No Acts & Articles mentioned in this case
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CASE NO.:
Appeal (civil) 3526 of 2007
PETITIONER:
Reliance Energy Limited & Another
RESPONDENT:
Maharashtra State Road Development Corporation Ltd. & Others
DATE OF JUDGMENT: 11/09/2007
BENCH:
DR. ARIJIT PASAYAT & S. H. KAPADIA
JUDGMENT:
J U D G M E N T
CIVIL APPEAL NO.3526 OF 2007
KAPADIA, J.
1. State of Maharashtra through Maharashtra State Road
Development Corporation Ltd. (for short, "MSRDC") floated
Global Tender for completing Mumbai Trans Harbour Link
("MTHL") between Mumbai and Navi Mumbai on BOT basis.
2. Reliance Energy Limited is a company registered under
the Companies Act, 1956. It is engaged in generation,
transmission and disbursement of power in Maharashtra,
Delhi etc.
3. Hyundai Engineering and Construction Company Ltd.
(for short, "HDEC") is a company incorporated in Korea. It is
specialized in construction of bridges.
4. At this stage, it may be noted that the above Project is to
be at the cost of Rs. 26000 million (Rs. 2600 crores). The
bidders were required to submit RFQ Document by 10.1.2005.
Under the PQ Document, M/s Jean Muller, France was
appointed as consultant by MSRDC. Under the PQ Document,
the bidders were required to submit financial statements of
three financial years subject to the condition that the latest
should not be earlier than the financial year ending
31.12.2002. REL/HDEC formed a consortium. As a
consortium they were required to comply with clause 7.2.2
which stipulated net cash profit at Rs. 200 crores. The said
consortium has been excluded from the second stage of
bidding on the ground that it has not fulfilled the said criteria
mentioned in clause 7.2.2. The consortium had submitted
their RFQ Document on 9.1.2005. The said consortium had
submitted three audited accounts for the financial years
ending 31.12.2001, 31.12.2002 & 31.12.2003. At this stage it
may be noted that the financial year for REL ended on 31st
March whereas the financial year for HDEC, Korea ended on
31st December.
5. At this stage, we may quote the relevant provisions of the
PQ Document which read as under:
"Section 5.1 in the PQ document -
The objective of the Pre-Qualification is to qualify
the applicants that have the necessary experience
and financial and technical capabilities to
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undertake the work for which the Request for
Proposal is to be invited.
Section 5.3.7 of the PQ document inter alia,
provides:
No change in, or supplementary information to an
application shall be accepted after its submission.
However, MSRDC reserves a right to seek additional
information from the applicants, if found necessary
during the course of evaluation of the applicants.
Section 7.2.2 For Application by a Consortium
In case of a Consortium, the entity declared as the
Lead Member would be required to
* hold a minimum of 26% of paid up and
subscribed equity capital in the Project Company
(MSRDC is of the view that a minimum paid up and
subscribed capital of Rs.5000 million may be
required for implementing the project.] until
completion of construction and thereafter for a
period of two years from the date of commencement
of operations and
* meet the financial eligibility criteria of Lead
Member as detailed below
In case of a Consortium, the following members
taken together shall commit to hold majority
(minimum of 51%) of the total paid up and
subscribed equity capital in the Project Company
until completion of construction and thereafter for a
period of two years from the date of commencement
of operations.
* Lead Member of the consortium committing to
hold a minimum of 26% of the paid up and
subscribed equity capital of the Project Company,
until completion of construction and thereafter for a
period of two years from the date of commencement
of operations and meet the financial eligibility
criteria of Lead Member as given below.
* Those members of the Consortium committing
to hold a minimum of 5% of the paid up and
subscribed equity capital of the Project Company
until completion of construction and thereafter for a
period of two years from the date of commencement
of operations.
The aggregate (taken as the arithmetic sum) of Net
Cash Profit and Net Worth as explained above) of all
subsidiary companies in which the respective
entities hold a minimum of 51% of total paid up and
subscribed equity capital would also taken into
consideration. In the case of financials of
subsidiary companies being considered as above,
the dividend paid by these subsidiary companies to
the parent company will be deducted from the Net
Profit of the parent company for the purpose of
evaluation. The financial evaluation criteria to be
satisfied by a Consortium are detailed below.
Criteria
To be satisfied
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by
Amount
Net worth (as per
the latest audited
balance sheet \026 not
earlier than the FY
ended December 31,
2002)
Lead Member
(Holding a minimum
of 26% equity in the
project company)
Total Consortium (to
be satisfied together
by the Lead member
and those
Consortium members
committing to hold a
minimum of 5%
equity in the project
company)
Rs.2,000 million
(or equivalent
foreign currency)
Rs.10,000
million (or
equivalent
foreign currency)
AND
Criteria
To be satisfied
by
Amount
Net cash profit
(simple average of
the audited financial
figures over the last
3 financial years of 2
calendar months
each, with the latest
not earlier than the
FY ended December
31, 2002, will be
considered for this
assessment).
Lead Member
(Holding a minimum
of 26% equity in the
project company)
Total Consortium (to
be satisfied jointly by
the Lead member
and those
Consortium members
committing to hold a
minimum of 5%
equity in the project
company)
Rs.500 million
(or equivalent
foreign currency)
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Rs.2,000 million
(or equivalent
foreign currency)
All figures quoted in a currency other than Indian
National Rupees (INR) would be converted into
Indian National Rupees (INR) at an exchange rate,
which is the Telegraphic Transfer (ASSESSEE-
COMPANY) buying rate of State Bank of India as on
the Due Date. In the event of non-availability of
exchange rate for any currency from the above
source, MSRDC reserves the right to use available
from any other source.
7.4 Basis of Evaluation
The information to be provided by the Applicant
must be in conformation with the following:
? The information provided by the applicant
should be based on the latest available audited
accounting statements.
? The latest audited accounting statements
should not be dated earlier than 31st
December, 2002.
? The Request for Qualification (RFQ) must be
accompanied by the last three audited annual
reports/accounts statements of the applicant
and should include the financial statements of
all subsidiary companies of the Applicant for
the last three financial years. In case of a
Consortium audited annual reports/account
statements of each member of the Consortium
for the last three financial years should be
provided and should include the financial
statement of all subsidiary companies of the
entities forming the Consortium.
? The applicant (all members of Consortium)
must submit information on all pending
litigations or proceeding regarding liquidation,
winding up, court receivership or other similar
proceedings that should have been initiated or
pending against the Applicant (or any member
of Consortium). In addition to the above,
information must also be provided of all
pending litigations against the Applicant (or
any member of Consortium) in which the
maximum value of liability that may arise in
the event of adverse judgment exceeds Rs.100
million (or equivalent foreign currency). A
consistent history of litigation/arbitration
awards against the applicant or any member of
the consortium "
(emphasis supplied)
6. Briefly the criteria and conditions were as follows:
"(a) In a consortium, the entity declared as "lead
member" was required to hold the minimum of 26
per cent of paid-up and subscribed equity capital
in the project company until completion of
construction.
(b) The aggregate of net cash profit and net worth
of the consortium was to be considered for
evaluation of financial criteria of the consortium.
(c) Two criteria were required to be satisfied by the
lead member (REL) as also the total consortium
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(REL/HDEC), namely, net worth and net cash
profit.
