Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

Query No. 24

 

Subject:     

Whether legal costs, fees paid to SEBI and merchant bankers, and

advertisement costs are part of cost of investments.[1]

A. Facts of the Case

 

1. X Ltd. and Y Ltd. are two investment companies incorporated in 1997.  These companies subsequently became wholly-owned subsidiaries of G Ltd., an engineering company, whose shares are listed on two recognised stock exchanges.

 

2. G Ltd. acquired about 9.52 percent of the equity shares of another company (hereinafter referred to as ‘the target company’) for strategic purposes.  The target company is also an engineering company engaged in the manufacture of goods similar to those manufactured by G Ltd.

 

3. The board of directors of X Ltd. also decided to acquire shares of the target company and accordingly made a public announcement in April, 1998 to the shareholders of the target company for acquiring upto 20 percent of the share capital of the said target company as per the provisions of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997 (hereinafter referred to as ‘the Takeover Regulations’).  Under the provisions of the Takeover Regulations, X Ltd., Y Ltd. and G Ltd. are regarded as ‘persons acting in concert’.  Under the Takeover Regulations, any person acting in concert can acquire any number of shares from the open market during the period of open offer.  Accordingly, during the period of the open offer made by X Ltd., Y Ltd. acquired from the open market about 10.2 percent of the share capital of the target company. Y Ltd. could not have acquired these shares had X Ltd. not made the public offer.

 

4. The open offer made by X Ltd. was open from the first week of June to the first week of July, 1998 for tendering of shares by the shareholders of the target company. The payments for acquisition of the offered shares were made in the last week of July, 1998.  As per the provisions of the Takeover Regulations, the offered shares were held by the Registrars (registered with SEBI) as trustees of the shareholders who had offered the shares in the tender and were handed over to X Ltd. after payment of the purchase consideration by it.

 

5. G Ltd., X Ltd. and Y Ltd. lodged shares for registration of transfer with the target company.  The target company refused to transfer the said shares on the alleged ground that the provisions of section 108A of the Companies Act, 1956 which require prior approval of the central government had not been complied with.  G Ltd., X Ltd. and Y Ltd. subsequently filed petitions under the provisions of section 111A of the Companies Act, 1956 before the Company Law Board.  G Ltd. and X Ltd. also filed a writ petition in the competent High Court.

 

6. The financial year of G Ltd. is from April to March each year.  The first financial year of X Ltd. and Y Ltd. was closed on 30th June, 1998 (16th June, 1997 to 30th June, 1998) and the next accounting year was for a period of 9 months ended on 31st March, 1999.  In respect of the financial year ended on 30th June, 1998, Y Ltd. accounted for the shares purchased by it upto 30th June, 1998 as ‘investment’ and recorded them at cost, being the price paid for purchase of the shares plus brokerage and stamp duty.  The shares acquired during the period from 1st July, 1998 to 4th July, 1998 (about 4.78%) are to be accounted for in the financial year 1998-99.  X Ltd. did not account for any investment upto 30th June, 1998 on the ground that the legal ownership of the shares vested in the company only after 3rd August, 1998.  X Ltd. did not receive a good response to the open offer and was able to acquire less than 1 percent of the capital of the target company in the open offer.  The present shareholding of all the persons acting in concert in the target company is as under:

 

        G Ltd.                              9.52%

 

        X Ltd.                              0.60%

 

        Y Ltd.                             10.20%

 

        Total                              20.32%

 

7. X Ltd., Y Ltd. and G Ltd. have incurred the following costs in connection with the acquisition of shares of the target company under the open offer (without which the co-subsidiary Y Ltd. could not have purchased shares from the market).

 

  Names of parties                    incurring the costs

 

        (i) Legal costs for defending   X Ltd. and G. Ltd.  certain suits and applications filed by the target  company.

 

        (ii) Legal costs in connection X Ltd., Y Ltd. and G Ltd. with pending litigation before the Company Law  Board Bench.

 

        (iii) Legal costs in connection X Ltd. and G Ltd.  with writ petition filed  by G Ltd.

 

        (iv) Costs in connection with  X Ltd. and G Ltd. public announcement and  open offer viz. fees to  SEBI and merchant bankers                     and advertisement costs.

 

The amounts paid by X Ltd. towards the aforesaid costs have been treated as advances in its accounts as at 30th June, 1998, as the shares had not been acquired till that date and are proposed to be accounted for during the financial year 1998-99.

