Query No. 16

Subject:

Valuation of investment in shares of a subsidiary for

non-cash consideration.¹

A. Facts of the Case

1. A State Government company (hereinafter referred to as ‘the company’) in which the State Government is holding 99.99% shares, is engaged in mining and selling of Rock Phosphate, Gypsum, Limestone and Lignite. Its mines are located at different places in the State of Rajasthan. The State Government company is also having Wind Power Mills installed in one of the districts of the State.

2. The Government of India (GOI), vide its letter dated 13.11.2006, has allocated coal blocks in certain Lignite mines in favour of the company for mining of Lignite in the State. As per the condition mentioned in the allotment letter, ‘in principle approval’ for the mining rights was given to the company for carrying out the Lignite mining either by that company or a separate company to be created with participation of the company provided that the separate company created is a Government company eligible to do mining as per the provisions of Coal Mines (Nationalisation) Act, 1983.

3. In view of the above, the company has entered into a Joint Venture (JV) Agreement on 27.12.2006 with a private company to form a JV company (JVC) in which the company shall be holding 51 % equity shares. As per the JV Agreement, the private company should make all the investments and the company shall have no financial liability with respect to the JVC. (Copy of the JV Agreement has been furnished by the querist for the perusal of the Committee.)

4. As per the terms and conditions of JV agreement, the company should obtain mining lease of the Lignite mines in reference from the Government of Rajasthan and transfer the same to the JVC. The company should also obtain all necessary licenses/consents/ approvals from the Government and regulatory approvals/consents from the Central as well as the State Government for use, operation, development and management of the mines. As per the terms of the agreement, all the expenses incurred /to be incurred by the company shall be borne by the JVC/private company. After transfer of mining leases in favour of JVC, the Lignite mines would be developed and operated by JVC/private company and the Lignite to be mined from the mines is to be consumed by the private company for power generation by lignite based power plant to be established by the private company.

5. In compliance with the terms of JV Agreement, a JVC was incorporated on 19.01.2007 with initial paid up capital of Rs. 5,00,000 and as per the terms of JV Agreement, 51% of the share capital of Rs. 5,00,000, i.e., shares having face value of Rs. 10 each, valuing Rs. 2,55,000 of JVC were allotted to the company. In future also, as and when subscribed and paid-up capital of the JVC is increased by the private company, 51% shares would be allotted in favour of the company and the value of such shares may be few crores of rupees depending upon the investment to be made in the JVC by the private company.

6. Since the company has not invested/paid any money for obtaining the shares in the JVC, the company treated the face value of shares (Rs. 2,55,000) as ‘Investment’ and credited the Capital Reserve in its Balance Sheet for the year ended on 31.3.2007. Besides, the company has also made disclosure in the ‘Notes to Accounts’ by giving a note as reproduced below:

      “The company has formed a joint venture company with … (name of the private company) namely ... (name of the JVC). The JVC will undertake the work of Lignite mining in… areas of ... District and supply the same to… (name of the private company) which is going to install Lignite based pit head power plant. As per terms of agreement between the company and … (name of the private company), the company shall have 51% shares in the JVC and ...(name of the private company) will hold the remaining 49% of the equity of the JVC. The shares will be issued to the company in lieu of fulfillment of various obligations and for transfer of mining lease rights by the company to the JVC. The company will not take any financial liability for its holding in the JVC. The JVC has allotted shares worth Rs. 5.00 lakh till 31.03.2007, out of which shares worth Rs. 2.55 lakh being 51% of the shares so allotted have been issued to the company.”

7. As per the querist, the statutory auditors of the company were of the view that the accounting treatment given by the company was not correct and have qualified the balance sheet of the company by stating that the company had shown under the head investment in a subsidiary company, the equity shares issued by the JVC of Rs. 2,55,000 being 25,500 equity shares, 51% of the paid up share capital. In their opinion, the same should be shown at zero value as the company had not paid any consideration for the same and therefore, the investment in subsidiary company and capital reserve had been overstated by Rs. 2,55,000.

B. Query

8. The querist has sought the opinion of the Expert Advisory Committee on the correct accounting treatment for the value of shares of the JVC issued/to be issued in future in favour of the company for which it will not pay any consideration in cash as per the terms of JV Agreement.