(d) Net worth is defined as total paid-up share
capital + reserves \026 accumulated losses,
revaluation of reserves and deferred revenue
expenditure only to the extent of it being not
written-off. Net worth was to be calculated as per
the latest audited balance sheet not earlier than
F.Y. ending 31st December, 2002.
(e) The leading member (REL) was required to have
a net worth of Rs.200 crores and the total of
Consortium (REL/HDEC) was required to have a
net worth of Rs.1,000 crores. At this stage, we
may clarify that this last criterion stands satisfied.
(f) As stated above, net cash profit of the lead
member under the PQ document was stipulated at
Rs.50 crores whereas for the Consortium it was
Rs.200 crores.
(g) For the sake of convenience we quote the
definition of NCP given in the PQ document which
reads as follows:
"NCP = PAT (profit after tax) + depreciation +
amortization, not in the form of cash transaction"
7. Therefore, the bidding process for selecting the BOT
Concessionaire was in two stages. In the first stage MSRDC
had to issue the Pre-Qualification (PQ) document with an
invitation to prospective Applicants to submit their Request for
Qualification (RFQ) for the Project. The prospective Applicants
were required to submit their RFQ document on or before
10.1.2005. It was to be evaluated on technical and financial
capability. Under clause 7.2.2 one of the criteria laid down
was that the Consortium should have net cash profit (NCP) of
Rs.2,000 million (Rs.200 crores). As per tender condition
7.2.2 the bidders were required to submit financial statement
of three financial years subject to the condition that the latest
should not be earlier than the financial year ending
31.12.2002. The choice of three years was left to the bidders.
REL/HDEC exercised their option by submitting the financial
statements of HDEC for three years, namely, 2001, 2002 and
2003.
8. HDEC had undertaken construction contracts in Iraq.
On account of war in Iraq their annual report for the year
2001 showed negative income. However, the said Company
achieved net profit of US$ 16 million in 2002, US$ 66 million
in 2003 and US$ 164 million 2004. These figures have been
taken from the letter of KPMG, Korea, dated 12.8.2005 giving
a schedule of net income after adjusting expenses and income
not in form of cash transaction. We quote hereinbelow the
entire letter dated 12.8.2005 along with the schedule of net
income which reads as under:
"10th Floor, Star Tower, Tel +82 (2) 21120100
737 Yeoksam-dong, Fax +82(2) 21120101
Gangnam-gu, Seoul 135-984 www.kr.kpmg.com
Republic of Korea
The Board of Directors and Management
Hyundai Engineering & Construction Co.,Ltd.
140-2 Kye-dong, Chongro-gu
Seoul, 110-793, Korea
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August 12, 2005
Dear Sir,
We have performed the procedures described below, which were agreed by
Hyundai Engineering & Construction Co., Ltd. (the 'Company'). The sufficiency
of the procedures is solely the responsibility of the Company. Consequently, we
make no representation regarding the sufficiency of the procedures described
below either for the purpose for which this report has been requested or for any
other purpose.
The procedures that we performed are as follows:
We compared the statements of cash flows for years ended December 31, 2001,
2002, 2003 and 2004 prepared by the Company to the accompanying schedule of
net income after adjusting expenses and income not in form of cash transaction
which the company prepared according to the Pre-Qualification criteria for
Mumbai Trans Harbour Link(MTHL) project in India. The financial statements
of the company for years ended December 31, 2001, 2002, 2003 and 2004 were
audited by us and we expressed an opinion that the financial statements of the
Company for years ended December 31, 2001, 2002, 2003 and 2004 were
presented fairly, in all material respects, in conformity with accounting standards
generally accepted in the Republic of Korea.
We audited the statements of cash flows for years ended December 31, 2001,
2002, 2003 and 2004 that under the indirect method of presenting the statements
of cash flows, net income is adjusted to arrive at net cash flows from operating
activities. The adjustments to net income I performed by removing the effects on
net income of all items that included in net income that do not affect cash receipts
and disbursements. (e.g., those that should be omitted altogether or categorized as
investing or financing activities, such as adding depreciation and amortization).
We found no exceptions as a result of the above agreed-upon procedures.
We were not engaged to, and did not perform an audit, the objective of which
would be the expression of an opinion on the specified elements, accounts, or
items. Accordingly, we do not express such an opinion. Had we performed
additional procedures, other matters might have come to our attention that would
have been reported to you.
Accounting principles and auditing standards and their application in practice
vary among countries. The financial statements are not intended to present the
financial position, results of operations and cash flows in accordance with
accounting principles and practices generally accepted in countries other than the
Republic of Korea. In addition, the procedures and practices utilized in the
Republic of Korea to audit such financial statements may differ from those
generally accepted and applied in other countries. Accordingly, this report and
the accompanying financial statements are for use by those knowledgeable about
Korean accounting procedures and auditing standards and their application in
practice.
This report is intended solely for the use of the Board of Directors and
Management of Hyundai Engineering & Construction Co., Ltd., and should not be
used by those who have not agreed to the procedures and taken responsibility for
the sufficiency of the procedures for their purposes.
Very truly yours
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Sd/-
S.H. Goo,.
Partner
(Attached: Cash flows from operating activities)
(Attached)
Schedule of net income after adjusting expenses and income not in form of cash
transaction.
Description
Dec
31st, 2001
Dec
31st, 2002
Dec
31st, 2003
Dec
31st, 2004
(1) Net Income
(610,507)
15,963
65,546
164,248
(2) Expenses not in form of a cash transaction
686,310
200,753
199,084
285,039
- Provision for retirement and severance benefit
27,009
39,173
32,706
39,541
- Depreciation
49,475
36,221
31,279
27,699
- Stock compensation expense
-
89
107
30
- Bad debt expense
183,192
7,357
8,480
-
- Other bad debts expense
199,186
-
39,147
171,080
- Interest expense
48,803
23,899
20,683
18,723
- Loss on valuation of foreign currence
107
1,986
3
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699
- Loss on disposal of trade note and accounts
receivables
2,770
17,772
10,844
-
- Loss on valuation of inventories
39,762
20,485
5,364
20,308
- Loss on disposal of Investment securities
42
-
309
43
- Loss on investment securities impairment
61,104
29,900
12,845
2,348
- Loss on disposal of investment in affiliates
using equity method
-
-
1,286
-
- Loss on disposal of investment assets
9,120
1,248
-
-
- Loss on valuation of investment in affiliates
using equity method (*)
5,805
-
-
-
- Loss on disposal of property, plant and
equipment (*)
7,888
4,121
3,933
1,591
- Loss on impairment of property, plant and
equipment
-
-
29,584
2,977
- Miscellaneous losses
(including other extraordinary loss)
-
13,802
2,513
-
- Loss on prior year adjustment
42,047
4,700
-
-
(3) Income not in form of a cash transaction
337,982
76,284
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44,486
55,723
- Interest income
64
2,860
2,117
705
- Gain on valuation of foreign currency
-
105
7
1,891
- Gain on disposal of investment assets
2,378
4,349
172
-
- Gain on disposal of property, plant and
equipment (*)
27,846
47,589
5,740
7,982
- Gain on disposal of investment securities
498
-
-
-
- Reversal of loss on investment securities
impairment
1,879
-
1,167
2,386
- Gain on valuation of investment in affiliates
using equity method (*)
-
2,722
4,941
4,771
- Gain on Debt exemption (*)
305,317
6,987
30,342
18,164
- Gain on redemption of debentures
-
1,933
-
95
- Miscellaneous gains
(Including other extraordinary gain)
-
-
-
19,729
- Gain on prior year adjustment
-
9,739
-
-
(4) Net income after adjusting expenses and
income not in form of cash transaction
[(1) + (2) \026 (3) ]
(262,179)
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140,432
220,143
393,564
(*) Gain on Debt exemption, Loss(gain) on valuation of investment affiliates using equity
method. (Loss(gain) on disposal property, plant and equipment are included for
calculation of net income after adjusting expenses and income not in form of cash
transaction
(Note)
We translated Korean Won into U.S. dollars at the basic exchange rates on December 31,
2001, 2002, 2003 and 2004 to US$. The corresponding rates are as follows:
Dec 31, 2001
Dec 31, 2002
Dec 31, 2003
Dec 31, 2004
W 1,326.1 to US$ 1
W 1,200.4 to US$ 1
W 1,197.8 to US$ 1
W 1,043.8 to US$ 1"
(emphasis supplied)
9. At this stage, we need to clarify that HDEC had
undertaken construction contracts in Iraq. That, large
receivables had arisen prior to 1999 on account of war in Iraq.
