There is a paradigm shift in the pattern of the auditing question paper
of the professional competency course (PCC) compared to what it was in
the erstwhile professional education II (PE-II) course. Candidates are
required to answer all the questions as against six among the eight in
PE II.
‘True or false’ questions have been introduced. These cover a wide

range of topics and test the conceptual clarity of the candidates. The
students have to be careful as 20 marks are at stake and how well they
tackle this section can have a bearing on the overall result.

The focus continues to be on audit and assurance standards (AAS) and
company audit, with 57 marks earmarked to the two topics, at 38 and 19
respectively. Perhaps, this has been done keeping in mind the fact that
the candidates are writing the examinations after completing a certain
period of articled training.Thus, by the time they take the examination,
they would have (under normal circumstances) undergone considerable
amount of practicaltraining.

Question 1: Candidates have to answer 10 of the 12 ‘true or false’ questions — four of these are on AAS and six on company audit.

Question 2: This 20-mark question is on comments of the auditor with regard to AAS and it covers three different standards.

Question 3: This is on precautions to be taken in applying test
checks; a purely text-bookish question. The second part (Question
3(b)), on directors’ responsibility statement, might have taken the
candidates by surprise. Only those with practical experience could have
tackled this question comfortably.

Question 4: Part (a) of this question, on computer-aided audit

techniques, tests more the writing skills of the candidates. And part
(b), on differences between capital expenditure and deferred revenue
expenditure, would have lured many candidates, but the answer to the
question is not as simple as it appears.

Question 5: Divided into two parts, on inherent limitations of

internal control systems and special audit, this question would have
been handled easily by those used to rote learning.

Question 6: Part (a) of this question, on examining the income

and collections by an NGO, would have been a brain teaser. So is part
(b) of the query on AS 1, where there are about ten areas in which
different accounting policies may be encountered.

The candidates may, readily, have thought of depreciation and

valuation of inventories. And, at best, they may have recollected two
or three more. Going beyond six items at the PCC level is a tall order.

Question 7: This 10-mark question is on vouching/verification.

In the PE-II format, 16 marks were allotted to this topic. On the audit
procedures chapter, the opportunity to score marks has been reduced as
the paper has only a two-part question for five marks each as against
the usual four parts of four marks each. So is the case with Question 8
on short notes, where the marks allocated have been curtailed to 10
from the earlier 16.

The marks for certain topics, earlier considered to be the mainstay

of an auditing paper, such as EDP audit, government audit, audit of
specialised institutions such as educational institutions and hotels,
audit procedures of vouching and verification, have been reduced.

Overall, the question paper is balanced and has a wide coverage of

topics. Unless one is conceptually clear and has put in sufficient
amount of preparation for the examination, scoring high marks would be
difficult.

But those candidates who depended only on the study modules of the

ICAI and other academic publications would also have done
satisfactorily as a part of the paper is purely academic.

It is better the candidates adapt to the changed pattern and consider if their preparation methods warrant a change.

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DISTINCTION BETWEEN SHARES HELD AS INVESTMENTS AND THOSE HELD AS STOCK IN TRADE

Distinction between shares held as stock-in-trade and shares held as investment - tests for such a distinction

The Income Tax Act, 1961 makes a distinction between a capital asset and a trading asset.

2. Capital asset is defined in Section 2(14) of the Act. Long-term capital assets and gains are dealt with under Section 2(29A) and Section 2(29B). Short-term capital assets and gains are dealt with under Section 2(42A) and Section 2(42B).

3. Trading asset is dealt with under Section 28 of the Act.

4. The Central Board of Direct Taxes (CBDT) through Instruction No.1827 dated August 31, 1989 had brought to the notice of the assessing officers that there is a distinction between shares held as investment (capital asset) and shares held as stock-in-trade (trading asset). In the light of a number of judicial decisions pronounced after the issue of the above instructions, it is proposed to update the above instructions for the information of assessees as well as for guidance of the assessing officers.

5. In the case of Commissioner of Income Tax (Central), Calcutta Vs Associated Industrial Development Company (P) Ltd (82 ITR 586), the Supreme Court observed that:

Whether a particular holding of shares is by way of investment or forms part of the stock-in-trade is a matter which is within the knowledge of the assessee who holds the shares and it should, in normal circumstances, be in a position to produce evidence from its records as to whether it has maintained any distinction between those shares which are its stock-in-trade and those which are held by way of investment.

6. In the case of Commissioner of Income Tax, Bombay Vs H. Holck Larsen (160 ITR 67), the Supreme Court observed :

The High Court, in our opinion, made a mistake in observing whether transactions of sale and purchase of shares were trading transactions or whether these were in the nature of investment was a question of law. This was a mixed question of law and fact.

7. The principles laid down by the Supreme Court in the above two cases afford adequate guidance to the assessing officers.

8. The Authority for Advance Rulings (AAR) (288 ITR 641), referring to the decisions of the Supreme Court in several cases, has culled out the following principles :-

(i) Where a company purchases and sells shares, it must be shown that they were held as stock-in-trade and that existence of the power to purchase and sell shares in the memorandum of association is not decisive of the nature of transaction;

(ii) the substantial nature of transactions, the manner of maintaining books of accounts, the magnitude of purchases and sales and the ratio between purchases and sales and the holding would furnish a good guide to determine the nature of transactions;

(iii) ordinarily the purchase and sale of shares with the motive of earning a profit, would result in the transaction being in the nature of trade/adventure in the nature of trade; but where the object of the investment in shares of a company is to derive income by way of dividend etc. then the profits accruing by change in such investment (by sale of shares) will yield capital gain and not revenue receipt.

