Latest Post :
Home » » Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(xvii)

Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(xvii)

Written By Admin on Sunday, 1 April 2012 | Sunday, April 01, 2012

Clause  4(xvii)

whether the funds raised on short-term basis have been used for long-term investment; If yes, the nature and amount is to be indicated.

1) The principles of financial management suggest that the long-term assets of an enterprise should be financed from long-term funds. The genesis of the principle is that if funds raised from short-term sources are used for long-term
investments, the enterprise can face liquidity problems as soon as the short-term sources fall due for payment. However, an exception to the principle would be the situation where an enterprise is able to generate sufficient funds from long-term sources either through its operations or other means to meet the working capital requirements arising from the event of short-term sources falling due for payment. The application of the principle is considered to be of utmost importance for the financial health of an enterprise. The clause requires the auditor to comment whether the funds raised on short-term basis have been used for long-term investment, so that the readers can assess whether the company has followed the above-mentioned principle of financial management. Examples of use of funds raised on short-term basis and used for long-term purposes would include investing money from overdraft facilities in long-term investments in shares of subsidiaries/associates/joint ventures or investing money raised from public deposits due for repayment in three years in a project whose pay back period is ten years. Further, cash from operating activities represent a long term source of funds.

2) The auditor uses the data contained in the balance sheet to ascertain whether the funds raised on short-term basis have been used for long-term investment. Short-term sources of funds include temporary credit facilities like cash credits, overdraft. Reduction in current assets or increase in current liabilities are also sources of short-term increase in funds. Long-term application of funds includes investment in fixed assets, long-term investments in share, debentures and other securities and other assets of similar nature, repayment of long-term loans and advances or redemption of long-term debt or securities, etc. Application of funds which is not long-term may be categorised as the short-term application. Increase in current assets or decrease in current liabilities also indicate short-term application of funds.
 
3) The auditor should determine the long-term sources and the long-term application of funds by a company using the data contained in the financial statements. It should also be noted that the clause requires the auditor to state whether the company has utilized short-term funds for long-term application. It should be noted that funds, whether generated from long-term sources or short-term sources, would, generally, result in an increase in current assets—whether in the form of increase in cash and bank balances or may be in the form of increase in receivables, etc. If the quantum of long-term
funds of a company is not significantly different from the long-term application of funds, it is an indication that the long term assets of the company are financed from the long-term sources. However, if the quantum of long-term funds is
significantly less than the long-term application of funds, it is an indication that short-term funds have been used to finance the long-term assets of the company. The difference between the figures of long-term funds and long-term assets of the company indicate the extent to which short-term funds have been used to finance long-term assets of the company.

4) Working capital is normally understood to be a short-term application of funds which keeps on changing its form throughout the working capital cycle. It may, however, be noted that core or permanent working capital of an enterprise should be financed from long-term funds (preferably the owners’ capital). Core or permanent working capital is that component of the working capital of the enterprise that always remains invested in business and is never allowed to exit. Therefore, if the quantum of long-term funds is significantly more than the long-term application of funds, the auditor should determine whether long-term funds have been used to finance the core working capital of the company. For this purpose, the auditor should compute the figure of working capital and compare it with the difference between the quantum of long-term funds and long-term applications of funds. Still, if the long-term funds are more than the working capital of the company the auditor’s report should state that the company has used long-term funds to finance current assets.

5) Certain companies deploy funds based on their respective maturity pattern as a risk management technique. In case a company does so, it would be easier for the auditor to comment upon the clause since a comparison of sources of funds with their deployment based on their respective maturity patterns would be a significantly more sophisticated way of analysing whether short-term funds have been used to finance long-term assets of the company. To take a highly simplified example, if an enterprise has a long term debt that is to mature within the next 12 months and an equivalent amount in a long-term investment that would mature after 3 years, the maturity pattern analysis would indicate the potential inability to meet the liability on the debt on due date, but the traditional analysis would not do so.

6) The clause also requires the auditor to state the nature of application of funds if the company has financed long-term assets out of short-term funds. The nature of application of funds can be determined only if the funds raised can be directly identified with an asset. The determination of direct relationship between particular funds and an asset from the balance sheet may not be feasible. Further, such movement in funds should be supported by relevant documentation. A more practical approach would be to determine the overall picture of the sources and application of funds of the company unless an evident trail is available that enables the auditor in establishing a direct relationship between sources and applications of funds.

7) Another question that arises in this context is whether this clause is relevant in the case of branches of Indian companies. There are a number of clauses in the Order, which can be properly answered only in the context of the company as a whole, for example, the clause relating to preferential allotment of shares. Similarly, the clause relating to use of funds should also be evaluated in the context of the enterprise as a whole and the branch auditor may merely state that the clause is not relevant at the branch level. However, in the case of a branch of a foreign company, this clause would be applicable.

8) An example of reporting under the clause is as follows:

“According to the information and explanations given to us and on an overall examination of the balance sheet of the company, we report that no funds raised on short-term basis have been used for long-term investment by the company.”

9) An example of negative reporting under the clause is as follows:

“According to the information and explanations given to us and on an overall examination of the balance sheet of the company, we report that the company has used funds raised on short-term basis for long-term investment. The company has accepted public deposits amounting to rupees 5 crores which would fall due for repayment two years from the date of their acceptance. The company has invested the money for the increase of the production capacity which would be completed in the next four years.”
Share this article :

0 comments :

Speak up your mind

Tell us what you're thinking... !

2500 + Subscribers

Get Toolbar

Get our toolbar!

Read article on Android Phone

Share your file

Forum

Get updates on Facebook

Popular Posts

 
Support : Creating Website | Johny Template | Mas Template
Copyright © 2011-2013. YourKnowledgeportal - All Rights Reserved
Original Design by Creating Website Modified by Adiknya
Blogger Widgets