Query No. 2
Subject:
Valuation
of long-term investments.1
A. Facts of
the Case
1. A
government company (within the meaning
of section 617 of the Companies Act,
1956), inter alia, has been co-ordinating the policies and activities of its
subsidiaries as a holding company. In most cases, the company
is holding 100%
shares in its
subsidiaries, which are
also government companies (within
the meaning of section 617 of the Companies Act, 1956), as investments. The
company’s 100% shareholding is in the name of the President of India.
2. The company
has been receiving substantial funds year after year by way of equity from the
Government of India. These funds are
used by the company, on the instructions of the Government of India, for
investing in the shares of its subsidiaries, which in turn invest such money in
procuring assets, which is also as per the directions of the Government of
India.
3. Due to
massive setback in the performance of the subsidiaries, mass scale separation through
Voluntary Retirement Scheme/Voluntary Separation Scheme (VRS/VSS) is under
implementation. Some of the subsidiaries have been served with closure
notices while in
some cases winding
up, as recommended by BIFR, is
in process for decision by the Hon’ble Court.
4. Majority of
the subsidiaries are incurring losses for the last several years. These subsidiaries have negative net
worth. As per the querist, on account
of continuing bad financial position and the wiping out of the entire net worth,
the auditors have observed that most of the subsidiaries in which the company
had invested money as long-term investment have negative net worth and as such,
from accounting point of view as per Accounting Standard
(AS) 13, ‘Accounting for Investments’, suitable provision
should have been made in the annual accounts for diminution in the value of
investments.
5. According to
the querist, the company has contended that investments made by the company in
its subsidiaries are long term investments.
The company is making fresh investments at par out of the funds released
by the Government of India for investing in specific subsidiaries and in line
with the BIFR approved revival
scheme for some
subsidiaries. Some of
the subsidiaries are in the process of disinvestment and realisable
value of their shares will be known at the time of disinvestment. Incidentally, the querist has mentioned that
the company could obtain a price of Rs. 4000 per share for disinvestment of 74%
of equity shares in one subsidiary in July 2000. The par value of shares was
Rs. 1000 each and intrinsic value was also around the same level. As per the querist, the Board of Directors
is of the view that diminution in
the value of shares of the subsidiaries is not of permanent nature.
6. As per the
querist, the company has made no provision for any diminution in the value of such investments, in view of the foregoing
contention. The company’s accounting policy, inter alia, discloses the
accounting treatment of investments as under:
“INVESTMENT:
3. Long-term
investments in subsidiaries are valued at cost and no pr ovis ion is made for any diminu tion in the val ue o f su
ch investments.
7. The querist
has stated that the assets of the subsidiaries have not been revalued since
their inception. The statutory auditors
have qualified their report for the year 2000-01 regarding non-provision of
diminution in the value
of investments while the Comptroller and Auditor General of
India have not made any comments on the accounts till date.
B . Query
8. The querist
has sought the opinion of the Expert Advisory Committee on the following
issues:
(a) Whether
provision should be made for any diminution in the value of investments in the
subsidiaries to recognise a decline with reference to the deteriorating
performance represented by the negative net worth of the subsidiaries.
(b) If the reply
to (a) above is in the affirmative, how should the quantum of diminution be
ascertained since most of the subsidiaries are unlisted companies?
(c) How should
the quantum of diminution be ascertained for investments at par during the
current year under directive from the Government of India?
(d) If it is
suggested that provision in the value of investments should be made in view of
the negative net worth, whether it will be prudent to ascertain net worth on
the basis of historical cost as the subsidiaries have very highly valuable
asset base.
(e) Whether it
is possible to recognise the decline in the value of investments of those
particular subsidiaries which are in the process of closing down/winding up
while leaving aside the subsidiaries which are carrying on as going concerns.
C. Points considered by the Committee
9. The
Committee notes from the facts of the case that the investments made by the
company in its subsidiaries are long term investments. The Committee notes
paragraphs 17, 18 and 32 of AS 13 which provide as below:
“17. Long-term
investments are usually carried at cost. However, when there is a decline,
other than temporary, in the value of a long term investment, the carrying
amount is reduced to recognise the decline.
Indicators of the value of an investment are obtained by
reference to its market value, the investee’s assets and results and the
expected cash flows from the investment. The type and extent of the investor’s
stake
in the investee are also taken into account. Restrictions on
distributions by the investee or on disposal by the investor may affect the
value attributed to the investment.”
“18. Long-term
investments are usually of individual importance to the investing enterprise.
The carrying amount of long-term investments is therefore determined on an
individual investment basis.”
“ 3 2 . Investments classified as long term investments
should be carried in the financial statements at cost. However, provision for diminution shall be made to
recognise a decline, other than temporary, in the value of the investments,
such reduction being determined and made for each investment individually.”
10. On the basis
of the above, the Committee is of the view that in the case
of long-term investments only where there is a decline,
other than temporary, in the value of investments, the carrying amount is reduced
to recognise the decline. The Committee is further of the view that to
determine whether there is a decline other than temporary, in the value of
investments, an assessment should be made keeping in view the assets of the
subsidiaries, its results, the expected cash flows from the investment,
etc. Such an assessment should be made
on an individual investment basis. Only
where it is concluded that the decline in the value is other than temporary, a
reduction in the carrying amount is required. The
Committee is further of the view that in determining the net worth of the
subsidiaries fair value may be used instead of historical cost.
D. Opinion
(a) Only where
it is concluded that the decline in the value of long- term investments is
other than temporary, the carrying amount should be reduced to recognise the
decline.
(b) If the
decline is other than temporary, the quantum of diminution may be determined
keeping in view the assets of the subsidiaries, its results, the expected cash
flows from the investments, etc.
(c) The quantum
of diminution for investments at par during the current
year under directive from the Government of India should be
determined on the same basis as (b) above.
(d) For
determining the net worth, fair value may be used instead of historical cost.
(e) Decline in
the value of long-term investments is recognised, if it is other than
temporary. Even if the subsidiaries are not in the process of closing
down/winding up, the decline in the value of investments, has to be recognised,
if it is other than temporary. The assessment as to whether the decline in the
value of long-term investment is other than temporary or not, should be made on
an individual investment basis, as required in paragraph 18 of AS 13.
11. On the basis
of the above, the Committee is of the following opinion on the issues raised in
paragraph 8:
_____________________________
1Opinion finalised
by the Committee on 26.3.2002.