How to Calculate Net Profit of a Company – Complete Research

Section 198 of the Companies Act, 2013, provides guidelines for determining the remuneration of 16 key managerial personnel for a financial year, as specified under Section 197. The provisions under subsection (2) outline the sums to be credited, whereas subsection (3) specifies amounts that shall not be considered as credits. Further, subsections (4) and (5) enumerate amounts that should not be deducted while calculating net profits.

The Companies Act prescribes that the net profit reflected in the financial statements, specifically the Profit and Loss (P&L) statement, should not be directly used to determine the remuneration of directors. Instead, the net profit must be computed as per Section 198. Furthermore, this calculation is also applicable for determining the contribution required under Corporate Social Responsibility (CSR) obligations.

When computing net profit under Section 198, several provisions must be taken into consideration. Once the profit is calculated in accordance with the section, the limits on managerial remuneration prescribed under the Act can be applied to determine the maximum permissible remuneration. If the actual remuneration exceeds the prescribed limit, prior approval from the Central Government is no longer mandatory. Instead, passing a special resolution by the company’s members is sufficient. For the computation of net profits under Section 197, credits must be accounted for as per subsection (2), while those listed under subsection (3) shall be excluded. Deductions must be made per subsection (4), whereas items under subsection (5) shall remain undeducted. Additionally, government grants and subsidies received shall be included in the calculation unless directed otherwise by the Central Government under subsection (2).

While computing net profits, certain amounts shall not be credited under Section 198(3). These include premiums on shares unless the entity qualifies as an investment company under Section 186, profits earned from the sale of forfeited shares, capital gains including proceeds from the sale of a company’s undertaking or part thereof, and gains from selling fixed assets or immovable property unless the company’s business involves trading such assets. Unrealized gains or revaluation adjustments of assets, as well as any change in asset or liability value recognized in equity reserves or surplus in the profit and loss account, shall also not be credited.

Certain expenditures must be deducted while computing net profit as specified under Section 198(4). These include standard operational expenses, directors’ remuneration, and bonuses or commissions payable to staff, engineers, technicians, or consultants, irrespective of employment status (full-time or part-time). Taxes imposed on excess or extraordinary profits, as notified by the Central Government, business profit tax levied under special circumstances, interest on debentures and secured or unsecured loans, and repairs and maintenance expenses, provided they are not of a capital nature, must also be deducted. Additionally, charitable donations made under Section 181, depreciation as per Section 123, excess expenditure over income from previous years that has not been deducted earlier, compensation or damages arising from legal liabilities or breach of contract, insurance payments for covering legal liabilities, and bad debts written off or adjusted during the financial year are deductible expenses.

On the other hand, certain amounts are explicitly not deductible while computing net profits, as outlined under Section 198(5). These include income tax and super-tax payable under the Income-tax Act, 1961, or any other tax on company income, voluntary payments of compensation or damages that do not arise from a legal obligation, capital losses including losses incurred from selling the company’s undertaking or any of its parts, and changes in asset or liability valuation recorded in equity reserves or surplus in the profit and loss account.

Section 198 of the Companies Act, 2013, plays a crucial role in ensuring a standardized approach to net profit computation for determining remuneration and CSR contributions. It outlines inclusions and exclusions to maintain consistency and compliance with statutory regulations. By adhering to these guidelines, companies can ensure fair and legal financial reporting while fulfilling their managerial compensation and corporate social responsibility obligations.

Related Resources

• CS (Dr.) K R Chandratre, FCS, Computation of Net Profit under Section 198 of the Companies Act, 2013 for the purposes of Managerial Remuneration and CSR
• Section 198, The Companies Act, 2013

This article is presented by CA B K Goyal & Co LLP Chartered Accountants, your trusted partner in audit and compliance solutions. For expert assistance, feel free to contact us.