The Iraq contract receivables had nothing whatsoever to do
with the three accounting years \026 2001, 2002 and 2003,
therefore, there were no Iraq contract receivables nor was
there any write-off as and by way of bad debt in any of the
above three accounting years. Further, according to
REL/HDEC, HDEC had incurred "non-cash expenses"
amounting to US$ 686.310 million in 2001, US$ 200.753
million in 2002 and US$ 199.084 million in 2003 which did
not involve direct cash outflow and, therefore, the said "non-
cash expenses" ought to have been added back to NCP and if
so added then the Consortium had NCP of Rs.2,000 million
(Rs.200 crores) as mentioned in clause 7.2.2.
10. The aforestated contention advanced by the Consortium
was rejected by M/s. Jean Muller Consultant of MSRDC in
following words:
"In case of 'Provision' for bad debts even though
they are just 'Provision' but not a 'write-off', the
same is treated as cash expense because once a
'Provision' has been made, the 'write-off' does not
get routed through the profit and loss account.
Moreover, the 'Provision' for bad debt relates to a
revenue item that has already been treated as cash
inflow on accrual basis."
11. In view of the position taken by MSRDC's Consultants,
REL/HDEC stood excluded from the second stage of the
bidding process.
12. To complete the chronology of events, by letter dated
22.6.2005, MSRDC informed REL/HDEC that their RFQ
document was under scrutiny and accordingly REL/HDEC
were requested to extend the validity of their Offer up to
6.10.2005. By letter dated 24.6.2005, MSRDC requested
REL/HDEC to submit further details and clarifications and
accordingly the Consortium of REL/HDEC was once again
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requested to extend the validity of their Offer till 6.10.2005.
Accordingly, by letter dated 18.7.2005, REL/HDEC extended
the validity of their Offer up to 6.10.2005 (90 days). By
another letter dated 6.8.2005, MSRDC sought clarifications
from REL/HDEC in respect of certain financial aspects and
the said Consortium was given time up to 19.8.2005 to
furnish such clarifications. By the said letter, MSRDC stated
that there were no queries in respect of REL, but there were
queries in respect of HDEC. By the said letter, MSRDC
referred to the break-up of net cash profit submitted by
REL/HDEC and asked for the basis for classifying certain
heads of expenditure under the heading "non-cash
expenditure". By reply dated 18.8.2005, REL/HDEC
submitted its clarification by pointing out that as on
10.1.2005 when RFQ document was submitted the audited
accounts for FY ending 31.12.2004 were not ready, so far as
HDEC was concerned and, therefore, it had submitted the
audited accounts of HDEC for the years 2001, 2002 and 2003.
By the said letter dated 18.8.2005, the REL/HDEC also
submitted audited accounts of HDEC for FY ending
31.12.2004. In other words, by 18.8.2005 (i.e. before
6.10.2005 which was date up to which REL/HDEC had kept
its Offer open) the said Consortium had submitted the audited
accounts for the financial years ending 31st December \026 2002,
2003 and 2004. Therefore, according to REL/HDEC, they had
also complied with the conditions mentioned in the PQ
document by supplying audited account for the reference
years, namely, 2002, 2003 and 2004.
13. Since REL/HDEC did not submit audited accounts
concerning HDEC for the financial year ending 31.12.2004 by
10.1.2005, the Consultants of MSRDC took the position that
REL/HDEC were not entitled to bid in the second stage of the
bidding process. According to the said Consultants, the
audited accounts of HDEC for the FY 31.12.2004 constituted
subsequent information (i.e. information supplied after the
cut-off date of 10.1.2005) and, therefore, REL/HDEC stood
excluded from the second stage of the bidding process.
14. On 22.8.2005, a committee by the name "Peer
Committee" was constituted by MSRDC to review the draft
evaluation report submitted by the consultants, M/s. Jean
Muller Consortium, relating to pre-qualification of bidders to
suggest process of evaluation and to provide recommendations
to MSRDC. The said Committee met on 21.9.2005. The
consultants M/s. Jean Muller Consortium and M/s. Crisil
were both called to give clarifications. The said Committee
was headed by Mr. Justice R.J. Kochar, Judge of Bombay High
Court (retired), Shri A.K. Banerjee (Technical Member) in
NHAI, Mr. R.S. Agarwal, Executive Director of IDBI (retired),
Mr. V. Giriraj, Joint Managing Director of MSRDC etc. The
Committee noted that pre-qualifications bids were received
only from six Applicants, one of them was REL/HDEC. The
Committee noted that while Indian companies could submit
their audited accounts up to 31.3.2004 as their FY ended on
31st March the foreign companies could submit their audited
accounts only up to 31.12.2003 as their FY ended on 31st
December. The Committee further observed that although the
cut-off date was 10.1.2005, clarifications on break-up of non-
cash expenses were sought from REL/HDEC up to 22.8.2005
and since in the mean time audited accounting statements
were furnished by HDEC up to 31.12.2004, the same could be
considered for evaluation. The Peer Committee did not agree
with the opinion expressed by MSRDC's Consultants that the
loss incurred by HDEC for the financial year ending
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31.12.2001 would have a cash impact in future. At this stage,
we may reiterate that even according to the Consultants of
MSRDC, provision for bad debt may not involve cash outflow
in the year of incidence but it would have cash impact at a
future date and, therefore, out of abundant caution they
decided to exclude REL/HDEC. However, the Peer Committee
did not concur with this accounting interpretation. According
to the Peer Committee the major provision for bad debt was in
the accounts for the year 2001 and it related to receivables
from their contract in Iraq affected by war and since it was
only a provision for bad debt and not a write-off, the
Committee came to the conclusion that there would be no
cash impact in future. The Committee took the view that even
without taking into account the audited accounts for the year
2004, REL/HDEC fulfilled the financial criteria in clause
7.2.2. Accordingly, the Peer Committee opined that
REL/HDEC should not be excluded from the second stage of
the bidding process. At this stage, it may be noted that after
receipt of the said report, made by the Peer Committee dated
1.10.2005, MSRDC placed the report of the Peer Committee
before their Consultants. Needless to add that the
Consultants of MSRDC retained their original position,
namely, that since the audited accounts for the year ending
31.12.2004 could not have been submitted after 10.1.2005,
the said accounts of HDEC could not have been taken into
account as it would violate the tender conditions and,
therefore, REL/HDEC should be excluded from the second
stage of the bidding process.
