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Query No. 5
Subject:
Applicability of Accounting Standards to schemes
of mutual funds1.1
A. Facts of the Case
1. Mutual funds in India are required to comply with the Securities
and Exchange Board of India (SEBI) (Mutual Funds) Regulations,
1996 (hereinafter referred to as ‘Regulations’) as amended from
time to time. These Regulations specify the operational/procedural
policies, accounting policies and standards and other guidelines to
be followed by the mutual funds. In addition to the above
Regulations, SEBI also issues various circulars and guidelines
from time to time governing the operations and various other
aspects of a mutual fund.
2. The significant Regulations, as per the querist, are as under:
(i) Regulation 50 casts responsibility on the Asset
Management Company (AMC) to maintain the accounts
of the mutual fund.
(ii) Regulation 50(3) of the Regulations specifies that the
AMC shall follow Ninth Schedule of the Regulations so
as to provide appropriate details, scheme-wise.
(iii) Ninth Schedule to the Regulations deals with the
accounting policies and standards to be followed for
providing the above information including the preparation
of financial statements. These mainly comprise policies
relating to investments, dividend, interest income, income
equalisation, commission, etc. This Schedule is silent
on areas, such as, related party disclosures, cash flow
disclosures, segmental reporting, etc.
(iv) Apart from the above, Regulations 54 and 56(2) of the
Regulations deal with the following:
● Accounting policies and standards including policies
in respect of valuation and revenue recognition
● Form and contents of Auditor’s Report
● Matters to be included in the Auditor’s Report
● Other disclosures to be given in the notes to
accounts including historical data.
These regulations are also silent on areas, such as, related
party disclosures, cash flow disclosures and segmental
reporting, etc.
3. The querist has stated that an issue arises whether the mutual
funds are required to comply with the Accounting Standards issued
by Institute of Chartered Accountants of India (ICAI), while preparing
the financial statements for the various schemes of the mutual
fund. In particular, whether a mutual fund has to comply with the
following standards:
(i) Accounting Standard (AS) 3, ‘Cash Flow Statements’
(ii) Accounting Standard (AS) 17, ‘Segment Reporting’
(iii) Accounting Standard (AS) 18, ‘Related Party Disclosures’
4. The querist has given the following arguments which seem to
indicate that compliance with Accounting Standards (including AS
3, AS 17 and AS 18) is required in preparing the financial
statements of a mutual fund scheme:
(i) The Preface to the Statements of Accounting Standards,
issued by the ICAI states the following:
“3.3 Accounting Standards are designed to apply to the
general purpose financial statements and other financial
reporting, which are subject to the attest function of the
members of the ICAI. Accounting Standards apply in
respect of any enterprise (whether organised in
corporate, co-operative or other forms) engaged in
commercial, industrial or business activities, irrespective
of whether it is profit oriented or it is established for
charitable or religious purposes. Accounting Standards
will not, however, apply to enterprises only carrying on
the activities which are not of commercial, industrial or
business nature, (e.g., an activity of collecting donations
and giving them to flood affected people). Exclusion of
an enterprise from the applicability of the Accounting
Standards would be permissible only if no part of the
activity of such enterprise is commercial, industrial or
business in nature. Even if a very small proportion of
the activities of an enterprise is considered to be
commercial, industrial or business in nature, the
Accounting Standards would apply to all its activities
including those which are not commercial, industrial or
business in nature.”
From the above, according to the querist, it seems that since
mutual funds (or mutual fund schemes) engage in commercial
activities, Accounting Standards are applicable to them. (Emphasis supplied by the querist.)
(ii) Paragraph 4.2 of the Preface to the Statements of
Accounting Standards, inter alia, states that Accounting
Standards “do not override the local regulations”. This,
according to the querist, implies that if a particular
Accounting Standard is found to be not in conformity
with law (SEBI Regulations in this case), the provisions
of the said law will prevail and the financial statements
should be prepared in conformity with such law. Thus,
the SEBI Regulations will have an overriding effect if an Accounting Standard is not in conformity with them.
However, the areas on which the Regulations are silent,
the Accounting Standards still apply. Where the law
lays down additional requirements compared to those
provided by the Standards, these should also be
complied with. (Emphasis supplied by the querist.)
(iii) The fact that there is no general exemption to mutual
funds from the applicability of accounting standards is
supported by the fact that Accounting Standard (AS)
13, ‘Accounting for Investments’, specifically excludes
mutual funds from its application. This implies that other
standards apply to mutual funds in the absence of any
specific exemption. (Emphasis supplied by the querist.)
