Subject: Applicability of Accounting Standards to schemes of mutual funds 1.

Transcription

1 Query No. 5 Subject: Applicability of Accounting Standards to schemes of mutual funds 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: Regulation 50 casts responsibility on the Asset Management Company (AMC) to maintain the accounts of the mutual fund. 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: Accounting Standard (AS) 3, Cash Flow Statements 1 Opinion finalised by the Committee on Page 1 of 8

2 (iii) Accounting Standard (AS) 17, Segment Reporting 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: 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.) 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 Page 2 of 8

3 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) 28 2, 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: (iii) (iv) (v) (vi) (vii) Enterprises whose equity or debt securities are listed whether in India or outside India. Enterprises which are in the process of listing their equity or debt securities as evidenced by the board of directors resolution in this regard. Banks including co-operative banks. Financial institutions. Enterprises carrying on insurance business. 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. 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. 2 Auditing and Assurance Standard (AAS) 28 has been renamed as Standard on Auditing (SA) 700. Page 3 of 8

4 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. (iii) (iv) 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. 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. 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. 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. Page 4 of 8

5 B. Query 7. Keeping in view the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues: 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. 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 Page 5 of 8

6 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, 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 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; Balance Sheet and Revenue Account in accordance with paras 2, 3 and 4, respectively of this Schedule; Page 6 of 8

7 (iii) Auditor s Report in accordance with paragraph 5 of this Schedule; 3. Contents of Balance Sheet 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 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 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. 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 Page 7 of 8

8 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 scheme-wise 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: 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, 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. 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 noncompliances with the Accounting Standards. Page 8 of 8