Query No. 14

 

Subject:           

Accounting for the amount received on transfer

of the right to  receive  power. 1

 

A.  Facts  of  the  Case

 

1.  ‘X’ Ltd.,  a  government  company,  set  up  for  the  development  and manufacture  of  electronic  products,  under  the  administrative  control  of Department of Atomic Energy, is acquiring power for its operations from a State  Electricity  Board.   ‘Y’  is  a  company  floated  by  5  public  sector undertakings and 20 private sector companies to generate power at a cheaper rate. ‘X’ is one of the promoters of ‘Y’ and is holding 2,68,000 equity shares of Rs. 10 each. ‘Y’ issued rights shares in the ratio of 1:1 and ‘X’ subscribed the rights and paid @ Rs. 24 for 2,68,000 shares.  The investment is shown in the balance sheet of ‘X’ under the head ‘Investments’.  The shares held in ‘Y’ are not freely transferable in view of the undertaking given to IDBI by ‘X’ as a promoter shareholder of ‘Y’.

 

2.  During the year 1996-97, ‘Y’ offered 2,68,000 rights shares at Rs. 30 per share and 1,92,960 bonus shares to ‘X’.  ‘X’, in its Board of Directors’ meeting, deliberated upon the offer of ‘Y’ and taking into account various factors including the power requirement of the company decided to approach ‘Z’  a  sister  organisation  of  ‘X’  by  virtue  of  it  being  under  the  same administrative Ministry, i.e., Department of Atomic Energy, to ascertain their interest in this regard.   A Memorandum of Undertaking was entered into between ‘Z’ and ‘X’ on 2-9-1997 on the following points:

 

(a) ‘X’, as a promoter shareholder in ‘Y’, was eligible for additional power of 1 MW on rights basis and 0.72 MW as bonus totalling to1.72 MW, from ‘Y’. The company has to invest in the additional equity of 2,68,000 shares at Rs. 30 each to draw 1 MW. 

(b) ‘Y’ allowed ‘X’ to transfer its share of additional power entitlement to ‘Z’ who will directly draw the power from ‘Y’, and will be billed as per ‘Y’s tariff.

(c) ‘Z’ agreed to pay Rs. 128.64 lakh to ‘X’, being the tentative price, for 4,28,800 shares (equivalent to 1.72 MW) at Rs.10 per share ata premium of Rs. 20 per share, before the receipt of the additional power from ‘Y’, as below:

 

 

Value (Rs.)

Rights Shares @ Rs.30 (For getting entitlement to draw 1 MW power)	2,68,000 Shares	80.40 lakh
Bonus Shares @ Rs. 30 (For getting entitlement to draw 0.72 MW power)	1,60,800 Shares	48.24 lakh
Total	4,28,800 Shares	128.64 lakh

(d)  All other terms and conditions for share of power between ‘Z’ and ‘X’ shall be governed by the relevant clauses of the MOU between ‘X’ and ‘Y’.

 

3.  ‘X’ invested in the shares of ‘Y’ to the extent of Rs. 64.32 lakh for 2,68,000 rights shares of Rs.10 each with a premium of Rs.14 only which is shown  under  the  head  ‘Investments’.  ‘Y’  conveyed  to  company  ‘X’  its decision to reduce the premium to Rs.14 per share.

 

4.  According to the querist, in accordance with the above arrangement, ‘X’ has received the following payments from‘Z’:

5. The querist has stated that the Board of Directors of ‘X’, at its meeting, held on 28.5.1996, accepted the proposal of the deposit from ‘Z’ for investments in ‘Y’ for additional power.  However, the Board categorically stated that whenever ‘X’ wants to withdraw this facility from ‘Z’, it can do so by repaying the initial amount funded by ‘Z’ at the rate of Rs. 80.40 lakh for 1 MW.

 

6.  As per the querist, on 14th  September 1996, ‘Z’ intimated to ‘X’, that the Department of Atomic Energy has approved the proposal to deposit an amount not exceeding Rs. 3 crore with ‘X’ for purchase of shares in ‘Y’ and, therefore, requested to take further action in the matter to enable ‘Z’ to release the deposit amount to the company.

 

7. The querist has argued that it can be seen from the above that the intention of ‘X’ as well as ‘Z’ is to treat the transactions purely as a ‘Deposit’.  There is no right being transferred to ‘Z’ as deemed shareholder. Further, the formal MOU entered into on 4-9-1997 between ‘Z’ and ‘X’ also emphasises that ‘Z’ is entitled only for getting energy and power from  ‘Y’ upto 1.72 MW.  There was no clause whatsoever with regard to the deemed ownership of the shares acquired by ‘X’ for getting the said quantum of power.