(iv) The Ninth Schedule to the Regulations requires an
auditor to give his opinion as to whether the balance
sheet and the revenue account give a true and fair
view. Auditing and Assurance Standard (AAS) 282, ‘The
Auditor’s Report on Financial Statements’, issued by
the ICAI, inter alia, provides that “the opinion paragraph
of the auditor’s report should clearly indicate the
financial reporting framework used to prepare the
financial statements and state the auditor’s opinion
as to whether the financial statements give a true
and fair view in accordance with that financial
reporting framework and, where appropriate,
whether the financial statements comply with the
statutory requirements.” This is the reason that the
auditor of a mutual fund scheme also states that the
financial statements give a true and fair view in
conformity with the accounting principles generally
accepted in India. Based on the above, the framework
for the preparation and presentation of financial
statements of the mutual funds would include Accounting
Standards issued by the ICAI apart from the SEBI
Regulations. Thus, even if the SEBI Regulations are
silent regarding compliance with Accounting Standards issued by the ICAI, the auditor would need to consider
them to conclude the opinion on the financial statements.
(Emphasis supplied by the querist.)
5. As far as Accounting Standards 3, 17 and 18 are concerned,
these are mandatorily applicable only to the Level I enterprises
which include the following:
(i) Enterprises whose equity or debt securities are listed
whether in India or outside India.
(ii) Enterprises which are in the process of listing their equity
or debt securities as evidenced by the board of directors’
resolution in this regard.
(iii) Banks including co-operative banks.
(iv) Financial institutions.
(v) Enterprises carrying on insurance business.
(vi) All commercial, industrial and business reporting
enterprises, whose turnover for the immediately
preceding accounting period on the basis of audited
financial statements exceeds Rs. 50 crore. Turnover
does not include ‘other income’.
(vii) All commercial, industrial and business reporting
enterprises having borrowings, including public deposits,
in excess of Rs. 10 crore at any time during the
accounting period.
(viii) Holding and subsidiary enterprises of any one of the
above at any time during the accounting period.
The querist has stated that an issue that will arise in applying the
above classification in the present case is whether it is the mutual
fund that should be considered as the ‘enterprise’ or whether each
scheme of a mutual fund should be so considered. As per the
querist, the term ‘enterprise’ should be interpreted as referring to
the reporting entity which in the present case is a mutual fund
scheme and not the mutual fund as a whole.
Thus, if a mutual fund scheme falls in Level I, the three standards
(AS 3, AS 17 and AS 18) are applicable to it even if the SEBI
Regulations relating to financial statements of mutual funds do not
contain any stipulation for compliance with Accounting Standards. (Emphasis supplied by the querist.)
6. As against the above, the querist has also given the following
arguments indicating that Accounting Standards issued by the ICAI
(including AS 3, AS 17 and AS 18) are not applicable to mutual
funds and mutual fund schemes.
(i) The Preface to the Statements of Accounting Standards
states that in case there is a conflict between the
requirement of local regulations and those required by
an Accounting Standard, the local regulations shall
prevail over the Accounting Standard. In the instant case,
as per the SEBI Regulations, AMC is responsible to
follow those accounting standards and policies as
specified in the Ninth Schedule. It does not lay a
responsibility on AMC to ensure compliance with the
applicable Accounting Standards issued by the ICAI.
Further, the Regulations do not specifically require
compliance with Accounting Standards issued by the
ICAI. Thus, a mutual fund is governed by a specific
regulatory framework which lays down the accounting
policies and standards to be followed, and disclosures
to be made in the financial statements. According to the
querist, the regulatory framework considers these
requirements to be self-contained as is evident from the
fact that there is no reference to Accounting Standards
in the Ninth Schedule. As the Ninth Schedule does not
recognise Accounting Standards, a mutual fund is
justified in not following them.
(ii) As per the Regulations, the statutory auditors are
required to verify and report whether the financial
statements have been prepared in accordance with the
accounting policies and standards as specified in the
Ninth Schedule. Thus, the audit report format which is
provided by the Regulations, also does not require a mention on the compliance with Accounting Standards
issued by the ICAI.
(iii) The Companies Act, 1956, had to be specifically
amended to incorporate provisions regarding compliance
with Accounting Standards, implying thereby that prior
to the aforesaid amendment, a company was not obliged
to follow the Accounting Standards.
