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Thread: Accounting Standard (AS) 13 - Accounting for Investments

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    Thumbs up Accounting Standard (AS) 13 - Accounting for Investments

    Accounting Standard (AS) 13

    Accounting for Investments
    (This Accounting Standard includes paragraphs 26-35 set in
    bold italic

    type and paragraphs 1-25 set in plain type, which have equal authority.
    Paragraphs in bold italic type indicate the main principles. This
    Accounting Standard should be read in the context of the Preface to the
    Statements of Accounting Standards
    1.)

    The following is the text of Accounting Standard (AS) 13,
    ‘Accounting

    for
    Investments’, issued by the Council of the Institute of Chartered
    Accountants of India.
    2

    Introduction
    1. This Statement deals with accounting for investments in the financial
    statements of enterprises and related disclosure requirements.
    3

    Attached Files Attached Files

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    Thumbs up Determination of carrying amount of long-term investments on their disposal

    A. Facts of the Case
    1. A company made certain investments in the form of shares of another company, (‘investee company’) jointly promoted by the company with another company as long term strategic investment in two stages. In the first stage, the company received shares through direct allotment by the investee company at par. In the second stage, the company acquired further shares in the investee company at a discount from the other promoter of the investee company.
    2. As per the querist, the company carried, in its books of account, this long-term investment at its actual cost as per paragraph 17 of Accounting Standard (AS) 13, ‘Accounting for Investments’, issued by the Institute of Chartered Accountants of India. The investee company incurred losses in excess of its paid-up capital. However, considering the long term nature of investments and a strategy to revive the net worth, the erosion was considered by the company as temporary, and consequently, the carrying cost of the investment was not reduced in its books of account.
    3. In a subsequent period, the company sold, as per the querist, the specific part of the above investment which was acquired in the second stage at a price less than its par value, but more than its acquisition cost, and thus, recorded a profit as a result of valuing the carrying cost of the shares disposed off at the actual acquisition cost. As per the querist, this is in accordance with paragraph 17 of AS 13. According to the querist, the company contends that as the investment was acquired in two stages, there were two specific parts of the investment out of which one specific part was sold and the other specific part remained with the company which, as per paragraph 17 of AS 13, the company was entitled to value at its actual acquisition cost. In case the company had followed paragraph 22 of AS 13, there would have been a loss to be debited to the profit and loss account instead of recording a profit.
    4. As per the querist, the auditors of the company have taken the view that paragraph 22 and not paragraph 17 of AS 13 is applicable and have, thus, qualified their audit report to this extent. The auditors have also qualified their report as to the state of affairs of the company, stating that the investments are carried at a higher value by the company in its books of account as a result of non-compliance with AS 13 in respect of paragraph 22. The auditors continued to express a qualified opinion in subsequent years as regards the state of affairs reflected by the balance sheet in respect of the investments being carried at a higher value on account of non- compliance with AS 13 in the past.
    5. According to the querist, the company contends that in view of the fact that:
    (a) under paragraph 17 of AS 13, the ‘long term investments’ are to be carried at cost, which the enterprise is complying with, and
    (b) paragraph 22 of AS 13 is applicable for computing carrying cost of the part of the investment disposed of (and not to the balance investment);
    the company was right in carrying the balance investment at its actual acquisition cost. Hence, according to the company, the auditors are not justified in qualifying the state of affairs in the subsequent periods. The auditors’ qualification in respect of the carrying amount of the balance ‘long term investment’ has to be dispensed with because there is no ‘non-adherence’to the provisions of AS 13 subsequent to the year in which a part of the investment was disposed of.
    6. As per the querist, the company contends that determining the carrying amount of the investment sold on the basis of average cost of the investment acquired in two stages, for the purpose of reporting, especially when the enterprise has made actual profit, would have completely distorted the financial statements of the relevant period. Also, if the carrying amount of the balance investment is averaged out, especially when the diminution in the value is considered as temporary, the financial statements would get distorted for all times to come. The company also contends that even for the purposes of computing ‘capital gains’ under the provisions of the Income-tax Act, 1961, it is the cost (and not the average cost) and proceeds, which are relevant. This is true even in case of partial disposal of an investment, as long as the investment purchased and sold is specific and is appropriately identifiable.
    7. The querist has stated that the company also contends that since the auditors have qualified the accounts once and there being no further non- compliance, the accounts of the enterprise should not be qualified repeatedly since it would serve no useful purpose for the stakeholders of the company. However, the auditors are of the view that non-compliance with paragraph 22 in the year of disposal has resulted in the carrying amount of the balance investment being higher and its consequent impact on the net worth of the company and, hence, there is importance of a continuing qualified opinion as regards the state of affairs of the company.
    8. The querist has drawn the attention of the Committee to paragraphs 7, 8, 17, 18, 19, 21 and 22 of AS 13 in respect of the above. The querist has also stated that if an enterprise deviates from the provisions of the Standard in any manner, to the extent of the deviation, the financial statements prepared by the enterprise shall be subject to qualification by the auditor.
    B . Query
    9. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
    (a) What should be the correct accounting treatment of the above transaction?
    (b) Whether the company is justified in its contention that the specific portion of the balance investment should be carried at its actual acquisition cost according to paragraph 17 of AS 13.
    (c) Whether the auditors are justified in their stand that despite the fact that the investment was held in two specific lots acquired at different costs, upon sale of one specific lot, the balance investment should be carried at average cost and not the actual cost, in view of paragraph 22 of AS 13.
    (d) Whether the auditors are justified in qualifying their report on the financial statements of the subsequent periods on the ground that investments are not carried at the average cost as per paragraph 22 of AS 13.