 

8.  The querist has stated that in addition to the said deposit of Rs. 128.64 lakh, an amount of Rs. 43.34 lakh was also paid by ‘Z’ towards the security deposit for power consumption.  The security deposit is grouped under the head ‘Current Liabilities’ in Schedule-L of the balance sheet of ‘X’, whereas the deposit of Rs.128.64 lakh received from ‘Z’ for investment in the shares of ‘Y’ and for transferring the consequential energy and power entitlement, including  bonus  power,  is  shown  under  the  head  ‘Unsecured  Loans’ in Schedule-D of the balance sheet of ‘X’.

 

9.  The Comptroller and Auditor General of India, while issuing the final comments on the accounts of ‘X’ as on 31.03.2000, observed as follows:  

 

 

Comment

Management’s  Reply

The company received Rs. 128.65 lakh from ‘Z’ for investment in the shares of ‘Y’ and for transferring the consequential energy and power entitlement including bonus power. Pending settlement of various issues between ‘Z’ and the company with reference  to  investment  in  shares of  ‘Y’  and  the  transfer  of  power and  energy,  classifying the  entire amount as “unsecured loans” is not in order.

Noted :  However,  this  has  no impact  on  the  profit  and  loss account.

 

 

10.During the year 2000-2001, a provisional comment was issued on thesame subject which is reproduced below with the reply of the company’s management:

Provisional  Comment

Management’s  Reply

SCHEDULE – D UNSECURED LOANS DEPOSITS RECEIVED FROM ‘Z’ – Rs.128.64 LAKH   The company received Rs. 128.64 lakh from ‘Z’ during 1996-97 and   1997-98  in  consideration  o f transfer  o f  1.72  MW  power allocated from ‘Y’ on account of rights and bonus issue of shares to ‘X’.  The ownership of above s h a r e s   r e s t s   wi t h   ‘ X ’   a n d classification  of  the  amount deposited by ‘Z’ as ‘Unsecured Loans ’  is not in order.  A reference is also invited to comment no.1 on the accounts of the company for the year 1999- 2000.

During the year 1996-97, ‘Y’ offered 2,68,000 rights shares and 1,92,960 bonus   shares   t o   ‘X’   with   an entitlement  to  draw  an  additional power of 1.72 MW.  The additional power offered by ‘Y’ was considered surplus (i.e., in excess of ‘X’s power requirements) . ‘ X ’ , therefore , approached ‘Z’, a sister organisation of same ministry, through DAE for providing funds for investment so that they can avail the additional power of 1.72 MW which is quite economical compared  to  the  rate  charged  by another  company.  Thus,  this  is  a permanent arrangement in real terms, irrespective of  the  flexible  clauses contained in the agreement concluded between the company and ‘Z’.   Normally,  current  liabilities  are understood to be in identifiable nature with  current  assets  or  the  trading activity, either directly or indirectly and are short term in nature.  Since the above amount was not identifiable with any of the current assets or the trading or manufacturing activity and also as the same is obtained for the specific purpose of funding the ‘long term’ investment in rights shares of ‘Y’,  treating  this  amount  under   ‘Unsecured Loans’ is considered to be in order. This observation was already brought to  the  notice  of  the  shareholders through a comment by C&AG and replied by the company in the printed accounts for the year 1999-2000.

 

   

11. The querist has stated that besides furnishing replies to government auditors on the provisional comments, an assurance was given during the course of personal discussion that the matter raised will be taken up with the Expert Advisory Committee of the Institute of Chartered Accountants of India for its opinion which shall be the basis for determining and deciding the manner of accounting in the accounts for the year 2001-2002.

 

12. As per the querist, when the final comments were issued for the year 2000-2001, the same appeared as under:

 

“The Company received Rs. 128.64 lakh from ‘Z’ for investment i n the ‘Rights and Bonus’ shares of ‘Y’ and for transferring the consequential energy and power entitlement including bonus power. The ownership of the shares rests with the company.  Pending settlement of various issues between ‘Z’ and the company with reference to investment in shares and transfer of power, the entire amount deposited by ‘Z’ has been classified as ‘Unsecured Loans’.”

 

B .   Query

 

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

 

(a)   Whether the presentation of the amount paid by ‘Z’, pursuant to the MOU, in the accounts under ‘Unsecured Loans’ is appropriate.

(b)    If not, what should be the correct method of presentation.

 

C.   Points  considered  by  the  Committee

 

14.  The Committee restricts its reply only to the query raised by the querist, viz., the accounting treatment of the amount received from ‘Z’ towards the value of consideration worked out on the basis of equity shares received by ‘X’ Ltd., in respect of the rights issue and bonus issue by ‘Y’ Ltd., in return for entitlement  of additional  power transferred  by ‘X’  Ltd. to  ‘Z’.   The Committee has, accordingly, not considered any other accounting treatment which may arise from the facts of the case, e.g., accounting treatment of the amount of security deposit received by ‘X’ from ‘Z’, which has been shown under the head ‘Current Liabilities’ in the balance sheet of ‘X’ Ltd.   The Committee notes that there are certain contradictions between the facts stated in the query and the copy of the Memorandum of Understanding (MOU) submitted along with the query. For instance, according to MOU, 0.6 MW are given  as  bonus  and  1.12  MW  as  rights,  whereas  as  per  the  facts,  the corresponding figures are 0.72 MW and 1 MW. The Committee has relied on the figures given by the querist.   The Committee also notes that there  is inconsistency at certain places in the facts of the case supplied by the querist with respect to the number of shares and the amount paid.  The Committee wishes to state that the opinion given hereafter holds good in principle, irrespective of the data of the aforesaid type.