15. By letter dated 28.9.2005, in view of the position taken
by their Consultants, MSRDC requested REL/HDEC to extend
the validity of their Offer for further six months as they wanted
to study the implications arising from the audited accounts
submitted by HDEC for the year ending 31.12.2004. MSRDC
basically wanted to know as to what would be cash impact of
the provision for bad debts in the accounts of HDEC for the
year 2001. Accordingly by letter dated 6.10.2005, REL/HDEC
extended the validity of their Offer up to 6.4.2006.
Ultimately, by letter dated 7.11.2006, MSRDC informed
REL/HDEC that they stood disqualified as they had failed to
meet the qualification criteria.
16. In the circumstances, REL/HDEC moved the Bombay
High Court vide Writ Petition No.39 of 2007 in which they
alleged that a decision to disqualify, taken by MSRDC, was
arbitrary, unjustified and contrary to the terms of the tender
documents; that REL/HDEC met the financial criteria
specified by MSRDC both in terms of the original submission
of RFQ document made on 9.1.2005 and further information
given to MSRDC; that in the alternative the decision of MSRDC
was unjustified and incorrect, particularly when the
Consortium had given audited accounts of HDEC for the FY
ending 31.12.2004 and, therefore, on the said basis it was not
open to MSRDC to exclude REL/HDEC from the second stage
of the bidding process. It was further submitted in the said
writ petition that the PQ document did not specify any
accounting standard (AS) and in the circumstances it was not
open to MSRDC to exclude REL/HDEC by applying AS No.26;
that the accounts of HDEC indicated "net profits" for the FY
ending December 31 \026 2002, 2003 and 2004 and on that basis
it had calculated NCP in accordance with internationally
accepted ASs (GAPP) which has been certified by KPMG,
Chartered Accountants in Korea. According to REL/HDEC, no
particular AS was mentioned in the PQ document and,
therefore, it was implied that the Consortium were free to
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adopt GAAP. That, in the circumstances, the impugned
decision taken by MSRDC was arbitrary, unjust and wrongful
and contrary to the tender document (PQ document) issued by
MSRDC.
17. By the impugned judgment dated 4.6.2007, the High
Court ruled that admittedly HDEC had suffered net loss of
approximately US$ 610 million in 2001; that they had earned
net profits in 2002, 2003 and 2004; that audited accounts for
2004 were made available only after 10.1.2005 and, therefore,
could not have been taken into account by the Peer Committee
and, therefore, MSRDC was right in excluding REL/HDEC
from the second stage of the bidding process. According to the
impugned judgment, the basic debate was about accounting
treatment to be given to "non-cash expenses". The High Court
was of the view that it had no jurisdiction under Article 226 of
the Constitution to interfere with the decision of MSRDC,
particularly, when there were two different opinions regarding
adjustment to net income. According to the High Court, the
decision of MSRDC on the future cash impact of "the provision
for bad debts" made by HDEC in its accounts for 2001 cannot
be said to be arbitrary or unreasonable. For the aforestated
reasons, without going into the question whether provision for
bad debts is or is not a "non-cash expense" liable to be added
back to arrive at net cash profit, the High Court dismissed the
writ petition, hence this civil appeal.
18. Mr. K.K. Venugopal, learned senior counsel appearing on
behalf of REL/HDEC (Consortium), submitted that the
decision-making process stood vitiated for the reason that the
report of the Peer Committee, which disagreed with the
Consultants of MSRDC, was not referred to an independent
firm of chartered accountants. That, Crisil was rating agency
and not chartered accountants. He submitted, in this
connection, that it was obvious to MSRDC that Crisil had
already taken a position in its first report that REL/HDEC
were disqualified and, therefore, fairness and transparency
which are important aspects of Article 14 of the Constitution
required MSRDC to have placed both the reports of Crisil and
the Peer Committee, before any independent firm of chartered
accountants. Learned counsel submitted that by not doing so
the decision-making process itself stood vitiated. In any event,
learned counsel urged that Crisil was wrong if one looks at the
audited balance sheet of HDEC for the accounting year ending
31.12.2004. Learned counsel urged that even according to
Crisil the provisioning for bad debts was "non-cash expense",
however, according to Crisil, such provisioning could have a
cash impact in future years. Learned counsel submitted that
the conclusion of Crisil, namely, that such provisioning could
have a cash impact in future years was unjustified if one takes
into account the audited balance sheet for the year ending
31.12.2004. Therefore, according to the learned counsel, the
decision of Crisil was arbitrary, since, its conclusion was not
based on application of proper AS. Learned counsel further
submitted that when the entire basis of Crisil's report against
HDEC was on the issue of future cash impact, the decision to
exclude the audited accounts for the FY 2004, clearly vitiated
the decision-making process. In the alternative, learned
counsel submitted that in any case where two views are
possible, the view holding that the person/party concerned
should not be disqualified, should be accepted as
disqualification prevents the applicant from participating in
the bidding process, it affects its fundamental rights under
Article 19(1)(g) of the Constitution as also larger public interest
including State finances which ultimately makes MSRDC a
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loser.
19. Mr. S. Ganesh, learned senior counsel appearing on
behalf of REL/HDEC, submitted that provision for doubtful
debts in the present case has not been written-off till
31.12.2004; that by adding back provision for doubtful debts
made by HDEC in 2001, the Consortium had met the
requirement of NCP for the years 2001, 2002 and 2003; that
the said provision was made only in the accounts of 2001; that
Iraq contract receivables had nothing to do with the years
2001, 2002 and 2003 (reference years); that provision for
doubtful debts is only appropriation of profits and not a
charge on profits and that in fact regarded as "Reserve" for
purpose of "sur-tax" and since it is only appropriation the
amount under it has to be added back to determine the NCP in
terms of the definition in the PQ document. Learned counsel
further urged that provision for doubtful debts ought to be
included in the net profit; that since NCP is always more than
the net profit it is obvious that the said provision for doubtful
debt has to be included in the NCP. Learned counsel further
urged that there was no "write-off" during 2001, 2002 and
2003 and, therefore, during those years there was no cash
impact on the cash profit of REL/HDEC or on the net profit of
the said Consortium.
20. Mr. Altaf Ahmed, learned senior counsel appearing on
behalf of the MSRDC submitted that REL/HDEC had failed to
satisfy clause 7.2.2 of the PQ document and, therefore, they
were disqualified rightly. It was urged that the evaluation of
prequalification criteria was done by reputed international
consultants, namely, M/s. Jean Muller which in turn took
opinion from Crisil. The entire exercise was carried out by
experts and according to the recommendations of Crisil, duly
accepted by the consultants, the impugned decision was taken
and, therefore, the High Court was right in refusing to
intervene under Article 226 to the Constitution. Learned
counsel submitted that the failure to satisfy the financial
criteria laid down in clause 7.2.2 was the decision of the
consultants and not the decision of MSRDC which had merely
acted on the basis of evaluation done by the consultants and,
therefore, it cannot be said that the impugned decision taken
by MSRDC was arbitrary or unjustified. Learned counsel
submitted that according to the opinion expressed by the
consultants, the financial position of HDEC for the year ending
31st December 2001 was poor and the provisioning made by
HDEC for the years 1999, 2000 and 2001 would have future
cash impact. This was the view of the experts which MSRDC
accepted. That, the entire process was transparent and every
aspect was considered. There were detailed discussions
during the decision-making process. Queries were raised from
time to time. Explanations and clarifications were sought
from time to time. Full opportunity was given to the
Consortium to put forth their case. In the circumstances,
learned counsel submitted it cannot be said that the decision-
making process was faulty, arbitrary, unjust or wrongful.
