiary of a non-SMC will automatically be treated as a non-SMC, regardless of whether it independently meets the turnover and borrowing thresholds.
This criterion is designed to ensure consistent application of accounting standards within corporate groups and prevent companies from using group structures to evade compliance.
Determining Holding and Subsidiary Status
The determination of whether a company is a holding or subsidiary depends on ownership and control criteria as per the Companies Act, 2013. Typically:
- A holding company controls the composition of the board of directors or holds more than 50% of the voting power in the subsidiary.
- A subsidiary company is controlled by the holding company as per the above definition.
The assessment is done at the end of the relevant accounting period to reflect the company’s status within the group accurately.
Exclusions: Joint Ventures and Associates
It is important to note that the holding and subsidiary relationship criterion does not extend to joint ventures or associate companies. Unlike the Indian Accounting Standards (Ind AS) roadmap, which considers these relationships for group classification, the 2021 Rules restrict this criterion solely to holding and subsidiary links.
Thus, joint ventures and associates do not influence the SMC classification directly under the revised rules.
Practical Examples of Holding/Subsidiary Relationship Effects
If Company A qualifies as an SMC based on turnover and borrowing but is a subsidiary of Company B, which is a non-SMC, Company A will be classified as a non-SMC. This means Company A must comply with full accounting standards applicable to non-SMCs.
Conversely, if Company C is a holding company with multiple subsidiaries that all meet SMC criteria independently, but Company C itself exceeds the thresholds, all its subsidiaries will be treated as non-SMCs.
This approach ensures uniformity of financial reporting standards within groups and prevents dilution of compliance through subsidiaries.
Implications for Financial Reporting and Compliance
Accounting Standards Applicability
The revised definition of SMC affects the accounting standards a company must follow. SMCs are eligible for certain exemptions and relaxations in the application of accounting standards, designed to reduce the compliance burden on smaller companies.
However, companies that do not qualify as SMCs must adhere to the full accounting standards framework without such exemptions.
Disclosure Requirements
Companies must disclose their SMC status and any exemptions availed in the notes to their financial statements. This transparency aids users of financial statements in understanding the accounting policies and potential impacts of relaxed standards.
In the case of group companies, the holding and subsidiary relationships influencing SMC status should be clearly documented and disclosed.
Impact on Audit and Reporting
The classification as an SMC or non-SMC influences not only the accounting policies but also audit requirements and reporting formats. Auditors will verify whether companies have correctly applied the revised criteria and adhered to the appropriate standards.
Misclassification can lead to regulatory scrutiny, penalties, or the need for restatement of financial statements.
Monitoring and Periodic Evaluation
Annual Assessment of SMC Status
Companies are required to evaluate their eligibility for SMC classification at the end of every financial year based on the turnover and borrowing data from the immediately preceding year.
This periodic evaluation ensures that changes in business scale or borrowing patterns are promptly reflected in the company’s classification and accounting practices.
Keeping Track of Borrowing Levels
Given that borrowings are assessed on the peak amount during the year, companies should implement robust monitoring systems to record borrowing levels monthly or quarterly.
Timely knowledge of borrowing breaches can help companies plan financing and repayments strategically to maintain or regain SMC status where desirable.
Importance of Group Structure Analysis
Companies operating as part of a group need to maintain updated records of ownership and control relationships.
Changes in shareholding or board composition affecting holding or subsidiary status must be carefully tracked as they directly impact SMC classification. This is especially important during mergers, acquisitions, or restructuring events.
Challenges and Considerations for Companies
Managing Borrowing Limits
For companies close to the Rs. 50 crores borrowing threshold, strategic financial planning becomes essential. Decisions around loan agreements, public deposits, and other funding mechanisms should consider their impact on SMC status.
Borrowing slightly above the limit could result in the loss of beneficial exemptions, increasing compliance costs.
Handling Group Relationships
Complex corporate structures with multiple layers of holding and subsidiary companies require careful analysis to ascertain SMC status consistently.
In some cases, it may be beneficial to restructure holdings or divest interests to maintain SMC classification for certain group entities, depending on strategic priorities.
Understanding the Limits of the Criteria
The revised rules provide clarity but also impose rigid limits that companies cannot easily circumvent. Temporary fluctuations in borrowings or marginal changes in turnover can affect SMC status, making it critical to maintain accurate financial records and forecasting.
Coordination between Finance and Legal Teams
Effective coordination between finance and legal departments is crucial for monitoring ownership changes and borrowing patterns. Regular internal reviews and audits help ensure compliance and timely disclosures.
Illustrative Case Studies
Case Study 1: Company Exceeding Borrowing Threshold Temporarily
Company Z borrows Rs. 55 crores in the middle of the financial year to fund expansion but repays Rs. 10 crores by year-end. Although the year-end borrowing is Rs. 45 crores, the peak borrowing exceeded Rs. 50 crores, classifying Company Z as a non-SMC. Company Z must apply full accounting standards and disclose this classification.