 

8. It is proposed that all costs already incurred or that may be incurred (estimated to be Rs.20 per share of the face value of Rs.10) in the nature of legal costs, fees to SEBI and merchant bankers, advertisement costs, etc., be taken into account and allocated amongst G Ltd., X Ltd. and Y Ltd. in proportion to the number of shares acquired by these three companies.  All the three companies propose to include the said expenditure in the cost of investment.  The average cost per share including the purchase price paid and the abovementioned acquisition costs is estimated between Rs. 65 and Rs. 70 per share.  The market price of the shares of the target company is Rs. 35 per share and the break up value (i.e. book value) is Rs. 75 per share.

 

9. The three companies are of the view that the above treatment of costs incurred for acquisition of the shares would be in conformity with Accounting Standard (AS) 13, ‘Accounting for Investments’ on the following grounds :

 

(a) The investment in the target company by the three companies is in the nature of one economic activity and, therefore, all the three companies should share the acquisition costs in proportion to the number of shares acquired by them.

 

(b) The investment is a long term strategic investment.

 

(c) Paragraphs 9 and 28 of AS 13 require that the cost of an investment should include acquisition charges such as brokerage, fees and duties.  Brokerage, fees and duties are only indicative in nature and other acquisition costs in the nature of advertisement, fees to SEBI and merchant bankers, and legal costs for obtaining proper title to the shares should also be capitalised.

 

B. Queries

 

10. The opinion of the Expert Advisory Committee has been sought on the following issues:

 

(a) Whether the three companies are justified in treating the aforesaid as one economic activity and allocating the various items of expenditure incurred in connection with acquisition of the shares of the target company in proportion to the number of shares acquired by them.

 

(b) Whether the various items of expenditure enumerated above should be included in the cost of investment or treated as revenue expenditure and charged to the profit and loss account.

 

(c) Whether the legal costs incurred and to be incurred in connection with defending the suits and applications filed by the target company and in connection with pending litigation before the Company Law Board and the writ petition filed in the High Court should be treated as part of cost of acquisition or as revenue expenditure and charged to the profit and loss account.

 

C. Points Considered by the Committee

 

11. The Committee notes that the querist has sought the opinion of the Committee on three specific issues.  The Committee has accordingly restricted itself to these issues and has not considered other accounting aspects dealt with in the query, e.g., whether the expenditure on acquisition of shares should be shown as investments or in some other manner, considering that the transfer of the shares has been rejected by the target company.

 

12. The querist has stated that legal costs, fees paid to SEBI and merchant bankers, advertisement costs, etc., incurred in connection with the acquisition of the shares of the target company by G Ltd., X Ltd. and Y Ltd. are proposed to be shared by the three acquiring companies in proportion to the number of shares acquired by them in the target company.  Such a sharing of costs is a matter of arrangement among the three companies and does not involve any specific accounting issue.  As such, the Committee does not express any opinion on whether the three companies should share the aforesaid costs or not.

 

13. The querist has stated that the three companies propose to include their respective share of legal costs, fees paid to SEBI and merchant bankers, advertisement costs, etc., in the cost of shares acquired by them in the target company.  In this regard, Accounting Standard 13, ‘Accounting for Investments’, states (paragraph 9) that “the cost of an investment includes acquisition charges such as brokerage, fees and duties”.  The use of the expression “such as” implies that brokerage, fees and duties are merely examples of acquisition charges and that other acquisition charges are also a part of cost of investments.  The Committee is of the view that in the instant case, advertisement costs and fees paid to SEBI and merchant bankers are clearly attributable to acquisition of the shares and, therefore, are a part of cost of those shares.

 

14. As per generally accepted accounting principles, any expenditure incurred on bringing an asset to a condition where it is ready for its intended use is a part of the cost of the asset.  Accordingly, the Committee is of the view that the legal costs incurred by the acquiring companies are a part of the cost of the shares.

 

D. Opinion

 

15. Based on the above, the Committee is of the following opinion on the issues raised in paragraph 10  :

 

(a) The sharing of expenditure incurred in connection with the acquisition of the shares of the target company by G Ltd., X Ltd. and Y Ltd. is a matter of arrangement among the three companies and does not involve any specific accounting issues.  Therefore, the Committee does not express any opinion on this aspect.

 

(b) The fees paid to SEBI and merchant bankers and advertisement costs are a part of the cost of acquisition of the shares and should be treated accordingly.

 

(c) Legal costs incurred in connection with the pending litigation before the Company Law Board and the High Court are also a part of the cost of acquisition of the shares and should be treated accordingly.

 

________

 

[1] Opinion finalised by the Committee on 28.5.1999.