Learned counsel next contended that the cut-off date was
10.1.2005. That cut-off date, according to the learned
counsel, was applicable in the case of all the six bidders.
Hence, it was not possible to look into the audited balance
sheet for the year 2004 which was placed by the Consortium
only in August 2005. In other words, learned counsel
submitted that the audited balance sheet for the year 31st
December, 2004 could not have been taken into account after
the cut-off date. This was the view of the Consultants for
MSRDC and that view has been accepted by MSRDC.
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21. Learned counsel submitted that Mumbai Trans Harbour
Link (MTHL) Project is based on BOT, therefore, global tenders
were invited. It is an important project which is required to be
given to the bidder who qualifies and goes successfully
through both the stages of the bidding process; that REL had
entered into an agreement with HDEC; that it was a
consortium; that the said Consortium did not fulfill the
financial criteria of Rs.200 crores (NCP); that according to the
annual accounts of HDEC there was a loss of US$ 610 million
in the year 2001; that in Form F-S submitted by the
appellant's Consortium, non-cash expenses for financial years
ending December 31 - 2001, 2002 and 2003 in respect of
HDEC were US$ 686 million, US$ 201 million and US$ 199
million respectively which cannot be added back to net
profit/loss. Learned counsel further contended that according
to the Consultants of MSRDC "adding back" was not
permissible and even if it is held to be permissible it is not
advisable as it would result in future cash impact on the net
profits of HDEC. Learned counsel submitted that provision for
bad debts were examined by the consultants and upon
examination of bad debts expenses, the consultants opined
that the said expenses may not involve a direct cash outflow in
the year of incidence but they may have a cash impact at a
future date and hence they cannot be treated as non-cash
expenses. Learned counsel submitted that there is a
difference between "cash expense" and "non-cash expense".
The distinction lies in the answer to the question as to
whether there is a cash impact in the current year or future
years and if it has cash impact at a future date then it would
constitute an item of cash expense, even though in the year of
incidence the item may be non-cash expense. Therefore, the
impugned decision, namely, that REL/HDEC did not satisfy
the financial criteria under clause 7.2.2, was right. Learned
counsel lastly submitted that bad debt expenses did not
qualify as "amortization" and, therefore, such provision cannot
be added back to net profits of HDEC. Learned counsel lastly
submitted that in the present case that Consultants of
MSRDC had rightly relied on AS 26 under which the terms
"amortization" and "write-off" are interchangeable and,
therefore, provisioning for doubtful debts did not constitute
"amortization" and, therefore, it could not have been added
back to the net profits, particularly when the definition of NCP
in the tender document defined NCP to mean "PAT +
depreciation + amortization, not in the form of cash
transaction".
22. We find merit in this civil appeal. Standards applied by
courts in judicial review must be justified by constitutional
principles which govern the proper exercise of public power in
a democracy. Article 14 of the Constitution embodies the
principle of "non-discrimination". However, it is not a free-
standing provision. It has to be read in conjunction with
rights conferred by other articles like Article 21 of the
Constitution. The said Article 21 refers to "right to life". In
includes "opportunity". In our view, as held in the latest
judgment of the Constitution Bench of nine-Judges in the case
of I.R. Coelho vs. State of Tamil Nadu \026 (2007) 2 SCC 1,
Article 21/14 is the heart of the chapter on fundamental
rights. It covers various aspects of life. "Level playing field" is
an important concept while construing Article 19(1)(g) of the
Constitution. It is this doctrine which is invoked by
REL/HDEC in the present case. When Article 19(1)(g) confers
fundamental right to carry on business to a company, it is
entitled to invoke the said doctrine of "level playing field". We
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may clarify that this doctrine is, however, subject to public
interest. In the world of globalization, competition is an
important factor to be kept in mind. The doctrine of "level
playing field" is an important doctrine which is embodied in
Article 19(1)(g) of the Constitution. This is because the said
doctrine provides space within which equally-placed
competitors are allowed to bid so as to subserve the larger
public interest. "Globalization", in essence, is liberalization of
trade. Today India has dismantled licence-raj. The economic
reforms introduced after 1992 have brought in the concept of
"globalization". Decisions or acts which results in unequal
and discriminatory treatment, would violate the doctrine of
"level playing field" embodied in Article 19(1)(g). Time has
come, therefore, to say that Article 14 which refers to the
principle of "equality" should not be read as a stand alone item
but it should be read in conjunction with Article 21 which
embodies several aspects of life. There is one more aspect
which needs to be mentioned in the matter of implementation
of the aforestated doctrine of "level playing field". According to
Lord Goldsmith - commitment to "rule of law" is the heart of
parliamentary democracy. One of the important elements of
the "rule of law" is legal certainty. Article 14 applies to
government policies and if the policy or act of the government,
even in contractual matters, fails to satisfy the test of
"reasonableness", then such an act or decision would be
unconstitutional.
23. In the case of Union of India and another vs.
International Trading Co. and another - (2003) 5 SCC 437,
the Division Bench of this Court speaking through Pasayat, J.
had held :
"14. It is trite law that Article 14 of the Constitution
applies also to matters of governmental policy and if
the policy or any action of the Government, even in
contractual matters, fails to satisfy the test of
reasonableness, it would be unconstitutional.
15. While the discretion to change the policy in
exercise of the executive power, when not
trammelled by any statute or rule is wide enough,
what is imperative and implicit in terms of Article
14 is that a change in policy must be made fairly
and should not give impression that it was so done
arbitrarily or by any ulterior criteria. The wide
sweep of Article 14 and the requirement of every
State action qualifying for its validity on this
touchstone irrespective of the field of activity of the
State is an accepted tenet. The basic requirement of
Article 14 is fairness in action by the state, and
non-arbitrariness in essence and substance is the
heart beat of fair play. Actions are amenable, in the
panorama of judicial review only to the extent that
the State must act validly for a discernible reasons,
not whimsically for any ulterior purpose. The
meaning and true import and concept of
arbitrariness is more easily visualized than precisely
defined. A question whether the impugned action is
arbitrary or not is to be ultimately answered on the
facts and circumstances of a given case. A basic and
obvious test to apply in such cases is to see whether
there is any discernible principle emerging from the
impugned action and if so, does it really satisfy the
test of reasonableness."
24. When tenders are invited, the terms and conditions must
indicate with legal certainty, norms and benchmarks. This
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"legal certainty" is an important aspect of the rule of law. If
there is vagueness or subjectivity in the said norms it may
result in unequal and discriminatory treatment. It may violate
doctrine of "level playing field".