(iv) A quick survey of the published annual reports of mutual
funds indicates that some mutual funds in India are not
making disclosures, such as, cash flows, segmental,
related parties, etc., while some other mutual funds are
giving these disclosures.
B. Query
7. Keeping in view the above, the querist has sought the opinion
of the Expert Advisory Committee on the following issues:
(i) Whether it is mandatory for a mutual fund to comply
with the Accounting Standards issued by the ICAI
generally, and AS 3, AS 17 and AS 18 in particular, in
preparing the financial statements of various schemes
operated by it.
(ii) If the answer to the above question is in the affirmative,
what is the duty of the auditor if the financial statements
of a mutual fund scheme do not comply with one or
more of the Accounting Standards, e.g., if disclosures
required under AS 3, AS 17 and/or AS 18 are not made
in the financial statements?
C. Points considered by the Committee
8. The Committee notes paragraphs 3.3 and 4.1 of the Preface
to the Statements of Accounting Standards. Paragraph 3.3 is
reproduced in paragraph 4 above and paragraph 4.1 is reproduced
below:
“4.1 Efforts will be made to issue Accounting Standards which
are in conformity with the provisions of the applicable laws, customs, usages and business environment in India. However,
if a particular Accounting Standard is found to be not in
conformity with law, the provisions of the said law will prevail
and the financial statements should be prepared in conformity
with such law.”
9. On the basis of paragraph 3.3 of the Preface, the Committee
notes that the Accounting Standards are applicable to an enterprise
if it is engaged in commercial, industrial or business activities. The
Committee notes that the activities of a mutual fund or mutual
fund schemes are commercial in nature. Therefore, they are
required to comply with the Accounting Standards issued by the
Institute of Chartered Accountants of India (ICAI). Keeping in view
paragraph 4.1 of the Preface, and the Ninth Schedule and
Regulations 54 and 56(2) of the SEBI (Mutual Funds) Regulations,
1996, which prescribe the accounting policies and standards to be
followed by the mutual funds for preparation of accounts, the
Committee is of the view that in case of any contradiction between
the Accounting Standards issued by the ICAI and the Regulations,
the Regulations will prevail. However, in respect of the aspects on
which the Regulations are silent, the Committee is of the view that
the Accounting Standards issued by the ICAI would be applicable.
10. The Committee notes paragraph 6.1 of the Preface to the
Statements of Accounting Standards which provides as below:
“6.1 The Accounting Standards will be mandatory from the
respective date(s) mentioned in the Accounting Standard(s).
The mandatory status of an Accounting Standard implies that
while discharging their attest functions, it will be the duty of
the members of the Institute to examine whether the
Accounting Standard is complied with in the presentation of
financial statements covered by their audit. In the event of
any deviation from the Accounting Standard, it will be their
duty to make adequate disclosures in their audit reports so
that the users of financial statements may be aware of such
deviation.”
11. From the above, the Committee is of the view that even though
it is not mentioned in the Regulations that the auditor should
examine whether the Accounting Standards issued by the ICAI have been complied with or not, if the auditor finds any deviation
from the Accounting Standards issued by the ICAI, except for
those requirements of Accounting Standards for which accounting
policies or standards have been prescribed by the Regulations,
the audior should make adequate disclosures, in the audit report
in accordance with Standard on Auditing (SA) 700, ‘The Auditor’s
Report on Financial Statements’, issued by the ICAI.
12. For determining whether a mutual fund scheme or a mutual
fund as a whole should be considered as an enterprise for the
applicability of AS 3, AS 17 and AS 18 which are mandatory for
enterprises falling in Level I, the Committee notes paragraphs 3.3
and 3.4 of the Preface to the Statements of Accounting Standards,
Regulation 54 and the Eleventh Schedule to the Regulations. While
paragraph 3.3 of the Preface is reproduced in paragraph 4 above,
paragraph 3.4 of the Preface, Regulation 54 and the relevant
portion of the Eleventh Schedule are reproduced below:
Preface to the Statements of Accounting Standards
“3.4 The term ‘General Purpose Financial Statements’
includes balance sheet, statement of profit and loss, a cash
flow statement (wherever applicable) and statements and
explanatory notes which form part thereof, issued for the use
of various stakeholders, Governments and their agencies and
the public. References to financial statements in this Preface
and in the standards issued from time to time will be construed
to refer to General Purpose Financial Statements.”