    C. Points considered by the Committee
    10. The Committee restricts itself to the particular queries raised by the querist in paragraph 9 above, and has not examined any other issue that may be contained in the facts of the case, such as, whether non-recognition of the diminution in the value of investments held as long-term strategic investments is appropriate or not.
    11. The Committee notes from the facts of the case that the ‘investment’in question was acquired by the company in two lots and both the lots were held as a long-term strategic investment in the books of account of the company.
    12. The Committee notes paragraphs 17 and 22 of AS 13 which are reproduced 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."
    "22. When disposing of a part of the holding of an individual investment, the carrying amount to be allocated to that part is to be determined on the basis of the average carrying amount of the total holding of the investment.
    2 "
    13. From the above, the Committee is of the view that the two lots of investment were held collectively as a long-term investment in the books of account of the company. In other words, the company did not make any distinction between the two lots of investment as to the purpose of their holding. Accordingly, the Committee is of the view that the two lots of the investment cannot be treated as separate investments, and, therefore, paragraph 22 of AS 13, reproduced above, is applicable. In accordance with paragraph 22 of AS 13, upon sale of the part of the investment, the carrying amount to be allocated to the lot sold should be determined on the basis of the average carrying amount of the total holding of the investment, i.e., by averaging the cost of investments acquired in the two lots. Consequently, the carrying amount of the balance portion of the investment will also be determined on the basis of the average cost. Thus, as per the facts of the case supplied by the querist, the company should have accounted for a loss on the sale of the part of the investment and should have carried the balance portion of the investment at a reduced amount, i.e., the average carrying amount.
    14. The Committee also notes that paragraph 3.16 of the ‘Statement on Qualifications in Auditor’s Report’, issued by the Institute of Chartered Accountants of India, states that "Each year’s accounts being independent, the essential facts relating to a qualification made in an earlier year must be repeated where appropriate".
    15. From the above, the Committee is of the view that an auditor has to report on the truth and fairness of the financial statements of a particular financial year, and, therefore, if the amount in respect of an item of asset in the balance sheet of the company is not appropriately reflected, the auditor is professionally bound to report on the same. The said inappropriate amount might be reflected as a result of an incorrect treatment followed by the company in an earlier year. However, since the same has an effect on the current year’s financial statements, the auditor should qualify his report in accordance with the ‘Statement on Qualifications in Auditor’s Report’.
    16. The Committee notes that considerations different from accounting may apply for taxation purposes. Therefore, ‘cost’ for the purpose of determination of capital gains tax liability is not necessarily relevant for the purpose of accounting.
    D. Opinion
    17. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9 above:
    (a) The correct accounting treatment of the transaction would be to determine the carrying amount of the portion of investment sold, on the basis of average cost of the two lots of the investment. Accordingly, as per the facts supplied, a loss should be booked on the sale of the part of the investment and the carrying amount of the remaining investment should be reduced to the average cost.
    (b) No, the company is not justified in its contention that the specific portion of the balance investment should be carried at its actual acquisition cost. For this purpose, paragraph 22 of AS 13 is applicable, and not paragraph 17 thereof.
    (c) Yes, the auditors are justified in their stand that despite the fact that the investment was held in two specified lots acquired at different costs, upon sale of one specified lot, the balance investment should be carried at average cost and not the actual cost, in view of paragraph 22 of AS 13.
    (d) Yes, the auditors are justified in qualifying their report on the financial statements of the subsequent years on the ground that investments are not carried at the average cost as per paragraph 22 of AS 13.