25. In the case of Reliance Airport Developers (P) Ltd. v.
Airports Authority of India and others -(2006) 10 SCC 1,
the Division Bench of this Court has held that in matters of
judicial review the basic test is to see whether there is any
infirmity in the decision-making process and not in the
decision itself. This means that the decision-maker must
understand correctly the law that regulates his decision-
making power and he must give effect to it otherwise it may
result in illegality. The principle of "judicial review" cannot be
denied even in contractual matters or matters in which the
Government exercises its contractual powers, but judicial
review is intended to prevent arbitrariness and it must be
exercised in larger public interest. Expression of different
views and opinions in exercise of contractual powers may be
there, however, such difference of opinion must be based on
specified norms. Those norms may be legal norms or
accounting norms. As long as the norms are clear and
properly understood by the decision-maker and the bidders
and other stakeholders, uncertainty and thereby breach of
rule of law will not arise. The grounds upon which
administrative action is subjected to control by judicial review
are classifiable broadly under three heads, namely, illegality,
irrationality and procedural impropriety. In the said judgment
it has been held that all errors of law are jurisdictional errors.
One of the important principles laid down in the aforesaid
judgment is that whenever a norm/benchmark is prescribed
in the tender process in order to provide certainty that
norm/standard should be clear. As stated above "certainty" is
an important aspect of rule of law. In the case of Reliance
Airport Developers (supra), the scoring system formed part of
the evaluation process. The object of that system was to
provide identification of factors, allocation of marks of each of
the said factors and giving of marks had different stages.
Objectivity was thus provided.
26. One of the points which arise for determination in this
case is whether the criteria of objectivity stand satisfied in the
present case. "Profit/net income" and "cash" are concepts.
However, there is a difference. "Profit" is based on "value
judgment" whereas "cash" is "fact-specific". In the PQ
document, "net cash profit" has been defined to mean - "PAT +
depreciation + amortization, not arising from cash
transaction". The last five words which have underlined are
descriptive. They merely indicate the meaning of
"amortization". It is not in dispute that depreciation and
amortization are "non-cash expenses".
27. In the present case, REL/HDEC claims adding back of
the non-cash expenses of US$ 686,310 million for the year
2001, of US$ 200,753 million for the year 2002 and of US$
199,084 million in the year 2003, to the net loss of US$
610,507 million; net profit of US$ 15,963 million and US$
65,545 million during the years 2001, 2002 and 2003.
However, according to the Consultants of MSRDC, such "add
back" was not possible because even though provisions are
not "write-offs" the former should be treated as cash expense
because once a provision is made, the "write-off" does not get
routed through the P&L account and that in any event if such
add back is allowed then it would result in "cash impact" in
future.
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28. To answer the first point we need to know what is
"provision" and how it is made.
29. "Provisioning" is a matter of estimation. ASs are policy
documents. Accounting interpretation depends on application
of several ASs simultaneously. The concept of "amortization"
is not restricted only to AS 26. Similarly, the concept of "cash
flow analysis" is not restricted to AS 3. Therefore, different
methods are prescribed for estimating net profits and/or net
cash profits. There are no two views on this point.
Provisioning for doubtful debts cannot be equated to "write-
off". In the case of provisioning there is no "cash outflow".
This proposition is undisputed. What is being argued is that
once there is "provisioning", the "write-off" does not get routed
through the P&L account and, therefore, there will be cash
impact in future. This argument amounts to begging the
question. If this argument is to be accepted then we are
obliterating the difference between "provisioning" and "write-
offs". The question of "cash impact" in future is a separate
question. It has to be answered in terms of "cash flow
reporting" which falls in AS 3 which has been invoked by the
chartered accountants of REL/HDEC. In the case of
Commissioner of Income-tax and Excess Profits Tax,
Central, Bombay v. Jwala Prasad Tiwari \026 1953 (24) ITR
537, the Division Bench of the Bombay High Court speaking
through Chagla, C.J. has held as follows:
"'Writing Off' is a technical term used by
financiers and auditors. There are two methods of
dealing with a debt which has been written off in
the books of account, (1) by giving the
corresponding credit to the debtor's account, and (2)
by giving the corresponding credit to the bad and
doubtful debts account. The first method is only
employed where it is desired to close the account of
the debtor. The second method is employed where
there are some chances of recovery, howsoever
remote they may be.
When we talk of 'writing off' we are not
concerned with the credit to be given to an account.
'Writing off' means the raising of a debit entry. This
can only be to the debit of the profit and loss
account. This is the only debit which can possibly
be raised as a result of writing off a bad debt."
30. In the case of Metal Box Company of India Ltd. v.
Their Workmen \026 1969 (73) ITR 53, this Court has brought
out succinctly difference between "provision" and "reserve" as
follows:
"The next question is whether the amount so
provided is a provision or a reserve. The distinction
between a provision and a reserve is in commercial
accountancy fairly well known. Provisions made
against anticipated losses and contingencies are
charges against profits and, therefore, to be taken
into account against gross receipts in the P. & L.
account and the balance sheet. On the other hand,
reserves are appropriations of profits, the assets by
which they are represented being retained to form
part of the capital employed in the business.
Provisions are usually shown in the balance-sheet
by way of deductions from the assets in respect of
which they are made whereas general reserves and
reserve funds are shown as part of the proprietor's
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interest (see Spicer and Pegler's Book-keeping and
Accounts, 15th edition, page 42). An amount set
aside out of profits and other surpluses, not
designed to meet a liability, contingency,
commitment or diminution in value of assets known
to exist at the date of the balance-sheet is a reserve
but an amount set aside out of profits and other
surpluses to provide for any known liability of which
the amount cannot be determined with substantial
accuracy is a provision: (see William Pickles
Accountancy, second edition, p. 192 ; Part III,
clause 7, Schedule VI to the Companies Act, 1956,
which defines provision and reserve)."
31. Applying the tests laid down in the aforesaid two
judgments [Jwala Prasad (supra) and Metal Box (supra)] it is
clear that the concept of "provision for doubtful debts" is
different from the concept of "write-off". The effect of the two
is quite different. Provisions made against anticipated losses
are charges against profits and, therefore, to be taken into
account against gross receipts in the P&L account and the
balance-sheet. "Provisions" are usually shown in the balance-
sheet by way of deduction from the assets whereas "reserves"
are shown as part of the interest of the proprietor. In the
present case, there is no dispute regarding the aforestated
concepts. However, according to the consultants for MSRDC
though provision for doubtful debt is a non-cash expense it
has to be treated as a cash expense because once a provision
has been made, the write-offs cannot be routed through P&L
account and, therefore, what is conceptually a non-cash
expense is being treated as a cash expense. As stated above,
this is begging the question. If the aforestated argument is to
be accepted it would obliterate the conceptual difference
between "provision" and "write-off". The above reasoning
shows that the only reason for excluding REL/HDEC is the
future cash impact of the provision made in the accounts of
HDEC for the FY 2001. This aspect has been discussed by us
in the following paragraphs.