SEBI (Mutual Funds) Regulations, 1996
“54. Every mutual fund or the asset management company
shall prepare in respect of each financial year an annual report
and annual statement of accounts of the schemes and the
fund as specified in Eleventh Schedule.”
Eleventh Schedule
“1. Annual Report
The annual report shall contain–
(i) Report of the Board of Trustees on the operations of
the various schemes of the fund and the fund as a
whole during the year and the future outlook of the
fund;
(ii) Balance Sheet and Revenue Account in accordance
with paras 2, 3 and 4, respectively of this Schedule;
(iii) Auditor’s Report in accordance with paragraph 5 of this
Schedule;
..."
“3. Contents of Balance Sheet
(i) The Balance Sheet shall give schemewise particulars
of its assets and liabilities. These particulars shall
contain information enumerated in Annexures 1A
and 1B hereto. It shall also disclose, inter alia, accounting policies relating to valuation of
investments and other important areas.
..."
“4. Contents of Revenue Account
(i) The Revenue Account shall give schemewise
particulars of the income, expenditure and surplus
of the mutual fund. These particulars shall contain
information enumerated in Annexure 2 of this
Schedule.
..."
“5. Auditor’s Report
(i) All mutual funds shall be required to get their accounts
audited in terms of a provision to that effect in their trust
deeds. The Auditor’s Report shall form a part of the
Annual Report. It should accompany the Abridged
Balance Sheet and Revenue Account. The auditor shall
report to the Board of Trustees and not to the unitholders.
(ii) The auditor shall state whether:
1. he has obtained all information and explanations
which, to the best of his knowledge and belief, were
necessary for the purpose of his audit,
2. the Balance Sheet and the Revenue Account are in
agreement with the books of account of the fund.
(iii) The auditor shall give his opinion as to whether:
1. the Balance Sheet gives a true and fair view of the
schemewise state of affairs of the fund as at the
balance sheet date, and
2. the Revenue Account gives a true and fair view of
the schemewise surplus/deficit of the fund for the
year/period ended at the balance sheet date.
…”
13. The Committee notes that as per paragraph 3.3 of the Preface
to the Statements of Accounting Standards, Accounting Standards
issued by the ICAI are applicable to general purpose financial
statements. Paragraph 3.4 of the Preface explains that general
purpose financial statements include balance sheet, statement of
profit and loss, a cash flow statement (wherever applicable) and
statements and explanatory notes which form part thereof. The
Committee also notes from the above reproductions from the
Eleventh Schedule to the Regulations that a mutual fund is required
to prepare balance sheet and revenue account giving schemewise
particulars. The Committee is of the view that balance sheet
and revenue account giving scheme-wise particulars are general
purpose financial statements referred to in paragraph 3.4 of the
Preface. The Committee is, further, of the view that the auditor is
also required to give his opinion on the scheme-wise state of
affairs and the scheme-wise surplus/deficit of the fund as reflected
in the balance sheet and the revenue account respectively. The
Committee is of the view that while the reporting entity or the
‘enterprise’ is a mutual fund, since mutual fund schemes are an
integral part of the mutual fund and as per the SEBI (Mutual
Funds) Regulations, 1996, schemewise particulars are required to be given in the balance sheet and revenue account, the various
provisions of AS 3, AS 17 and AS 18 are applicable to a mutual
fund scheme also.
D. Opinion
14. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 7 above:
(i) A mutual fund is required to comply with the Accounting
Standards issued by the ICAI generally, except for those
requirements of the Accounting Standards for which
specific accounting policies and standards have been
prescribed by the SEBI (Mutual Funds) Regulations,
1996. AS 3, AS 17 and AS 18 are required to be
complied with by a mutual fund while preparing financial
statements of various schemes, as discussed in
paragraph 13 above.
(ii) If the financial statements of a mutual fund scheme do
not comply with one or more of the Accounting Standards
except for those requirements of Accounting Standards
for which specific accounting policies and standards have
been prescribed by the Regulations, and if disclosures
required under AS 3, AS 17 and AS 18 if applicable to
the mutual fund scheme, are not made, where applicable,
the auditor should make adequate disclosures in the
audit report for non-compliances with the Accounting
Standards.
1Opinion finalised by the Committee on 30.4.2008
2Auditing and Assurance Standard (AAS) 28 has since been renamed,
renumbered and categorised as Standard on Auditing (SA) 700, ‘The Auditor’s
Report on Financial Statements’.
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