Query No. 22 Subject: Valuation
of investments.1
A. Facts of
the Case
2. The acquired
company is a stand-alone marketing company and since inception, it has been
predominantly operating in the retail segment having
3. As per the
querist, the strategic premium of Rs. 675 per share has been paid considering
various tangible and intangible factors such as:
(a) Maintaining
the current market share. (b) Avoidance of
erosion of refining volume currently supplied to acquired company. (c) Higher
refinery throughput. (d) Significant
potential to add value to the existing retail marketing capabilities. (e) Higher
retail volume thereby providing stability to cash flow, as the retail sale is
less susceptible to risk as compared to bulk sale.
(f) Retail
margins are relatively insulated as compared to bulk sales. (g) Access to
positive cash flow and zero debt company – significant Further, in a deregulated environment, generation of
additional business volume through new retail outlets will in no way be
comparable with the volumes being achieved by the existing 1,553 retail outlets
of the acquired company. Also, if 1,553 retail outlets are opened by the
acquiring company, the cost would be phenomenal. In view of the above factors, the purchase price of Rs. 1,551 per
share was offered to Government of India considering the long-term perspective. 4. The above
investment in the shares of the acquired company has been considered as
long term/strategic investment
and, therefore, has
been accounted for at cost, i.e., at Rs. 1,551 per share in the
financial statements. No provision for diminution in value has been made in the
books of account as per the accounting policy which is as under:
“All long term investments are valued at cost and provision
for diminution As per the requirement of Schedule VI to the Companies Act,
1956, the aggregate market value of the quoted shares has been properly
reflected in the financial statements. 5. The querist
has drawn attention of the Committee to paragraph 17 of
“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. ….” According to the querist, it is evident from the above that
the market value is not the single indicator to judge the value of the
investment. Certain other factors such as the investee’s assets, results and
the expected cash flows from the investment are also to be considered in
addition to the market value 6. On March 28,
2002, the acquired shares were quoted at Rs. 880 per
7. Considering
the tangible and intangible benefits as explained above, in the view of the
management, there is no permanent diminution in the value
B. Query
8. The querist
has sought the opinion of the Expert Advisory Committee on the following
issues:
(a) Whether the
accounting treatment ‘at cost’ under the head ‘Long (b) If not, what
should have been the accounting treatment in such a situation particularly
considering the fact that there is no material change in the circumstances and
strength of the acquired company further supported by the expected benefits
from such synergy. Whether the reduction in market value should be considered
in isolation for ascertaining the value of such an investment. What methodology should be adopted for
ascertaining the provision for diminution in the value of investment, if any. (c) If any
provision for diminution in the value is to be made, whether such provision
should be charged to the profit and loss account or whether the same can be
considered as deferred expenditure and amortised over a period of 3 to 5 years.
Whether it is open for the company to charge off such diminution in the value
in the books of account instead of creating a provision.
(d) Whether the premium paid for strategic benefits for investment described in the facts of the case, can be accounted for separately in the books of account keeping in view that AS 13 specifies that long term investments should be recorded at cost and there is no specific provision in the Standard in respect of accounting for premium paid for strategic benefits. C. Points considered
by the Committee
9. The
Committee notes from the facts of the case that the company has acquired shares
of another company for strategic reasons which it intends to hold for a long
period. Accordingly, the Committee is
of the view that the investment should be classified as a long term investment
in the separate financial statements of the company.
10. The Committee
notes paragraph 17 of AS 13, reproduced at paragraph
“ 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.”
11. On the basis
of the above, the Committee is of the view that in case of long-term
investments only where there is a decline, other than temporary, in the value
of investments, the carrying amount thereof 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 acquired company, its
results, the expected cash flows from the investment, etc. The market value of
the shares is not the sole indicator of decline, other than temporary, in the
value of investments.
12. On the
question whether the provision for diminution in the value of long term
investments should be made by way of a charge to the profit and loss account or
whether the same can be considered as deferred expenditure and amortised over a
period of 3 to 5 years, the Committee notes paragraph
“ 3 3 . Any reduction in the carrying amount and any
reversals of such reductions should be charged or credited to the profit and
loss statement.”
D. Opinion
13. On the basis
of the above, the Committee is of the following opinion on the issues raised in
paragraph 8:
(a) The
accounting treatment ‘at cost’ under the head ‘Long Term (b ) If the
decline in the value of investments is not other tha n temporary, compared to
the time when the shares were purchased, no provision is required to be
made. The reduction in market value
should not be considered in isolation to determine the decline, other than
temporary. The amount of the provision for diminution in the value of
investment may be ascertained by considering the factors indicated in paragraph
17 of AS 13 reproduced above.
(c) The
provision for diminution in the value of investment should be created as a
charge to the profit and loss statement.
As per the requirements of AS 13, the diminution in the value of
investment can neither be accounted for as a deferred revenue expenditure nor
it can be written-off in the statement of profit and loss. (d) The long
term investments should be carried at cost as per the requirements of AS
13. The amount paid over and above the
market price can not be accounted for separately. 1 Opinion finalised
by the Committee on 20.1.2003.
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