32. On the second question of future cash impact it may be
reiterated that KPMG, the chartered accountants for
REL/HDEC has invoked the principle of "cash flow reporting"
which also finds place in AS 3. According to the said principle
of "cash flow reporting", when P&L accounts and balance-
sheets are prepared on accrual basis, revenues and expenses
are recognized on accrual basis, i.e., when the transaction or
event occurs. However, timing of cash flow is not reckoned in
such system of accounting. Similarly, in cases where
accounts are based on accrual system of accounting,
recognition of assets and liabilities is not dependent on the
actual timing of cash spent on capital expenditure and cash
inflow on account of capital receipt. Thus the financial
statements prepared on accrual basis do not reflect the timing
of the cash flow and amount of cash flow. The object of the
cash flow statement is to assess the company's ability to
generate the cash flow in future and to assess reasons for
difference between "net profit" and "net cash flow" from
operations.
33. "Operating cash profit" can be derived by either "Direct
Method" in which cash items of cash inflow are listed like cash
received from customers, payment of interest etc. as against
cash outflows like payment to supplier, payment for taxes etc.
or by "Indirect Method" which is also known as "Reconciliation
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Method" in which the "operating cash profit" is derived by
adding to the net profit non-cash items like provision for taxes,
provision for doubtful debts, loss on sale of fixed assets and
investments, depreciation, amortization of intangibles etc.
because these items do not affect cash. Similarly, profit on the
sale of fixed assets and investments are deducted from the net
income figure as these items also do not affect cash. Similarly,
adjustments in respect of current assets and liabilities are also
required to make to net income (loss) figure to arrive at cash
profits. Both the methods give the same results in respect of
the final total.
34. We quote hereinbelow some of the illustrations of
"Indirect Method" which shows that provision for bad debts
can be added back to "net profit" in order to arrive at "net
cash" from operating activities:
(1) "Advance Accounts" by Shukla, Grewal and Gupta,
Vol.II, Edition 2008, pages 23.20 - 23.21, which read as
under:
""(ii) Indirect Method:
Zed Ltd.
Cash Flow Statement for the year ended 31st March, 2001
Rs.
Rs.
Cash Flows from Operating
Activities
Net profit before income tax and extra-
ordinary item:
Adjustments for:
Depreciation
Provision for bad debts
Underwriting commission amortised
Profit on sale of investments
Income from investments
Interest on debentures
Operating profit before working capital
changes
Adjustments for:
Increase in inventory
Increase in trade debtors
Increase in trade creditors
Increase in outstanding expenses
Cash inflow from operations
Income tax paid
Cash flow from extraordinary item:
Compensation recd. in lawsuit
Net cash from operating activities
Cash Flows from Investing Activities
Purchase of fixed assets
Sale proceeds of investments
Interest recd. on investments*
Net cash used in investing activities
Cash Flows from Financing
Activities
Redemption of debentures at par*
Interest on debentures paid
Dividends and corporate dividend tax
paid
Net cash used in financing activities
Net increase in cash and cash
equivalents
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Cash and cash equivalents as on
31st March,2000 (Opening Balance)
Cash and cash equivalents as on
31st March,2001(Closing Balance)
7,77,000
1,80,000
1,000
1,200
(7,500)
(21,000)
_____66,000
9,96,700
(93,800)
(20,000)
19,200
______5,600
9,07,700
___(4,16,000)
4,91,700
_____55,000
(2,00,000)
1,57,500
_____21,000
(1,00,000)
(66,000)
___(3,30,000)
5,46,700
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(21,500)
____(4,96,000)
29,200
_____1,64,200
_____1,93,400
*Alternatively, interest received on investments and interest paid on
debentures may be treated as flows from operating activities.
Working Notes:
(i) Net profit before income-tax and extraordinary item: Rs.
Net profit before income tax 8,32,000
Less: Compensation received in lawsuit 55,000
7,77,000
Working notes (iii), (iv) and (v) as prepared under the direct method are also
relevant under the indirect method."
(emphasis supplied)
(2) "Fundamentals of Corporate Accounting" by J.R.
Monga, 11 Edition 2005-06, pages 12.15, 12.16, 12.17, 12.20,
which read as under:
"12.15.
CASH FLOWS FROM PERATING ACTIVITIES
[CASH PROVIDED BY (OR USED IN) OPERATING ACTIVITIES]
One of the major items of information in the cash flow statement is the net
cash flow provided by (or used in) operating activities. In fact it is the
regular source of cash in any enterprise that determines whether or not an
enterprise will continue to exist in the long run. The logic for
determining the net cash flow from operating activities is to
understand why net profit (loss) as reported in the profit and loss
account must be converted. As we know that financial statements are
generally prepared on accrual basis of accounting which requires that
revenues be recorded when earned and the expenses be recorded when
incurred. Earned revenues more often include credit sales that have not
been collected in cash and expenses incurred that may not have been paid
in cash during the accounting period. Thus under accrual basis of
accounting net income will not indicate the net cash provided by operating
activities or net loss will not indicate the net cash used in operating
activities. In order to calculate the net cash provided by (or used in)
operating activities, it is necessary to replace revenues and expenses
on accrual basis with actual receipts and actual payments in cash.
This is done by eliminating the non-cash revenues and non-cash expenses
from the given earned revenues and incurred expenses in the profit and
loss account. In addition to regular non-cash revenue and non-cash
expense items, the profit and loss account is also debited and credited with
purely non-cash items which reduce and increase the profits respectively
but do not affect the cash at al e.g. depreciation, loss (or profit) on the
sale of fixed assets, amortization of intangible assets like goodwill, patents
trademarks etc. deferred revenue expenditures like preliminary expenses,
discount on the issue of shares and debentures and so on. Since cash
provided by operations is to be calculated, certain non-operating items
like rent income, interest income, dividend income, refund of tax etc.
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should also be adjusted although these items may have been recorded on
cash basis. Such items are analysed separately in the cash flow
statement as operating, investing and investing activities.
ATTENTION PLEASE
The term 'operating activities' means business transactions pertaining
to regular business activities, e.g., purchase and sale of goods and
services.
DIRECT VS. INDIRECT METHOD
There are two method of preparing the Cash Flow Statement. Both
methods give the identical or same results in respect of the final total as
well as the sub-totals of the three sections \026 operating, investing and the
financing. They differ only in the manner the data or information is
presented in Cash Flows from Operating Activities section.
The direct method lists separately each significant cash inflows and
outflows from operating activities, e.g.,
Cash inflows :
(i) Cash received from customers
(ii) Receipts of interest payments
(iii) Receipts of cash dividends on investment in the shares of other
companies
Cash outflows :
(i) Payments to suppliers for goods purchased
(ii) Payments for operating expenses
(iii) Payments for interest
(iv) Payments for taxes
The outflows (payments) are subtracted forms the inflows (receipts) to
determine the net cash provided (or used) by operating activities."
"12.16-12.17. The indirect method provides less information because it
does not disclose the individual cash inflows and cash outflows from the
operating activities. Instead under this method we start with net profit (or
loss) and adjusts this figure to obtain net cash flows from operating
activities. The indirect method is also known as 'Reconciliation
Method' because it involves reconciliation between net profit (or loss) as
given in the profit and loss account and the net cash flow from operating
activities as calculated on the cash flow statement.
DIRECT VS. INDIRECT METHODS
Direct Method
Cash Flows from operating Activities
(A) Cash receipts from customers.
(B) Cash paid to suppliers and employees.
(A-B) Cash generated from operations.
Less: Interest and tax.
(C) Cash before extraordinary items.
Adjust for extraordinary items to get:
(1) Net cash from operations.
(2) Net cash from (used on) investing activities.
(3) Net cash from (used on) financing activities.
