Statutory Audit of Non-Current Investments in Indian Companies [Company Law]

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Introduction

Non-current investments, also known as long-term investments, are those investments that a company intends to hold for more than one financial year, typically for strategic purposes rather than for short-term gains. These investments can include equity shares, preference shares, debentures, bonds, real estate, or stakes in subsidiaries and joint ventures. The primary objective of auditing non-current investments is to verify their existence, valuation, and disclosure in compliance with Indian legal and accounting standards.

Legal Framework

The statutory audit of non-current investments in India is governed by a range of laws, regulations, and accounting standards. A thorough understanding of the legal framework is crucial for auditors to ensure the investments are fairly valued, properly classified, and fully disclosed in accordance with Indian legal and regulatory requirements. Here’s an expanded look at the legal framework for auditing non-current investments.

1. Companies Act, 2013

• • Section 128 – Books of Account: Section 128 requires companies to maintain accurate and detailed records of all financial transactions, including investments. Auditors must verify that non-current investments are properly documented, with supporting evidence like investment certificates, contract documents, or digital records.
  • Section 129 – Financial Statements: This section mandates companies to prepare financial statements that give a true and fair view of the financial position of the company. Non-current investments must be appropriately classified under the balance sheet heading as per Schedule III of the Companies Act, 2013, and they should distinguish between investments in related parties (such as subsidiaries and associates) and other investments.
  • Section 186 – Loans and Investments by Company: Section 186 of the Companies Act lays out specific requirements for investments made by a company, including those in subsidiaries, associates, or unrelated companies. Companies cannot make investments exceeding prescribed limits without board approval, and certain significant investments may also require shareholder approval. Auditors need to check whether board and shareholder approvals for investments were obtained where necessary and ensure that the company has complied with the limits and reporting requirements stipulated by the Act.
  • Schedule III – Disclosure Requirements: Schedule III of the Companies Act prescribes the presentation of non-current investments in the balance sheet. The schedule requires that these investments are classified by category (such as equity shares, preference shares, or bonds), detailing the cost of each investment, fair value adjustments, and any pledge or encumbrance on these investments. Schedule III also requires separate disclosure of investments in subsidiaries, associates, and joint ventures, which must be categorized to provide users with clarity on the nature and purpose of each investment. The schedule’s compliance ensures a transparent presentation of investment types and potential risks.

2. Accounting Standards (AS)

For companies not covered under Ind AS, the Accounting Standards (AS) issued by the Institute of Chartered Accountants of India (ICAI) provide the relevant guidance:

• • AS 13 – Accounting for Investments: AS 13 specifies the accounting treatment for investments, requiring companies to classify them as either current or non-current. Non-current investments must be carried at cost, unless there is a permanent diminution in their value, which would require an impairment adjustment. If there is a decline in the value of an investment that is not expected to recover, the company should recognize an impairment loss and adjust the carrying amount to reflect the lower value. This helps in providing a realistic view of asset value and guards against overstating assets on the balance sheet.

3. Indian Accounting Standards (Ind AS)

Larger Indian companies are required to follow Ind AS, which are more detailed and internationally aligned than AS. Key standards for non-current investments include:

• • Ind AS 109 – Financial Instruments: This standard classifies financial instruments, including non-current investments, based on their characteristics and the business model for holding them. Non-current investments in equity instruments can be categorized as either “Fair Value through Other Comprehensive Income” (FVOCI) or “Fair Value through Profit or Loss” (FVTPL). Auditors need to confirm that investments are correctly classified and that fair value adjustments are recorded in the appropriate financial statement section (OCI or P&L). If non-current investments are classified as FVTPL, the fair value changes are recognized in the income statement, while under FVOCI, the changes are recorded in equity.
  • Ind AS 27 – Separate Financial Statements: Ind AS 27 provides guidance for accounting investments in subsidiaries, associates, and joint ventures in the financial statements of the parent company. Investments in subsidiaries, associates, and joint ventures are generally measured at cost or in accordance with Ind AS 109. Auditors need to ensure that the company has applied the correct accounting treatment and has adequate disclosures regarding these investments in the standalone financial statements.
  • Ind AS 36 – Impairment of Assets: This standard mandates annual impairment testing for non-current investments, especially if indicators of impairment are present. If the carrying amount of an investment exceeds its recoverable amount, an impairment loss should be recognized. Auditors must verify whether impairment assessments were conducted properly, taking into account recent financial performance, market value trends, and any other factors indicating that the investment’s value has declined.
  • Ind AS 28 – Investments in Associates and Joint Ventures: Ind AS 28 provides guidance on applying the equity method for investments in associates and joint ventures, which is crucial for investments that grant significant influence but not full control. The standard requires regular adjustments to the carrying amount of the investment based on the investor’s share of the associate’s or joint venture’s profit or loss. Auditors must review the proper application of the equity method and ensure the fair representation of these investments in the financial statements.

