1.32 Query: Recognition of premium receivable on maturity of debentures, as realised income in the books of a Mutual Fund and its utilisation for income distribution to the unit holders.
1. The querist has submitted the following details about various Mutual Fund schemes:
Introduction
A Mutual Fund is a trust that pools the savings of a number of investors who share a common financial goal. Each scheme of a Mutual Fund has a defined investment objective and strategy. The money thus collected is then invested by the fund manager in different types of securities. These could range from shares to debentures to money market instruments, depending upon the scheme’s stated objectives. The income earned through these investments and the capital appreciation realised by the schemes are shared by its unit holders in proportion to the number of units owned by them.
There are a wide variety of Mutual Fund Schemes as follows:
(a) By Structure
Open-Ended Schemes
These schemes do not have a fixed maturity. The key feature is liquidity. One can conveniently buy and sell units at net asset value (NAV) related prices directly from the Mutual Fund.
Close- Ended Schemes
These schemes have a stipulated maturity period. One can invest directly in the scheme at the time of the initial issue and thereafter buying or selling of units of the scheme would be through the stock exchanges where they are listed. Some close-ended scheme give an additional option of selling units directly to the Mutual Fund through periodic repurchase at NAV related prices.
Interval Schemes
These schemes combine the features of open-ended and close-ended schemes. They may be traded on the stock exchange or may be open for sale or redemption during predeterminded intervals at NAV related prices.
(b) By Investment Objective
Growth Schemes
Aim to provide capital appreciation over the medium to long term. These schemes normally invest a majority of their funds in equities and are willing to bear short-term decline in value for possible future appreciation.
Income Schemes
Aim to provide regular and steady income to investors. These schemes generally invest in fixed income securities such as bonds and corporate debentures.
Balanced Schemes
Aim to provide both growth and income by periodically distributing a part of the income and capital gains they earn. They invest in both shares and fixed income securities in the proportion indicated if their offer documents.
Money Market Schemes
Aim to provide easy liquidity, preservation of capital and moderate income. These schemes generally invest in safer, short-term instruments, such as treasury bills, certificates of deposit, commercial paper and inter bank call-money.
Returns on these schemes may fluctuate, depending upon the interest rates prevailing in the market.
Operations
Operations of a Mutual Fund are governed by the SEBI (Mutual Funds) Regulations, 1996 (SEBI Regulations).
Any earnings by way of:
- profit/loss on sale of equity and dividend received on equity
- interest income on debentures
- interest/ discount income on money market investment is accounted for as realised income (Gains).
Besides, on every NAV determination day, investments are valued and appreciation/depreciation in value of investments is accounted for as unrealised gain. The SEBI Regulations 1996, vide Scheme Eight, have laid down Investment Valuation Norms (copy submitted by the querist) that are to be followed by a Mutual Fund for valuing investments while preparing accounts.
NAV is then calculated by using the following formula:
Market value of Investments + Accrued Income +Receivables+ Other Assets+ Unamortised Portion of Initial Issue expenses (-) Accrued Expenses (-) Payables (-) Other Liabilities
Number of Units
The NAV so calculated is used for redeeming or selling units.
The SEBI Regulations, vide Schedule Nineth and Eleventh have further laid down Accounting policies and standards, etc., that are to be followed by a Mutual Fund while preparing accounts (copies submitted by the querist).
2. The querist has further submitted that as per the SEBI Regulations, all listed securities are to be valued at the last quoted closing price on the stock exchange, while unlisted/non-traded securities are to be valued in good faith by the AMC. Unlisted/non-traded debt instruments shall generally be valued on a yield to maturity basis. The financial statements are to be prepared on a marked to market/YTM basis and the appreciation/depreciation (if any) between the cost and the market/YTM value to be disclosed separately as unrealised gain or loss. Sine unrealised gain arising out of appreciation on valuation of investments cannot be distributed, provision has to be made for its exclusion while calculating distributable income. In accordance with the SEBI Regulations, debentures will be valued on “Marked to Market” or on “Yield to Maturity” basis. The premium receivable on redemption of debentures and the difference between cost of purchase of debentures and the face value (for normal as well as for Deep-discount bonds/Debentures and quoted warrants) will also be accounted for/accrued by way of income in the books as “Premium/profit receivable on Maturity”. This premium/profit (which is a confirmed gain) will also be considered as the income earned during the year as part of “Realised Gains” for calculating distributable income. The financial statements shall be prepared on a marked to market/YTM basis and the appreciation/depreciation (if any) between the cost, the market/YTM value and the premium/profit receivable on maturity will be disclosed separately as unrealised gain or loss.
3. Based on the above details, the queirst has sought the opinion of the Expert Advisory Committee on the following issues:
Opinion March 17, 1998
1. The Committee notes that the general treatment of accounting for premium receivable on redemption of debentures has been explained in Accounting Standard (AS) 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, that “usually discount or premium on debt securities held is treated as though it were accruing over the period to maturity (para 8.2).” The Committee is of the view that the aforesaid accounting treatment would be applicable where the debt securities are valued at cost or the lower of cost and market value. Thus, where the debt securities are valued by a Mutual Fund, at market price or on Yield-To-Maturity (YTM) basis, the said values would take cognisance of premium on redemption and the difference between the cost/carrying value and market price/YTM value would automatically be recognised in the profit and loss account. The Committee is, accordingly, of the view that the question of accruing such premium does not arise where the debentures are valued at market price/YTM basis.
2. The opinion of the Committee on issues raised in para 3 of the query is as follows:
(i) No, if the debentures are valued at market price/YTM basis.
(ii) If the debentures are valued at market price/YTM basis, the premium cannot be recognised as accrued and realised and, therefore, cannot be distributed as dividends
(iii) The accounts will not give a true and fair view if the premium is recognised as accrued and realised, where the debentures are valued at market price/YTM basis. _______________________
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