    -------
    1 Opinion finalised by the Committee on 28.10.2003.
    2
    In respect of shares, debentures and other securities held as stock-in-trade, the cost of stocks disposed of is determined by applying an appropriate cost formula (e.g. first-in first-out, average cost, etc.). These cost formulae are the same as those specified in Accounting Standard (AS) 2, in respect of Valuation of Inventories.

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    Thumbs up Accounting for incentive received in respect of purchase of investments

    A. Facts of the Case

    1. A not-for-profit company is engaged in promoting trade through organising/participating in fairs/exhibitions in India and abroad. According to the querist, investment of surplus funds is done in accordance with the guidelines of the Department of Public Enterprises, Ministry of Industry, either in term deposits with approved banks or in the schemes of Unit Trust of India (UTI) etc.
    2. During the year 1997-98, the company purchased 49,28,730 units of US-64 of UTI at the rate of Rs. 14 per unit amounting to Rs.690.02 lakh. Subsequently, the Unit Trust of India paid Rs.10.35 lakh as incentive to the company for direct purchase of units from it. The cost of the units was arrived at after deducting the above incentive from the gross investment value. According to the querist, the accounting policy of the company on this issue stipulates that long term investments are to be stated at cost or market value whichever is lower. Since the cost of the investment at the close of the year on 31.3.98 was lower than its market value, the investment cost of Rs.679.67 lakh (Rs.690.02 lakh less Rs.10.35 lakh) was reflected in annual accounts.
    3. According to the querist, while auditing the accounts of the company for the year 1997-98, the government auditors opined that the incentive of Rs.10.35 lakh received from the Unit Trust of India should have been shown as ‘income’ in the income and expenditure account of the company instead of being deducted from the cost of the investment.
    4. As per the querist, the company’s contention is that as per Accounting Standard (AS) 13, ‘Accounting for Investments’, issued by the Institute of Chartered Accountants of India, the cost of an investment should include acquisition charges such as brokerage, fee and duties. According to the querist, this implies that the amount received by the investor on account of incentive or such other related receipts should be deducted from the investment amount to arrive at the cost of an investment. Therefore, deduction of the amount of Rs.10.35 lakh received as incentive for purchase of units directly from UTI from the cost of the investment is appropriate.
    B. Query

    5. The opinion of the Expert Advisory Committee has been sought by the querist as to whether the incentive received from the UTI should be reflected in the annual accounts as a deduction from the cost of the investment or whether it should be shown as an ‘income’ in the income and expenditure account.
    C. Points Considered by the Committee

    6. The Committee notes paragraph 32 of AS 13 which states as below:
    “32. 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.”
    Though the querist has not sought the opinion of the Committee on the appropriateness of its accounting policy relating to long-term investments, the Committee observes that the same is not in accordance with AS 13.
    7. The Committee notes that paragraph 9 of AS 13, ‘Accounting for Investments’, states the following:
    “9. The cost of an investment includes acquisition charges such as brokerage, fees and duties.”
    The Committee notes that the above paragraph does not specifically deal with the treatment of incentives received or receivable by an investor in connection with an investment made by him.
    8. The Committee is of the view that the incentive received by the company is clearly attributable to the purchase of units and, therefore, it is of the nature of a rebate for direct purchase. The general principle of accounting for such a rebate is to deduct it in arriving at the cost of the asset concerned. For example, rebates relating to inventories and fixed assets are deducted in arriving at their cost (paragraph 6.3 of AS 2, ‘Valuation of Inventories’ as originally issued in June, 1981, and paragraph 9.1 of AS 10, ‘Accounting for Fixed Assets’). On this basis, the Committee is of the view that the incentive should be adjusted in arriving at the cost of the investment rather than being treated as an income.
    D. Opinion

    9. On the basis of the above, the Committee is of the opinion that the incentive received from UTI should be deducted in arriving at the cost of the investment.

