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Home » » Companies (Auditor's Report)(Amendment) Order, 2004 - Clause 4(xviii)

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

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

Clause 4(xviii)

whether the company has made any preferential allotment of shares to parties and companies covered in the Register maintained under section 301 of the Act and if so whether the price at which shares have been issued is prejudicial to the interest of the company.

1) The clause requires the auditor to report whether the company has made any preferential allotment of shares to parties and companies covered in the register maintained under section 301 of the Act. Further, if the company has made any preferential allotment of shares to such parties, the auditor has to give his opinion whether the price at which shares have been issued is prejudicial to the interest of the company.

2) It may be noted that the term “preferential allotment” is not defined under the Act. It may also be noted that the clause requires the auditor to report on the preferential allotment only in the case of shares issued by the company and not on preferential allotment of other securities issued by the company. The term “shares” includes both equity as well as preference shares. For the purpose of this clause, preferential allotment of shares would mean an allotment of shares to parties and companies covered in the register maintained under section 301 of the Act in preference to others. The preference can be with regard to the price or other terms and conditions associated with the allotment.

3) In the case of a listed company, preferential allotment of securities is governed by the SEBI (Disclosure and Investor Protection) Guidelines, 2000. A listed company can make preferential issues of equity shares, fully convertible
debentures, partly convertible debentures or any other instrument which may be converted into or exchanged with equity shares at a later date. A listed company can issue shares on a preferential basis at a price not less than the higher of the following:

(i) the average of the weekly high and low of the closing prices of the related shares quoted on the stock exchange during the six months preceding the relevant date;
or
(ii) the average of the weekly high and low of the closing prices of the related shares quoted on a stock exchange during the two weeks preceding the relevant date.

4) In the case of a listed company, if the pricing of the shares issued in a preferential allotment is in accordance with the requirement of the Guidelines laid down in this regard by the Securities and Exchange Board of India, the auditor may conclude that the price at which shares have been issued is not prejudicial to the interest of the company. In such a case, the auditor should gather sufficient appropriate audit evidence that the company has complied with the Guidelines issued by the Securities and Exchange Board of India in this regard.

5) It is also important to consider the question whether the clause applies to issue of shares under the Employees Stock Option Scheme by private companies constitute preferential allotment for the purposes of this clause. As has been mentioned in the foregoing paragraphs, in the case of a listed company, if the pricing of the shares issued in a preferential allotment is in accordance with the requirement of the Guidelines laid down in this regard by the Securities and Exchange Board of India, the auditor may conclude that the price at which shares have been issued is not prejudicial to the interest of the company. Thus, as far as a listed company is concerned, only preferential allotment of shares covered under the SEBI (Disclosure and Investor Protection) Guidelines 2000, is to be examined. In the case of a private company and an unlisted public company, the auditor would have to examine whether the price at which the company has made the preferential allotment of shares is prejudicial to the interest of the company. In so far as the price at which preferential allotment is made is concerned, it may be noted that valuation of shares of a company involves use of judgment, knowledge of the business, analysis and interpretation and the use of different methods, which may result in assigning different values based on different methods. There are certain basic factors, which affect the value of a company’s shares for which the price calculated is adjusted. The factors are earnings, dividends declared,
asset value and goodwill of the company. Methods generally used for determining the fair value of the business by the company, which take into consideration one or more factors mentioned above are:

(i) Net Assets Basis – considers the valuation of assets, subtracting therefrom liabilities, etc., to arrive at the value
of the equity shares.

(ii) Maintainable Profits Basis – this is based on the future maintainable profits/earnings of the company.
 
(iii) Yield Basis – this method recognises the yield/dividends as a base for arriving at the fair value of the shares.
 
(iv) Discounted Cash Flow Method – this method estimates the value of shares by estimating the future cash flows from operations and discounting the cash flows at a specified rate.
 
6) It is not rare to find a combination of different methods used in the context of valuation of shares; for example, an averaging of maintainable profits basis and the net assets basis.

7) The auditor should examine the method used for valuation of shares of the company and should also ascertain the reasonableness of the assumptions underlying the calculation. If necessary, the auditor may use the services of an expert. Whether the price of the shares for preferential allotment is prejudicial to the interests of the company is question that would require the use of professional judgement by the auditor. The auditor should give due consideration to the factors which affect the value of a company’s shares for which the price calculated is adjusted. Some of the main factors are mentioned at paragraph (5) above. On an examination of the methods and various factors, the auditor may come to a conclusion that better price for the shares issued could have been obtained if the difference between the price
that could have been obtained and that has actually been received by the company is so significant that no reasonable person would have allotted shares at the price at which the preferential allotment has actually been made. The auditor should also obtain a representation from the management as to why the company considers that the price of the shares issued under preferential allotment is not prejudicial to the interest of the company. If the auditor does not find the explanation convincing, it will be necessary for him to state that the price at which preferential allotment of shares has been made by the company is prejudicial to the interest of the company.

8) Companies sometimes do make allotment of shares based on the valuation reports issued by experts in this field. While the auditor uses the report of an expert to determine whether the price for the preferential allotment of share is not prejudicial to the interest of the company, the auditor should also comply with the requirements of Auditing and Assurance Standard (AAS) 9, “Using the Work of an Expert”.

9) In case, the company has made preferential issue of shares by passing an ordinary resolution under clause (b) of subsection (1A) of section 81 of the Act, apart from examining the method used for valuation of shares of the company and ascertaining the reasonableness of the assumptions underlying the calculation, the auditor should also examine the Order of the Government as to its satisfaction that the proposal is most beneficial to the company. Where the Government is satisfied in this regard, the auditor need not make his assessment as to the reasonableness of the prices of the shares for the preferential allotment of shares. The auditor, however, is not precluded from doing so. If the auditor forms his opinion on the basis of the Order issued by the Government, he should state the fact of his reliance on the Government Order for the purpose of reporting.

 
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