Case Study 2: Subsidiary of a Non-SMC Parent Company
Company Y, a manufacturing unit with turnover below Rs. 250 crores and borrowings under Rs. 50 crores, is a subsidiary of Company X, which is a non-SMC due to its high turnover. Despite its standalone financials, Company Y is treated as a non-SMC, subject to full accounting standards and disclosures.
Case Study 3: Group Restructuring Affecting SMC Status
Company P and Company Q are subsidiaries of a holding company R, which qualifies as an SMC. However, after acquiring a large entity, Holding Company R ceases to qualify as an SMC. Consequently, both Company P and Q lose their SMC status, affecting their accounting and reporting frameworks.
Change in Status from Non-SMC to SMC
Transition Period and Eligibility for SMC Exemptions
A company that changes its status from non-SMC to SMC does not immediately become eligible to apply the relaxed accounting standards and exemptions available to SMCs. According to the Rules, such a company must meet the SMC criteria for two consecutive accounting periods before availing any SMC exemptions.
This approach is designed to prevent companies from frequently switching between classifications and selectively applying accounting standards, which could undermine the consistency and reliability of financial reporting.
Practical Illustration of Transition from Non-SMC to SMC
For example, Company A was classified as a non-SMC as of March 31, 2021. It met all the revised SMC criteria as of March 31, 2022. Despite this, Company A is not permitted to apply SMC exemptions for the financial year 2021-22.
If Company A continues to satisfy the SMC criteria as of March 31, 2023, it will then become eligible to apply SMC-specific relaxations in accounting standards for the financial year 2022-23.
This two-year continuity requirement encourages stability in classification and enhances the comparability of financial information over time.
Accounting and Reporting Considerations During Transition
During the transition period, the company must continue to comply with the full set of accounting standards applicable to non-SMCs. The company should also maintain clear records demonstrating its compliance with these standards and document the timeline and conditions leading to its change in status.
Proper communication with auditors and stakeholders about this transition phase is essential to avoid confusion regarding the treatment of financial data and application of exemptions.
Change in Status from SMC to Non-SMC
Immediate Applicability of Full Accounting Standards
When a company that previously qualified as an SMC no longer meets the criteria, it must immediately comply with all applicable accounting standards without any exemptions or relaxations.
This ensures that companies with increased scale or complexity maintain the transparency and rigor required by full accounting norms.
Treatment of Comparative Figures and Restatement
The Rules specify that companies are not required to revise or restate figures for the corresponding previous periods solely because of a change in SMC status. This provision minimizes the administrative burden and avoids unnecessary adjustments to historical financial statements.
Disclosure of Change in Status and Historical Use of Exemptions
Although restatement of prior figures is not mandatory, the company must disclose in the notes to the financial statements the fact that it was classified as an SMC in the preceding period(s) and that it had availed of relevant exemptions or relaxations during that time.
This disclosure promotes transparency and informs users of the financial statements about the basis for accounting treatments applied in previous periods.
Example Illustrating Change from SMC to Non-SMC
Company B qualified as an SMC as of March 31, 2021, but failed to meet the criteria as of March 31, 2022. For the financial year 2021-22, Company B must apply the full set of accounting standards without any SMC exemptions.
In its financial statements for 2021-22, Company B is required to disclose its previous SMC status and the exemptions it had availed but is not required to restate the figures for the year 2020-21.
Disclosure Requirements on Change of SMC Status
Importance of Transparent Disclosures
Disclosures related to changes in SMC status are critical to ensure users of financial statements understand the context behind changes in accounting policies and treatments. Transparency helps maintain investor confidence and facilitates regulatory oversight.
Specific Disclosure Items
Companies should include the following information in the notes to their financial statements when there is a change in SMC status:
- The period during which the company was classified as an SMC.
- The accounting standards exemptions or relaxations availed during that period.
- The date from which the company ceased to be an SMC and the consequent change in accounting policy.
- Any impact on the current year’s financial statements arising from the change.
Reporting the Impact on Financial Results
Where relevant, companies may also provide a qualitative or quantitative description of how the loss or gain of SMC status affects financial reporting, compliance costs, and disclosures. This information assists stakeholders in evaluating financial trends and assessing the company’s compliance environment.
Audit Considerations Related to SMC Status Changes
Auditors play an important role in verifying that companies have correctly applied transition rules and made appropriate disclosures regarding their SMC status changes. They review whether:
- The classification criteria have been properly applied.
- The transitional accounting standards have been followed accurately.
- Disclosure requirements have been met comprehensively.
Such audit scrutiny reinforces the reliability of financial statements during periods of classification change.
