Expert Advisory Committee

1.29 Query:

Portfolio management services

– Disclosure in financial statements.

1. A non-banking financial public limited company is engaged in the portfolio management schemes on behalf of its clients.

2.The querist has stated that according to Rule 17 of SEBI (Portfolio Managers) Regulations, 1993, any Portfolio Manager must, inter alia, maintain the following: -

(a) A copy of balance sheet at the end of each accounting period.

(b) A copy of profit and loss account at the end of each accounting period.

(d) A statement of financial position.

Rule 14(2) of the said Regulations also specifies that a Portfolio Manager will enter into a contract with every client stating, inter alia, the following: -

(a) Amount to be invested.

(b) Procedure of settling client’s accounts.

(c) He shall not either directly or indirectly guarantee or assure any return to his clients and the risk will be solely of the clients participating in his scheme.

3. The querist has informed that the funds received from the clients are deposited in a separate bank account so as not to mix the company’s funds with the client’s funds. The funds received are deployed in purchase of shares and other securities in the secondary market. The cost of securities is debited to the clients’ accounts along with the expenses incurred such as notary charges, stamp duty, transfer fees and management fees recoverable from the clients. At any point of time, the clients’ accounts will show the cost of securities purchased, expenses incurred and the balance of uninvested funds.

4. The querist has further informed that the following three different views are being expressed as regards the disclosure of the funds collected, the securities purchased and the balance funds on hand, in the final accounts of the company: -

(i) In view of the fact that all these items do not belong to the company, they should not form part of the balance sheet of the company. A note on the balance sheet covering the above information would suffice.

(ii) According to the second view, the liability side of the balance sheet should disclose the total funds received and the asset side should disclose the cost of securities purchased and the balance of funds remaining uninvested.

(iii) While the third view holds that the net balances on the clients’ accounts alongwith the bank balance only need be shown.

5. In this context and considering the provisions of sections 209, 211 and 227 of the Companies Act, 1956, the querist has sought the opinion of the Expert Advisory Committee as to the correct method of disclosure of the portfolio management activity in the final accounts.

Opinion February 8, 1995

1. The Committee notes that the Institute of Chartered Accountants of India, in its ‘Guidance Note on Audit of Banks’ (1994) has dealt with the matter of accounting for the transactions related to portfolio management services (PMS) rendered by banks. The
Committee is of the view that the recommendations made in this regard in the aforesaid Guidance Note would also be relevant to a non-banking financial company.

2. The Committee notes para 17.18 and 17.23 of the said Guidance Note which are reproduced below:

“17.18 The portfolio management services rendered by banks are in the nature of fiduciary activities, provided such services are rendered in accordance with the applicable legal or regulatory requirements. The investments made by the bank on behalf of PMS clients’ account are not the investments of the bank and, therefore, are not included in its balance sheet. However, it is often considered appropriate to disclose the quantum of funds accepted and funds invested under portfolio management schemes in a note to the balance sheet.

17.23 It may be mentioned that one of the important concepts underlying the financial statements is that of ‘substance over form’. According to Accounting Standard (AS) 1, Disclosure of Accounting Policies, issued by the Institute of Chartered Accountants of India, “the accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form.” It is the duty of an auditor to exercise reasonable skill, care and caution in examining whether the financial statements present a true and fair view, including whether they reflect the substance of various transactions and not merely their legal form. An auditor has to exercise reasonable care and skill but need not proceed with suspicion unless the circumstances are such as arouse suspicion or as ought to arouse suspicion in a professional man of reasonable competence. Thus, while examining the PMS transactions as aforesaid, the auditor should exercise reasonable skill, care and caution in examining whether the PMS transactions were in substance of a fiduciary nature. Thus, where during his examination of PMS transactions, the auditor finds that fixed returns have been guaranteed in several cases, either directly or indirectly, or that the bank has otherwise assumed risk in respect of investments pertaining to PMS clients’ account, this ought to arouse the suspicion of the auditor. In such a case, the auditor should determine the further procedures that he should apply to resolve such suspicion. Thus, the auditor may decide to extend his examination of PMS transactions. Where such further examination confirms the suspicion of the auditor, the auditor would conclude that even though the transactions have been described by the bank as those on PMS clients’ accounts, they are in substance on the bank’s own investment account. In such a case, the auditor should examine whether the funds accepted by the bank from the clients have been shown as borrowings and the corresponding investments have been included in the bank’s own investment. He should, in such a case, apply the audit tests applicable in respect of bank’s own investments, including examination of compliance with the relevant legal requirements.”

3. On the basis of the above, the Committee is of the opinion that PMS transactions should be accounted for in accordance with para 17.18 of the Guidance Note on Audit of Banks, which is reproduced in para 2 above. However, in respect of those PMS transactions which in substance are not of a fiduciary nature, i.e., fixed returns have been guaranteed, directly or indirectly, or the company has otherwise assumed risk in respect of investments pertaining to PMS client’s accounts, the funds accepted by the company from the clients should be shown as borrowings and the corresponding investment should be shown as the company’s own investments.

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