4. Income Tax Act, 1961

• • The Income Tax Act outlines provisions regarding tax implications on investments, particularly capital gains tax on long-term and short-term capital gains, dividend distribution tax, and tax on income from mutual funds or similar financial assets. Auditors need to confirm that these investments’ tax-related aspects are correctly recorded in the financial statements to ensure compliance with tax laws and to facilitate accurate tax reporting. The Act also prescribes rules for determining the holding period and cost of acquisition for tax purposes, and auditors must ensure that these are correctly applied.

5. RBI and SEBI Guidelines

• • RBI Regulations for Banks and NBFCs: For banks and NBFCs, specific Reserve Bank of India (RBI) guidelines apply to investment accounting. RBI guidelines govern the classification, valuation, and income recognition of investments, often requiring a stricter classification and provisioning structure. Auditors of these entities need to verify compliance with RBI guidelines, especially regarding provisioning for non-performing investments.
  • SEBI Guidelines for Listed Companies: For listed companies, the Securities and Exchange Board of India (SEBI) requires detailed disclosures of investments in the annual report, specifically regarding any pledges, encumbrances, and transactions with related parties. SEBI also mandates transparency around fair value measurement methods, requiring auditors to confirm that companies have disclosed fair value calculations and any risks associated with their non-current investments.

Detailed Audit Procedures

1. Understanding the Nature and Purpose of Investments
   • Review the company’s investment policy and rationale for each non-current investment.
   • Confirm that these investments align with the company’s strategic goals, like acquiring stakes in subsidiaries, rather than speculative purposes.
2. Examination of Classification and Presentation
   • Ensure that investments are correctly classified as non-current and that adequate disclosures have been made as per Schedule III.
   • Review the types of non-current investments (e.g., equity, debt securities) and confirm their treatment in financial statements.
3. Verification of Existence
   • Obtain confirmations from custodians or third-party statements, especially for physical investments like real estate.
   • Physically verify documents, certificates, or statements where relevant.
4. Review of Valuation and Measurement
   • For investments classified at fair value (per Ind AS 109), verify that fair value adjustments have been correctly recorded, either through profit/loss or OCI.
   • For investments valued at cost (per AS 13), review the historical cost and assess if any impairment is necessary due to a permanent diminution in value.
5. Impairment Testing
   • Assess indicators of impairment for non-current investments, such as significant declines in fair value or deteriorating financial performance of investees.
   • Ensure any necessary impairment is recorded in line with Ind AS 36 or AS 13.
6. Review of Approvals and Compliance
   • Confirm that all non-current investments comply with the Companies Act, particularly Section 186 regarding inter-corporate loans and investments.
   • Review board and shareholder approvals for major investments and ensure compliance with Section 186 thresholds.
7. Income Verification
   • Check the income from these investments, such as dividends or interest, to ensure accuracy and timely recognition in the income statement.
   • Verify whether any unrealized gains or losses on fair-valued investments are recognized as per Ind AS requirements.
8. Examination of Pledging or Restrictions
   • Verify if any non-current investments are pledged or restricted, and ensure appropriate disclosure.
   • Confirm that all pledged investments have board approval and are clearly disclosed in the financial statements.
9. Disclosure Compliance
   • Ensure all required disclosures related to non-current investments are made in accordance with Schedule III and accounting standards.
   • Confirm that investments in related parties (subsidiaries, associates) are clearly identified and disclosed.