Managing Fluctuations in SMC Status
Challenges with Frequent Status Changes
Companies operating near the threshold limits for turnover or borrowings may face fluctuations in their SMC status year over year. This can create challenges related to accounting standard applications, compliance costs, and stakeholder communication.
Frequent changes can disrupt financial reporting consistency and complicate audit processes.
Best Practices to Manage Status Stability
To minimize the impact of such fluctuations, companies should consider:
- Strategic financial planning to maintain turnover and borrowings within thresholds where feasible.
- Careful monitoring and forecasting of financial metrics to anticipate classification changes.
- Clear documentation of accounting policies and decisions during transition periods.
- Early engagement with auditors and stakeholders to explain changes and their implications.
Use of Transition Periods to Prepare for Status Changes
The mandatory two-year continuity requirement before availing SMC exemptions after moving from non-SMC to SMC status allows companies time to prepare for adopting simplified accounting standards and align internal processes accordingly.
Similarly, when moving from SMC to non-SMC, companies should proactively plan for compliance with full accounting standards to avoid last-minute challenges.
Impact of SMC Status on Financial Statements and Stakeholders
Influence on Accounting Policies and Standards
SMC classification affects the choice of accounting policies, disclosures, and the overall complexity of financial statements. Relaxed standards for SMCs simplify financial reporting and reduce compliance effort.
Conversely, non-SMCs must comply with comprehensive accounting frameworks, including detailed disclosures and measurement requirements.
Effect on Financial Statement Users
Investors, lenders, and regulators rely on financial statements to make informed decisions. Knowing whether a company is an SMC helps them understand the extent of exemptions applied and assess the comparability and reliability of reported figures.
Disclosures about status changes are therefore essential to maintain the usefulness of financial information.
Implications for Corporate Governance and Compliance
Companies classified as non-SMCs may face enhanced scrutiny from regulators and shareholders due to the requirement to follow full accounting standards. This can influence internal controls, governance practices, and reporting rigor. Companies should be aware of these governance implications when their SMC status changes.
Case Studies on Transition and Disclosure
Case Study 1: Transition from Non-SMC to SMC with Two-Year Continuity
Company X was a non-SMC in FY 2020-21 but met the SMC criteria in FY 2021-22 and FY 2022-23 consecutively. Company X applied full accounting standards in FY 2021-22 and only availed SMC exemptions starting FY 2022-23.
The company disclosed this transition and related policies in its financial statements, ensuring transparency for stakeholders.
Case Study 2: Loss of SMC Status and Immediate Full Compliance
Company Y qualified as an SMC until FY 2020-21 but exceeded turnover limits in FY 2021-22. For FY 2021-22, Company Y applied full accounting standards, did not restate prior year figures, and disclosed its previous SMC status along with exemptions availed.
This clear disclosure helped users understand the changes without confusion.
Case Study 3: Frequent Status Fluctuations and Impact on Reporting
Company Z’s borrowings hovered near Rs. 50 crores for three years, resulting in alternating SMC and non-SMC classifications. This caused varying accounting treatments and audit complexities.
In response, Company Z implemented stricter financial controls and forecasting to stabilize its status and streamline reporting.
Recommendations for Companies Experiencing Status Changes
Establish Robust Monitoring Systems
Companies should implement systems that continuously monitor turnover and borrowings throughout the financial year to anticipate potential status changes.
Develop Clear Accounting Policies for Transitions
Having well-documented policies on how to handle SMC status changes ensures consistent application and eases auditor review.
Engage Stakeholders Proactively
Effective communication with shareholders, lenders, and auditors about status changes and their effects helps maintain confidence and smooth reporting processes.
Plan Financial and Operational Strategies
Strategic decisions regarding financing, investments, and operations should consider their impact on SMC status to optimize compliance benefits and costs.
Conclusion
The revised Companies (Accounting Standard) Rules, 2021 significantly reshape the framework for classifying Small and Medium-Sized Companies by expanding the turnover and borrowing thresholds. These changes reflect the evolving business environment and aim to ease compliance for a broader spectrum of companies while maintaining robust financial reporting standards for larger and more complex entities.
Understanding the updated criteria, covering turnover definitions, borrowing limits assessed on peak balances, and the critical holding and subsidiary relationship test, is essential for companies to accurately determine their SMC status. The rules also clearly define how companies should navigate transitions in status, emphasizing stability through consecutive period requirements and mandating transparent disclosures to ensure users of financial statements are well-informed.
Companies must proactively monitor financial metrics and group relationships, adopt appropriate accounting policies, and maintain clear communications with auditors and stakeholders to manage the implications of their SMC classification effectively. The clarity provided by these revised rules supports consistency, comparability, and transparency in financial reporting, ultimately contributing to a more reliable corporate financial ecosystem.
Adhering to these updated provisions will help companies align with regulatory expectations while optimizing their compliance burden, thus fostering better governance and investor confidence in India’s corporate sector.