Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 33

Subject:   

Treatment of initial issue expenses incurred by

open ended mutual fund schemes.1

A.  Facts of the Case

 

According to the querist, SEBI (Mutual Funds) Regulations, 1996, vide Regulation 52 (5) and Tenth Schedule on ‘Initial Issue Expenses’ allows two ways of accounting for the initial issue expenses for an open-ended load scheme:

 

(a)   Charging off of the initial issue expenses in the period in which they are incurred.

 

(b)   Amortisation over a period not exceeding five years.

 

2.   The querist has enumerated two cases wherein the Mutual Funds have charged off the entire initial issue expenses in the calculation of NAV but deferred the same in the annual accounts.  This has been reported by their respective auditors as follows:

 

(i) The auditors in one case have not referred to the treatment of initial issue expenses in their audit report.  The treatment is only discussed under significant accounting policies of the scheme as under:

 

         “Deferred Revenue Expenditure:

Costs incurred by the scheme in connection with issue are amortised over a period of five years.  However, the entire issue cost has been considered in the calculation of the NAV.”

 

(ii)  The auditors in the second case have made a reference to such treatment in their report as under:

 

“As indicated in Schedule 10–Note 2.5 the scheme as in earlier years is consistently not considering the unamortised portion of deferred revenue expenditure in arriving at the Net Asset Value per unit which is not in accordance with Regulation 52(5) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 as Management of the Scheme is of the view that such expenditure had been incurred by the Scheme prior to the issue of the Regulations.  Had the unamortised portion of the deferred revenue expenditure as at Mach 31, 1998 aggregating Rs. 1,59,01,329 been considered, the Net Asset Value per unit would have been higher by Re. 0.69 on that date.”

 

The Schedule 10 of the Mutual Fund on ‘Notes to accounts’ states in paragraph 2.5 as below:

 

“Deferred Revenue Expenditure

 

Expenditure incurred by the Scheme in the nature of preliminary and pre-operative expenses including lead manager’s fees, advertising, marketing, registrar’s fees and expenses, printing and dispatch, brokerage and incentive, etc., paid on initial public offering is being amortised over a period of five years from the date the scheme closed for initial subscription.”

 

“The Scheme is not considering the unamortised portion of deferred revenue expenditure in arriving at the Net Asset Value per unit since the expenditure has been incurred and debited to the Revenue Account for the purpose of computing the Net Asset Value per unit prior to the issue of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.”

 

B. Queries

 

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

 

    (a) Whether the initial issue expenses can be charged off completely for the purpose of calculation of NAV and deferred in the books of account.

     

    (b) If the answer to the above is in the affirmative, whether in a case where the same accounting treatment has been followed for the two purposes, the audit report has to be qualified or whether a detailed disclosure in the significant accounting policies will be sufficient

     

C. Points considered by the Committee

 

4. The Committee has not gone into the appropriateness of the auditors’ reports or disclosures in the cases enumerated by the querist.  The Committee restricts itself to the particular issues raised by the querist.

 

5. The Committee notes that paragraph (c) of Tenth Schedule to the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, on Initial Issue Expenses, provides that “for open-ended schemes floated on a ‘load’ basis, the initial issue expenses may be amortised over a period not exceeding five years”.  Paragraph (d) of the same Schedule states that “in case of close-ended and open-ended schemes floated on a ‘load’ basis, the un-amortised portion of the expenses shall be included in the calculation of the NAV”.

 

6. On the basis of the above, the Committee is of the view that in case a mutual fund decides to defer charging of initial issue expenses, unamortised portion should be included in the calculation of NAV.  Similarly, where such expenses have been completely charged off for books of account purposes, they should not be considered for the purpose of computation of NAV.

 

D.  Opinion

 

7. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 3:

 

    (a) No.  (Please see paragraph 6 above).

     

    (b) Since the answer of above is in the negative, this issue does not arise.  However, in case the same accounting treatment is not followed for the above two purposes, the auditor needs to qualify his report.

 

1Opinion finalised by the Committee on 25.9.2000