Practical Examples

1. Scenario 1: Valuation of Equity Investment in a Subsidiary
   • Scenario: A company holds a 30% equity stake in a subsidiary, but the subsidiary’s performance has deteriorated.
   • Audit Approach: Assess fair value of the investment and perform impairment testing per Ind AS 36.
   • Practical Insight: If impairment is evident, record the loss to reflect the true value, ensuring financial statement transparency.
2. Scenario 2: Unrealized Loss on Bond Investment
   • Scenario: The company has invested in government bonds, classified as FVOCI, which have declined in value due to interest rate changes.
   • Audit Approach: Verify fair value calculations and confirm the unrealized loss is recorded in OCI.
   • Practical Insight: Accurate valuation and recording prevent future shocks to the income statement and reflect current financial health.
3. Scenario 3: Investment in Associate with Long-term Decline
   • Scenario: A long-term investment in an associate company has lost value due to weak market performance.
   • Audit Approach: Conduct impairment tests per AS 13 to check for permanent diminution.
   • Practical Insight: If impairment is necessary, adjusting the carrying value will enhance accuracy in reflecting the company’s actual asset worth.
4. Scenario 4: Misclassification of Short-Term as Non-Current Investment
   • Scenario: Some investments held for resale within a year are classified as non-current.
   • Audit Approach: Reclassify as short-term, as per AS 13.
   • Practical Insight: Accurate classification ensures clarity for stakeholders and compliance with Schedule III.
5. Scenario 5: Investment in Foreign Entity Subject to Currency Risk
   • Scenario: The company has made a strategic investment in a foreign subsidiary with high currency risk.
   • Audit Approach: Verify if any foreign currency adjustments are needed and ensure compliance with Ind AS 21.
   • Practical Insight: Reflecting currency translation adjustments provides a realistic financial position.
6. Scenario 6: Real Estate Investment Valuation
   • Scenario: A company has invested in real estate as a long-term holding.
   • Audit Approach: Obtain recent property valuations and check for impairment indicators.
   • Practical Insight: Regular valuation updates provide accurate asset value and protect against overstatement.
7. Scenario 7: Dividends from Investment Not Recorded
   • Scenario: Dividend income from an investment in shares has not been recognized.
   • Audit Approach: Verify dividend declarations by investees and ensure accurate income recognition.
   • Practical Insight: Ensuring income recognition aligns reported income with the actual return on investment.
8. Scenario 8: Investment Subject to Pledge or Restrictions
   • Scenario: Certain investments are pledged as collateral for loans.
   • Audit Approach: Verify board approval for pledging and ensure disclosure.
   • Practical Insight: Transparent reporting of pledged assets clarifies asset availability and risk.
9. Scenario 9: Classification and Disclosure of Joint Venture Investment
   • Scenario: A company invests in a joint venture, but the investment is not adequately disclosed.
   • Audit Approach: Review joint venture agreements and confirm proper disclosure under Schedule III.
   • Practical Insight: Accurate classification as joint venture and disclosure ensures stakeholder awareness of shared control and risks.
10. Scenario 10: Over-Valuation of Investment in Listed Entity
    • Scenario: A listed stock investment is recorded at cost, despite market value being significantly lower.
    • Audit Approach: Assess whether a permanent diminution exists and adjust value if necessary.
    • Practical Insight: Recognizing impairment reflects actual market conditions and ensures compliance with fair value principles.

Conclusion

Auditing non-current investments requires a comprehensive understanding of the company’s investment policy, adherence to accounting standards, and rigorous assessment of impairment and fair value. Auditors must evaluate the strategic purpose of investments, verify compliance with regulatory requirements, and ensure transparent disclosures. Regular impairment testing, proper classification, and thorough documentation protect the accuracy of the financial statements, ensuring that non-current investments reflect their true economic value.

Author

CA Sourabh Kothari (C.A., B.Com)
He is currently working as Partner – Risk and Transaction advisory with a renowned firm in Jaipur having experience in Internal Audit, IFC Audit, Business consultancy, Due Diligence and Management consultancy.
E-mail: Sourabh.kothari@jainshrimal.in | LinkedIn: Sourabh Kothari

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