Query No. 9

 

Subject:          

  Valuation of investments. 1

 

A. Facts  of  the  Case

 

1. An engineering consultancy company is engaged in the business of providing engineering and consultancy services in the field of petroleum refineries, petrochemicals, oil and gas processing, offshore structures and platforms, fertiliser, metallurgy, power, etc.

 

2. As per the querist, the investment of surplus funds of the company is governed by the guidelines issued by the Ministry of Industry (Department of Public Enterprises) under OM No. DPE/4/94-Fin dated 14.2.1997.  As per the guidelines for investment of surplus funds, the company is allowed to invest its surplus funds in US-64 scheme of Unit Trust of India (UTI) apart from other modes of investments. As per the querist, the guidelines also stipulate the condition that Units of US-64 scheme cannot be disposed of at the risk of capital loss.

 

3. In terms of the approved investment policy as mentioned above, the company has invested its surplus funds from time to time in US-64 scheme of  UTI  during  the  period  July  1993  to  May  1998.   The  total  value  of investments of the company in US-64 scheme is Rs. 182.97 crore as on the date of sending the query, comprising 12,61,83,240 Units at an average cost price of Rs. 14.50 per Unit.

 

4. The company has invested its surplus funds in US-64 scheme of UTI on long-term basis considering its safety and liquidity with a view to earn dividend.  The company has been regularly receiving dividends from UTI which the company has been crediting under the head ‘other income’ on a year to year basis.

 

5. It has also been the policy and practice of the company to sell the Units directly to UTI at their declared repurchase price. So far, the company has disposed of 1,07,00,000 Units through UTI at their declared price only once, i.e., in March 1996. Units of US-64 scheme are being traded in the secondary market through Stock Exchanges.

 

6. The querist has informed that whilst the company does not have any immediate plan for disposal of the said Units, it is also prohibited from selling such Units below its average cost price as per the existing guidelines.

 

7. The querist has stated that considering the present traded price of Units of  US-64  scheme  in  the  secondary  market,  there  has  been  substantial depreciation in the value of investments made by the company in US-64 scheme as compared to the average cost price.

 

8.  As  per  the  querist,  at  the  time  of  sending  the  query,  UTI was  not declaring the repurchase price of the Units of US-64 scheme and was also not purchasing directly Units of US-64 scheme from the corporates.

 

9. The company is of the view that the notional loss due to depreciation in the value of such investments is a long-term loss and is not related to the day to day operations of the business.  The querist is of the view that if the value of such depreciation, as stated in paragraph 7 above, is adjusted in the profit and loss account of the current year, the same may not reflect true and fair view of the affairs of the company for the current year.

 

10. The  querist  has  drawn  the  attention  of  the  Committee  to  an announcement of the Unit Trust of India, published in UTI Bulletin, March 2002, issued subsequent to sending the query, which provides as follows:

 

            “Unit Scheme 1964 – at NAV Based Price

(a) Sale of units: Units are available for sale at NAV during March ’02.

 (b)  Repurchase of units: Unit Certificates/Membership Advices/RI Statements issued prior to 30/6/2001 which are received by the Trust alongwith the Repurchase Application Form (RAF) will be repurchased at the Special Liquidity Package Price (Rs. 10.70 for March ’02) upto an overall limit of 5000 units per unitholder. Such units above the limit of 5000 will be repurchased at NAV based price upto 30/05/2003 and at NAV or Rs. 10 whichever is higher on 31/05/2003.  Investment made in the scheme from 01/01/2002 onwards will be repurchased at NAV based price.  It is clarified that the difference between the assured repurchase price under the Special Liquidity Package and the NAV is met by the Government of India and the same shall not affect the existing investors of the scheme.”

11. The  querist  has expressed  the  view  that  the  above  bulletin  clearly indicates that the likely NAV of Units of US-64 scheme will be continuously on the rise and could be far above Rs.10 after 31.5.2003.  Further, since the company is not likely to sell these Units currently, it is possible that after May 2003, the company may be able to get even more than its purchase price of Rs. 14.50 on an average.

 

B .  Query

 

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

 

(a)  What should be the methodology to be applied for determining the notional loss in the context of the following :

(i)  As per its policy and practice, the company has been selling the Units directly to UTI at their declared repurchase price and presently UTI is not selling/repurchasing such Units from corporates.

(ii) The company is prohibited to sell its Units at the risk of capital loss as per the Government guidelines.

(iii) The company does not have any immediate plan to sell the Units.

(iv)   This is not an operational loss and does not pertain to one single year.

(v) The only indicated price available for valuing depreciation in the value of investment could be either from secondary market or the value as fixed by UTI for small investors on a particular date or NAV as declared by UTI.

 

(b)  Considering the depreciation in the value of investments as a long- term loss, whether the company can adjust the same against the accumulated free reserves without giving effect in the profit and loss account of the current year, with suitable disclosure in the notes to accounts.

(c) Any other method which is appropriate under the given circumstances with the disclosure required.

C.  Points  considered  by  the  Committee

 

13. The Committee notes that the terms ‘current investment’ and ‘long term investment’ have been defined in paragraph 3 of Accounting Standard (AS) 13, ‘Accounting for Investments’, issued by the Institute of Chartered Accountants of India, as follows:

 

“A current investment is an investment that is by its nature readily realisable and is intended to be held for not more than one year from the date on which such investment is made.”

“A long term investment is an investment other than a current investment.”

 

14. The Committee notes from the facts of the case that the company has invested  its  surplus  funds  in  US-64  scheme  of  UTI on  long-term basis. Accordingly, the Committee is of the view that the aforesaid investment is a long term investment.

 

15. The Committee also notes paragraphs 32, 17 and 19 of AS 13 which provide as below:

 

“ 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.”

“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.”

“19.  Where there is a decline, other than temporary, in the carrying amounts of long term investments, the resultant reduction in the carrying amount is charged to the profit and loss statement. The reduction in carrying amount is reversed when there is a rise in the value of the investment, or if the reasons for the reduction no longer exist.”

 

16. 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, provision for diminution is required to be made to recognise the decline by debiting the profit and loss account.  Thus, in the present case, an assessment should be made as to whether the decline in the value of investments is other than temporary, keeping in view various factors such as expected market position of investments in which the funds of the unit holders have been invested, events occurring after the balance sheet date, announcements made by UTI from time to time, etc. Only where it is concluded that the decline in the value is other than temporary, a reduction in the carrying amount of the investments is required.   The Committee also  notes that the reduction in the carrying amount of the long-term investments, other than temporary, should be charged to the profit and loss account and not to the accumulated reserves.

 

17.  The  Committee  is  further  of  the  view  that  for  the  purpose  of determination of value of the investments, the company may use NAV of the investments on the date of the balance sheet, as declared by UTI. The reason being that the market value of the units may not reflect the fair value of the investments, since the company is prohibited to sell the units at the risk of capital loss as per the Government guidelines.

 

D.  Opinion

 

18.On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 12:

 

(a)  Only where it is concluded that the decline in the value of the long-term investments is other than temporary, a provision for diminution is required to be made to recognise the decline by debiting the profit and loss account. For the purpose of determining value of investments, the NAV on the date of the balance sheet, as declared by UTI, may be used.

(b) The decline in the carrying amount of long-term investments, other than temporary, has to be charged to the profit and loss account and it cannot be adjusted against the accumulated free reserves.

(c)  Under the given circumstances, the method prescribed in (a) above is appropriate.