    Opinion finalised by the Committee on 28.5.1999

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    Thumbs up Determination of carrying amount of long-term investments on their disposal

    A. Facts of the Case

    1. A company made certain investments in the form of shares of another company, (‘investee company’) jointly promoted by the company with another company as long term strategic investment in two stages. In the first stage, the company received shares through direct allotment by the investee company at par. In the second stage, the company acquired further shares in the investee company at a discount from the other promoter of the investee company.

    2. As per the querist, the company carried, in its books of account, this long-term investment at its actual cost as per paragraph 17 of Accounting Standard (AS) 13, ‘Accounting for Investments’, issued by the Institute of Chartered Accountants of India. The investee company incurred losses in excess of its paid-up capital. However, considering the long term nature of investments and a strategy to revive the net worth, the erosion was considered by the company as temporary, and consequently, the carrying cost of the investment was not reduced in its books of account.

    3. In a subsequent period, the company sold, as per the querist, the specific part of the above investment which was acquired in the second stage at a price less than its par value, but more than its acquisition cost, and thus, recorded a profit as a result of valuing the carrying cost of the shares disposed off at the actual acquisition cost. As per the querist, this is in accordance with paragraph 17 of AS 13. According to the querist, the company contends that as the investment was acquired in two stages, there were two specific parts of the investment out of which one specific part was sold and the other specific part remained with the company which, as per paragraph 17 of AS 13, the company was entitled to value at its actual acquisition cost. In case the company had followed paragraph 22 of AS 13, there would have been a loss to be debited to the profit and loss account instead of recording a profit.

    4. As per the querist, the auditors of the company have taken the view that paragraph 22 and not paragraph 17 of AS 13 is applicable and have, thus, qualified their audit report to this extent. The auditors have also qualified their report as to the state of affairs of the company, stating that the investments are carried at a higher value by the company in its books of account as a result of non-compliance with AS 13 in respect of paragraph 22. The auditors continued to express a qualified opinion in subsequent years as regards the state of affairs reflected by the balance sheet in respect of the investments being carried at a higher value on account of non- compliance with AS 13 in the past.

    5. According to the querist, the company contends that in view of the fact that:

    (a) under paragraph 17 of AS 13, the ‘long term investments’ are to be carried at cost, which the enterprise is complying with, and

    (b) paragraph 22 of AS 13 is applicable for computing carrying cost of the part of the investment disposed of (and not to the balance investment);

    the company was right in carrying the balance investment at its actual acquisition cost. Hence, according to the company, the auditors are not justified in qualifying the state of affairs in the subsequent periods. The auditors’ qualification in respect of the carrying amount of the balance ‘long term investment’ has to be dispensed with because there is no ‘non-adherence’to the provisions of AS 13 subsequent to the year in which a part of the investment was disposed of.

    6. As per the querist, the company contends that determining the carrying amount of the investment sold on the basis of average cost of the investment acquired in two stages, for the purpose of reporting, especially when the enterprise has made actual profit, would have completely distorted the financial statements of the relevant period. Also, if the carrying amount of the balance investment is averaged out, especially when the diminution in the value is considered as temporary, the financial statements would get distorted for all times to come. The company also contends that even for the purposes of computing ‘capital gains’ under the provisions of the Income-tax Act, 1961, it is the cost (and not the average cost) and proceeds, which are relevant. This is true even in case of partial disposal of an investment, as long as the investment purchased and sold is specific and is appropriately identifiable.

    7. The querist has stated that the company also contends that since the auditors have qualified the accounts once and there being no further non- compliance, the accounts of the enterprise should not be qualified repeatedly since it would serve no useful purpose for the stakeholders of the company. However, the auditors are of the view that non-compliance with paragraph 22 in the year of disposal has resulted in the carrying amount of the balance investment being higher and its consequent impact on the net worth of the company and, hence, there is importance of a continuing qualified opinion as regards the state of affairs of the company.

    8. The querist has drawn the attention of the Committee to paragraphs 7, 8, 17, 18, 19, 21 and 22 of AS 13 in respect of the above. The querist has also stated that if an enterprise deviates from the provisions of the Standard in any manner, to the extent of the deviation, the financial statements prepared by the enterprise shall be subject to qualification by the auditor.

