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Understanding the Legal Importance of Notes of Accounts in Financial Statements

Introduction

The interpretation and completeness of financial statements (‘FSs’), particularly balance sheets (‘BSs’), have perennially been a critical factor in the legal scrutiny of corporate disclosures.  On 16.04.2024, the Hon’ble Supreme Court (‘Apex Court’) delivered a judgment in the case of State of Bihar v. Ziqitza Health Care Ltd.[i] holding that the legal mandate requiring notes of accounts to be an integral part of the BS and that the absence of these notes can lead to the disqualification of a bidder in a tender process. 

Note: This analysis is limited to the relevance of explanatory notes of accounts in an entity's BS. Thus, the other incidental issues dealt with by the Apex Court are not taken into consideration. 

Brief Facts

  • A tender was floated by the state government which received the participation of several companies. One such company, namely M/s. BVG India Ltd. submitted its bid. However, the state government disqualified the said company since the explanatory notes of the BS were not attached to the tender documents.

  • This disqualification was challenged before the High Court (‘HC’). After reviewing the pertinent facts, the HC concluded that such disqualification was incorrect and untenable since there was no mandatory requirement to maintain and provide notes of accounts along with the BS, and the absence of such notes could not have affected the tender bidding process.

  • Thus, the primary issue for consideration of the Apex Court was whether the notes of accounts formed an integral part of the BS and whether non-submission of such notes was a valid ground for disqualification of a participant from the tender process.


Held

  • The Apex Court, relying on the interpretation of s. 134(7) of the Companies Act, 2013 (‘Act’), held that the HC’s decision to set aside the disqualification of M/s. BVG India Ltd. was not sustainable in law.

  • The court relied on the precedent set in State Bank of India v. Krishidhan Seeds Private Limited[ii], which recognised the importance of the explanatory notes of the BS as provided under s. 134(7) of the Act.

  • The Apex Court reinforced the idea that understanding BSs requires delving into the factual explanations provided in the accompanying notes and held that the explanatory notes are indispensable in the analysis of any BS.

  • Thus, the disqualification of the bidder who had submitted its BS without appending the relevant explanatory notes was upheld, emphasizing the importance of explanatory notes of accounts in interpreting the BS. Citing the prevailing laws and precedents, the court established that notes of accounts form an essential part of FSs and must be considered in conjunction with the BS. The failure to submit these notes can justify disqualification in the bidding process.


Our Analysis

This case references s. 134(7) of the Companies Act, which mandates the inclusion of notes alongside FSs. The Court emphasized that these notes provide essential clarifications and details that are not captured in the ledger entries alone. Thus, they are not merely ancillary but are in fact critical for a complete understanding of the financial health and specifics of a company.

This ruling aligns with prior decisions, including State Bank of India v. Krishidhan Seeds Private Limited (Supra), which acknowledged the legal necessity of including notes in financial disclosures to provide a transparent and complete picture of financial status.

Essentially, the notes serve to unpack the entries in the BS, offering explanations and additional data that might include contingent liabilities, commitments not listed in FSs, and significant accounting policies.

This judgment is likely to have significant implications on how FSs in a tender process are submitted by the bidders. Entities looking to participate in government and large corporate tenders should ensure rigorous compliance with the tender specifications and prepare for stringent scrutiny of their qualification documents, particularly their FSs.




End Notes

[i] [2024] 161taxmann.com723 (SC).

[ii] [2023] 1 SCC 209.



Authored by Shreya Manchanda, Intern at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.

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