The role of Books of Account while dealing with mismanagement under section 397 of Companies Act, 1956?

The provisions of Companies Act, 1956 makes it very clear that every company should maintain proper books of accounts and should record all the transactions of the Company pertaining to sales, purchases, expenses, receipts, liabilities and Assets. Not only recording the transactions, every Company is also supposed to maintain the documentary proof in support of the transactions as per law. Based on the records maintained by the Company and as per the requirement of the Companies Act, 1956, every Company presents its Annual Accounts before the Shareholders in the AGM and thereafter the Annual Accounts are filed with the Registrar of Companies. The principles, filing and disclosure requirements of a Company while maintaining, presenting and filing its Accounts depend upon the kind of the Company. The Institute of Chartered Accountants of India (ICAI) is a statutory body discharging various important functions for the benefit of the public at large and the industry. The ICAI prescribes various standards and when these standards prescribed by the ICAI are made mandatory, then, the companies should follow the standards while presenting its Accounts. Now, the standards prescribed by the ICAI have the statutory force and every company should follow the standards. The important standard being the Accounting Standards (AS). The Accounting Standards (AS) prescribed by the ICAI deals with the principles to be followed and the disclosure requirements for various business organizations and companies. While there is no exception per se when it comes to following the principles, the disclosure requirements are mandatory only to certain companies like listed public companies or the companies exceeding prescribed turnover etc. The disclosure requirement is mandatory as prescribed by the ICAI in its Standard itself.

Theoretically, it may all appear to be very simple, but, when an Auditor takes the responsibility of auditing the books of accounts, there tend to be many difficulties in the course and the complications in the auditing process were exposed in 'Satyam case'. It is also true that many companies neglect the accounting requirements, recording the transactions and maintaining the books of Accounts. In many cases, there may not be any proof in support of a transaction recorded by the Company and shown in the Annual Accounts.

Many closely held companies, private companies and small concerns do not strictly follow the accounting requirements and as such it is very easy to allege some irregularity in these companies. When there are differences between or among the groups in a Company, one group will try to trouble the other by seeking various reliefs before the Company Law Board under section 397/398 of the Companies Act, 1956 alleging oppression and mismanagement. It is very easy for a minority group or the shareholder who has the knowledge of all internal affairs of the Company to allege mismanagement in the Company. Not only pleading mismanagement in the Company, the Petitioner, at times, may press for perusal of all the Books of Accounts maintained by the Company and also may insist for appointment of Independent Auditor.

The evidentiary value of Books of Accounts in a proceeding under section 397/398 of the Companies Act, 1956 is a complicated issue to deal with. At times, the Books of Accounts can be taken as an evidence under section 397/398 of the Companies Act, 1956 and at times, despite the irregularities in the Books of Accounts maintained by the Company, the Petitioners under section 397/398 of the Companies Act, 1956 may not qualify to get the relief as prayed for taking other evidence, circumstances and law into consideration. It is true that establishing a case for mismanagement is very easy for a minority group in a private company or a closely held company if he or they have the knowledge of internal affairs. It is really a complicated issue to deal with.

While the Company Law Board has the powers to direct the parties before it to produce the Books of Accounts and other evidence in their custody, in my opinion, it may not be correct to completely depend upon the Books of Accounts maintained by the Company while deciding a petition under section 397/398 of the Companies Act, 1956. It is not the law that a Company to be wound-up if they failed to maintain the Books of Accounts as per the requirement and only consequences will follow. While it is true that there should not be any lenience towards the companies if they do not maintain the proper accounts, it is also not correct to allow a group to take advantage of the knowledge of the internal affairs of the Company and seek drastic measures from the Company Law Board under section 397/398 of the Companies Act, 1956.

To conclude, in my opinion, based on the law laid-down by the constitutional courts form time to time, an irregularity in maintaining books of accounts will not ipso facto lead to a conclusion that there exist a case of mismanagement under section 397 of the Companies Act, 1956 unless other events and circumstances prove to be so.

Note: the views expressed are my personal.

Understanding "Books of Account" under Companies Act, 1956?