    B . Query

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

    (a) What should be the correct accounting treatment of the above transaction?

    (b) Whether the company is justified in its contention that the specific portion of the balance investment should be carried at its actual acquisition cost according to paragraph 17 of AS 13.

    (c) Whether the auditors are justified in their stand that despite the fact that the investment was held in two specific lots acquired at different costs, upon sale of one specific lot, the balance investment should be carried at average cost and not the actual cost, in view of paragraph 22 of AS 13.

    (d) Whether the auditors are justified in qualifying their report on the financial statements of the subsequent periods on the ground that investments are not carried at the average cost as per paragraph 22 of AS 13.



    C. Points considered by the Committee

    10. The Committee restricts itself to the particular queries raised by the querist in paragraph 9 above, and has not examined any other issue that may be contained in the facts of the case, such as, whether non-recognition of the diminution in the value of investments held as long-term strategic investments is appropriate or not.

    11. The Committee notes from the facts of the case that the ‘investment’in question was acquired by the company in two lots and both the lots were held as a long-term strategic investment in the books of account of the company.

    12. The Committee notes paragraphs 17 and 22 of AS 13 which are reproduced 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."

    "22. When disposing of a part of the holding of an individual investment, the carrying amount to be allocated to that part is to be determined on the basis of the average carrying amount of the total holding of the investment.2 "

    13. From the above, the Committee is of the view that the two lots of investment were held collectively as a long-term investment in the books of account of the company. In other words, the company did not make any distinction between the two lots of investment as to the purpose of their holding. Accordingly, the Committee is of the view that the two lots of the investment cannot be treated as separate investments, and, therefore, paragraph 22 of AS 13, reproduced above, is applicable. In accordance with paragraph 22 of AS 13, upon sale of the part of the investment, the carrying amount to be allocated to the lot sold should be determined on the basis of the average carrying amount of the total holding of the investment, i.e., by averaging the cost of investments acquired in the two lots. Consequently, the carrying amount of the balance portion of the investment will also be determined on the basis of the average cost. Thus, as per the facts of the case supplied by the querist, the company should have accounted for a loss on the sale of the part of the investment and should have carried the balance portion of the investment at a reduced amount, i.e., the average carrying amount.

    14. The Committee also notes that paragraph 3.16 of the ‘Statement on Qualifications in Auditor’s Report’, issued by the Institute of Chartered Accountants of India, states that "Each year’s accounts being independent, the essential facts relating to a qualification made in an earlier year must be repeated where appropriate".

    15. From the above, the Committee is of the view that an auditor has to report on the truth and fairness of the financial statements of a particular financial year, and, therefore, if the amount in respect of an item of asset in the balance sheet of the company is not appropriately reflected, the auditor is professionally bound to report on the same. The said inappropriate amount might be reflected as a result of an incorrect treatment followed by the company in an earlier year. However, since the same has an effect on the current year’s financial statements, the auditor should qualify his report in accordance with the ‘Statement on Qualifications in Auditor’s Report’.

    16. The Committee notes that considerations different from accounting may apply for taxation purposes. Therefore, ‘cost’ for the purpose of determination of capital gains tax liability is not necessarily relevant for the purpose of accounting.

    D. Opinion

    17. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9 above:

    (a) The correct accounting treatment of the transaction would be to determine the carrying amount of the portion of investment sold, on the basis of average cost of the two lots of the investment. Accordingly, as per the facts supplied, a loss should be booked on the sale of the part of the investment and the carrying amount of the remaining investment should be reduced to the average cost.

    (b) No, the company is not justified in its contention that the specific portion of the balance investment should be carried at its actual acquisition cost. For this purpose, paragraph 22 of AS 13 is applicable, and not paragraph 17 thereof.

    (c) Yes, the auditors are justified in their stand that despite the fact that the investment was held in two specified lots acquired at different costs, upon sale of one specified lot, the balance investment should be carried at average cost and not the actual cost, in view of paragraph 22 of AS 13.

    (d) Yes, the auditors are justified in qualifying their report on the financial statements of the subsequent years on the ground that investments are not carried at the average cost as per paragraph 22 of AS 13.


    Opinion finalised by the Committee on 28.10.2003

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