(D) Net increase (decrease) in cash and cash equivalents (1+2+3)
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Opening balance of cash and cash equivalents.
Closing balance of cash and cash equivalents.
Indirect Method
Net Profit as per Profit and Loss Account
Adjusted for:
Provision for tax
Provision for doubtful debts.
Profit (Loss) on sale of fixed assets.
Depreciation
Profit (loss) on sale of investments.
Interest expenses.
Exchange rate effect
Dividend income.
Interest income.
Leave salary provision (earlier year)
Operating profit before working capital change.
Adjusted for:
Trade and other receivable.
Inventories and other current assets.
Trade payables and other current liabilities.
Cash generated from operations.
Income tax paid (Net of refunds)
The above provides:
Cash flow before extraordinary items.
Adjust for extraordinary items to get.
Net cash from operating Activities.
There are two stages for achieving the net cash flows from operating
activities:
Stage-1: Calculation of operating (cash) profit before working capital
changes, by adding to net profit as reported in the profit and loss account,
non-cash charges: depreciation, amortization of intangible assets, loss on
the sale of fixed assets and long term investments, provision for tax and
dividends and the like because these items do not affect cash. Similarly
profit on the sale of fixed assets and long term investments are deducted
from the net income figure as these items also do not affect cash. In fact,
it is a partial conversion of accrual basis profit to cash basis profit. Such
adjustments are made by analyzing individual non cash items in journal to
find out the absence of cash in these items. Moreover, non-operating
items (also known as extraordinary items) like rental income, interest
income, dividend income are deducted from the reported net income
figure because these items are disclosed separately on the cash flow
statement. The net result of these adjustments is operating (cash) profit
before working capital changes.
Some of the significant non-cash items are explained in the following
paragraphs followed by adjustment of current operating assets and
liabilities. (See Stage II).
Depreciation: This item of expense reduces the profit since it is a charge
made against revenue for the use of tangible fixed assets. The likely
journal entry to record the depreciation expense is:
(i) Depreciation Account Dr.
To Provision for Depreciation Account
(or Accumulated Depreciation)
Alternatively
Depreciation Account Dr.
To Fixed Asset Account
In either case the depreciation account would be closed be transfer to
Profit and Loss Account. The net affect would be:
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Either
Profit and Loss Account Dr.
To Provision for Depreciation Account
Or
Profit and Loss Account Dr.
To Fixed Asset Account
It is clear that cash is not affected in the above journal entries. The
depreciation does not require any expenditure in cash. Thus, the
amount of depreciation charge must be added to be reported net
income in order to arrive at the total increase in cash provided from
the operations.
Amortization of intangibles-goodwill, patents, etc.: The amortization of
(i.e., writing off) goodwill, trade marks, patents copyrights, etc., has the
same effect as the depreciation expense. The amount of amortization
reduces the profit but does not involve any flow of cash as is evident from
the following entry:
Profit and Loss Account Dr.
To Goodwill etc. Account
There is no change in cash. Thus amount of intangibles so written off
must also be added back to the reported net profit (income)."
"12.20.Stage-2 : Adjustments in respect of current assets and current
liabilities : The adjustments made in the net profit (income) figure as per
profit and loss account as outlined in Stage-I above, gives As Operating
Profit before Working Capital Changes. Several other adjustments
are made in respect of current (Operating) assets (e.g., debtors, bills
receivable, inventories, prepayments etc.) and current (Operating)
liabilities (e.g., creditors bills payable, outstanding liabilities etc.) to
obtain the final net cash from operating activities. There is an intimate
relationship between the revenue and expense items of income
statement and current assets and current liabilities items of the
balance sheet. Since the income statement is prepared on the accrual
basis, the resultant net income figure is affected by cash and non-cash
items. But the net income on a cash basis considers only cash receipts as
revenue and subtracts from cash receipts only cash spent for purchase of
goods or raw materials) and expenses.
The following general rules, as an aid to analysis of current assets and
current liabilities affecting cash, may be noted :
(i) An increase in an item of current asset causes a
decrease in cash inflow because cash is blocked in
current assets.
(ii) A decrease in an item of current asset causes an
increase in cash inflow because cash is released from the
sale or recovery from current asset.
(iii) An increase in an item of current liability causes a
decrease in cash outflow because cash is saved.
(iv) A decrease in an item of current liability causes
increases in cash outflow because of payment of
liability.
Some of the adjustments are discussed below :
(i) Debtors and Bills Receivable (Credit Sales) : It needs no
explanation that the major source of cash from operations is
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cash sales. But it is not uncommon to find a significant
amount of credit sales in the form of debtors and bills
receivable representing current assets. This indicates that
the sales were made both for cash and credit. Consequently
the net income (or profit) figure does not disclose the cash
from operations. The following adjustment, however,
enables to overcome this difficulty :
Cash from Operations = Operating Profit before Working Capital
Changes + Net Decrease in Debtors and Bills Receivable."
(emphasis supplied)
35. Taking into account the above principles, it is clear that
there are two methods of "cash flow reporting" i.e. direct and
indirect. Both give identical results in the matter of the final
total. They differ only in presentation of the data. They differ
only in presentation of the data contained in the cash flows
from operational activities. No reason has been given by the
Consultants of MSRDC for rejecting the indirect method
invoked by KPMG, Chartered Accountants of REL/HDEC in
their letter dated 12.8.2005. The said method is known as
"reconciliation method". In this case, as stated above, the only
reason given by the Consultants of MSRDC to exclude
REL/HDEC was the negative impact on the future cash flows
on account of the provisioning for doubtful debts in the
accounts of HDEC for the FY 2001. If future cash impact was
the basis to exclude REL/HDEC, then the Consultants for
MSRDC should have considered cash flow reporting methods,
which includes Reconciliation Method. There is no question of
difference of opinion or different views as far as the application
of cash flow reporting, which also falls in AS 3. There is
nothing to show whether indirect method has at all been
considered by Crisil, particularly when KPMG had invoked
that method. There is no reason given for rejecting it. Lastly,
in the PQ document, the referral years were three years. The
criteria was that there should be NCP of not less than Rs.200
crores. However, the opinion of the Consultants proceeds on
the basis that if "add back" is allowed it may have future cash
impact. In the evaluation process, the Consultants were
entitled to take into account future cash impact but in order to
do so they had to say why the indirect method of "cash flow
reporting" should not be accepted and if at all the impact of
the provisioning was to be seen then there was no reason for
not examining the audited accounts of 2004. There is a mix-
up of two concepts here. The concept of non-compliance of
financial criteria and the impact in future years on cash flow.
As stated above, the very purpose of "cash flow reporting" is to
find out the ability of HDEC to generate cash flow in future
and if an important method of cash flow reporting is kept out,
without any reason, then the decision to exclude REL/HDEC,
is arbitrary, whimsical and unreasonable. In our view, for non-
consideration of the Reconciliation Method, under cash flow
reporting system, the impugned decision-making process
stood vitiated.
36. In the result, we set aside the impugned judgment of the
High Court; we hold that REL/HDEC (Consortium) was
erroneously excluded from the second stage of bidding
process. Accordingly, we allow this civil appeal with no order
as to costs.
37. Since we have allowed this civil appeal, we extend the
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period for presenting financial bids by REL/HDEC up to
15.12.2007.
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