01.1 Query: Qualification in subsequent year’s auditors’ report regarding capitalisation of revaluation reserve pertaining to an earlier year. 1. A recently listed public limited company is a leading supplier of multiplayer films for flexible packaging industry and other specialty applications. The company made a public issue in November, 1994. It was incorporated as a private limited company on 7th May, 1981. It was converted into a closely held public limited company in June, 1994.
2. The company had created revaluation reserve based on revaluation of its certain assets, viz., land, buildings, plant and machinery and electrical installations to the extent of Rs. 2.11 crores as on 31.3.1994. A part of the revaluation reserve was subsequently utilised for issue of bonus shares in the ratio of 3:1 as on 29.6.94. Accordingly, paid up capital was increased from Rs. 50 lacs to Rs. 2 crores. Subsequently, public issue was made for 10 lacs shares of Rs. 10/- each at a premium of Rs. 30 per share. The break-up of the present paid-up capital is as under:
3. The querist has stated that they have followed the Guidance Notes on Availability of Revaluation Reserve for Issue of Bonus Shares, issued by the Institute of Chartered Accountants of India, published in the November, 1994, issue of The Chartered Accountant, and qualified their audit report for the year ended 31st March, 1995, as under:
“The company has issued Bonus Shares on 29th June, 1994, for Rs. 15 Million (1,500,000 Equity Shares of Rs. 10/- each) by capitalising Rs. 10 Million out of Revaluation Reserve and Rs. 5 Million out of General Reserve. Accordingly, the paid up Equity Share Capital of the Company stands increased by Rs. 15 Million and the Revaluation Reserve and General Reserve stand reduced by Rs. 10 Million and Rs. 5 Million respectively. The issue of Bonus Shares as aforesaid is contrary to the subsequent recommendation of November, 1994 issue of the Journal of the Institute of Chartered Accountants of India.”
4. The querist has also enclosed a copy of the company’s annual report. Further, the company’s management has also put forth the following views which have been communicated by the querist for the Committee’s consideration.
(a) The bonus shares were issued at the time when the company was closely held unlisted company to whom guidelines for issue of Bonus Shares as framed by Security Exchange Board of India (SEBI) did not apply at the relevant time. The relevant issue is covered by SEBI in Section M of their Guidelines for Disclosure and Investor Protection [as amended by RMB (DIP Series) Cir. No.94-95 dated April 15, 1994].
(b) Also ICAI’s recommendation vide Guidance Note published in November, 1994, on ‘Availability of Revaluation Reserve for Issue of Bonus Shares’ as issued in November, 1994, was subsequent to issue of bonus shares in June, 1994.
(c) The SEBI as well as Registrar of Companies, Gujarat, Ahamdabad, have respectively vetted and approved the Prospectus dated October, 1994, for the purpose of making the public issue.
5. The querist has stated that the company’s management has expressed its view that this qualification in auditors’ report is “one time” qualification and, accordingly, it is applicable only in the year of issue of bonus shares by capitalisation of revaluation reserve. The management is of the view that the qualification in the subsequent year’s audit report would not be necessary on the following grounds:
(a) The ICAI’s guidance note of November 1994 is silent on the applicability of the qualificatory report to years subsequent to the year of capitalisation of revaluation reserve.
(b) An illustrative manner of the qualification as recommended by the Institute also suggests that it is a one time qualification and has no relevance in subsequent years because issue of bonus shares refers to the event which has happened in a particular period covered by the audit report.
(c) Schedule VI, Part I, prescribing the form of balance sheet, while dealing with revaluation of fixed assets requires that where the fixed assets are revalued and the sums have been added by writing-up the assets, every balance sheet subsequent to such writing-up shall show the increased figure with the date of increase in place of original cost. Each balance sheet for the first five years subsequent to the date of writing-up shall also show the amount of increase made. Similarly, in respect of disclosure of the share capital it is stipulated that the company should specify the source from which the bonus shares were issued, e.g., capitalisation of profits or reserves or from share premium account. In view of the aforesaid reasoning the company’s management is of the view that Schedule VI provides for adequate disclosure of the fact of revaluation and issue of bonus shares therefrom and as such there is no need to qualify the audit report in the subsequent year where there is no issue of bonus shares by way of capitalisaiton of revaluation reserve.
