1.6  Query:     

Valuation of unquoted investments in case of Non-Banking

Financial Companies (NBFC’s).

1. According to paragraph 2 of the guidelines issued by the Reserve Bank of India for non-banking financial companies regarding the prudential norms for income recognition, accounting standards, provisioning for bad and doubtful debts, capital adequacy and concentration of credit/investment to single and group borrowers, unquoted shares held by an NBFC are to be valued at lower of cost and break-up value of shares as per the latest audited balance sheet.

2. According to the querist, in the case of an NBFC which is registered under the Companies Act, 1956, the provisions of Schedule VI to the Companies Act are applicable. In terms of Schedule VI, the nature of the investments and mode of valuation, for example, cost or market value, should be indicated. Aggregate amount of company’s unquoted investments should be shown. Thus, in the view of the querist, the Companies Act does not contemplate the disclosure of valuation of unquoted shares at the break-up value. According to the querist, if an NBFC adopts the valuation method prescribed by RBI which is its controlling agency, it would not be strictly in compliance with the provisions of the Companies Act under which the NBFC is incorporated.

3.  The querist has informed that, in the recent past, many corporate bodies, especially in financial services sector, have been going for bought-out deals. Generally, the consideration paid is more than the break –up value of the shares. The consideration is fixed on prospective value of the shares, expected EPS, future earnings, the market share of the company etc. the querist feels that, as per the provisions of the Companies Act, the price paid for acquiring these shares is cost to the company and accordingly the shares could be valued at that price. But as per the norms recommended by the RBI, these shares are to be valued at cost and provision should be made for any decline in value.

4.  The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) The correct procedure to be followed by an NBFC for valuing unquoted shares.

(b) Would the NBFC be correct in valuing the shares in bought-out deals at cost as contemplated in the Companies Act?

                                                                                Opinion                                      July 11, 1995

 1. The Committee notes that Schedule VI to Companies Act, 1956, provides that investments have to be disclosed by showing their nature and “mode of valuation, for example, cost or market value”.

2.  The Committee is, therefore, of the view that Schedule VI, inter alia, lays down the manner of disclosure of the methods used in the valuation of investments rather than prescribing the methods to be used. The Committee notes that the methods of valuation of investments have been laid down by the Institute of Chartered Accountants of India in Accounting Standard (AS) 13 on ‘Valuation of Investments’.

3.   The Committee notes paras 14, 17, 18 of AS-13 which prescribe the accounting treatment of investments as below:

“14. The carrying amount for current investments is the lower of cost and fair value. In respect of investments for which an active market exists, market value generally provides the best evidence of fair value. The valuation of current investments at lower of cost and fair value provides a prudent method of determining the carrying amount to be stated in the balance sheet. 

17. Long term Investments are usually carried at cost. However, when there is a decline, other than temporary in the value of a long term investment, the carrying amount is reduced to recognise the decline. Indicators of the value of an investment are obtained by reference to its market value, the investee’s assets and results and the expected cash flows from the investment. 

18. Long term investments are usually of individual importance to the investing enterprise. The carrying amount of long-term investments is therefore, determined on an individual investment basis.”

4.  The Committee further notes that paras 2.7.2, 2.7.3 and 2.7.4 of Prudential Norms for Income Recognition, Accounting Standards, Provisioning for Bad and Doubtful debts, Capital adequacy and concentration of Credit/Investments for Non-Banking Financial Companies prescribed by Reserve Bank of India, have also recommended the methods of valuation of investments. The aforesaid paragraphs are reproduced below:

“2.7.2 A current investment is an investment that is by its nature readily realisable and is intended to be held for not more than one year from the date on which such investment is made. Current investment should be valued at the lower of cost and market value (net of expenses necessarily to be incurred on or before disposal) for each investment. 

2.7.3 A long term investment is an investment other than a current investment. Long term investments should be valued at cost. However, provision for diminution should be made to recognise a decline, other than temporary in the value of long term investments, such reduction being determined and made for each investment individually. 

2.7.4 Unquoted shares are to be valued at cost or break-up value of the shares as per the last audited balance sheet of the company concerned, whichever is less.”

5. The Committee notes from the above that the methods of valuation of investments laid down in AS 13 and the RBI guidelines are broadly the same except that the latter specifically lays down the method for valuation of unquoted shares in para 2.7.4 thereof. A harmonious interpretation of para 2.7.4, read with paras 2.7.2 and 2.7.3 of the Guidelines and the methods prescribed in AS 13 is that the method recommended by RBI for valuation of unquoted shares presumes that the said investments are current investments.

6.  The Committee also notes para 27 of Guidance Note on Audit of Investments, issued by the Institute of Chartered Accountants of India, which is reproduced below:

“27. In case of unquoted securities, the auditor should ascertain the method adopted by the entity for determining the market value of such securities. He should examine whether the method adopted by the entity is one of the recognised methods of valuation of securities such as break-up value method, capitalisation of yield method, yield to maturity method, etc. In the case of investments other than in the form of securities (e.g., rare paintings), the auditor should examine that the market value has been ascertained on the basis of authentic market reports.”

7.   On the basis of the above, the following is the opinion of the Committee in respect of the issues raised by the querist in para 4 of the query:

(a) Unquoted shares should be valued at cost or break-up value, whichever is less, in case the said shares are of the nature of current investments.

(b) The shares acquired in bought-out deals should be valued as suggested in (a) above.

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