Accounting: The Importance Of Accounting

SECTION ONE

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: ACCOUNTING

The importance of Accounting  MF

BS is different from a bank or a company. MF have special requirements concerning accounting for the fund’s assets, liabilities and transactions with investors and other outside constituents such as banks, securities custodians and registrars.  Follow accounting policies laid down by SEBI regulations 1996.  Knowledge is essential to explain the scheme performance to the investors

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Net Asset Value (NAV)  Investors’ subscriptions are not accounted as liabilities or deposits but as Unit Capital  Investments made on behalf of the investors are reflected on the assets side.  Liabilities also form part of the balance sheet  NAV is asset minus liabilities and divided by total number of outstanding units.

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NAV = Assets - Liabilities

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NAV = Net assets of the scheme = Number of units outstanding Market value of investments + receivables + accrued income + other assets -accrued expenses-payablesliabilities No.of units outstanding on NAV date

DISCLOSURES  Daily

NAV for open-end schemes  Weekly NAV for close-end schemes  Those closed - end schemes which are not mandatorily required to be listed in any stock exchange may publish NAV at monthly or quarterly intervals (for e.g. MIPs)  A fund’s NAV is affected by  Purchase and sale of investment securities  Valuation of all investment securities held  Other assets and liabilities  Units sold or redeemed  Valuation of investment securities must be at their market prices.

 Other

Assets includes any income due but not received (for e.g. Dividend announced by a company)  Other Liabilities includes expenses payable by the fund (for e.g. Management fee to AMC)  All income and expenses have to be “accrued” upto the valuation date and included in the computation of the NAV.  Major expense such as management fees should be accrued on a day to day basis, while others need not be accrued, if non-accrual does not affect NAV by more than 1%  Sale or repurchase of units and sale or purchase of investment securities must be recorded within 7 days of the transaction provided the non-recording does not affect NAV by more than 2%.

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Pricing of Units   

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Repurchase price should not be lower than 93% of NAV (95% in case of closed-end schemes) Sale price can not be higher than 107% of NAV The difference between the repurchase and sale price can not be more than7% of the sale price

Fees and Expenses 

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The AMC may charge the scheme with a fees @1.25% for first 100 crores of weekly average net assets outstanding in the accounting year and @1% of weekly average net assets in excess of Rs.100 crores No load schemes may charge an additional management fee upto 1% of weekly average net assets outstanding in the accounting year. Initial expenses of launching schemes not to exceed 6% of initial resources raised

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Total expenses excluding issue or redemption expenses but including investment management and advisory fees are subject to following limits  First 100 crs of avg weekly net assets - 2.5%  Next 300 crs of avg weekly net assets - 2.25%  Next 300crs of avg weekly net assets - 1.75%  For bond funds, the above percentages are required to be lower by0.25%

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Initial Issue Expenses    

All expenses cannot be charged to a scheme in the first year itself. SEBI permits amortization as follows. CE scheme, the initial issue expenses shall be amortized on a weekly basis over the period of the scheme. OE scheme, initial issue expenses may be amortized over a period not exceeding five years. Unamortised portion of expenses shall be included for NAV calculation, considered as other assets.

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The investment advisory fee cannot be claimed on this asset. Hence, they have to be excluded while determining the chargeable investment management/advisory fees. While calculating the maximum amount of chargeable expenses, the unamortised portion of the initial issue expenses will not be included as part of the average weekly net assets figure.

Disclosures and Reporting Requirements   

Annual report and annual statement of accounts Annual statement of account to be audited Must dos  publish through an ad, scheme-wise annual report or an abridged summary of the report  mail the summary to all unit holders  forward to SEBI, a copy of the annual report and other information including details of investments and deposits held by the fund.

The fund shall furnish to SEBI once a year  copies of audited annual schemewise SOA  copy of six monthly unaudited accounts  quarterly statement of movements in the net assets for each scheme of the fund  quarterly portfolio statement, including changes from the previous periods for each scheme  Publish  unaudited financial results in one national English newspaper and one in the language of the region where the head office of the fund is situated.  The trustee to make  such disclosures to investors as are essential to keep them informed about any information which may have an adverse bearing on their investment. 

Specific half-yearly disclosures     

Expenses exceeding 10% of the total Portfolio Scripwise disclosure of NPAs Large unit-holdings (over 25% of the net assets) Indicate that unit-holders may seek annual report from the MF

Amortization: 

Initial Expenses charged over years

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Close ended schemes (Load basis): Amortized on a weekly basis over the period of the scheme. E.g for a 5 yr. scheme, 260 weeks must be taken.

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Open ended schemes (Load basis): Amortized annually over a period not greater than 5 years.

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Un-amortized portion to be added for NAV calculation. No AMC fee on this.