C. Points considered by the Committee

9. The Committee notes that the basic issue raised by the querist relates to valuation of investments in the shares of the JVC with 51% equity held by the company for presentation in the separate financial statements of the company. Therefore, the Committee has examined only this issue and has not examined any other issue that may be contained in the Facts of the Case, such as, accounting for the mining license received by the company, accounting in the books of the JVC, whether the JVC should be considered as a subsidiary or a jointly controlled entity, etc.

10. The Committee notes that the Institute of Chartered Accountants of India has issued Accounting Standard (AS) 13, ‘Accounting for Investments’. Paragraphs 28 and 29 of AS 13 read as below:

        “28. The cost of an investment should include acquisition charges such as brokerage, fees and duties.

         29. If an investment is acquired, or partly acquired, by the issue of shares or other securities, the acquisition cost should be the fair value of the securities issued (which in appropriate cases may be indicated by the issue price as determined by statutory authorities). The fair value may not necessarily be equal to the nominal or par value of the securities issued. If an investment is acquired in exchange for another asset, the acquisition cost of the investment should be determined by reference to the fair value of the asset given up. Alternatively, the acquisition cost of the investment may be determined with reference to the fair value of the investment acquired if it is more clearly evident.”

11. From the above, the Committee notes that AS 13, inter alia, deals with the determination of the cost of acquisition of an investment by way of either issue of securities or in exchange of another asset. The other asset may be either monetary or nonmonetary. Though AS 13 does not deal with acquisition of shares in exchange of services, the Committee is of the view that the above principles are equally applicable for investments acquired in exchange for services also. Further, the Committee is of the view that the above principles are equally applicable for securities to be issued/ assets to be transferred/ services to be rendered as consideration for the investment already acquired.

12. The Committee notes that in the present case, under the terms of the JV Agreement, the company in question is obliged to obtain and transfer the mining licenses to the JVC and to fulfill certain obligations. However, all the expenses under the JV Agreement incurred by the company are to be borne by the JVC/ private company. In addition, 51% of shares are also allotted to the company. The passing on of expenses to the JVC/private company is an additional benefit given to the company. That does not alter the principle that cost of the investment in shares of the JVC should be equal to fair value of the license and other services rendered by the company. Alternatively, if fair value of the investments is more clearly evident, that may be taken as cost of the investment as permitted in paragraph 29 of AS 13 quoted above.

13. The Committee notes paragraph 88 of the ‘Framework for the Preparation and Presentation of Financial Statements’, issued by the Institute of Chartered Accountants of India, which reads as below:

        “88. An asset is recognised in the balance sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and the asset has a cost or value that can be measured reliably.”

14. The Committee notes that the company is entitled not only to 51% of initial share capital but also to 51% of share capital to be issued in future without consideration in cash. The shares so obtained/to be obtained constitute investment by the company in the JVC. Further, it seems that the mining licenses are yet to be obtained and transferred to the JVC, since what is obtained is only ‘in principle approval’. From the copy of the JV Agreement furnished by the querist, the Committee notes that apart from obtaining licenses, approvals, etc., the company should also contribute its local knowledge, technical knowledge and other expertise in relation to mines, while the private company shall provide the management support and the entire investment to the JVC (clause 2 of the JV Agreement).

15. In case, there is a reliable measure of fair value of the license and the service, that fair value should be recorded as the cost of investment. The corresponding credit should be reflected as a liability to the extent of the fair value of obligations (to be fulfilled including license to be obtained) and to profit and loss account to the extent of fair value of obligations already fulfilled. As and when the obligation is fulfilled, the appropriate portion of the liability should be cleared by transfer to the profit and loss account.

16. In case the fair value of investment is more clearly evident and adopted as cost of investment, that should be allocated on a reasonable basis to fair value of obligations fulfilled and fair value of obligations yet to be fulfilled so that corresponding credit aspect of investment account can be accounted. Subsequent accounting will be as explained in paragraph 15 above.

17. The Committee is of the view that if the fair values as stated in the above paragraphs are not reasonably determinable, then, investment should be recorded at a nominal value, say, Re. 1.

D. Opinion

18. On the basis of the above, the Committee is of the opinion that the correct accounting treatment in the books of the company for the shares of the JVC issued/to be issued in future in favour of the company for which it will not pay any consideration in cash as per the terms of JV Agreement would be to recognise the same at fair value of the services and the license to be provided by the company to the JVC. However, in case the fair value of the shares is more clearly evident, the same should be recognised at fair value thereof.

¹ Opinion finalised by the Committee on 30.5.2008