6. The querist has stated that in his view, the Guidance Note is ambiguous on the issue whether qualification is “one time” or “life time”. The bonus shares, once issued, will form part of the share capital for the life of the company and cannot be deleted unless the company goes for reduction of capital. Guidance Note in para 5 states as under:
“Share capital represents the amount of money or money’s worth received from the owners and the capitalisation of earned profits or other gains arising out of an arm’s length transaction. It has, therefore, been a cardinal principle that only such profits as are earned or the relevant capital receipts (e.g., share premium), as are realised, can be capitalised.”
7. The querist is of the view that this would indirectly signify that the qualification should continue till such time that the Revaluation Reserve is actually converted into money or money’s worth upon the sale and realisation of revalued assets. Alternatively, the amount equivalent to Revaluation Reserve has to be provided and set aside by way of additional depreciation from the realised profits of the company to the extent of revalued amount.
8. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the qualification to auditor’s report as per the aforesaid Guidance Note should be “one time” or “life time”?
(ii) Whether adequate disclosure by way of notes to the accounts with regard to the amount of revaluation and its subsequent utilisation as stipulated under Schedule VI would be sufficient and that no further qualification in auditor’s report is needed in the subsequent year’s annual account?
(iii) If the Committee is of the view that the qualification should continue for lifetime, what should be the illustrative manner of the qualification in the subsequent year’s audit report?
Opinion September 23, 1996
1. The Committee notes that Part I of Schedule VI to the Companies Act, 1956, on the liability side, under the head Share Capital and Instructions in accordance with which liabilities should be made out, inter alia, states as below:
“Of the above shares……shares are allotted as fully paid up by way of bonus shares”
“Specify the source from which bonus shares are issued, e.g., capitalisation of profits or Reserves or from Share Premium Account.”
2. On the basis of the above, the Committee is of the view that as per Part I of Schedule VI, a disclosure of the source from which the bonus shares were issued has to be made every year. Thus, as per the facts in question, disclosure has to be made every year where bonus shares have been issued out of revaluation reserve. Accordingly, the figures of share capital and reserves would not be true and fair as the share capital would be overstated and the revaluation reserve is understated and, therefore, the auditor should qualify his report every year.
3. In this context, the Committee also notes Circular No. (17/32/93-CLV) issued by the Department of Company Affairs, to all Chambers of Commerce and Industries, regarding ‘Prohibition of Issue of Bonus Shares by Reserves Created by Revaluation of Fixed Assets’ which states as below:
“1. I am directed to say that it has come to the notice of the Department that a number of unlisted companies (existing private/closely held public companies) are resorting to revaluation of their assets and issuing bonus shares therefrom. The latest SEBI’s guidelines on bonus shares dated 13.4.94, inter alia, stipulate that the bonus issue has to be made out of free reserves built out of the genuine profits or share premium collected in cash only and reserves created by revaluation of fixed assets cannot be capitalised for this purpose. These guidelines are applicable only to listed companies.
2. This matter has been considered in the Department and the existing private/closely held and unlisted companies are hereby advised not to issue bonus shares out of the reserves created by revaluation of fixed assets.
3. The contents of this circular may please be brought to the notices of your constituent members-companies.”
4. On the basis of the above, the Committee is of the following opinion on issues raised in para 8 of the query:
(i) and (ii) The qualification in auditor’s report should continue in subsequent years also. Only disclosure by way of notes to the accounts as regards the amount of revaluation reserve and its utilisation for the purposes of bonus shares is not sufficient.
(iii) The suggested manner of the qualification in the subsequent year’s audit report is as below:
“The company has issued bonus shares in June, 1994, for Rs.______(______equity shares of Rs._______each) by capitalising its revaluation reserve. Accordingly, the paid-up equity share capital of the company stands increased by Rs._________ and the revaluation reserve stands reduced by that amount. The issue of bonus shares as aforesaid is contrary to the circular issued by the Department of Company Affairs issued in September, 1994 and the recommendations of the Institute of Chartered Accountants of India issued in November, 1994. Subject to the above ________________________” _________________________ |