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Accounting Policies   

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Investments marked to market Unrealised appreciation can not be distributed Dividend received by fund should be recognised on the date the share is quoted on ex-dividend basis and not on the date of declaration. To calculate gain or loss on sale of investments, the average cost method must be followed to determine the cost of purchase Purchase sale to be recognized on the date of transaction and not settlement Bonus/rights to be recognized on ex-bonus/ex-right day.

Investments that are NPAs  An asset shall be regarded as NPA, if the interest and/or principal has been outstanding for more than one quarter from the due date of receipt  Income that accrues in such cases should be provided for and no further accrual should be made for such investments.

Provision for NPAs

3 months after classification as NPA: 10% 6…………………………………… : 30% 9…………………………………… : 50% 12…………………………………. : 75% 15………………………………….. : 100%

SECTION TWO

: VALUATION

Valuation of traded securities  Valued at the last quoted closing price on the stock exchange where it is principally traded  IF not traded, then take the value at which it was traded on the earliest previous day provided it is not more than 30 days prior to valuation Thinly traded equities  Monthly trading value
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Thinly traded debt security  Traded value < Rs. 15 crores in a month.  Add value traded on all exchanges to compute this figure.  Such security to be valued using the method for non-traded debt security.

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Valuation of Non-traded Securities  Valuation of equity instrument is on the basis of capitalization of earnings solely or in combination with its balance sheet net asset value.  Capitalization rate will be determined by reference to the Price or earning ratios of comparable traded securities with an appropriate discount for lower liquidity to be used.

Valuation of Non-traded non-government debt with less than 182 days for maturity Upto 182 day maturity, valued as money market instrument (cost + accrual of interest)  Debt instruments are to be valued on YTM basis, the capitalization factor being determined for comparable traded securities with an appropriate discount for lower liquidity.  Call money, bills purchases under rediscount and short term deposits with banks are to be valued at (cost+accrual).  Other money market instruments at yield at which they are currently traded Non-traded non-government debt with over 182 days to maturity 

Investment grade: YTM basis Performing: 25% discount to face value

Non-investment grade Non-performing: Make provisions

Taxation Provisions 

Internationally, trusts are pass-through vehicles; hence, they pay no tax.

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In India, A

mutual fund pays 22% tax on the income distributed to unit holders  This tax bears no relationship to the unit-holder’s tax bracket.  Income distributed by a fund is tax exempt in the hands of investors

Tax rebate u/s 88 (now u/s-80 ccc)  ELSS

investment up to 10,000 tax rebate 20%  Total investment upto 60,000 qualifies for tax rebate to the extent of 20% of such investment.  Infrastructure MF investment upto 80,000 also 20%.  Now – all under Rs.1 Lac of Sec.80 ccc

Capital Gains on Sale of Units  If

units are held for not more than 12 months, it is short term capital asset, other wise long term. (36 months for assets except shares and securities)  Tax law definition of capital gains = sale consideration - (cost of acquisition + cost of improvements + cost of transfer)  If it crosses 12 months, then “indexation” is applicable. The purchase price is marked up by an inflation index.

Indexation  Purchase

price of a long term capital asset after indexation is computed 

Cost of acquisition or improvement = actual cost of acquisition or improvement * cost inflation index for the year of transfer / cost inflation index for the year of acquisition or 1981 which ever is later)

 Unit-holder

can have a choice between:

10% tax without indexation  20% tax with indexation 

 There

is 2% surcharge

Indexation Cost Inflation Index for 1999-2000: 389 An example: Mr. H invests Rs. 2,00,000 in FY 97-98 MF units After 1 year, he liquidates the asset to get Rs. 2,40,000. His returns would be: CII 99-00 : 389, CII 97-98 : 331, Ratio : 389/331 = 1.18 Indexed Cost (2,00,000 x 1.18) = Rs. 2,36,000 Capital Gains – Rs. 4,000 Long-term tax liability of Mr. H: Rs. 4,000 * 20% = Rs.800/-

Schemes for capital gains tax exemption  Capital

gains tax of sale of long term capital asset is exempt in section 54EC of IT Act

if the amount of the gain is invested in bonds of NABARD, NHAI, and REC within 6 months. These must be held for at least 3 years, and during this time, one cannot take loan/advance against security of such bonds.  Capital gains tax of sale of mutual funds, if long term in nature, is exempt in section 54ED of IT Act if the gain is invested in equity shares within 6 months. These units must then be held for at least 1 year. 

Wealth Tax Ownership of units is not considered as wealth in the wealth tax act, therefore no wealth tax.

Special Provisions 

Offshore Fund Investors  Income

by way of dividend/long-term capital gain on Indian MF units, purchased in foreign currency is taxed at 10%

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NRIs  Income

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on units of MF is exempt from tax

FIIs  Income

by way of dividends on units not purchased in foreign exchange is subject to tax @ 20% and the person making payment must make TDS at this rate.