Clause (a) to (c) of the sub-section (1) of section 209 requires every company to maintain books of accounts in respect of receipts, expenditure, sales, purchase, assets and liabilities. It is based on the fundamentals of accounting and the broad spectrum of preparation of mandatory final accounts by company. The clause (d) of the sub-section (1) refers to the books of accounts in view of the cost accounting requirements. Logically, even the company required to comply with the cost accounting requirements, has to maintain all the books referred to in clause (a) to (c) as there is no relaxation to any company in respect of filing of final accounts. But, what is interesting is that, the ‘proper books of account’ as referred to in the sub-section (1), has been further dealt with under sub-section (3). The sub-section (3) lays down two broad conditions for construing that the company maintains the proper books of accounts. Clause (a) and (b) of sub-section (3) are extracted below:

(a) if there are not kept such books as are necessary to give a true and fair view of the estate of the affairs of the company or branch office, as the case may be, and to explain its transactions; and
(b) if such books are not kept on accrual basis and according to the double entry system of accounting.

The wording ‘true and fair view’ as referred to under sub-section (1) is obviously refers to the need of recording the transactions as it took place. To conclude, there should not be any falsity or concealment. Though, the maintenance of books of accounts by the company can be seen as a clerical and mechanical, the preparation of final accounts is vital. The Accounting Standards prescribed by the Institute of Chartered Accountants of India, the provisions of the Act and other notes issued by the Institute, governs the issue of preparation of final accounts generally and broadly. The standards governing valuation of inventories, the depreciation, revaluation of fixed assets, ammortazisation principles, accounting for research and development etc. are few examples, where there was a great potential of giving an unfair view while presenting the company’s financial position if not checked. The provisions of the Act and in particular the Standards prescribed by the Board, are laudable. The Standards deal with the object of filing of accounts, basic assumptions, detailed principles and disclosure in a systematic and appreciable way. The Standards repeatedly stresses on the principle of conservatism and the principle that the substance should prevail over the rules. While preparing the final accounts, the Company is supposed to be fair in preparing estimates etc., represent before audit fairly and adhere to the interests of the external users broadly. Thus, though, the section refers to the ‘true and fairness’ in the context of maintaining accounts, in fact, it has very wide spectrum. While the reference to ‘true and fairness’ is very very wide in relation to the preparation of final accounts, the reference to the same under the section is really narrow as it implies that there should not be any falsity in conveying the events or transactions. Thus, clause (a) of sub-section (3) stresses that the events and transactions to be recorded as it occurred and without any falsity. The clause (b) of sub-section (3) lays down a requirement of the mode in which accounts are to be maintained rather referring to what all the books are to be maintained by the company. The clause (b) says that the books are to be maintained on accrual basis and according to the double entry system of account. In the accrual basis of accounting, the events and transactions are recorded as and when they occur without waiting for the actual receipt or payment of cash. Thus, there exist ‘cash basis system’ and the ‘accrual basis’, and in India, Act mandates to maintain the books of accounts for the purpose of preparation of final accounts in the ‘accrual basis’. Secondly, clause (b) of the sub-section (3) refers to the “double entry book keeping system”. Recording both the event and transaction separately in consonance with the principle that the expenses equals the receipts, will be basis for the double entry book keeping system. Usually, the prime entries, ledger accounts, trial balance, and preparation of final accounts etc. works on the basis of “double entry book keeping system”.
Though, presenting the fair view and the accrual basis of system, may not be ambiguous to understand, the maintenance of books of accounts according to double entry book keeping system is somewhat interesting to consider. Take an example, if accounting staff of the company who maintains the accounts forgot making an entry in their books of account though they recorded in one ledger, then, will the same be construed to say that the company has not maintained the books of account. The answer will be an obvious ‘No’. That’s why, the rectification entries and adjustments became a routine business of the accountants or the auditor while preparing the final accounts. But, if there is no mandate that the books need not be maintained in accordance with the double entry system, then, no one bothers to be systematic and which ultimately results in presenting an unfair view before the users of accounts and especially shareholders. Though, it can not be ruled out that the non-maintenance of books of accounts in accordance with the “double entry book keeping system” can be construed as a default under the proviso in some cases, the transaction omitted, the staff entrusted with the job, the track record of the company, the recording of other transactions etc. will be considered broadly while dealing with the issue of ‘default’ under the proviso. As such, broadly, the company is supposed to maintain the following books of account.

(a) Record of all events of transactions which fell in any one of the heads viz., receipts, expenses, sales, purchases, assets and liabilities in accordance with the accrual basis of accounting and in accordance with the double entry book keeping system.

(b) All books of accounts in compliance of the provisions of the Act and the cost accounting requirements in respect of the scheduled or specified industry under clause (d) of sub-section (1).