 

15.  The Committee notes from the facts of the case that the company, i.e., ‘X’, as a promoter shareholder of ‘Y’, was eligible for additional power of 1 MW on rights basis and 0.72 MW as bonus.  In return, the company was required to invest in the additional equity of 2,68,000 shares for Rs. 64.32 lakh.  This additional power was considered surplus by the management of the company and it decided to transfer this additional share to ‘Z’ for Rs. 128.64 lakh, (worked out on the basis of Rights Shares of ‘Y’ Ltd. received by ‘X’ Ltd. for Rs. 80.40 lakh and Bonus Shares of ‘Y’ Ltd., received by ‘X’ Ltd., for Rs. 48.24 lakh). A Memorandum of Understanding was reached between the company ‘X’ and ‘Z’ to the aforesaid effect.

 

16.  The Committee also notes from paragraph 5 above of the ‘Facts of the Case’ that the Board of Directors of ‘X’ Ltd., has ‘stated’ that whenever ‘X’ Ltd. wants to withdraw this facility from ‘Z’, it can do so by repaying the initial amount funded by ‘Z’ at the rate of Rs. 80.40 lakh for 1 MW, although, as the Committee notes, ‘Z’ has paid Rs. 128.64 lakh for 1.72 MW.  The Committee further notes from the ‘Memorandum of Understanding’ between ‘X’ Ltd. and ‘Z’, a copy of which has been separately supplied by the querist, that it does not contain any clause relating to withdrawal of this facility by ‘X’ Ltd., and so it is not clear whether the clause of withdrawal has been accepted by ‘Z’ or not.  The Committee further notes that the office of the C&AG  has  stated  in  their  report  that  there  are  various  issues,  pending settlement between ‘Z’ and the company ‘X’.  The Committee also notes that the nature of these issues has not been indicated.

 

17.  The Committee notes that ‘X’ Ltd., by investing in the shares of ‘Y’ and paying Rs. 64.32 lakh in return therefor, obtained a right to receive additional power and energy at cheaper rates from ‘Y’ Ltd.  The Committee is of the view that this right to receive power and energy is an intangible asset.  This view of the Committee regarding the nature of the right being an intangible asset is supported by the requirement contained in Schedule 24 to the format of the balance sheet prescribed in the Electricity Supply Annual Accounts Rules, 1985, according to which payments made to acquire rights to receive power from other bodies are required to be disclosed as an intangible asset.  The Committee also notes that this intangible asset was acquired by ‘X’ Ltd., along with investments in ‘Y’ Ltd., for Rs. 64.32 lakh and that the intangible  asset  has  been  transferred  to  ‘Z’  for  Rs.  128.64  lakh.   The Committee is of the view that the amount received by ‘X’ Ltd., from ‘Z’, is in substance, a consideration for sale of this intangible asset notwithstanding the unilateral statement of the Board of Directors of ‘X’ Ltd. that this facility can be withdrawn by ‘X’ Ltd. on repayment of initial amount funded by ‘Z’ at the rate of Rs. 80.40 lakh to ‘Z’.  Thus, the difference between the amount received from ‘Z’ by ‘X’ Ltd., and the amount paid by ‘X’ Ltd. to ‘Y’ Ltd. attributable to the transfer of the intangible asset, should be booked as income in the profit and loss account of ‘X’ Ltd. ‘X’ has paid Rs. 64.32 lakh to ‘Y’ Ltd., presumably only for investments in the shares of ‘Y’ Ltd.  However, in fact,  it  amounts  to  payment  of  the  aforesaid  sum for  acquisition  of  the intangible  asset  which  is  transferred  to  ‘Z’  and  the  investments.   The Committee is, accordingly, of the view that the sum of Rs. 64.32 lakh should be bifurcated between the investments and the intangible asset on appropriate basis, such as the fair value of investments or the intangible asset, whichever is more clearly evident.  The cost of investments should be reflected in the balance sheet and the profit on disposal of the intangible asset should be worked out accordingly. In view of this, the disclosure of Rs. 128.64 lakh as ‘Unsecured Loan’ in the balance sheet of ‘X’ Ltd. is not correct.

 

D.   Opinion

 

18.  On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 13:

 

(a)  The presentation of the amount paid by ‘Z’, pursuant to the MOU, as ‘Unsecured Loan’ is not appropriate.

(b)    The amount received from ‘Z’ is a consideration for the sale of intangible asset. Thus, the difference between the sale consideration and the amount at which the intangible asset was acquired should be booked as income in the profit and loss account of ‘X’ Ltd.