9. Dealing with the above three principles, the AAR has observed in the case of Fidelity group as under:-

We shall revert to the aforementioned principles. The first principle requires us to ascertain whether the purchase of shares by a FII in exercise of the power in the memorandum of association/trust deed was as stock-in-trade as the mere existence of the power to purchase and sell shares will not by itself be decisive of the nature of transaction. We have to verify as to how the shares were valued/held in the books of account i.e. whether they were valued as stock-in-trade at the end of the financial year for the purpose of arriving at business income or held as investment in capital assets. The second principle furnishes a guide for determining the nature of transaction by verifying whether there are substantial transactions, their magnitude, etc., maintenance of books of account and finding the ratio between purchases and sales. It will not be out of place to mention that regulation 18 of the SEBI Regulations enjoins upon every FII to keep and maintain books of account containing true and fair accounts relating to remittance of initial corpus of buying and selling and realizing capital gains on investments and accounts of remittance to India for investment in India and realizing capital gains on investment from such remittances. The third principle suggests that ordinarily purchases and sales of shares with the motive of realizing profit would lead to inference of trade/adventure in the nature of trade; where the object of the investment in shares of companies is to derive income by way of dividends etc., the transactions of purchases and sales of shares would yield capital gains and not business profits.

10. CBDT also wishes to emphasise that it is possible for a tax payer to have two portfolios, i.e., an investment portfolio comprising of securities which are to be treated as capital assets and a trading portfolio comprising of stock-in-trade which are to be treated as trading assets. Where an assessee has two portfolios, the assessee may have income under both heads i.e., capital gains as well as business income.

11. Assessing officers are advised that the above principles should guide them in determining whether, in a given case, the shares are held by the assessee as investment (and therefore giving rise to capital gains) or as stock-in-trade (and therefore giving rise to business profits). The assessing officers are further advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether, in a given case, the shares are held by the assessee as investment or stock-in-trade.

12. These instructions shall supplement the earlier Instruction no. 1827 dated August 31, 1989.

(F.No.149/287/2005-TPL)

SOLUTION TO NOVEMBER 2007 – AUDIT PAPER

Situation analysis

Q1(a): A company has debited Rs 1.75 lakh to Delivery Van Account received from a customer against credit sales of Rs 1.5 lakh to him who is not able to pay the amount. The delivery van has not been registered in the name of the company with R.T.O. till the date of finalisation of accounts.

Since the vehicle is a movable property, it is governed by sale of goods Act, wherein title in goods passes on delivery.

In the instant case, when the company received the delivery van from the debtor, title passed on to the company since he would have signed on the necessary documents. Registration of the delivery van is merely to further secure the title in the name of the company.

Therefore, the company is justified in debiting the delivery van account on receiving it, the fact that it was not registered in its name notwithstanding.

When the sale was for Rs 1.5 lakh, debiting the delivery van with the same amount would appear reasonable.

As per AS 10, in case of exchange of assets, the company can value the asset at the value of the old asset or the new asset, whichever can be determined with reasonable accuracy.

Thus, if the delivery van was valued at Rs 1.75 lakh by an independent expert (such as an automobile engineer), it would be justified in debiting the van with the same amount.

In such a situation, the difference of Rs 25,000 should be treated as profit and taken to profit and loss account and the company can charge depreciation on Rs 1.75 lakh.

Q1(b) PQ Ltd has given donations of Rs 50,000 each to a charitable school and a trust for blinds during the year ended March 31, 2007. The average net profit of the company during last three financial years amounts to Rs 12 lakh. The Companies Act places certain restrictions on donations to political parties.

These restrictions are not applicable to donations made to non-government organisations such as those mentioned in the question.

Therefore, the company has not made any violation in making such donations.

Q1(c): AAS Ltd had provided for doubtful debts to the extent of Rs 23 lakh during the year 2004-05. The amount since had been collected in the year 2006-07. Another debt of Rs 25 lakh had been identified to be doubtful during the year 2006-07. The company made an additional provision of Rs 2 lakh during the year. The profit and loss account for the year ended March 31, 2007 disclosed in debit side — provision for doubtful debts Rs 2 lakh.

Collection of doubtful debts provided in earlier years has no relevance to the debts of current year being identified as doubtful. They belong to two accounting periods. The provision of Rs 23 lakh made in the year 2004-05 should be written back since it is no longer required. A fresh provision of Rs 25 lakh is to be made for the current year.

Setting off the provision of an earlier year against a provision to be made for the current year vitiates the true and fair view of the profit and loss account.

In the given question, the entry made by the company does not portray the information about collection of debtors pertaining to 2004-05 and that further Rs 25 lakh are identified doubtful in the current year. Therefore, the entry passed by the company is not acceptable.

Q1(d): Alagar Ltd is a company engaged in the business of chassis building and bus transportation services. It accounts all expenses and income in profit and loss account under various heads explaining clearly the nature of operations. The auditor of the company requires that the profit and loss account should depict the profit or loss from the businesses of assembly as well as of operation of bus services separately.

Preparation and presentation of the financial statements is the responsibility of the management. The auditor merely expresses an opinion whether or not the financial statements give a true and fair view of the financial position of the entity.

Provisions of the Company Law require every company to maintain its accounts so that profit or loss can be determined. AS 17 on segment reporting also requires companies to report on activities of various segments as an additional information. There is nothing in the Companies Act or in Accounting Standard that requires the profit and loss account to depict separately profit or loss from different activities.

Thus, the auditor requiring the company to depict the profit or loss from the businesses of assembly as well as of operation of bus services separately is not justified.

SOME Comments

2(a): Seeman & Co had been the company auditor for Amudhan Company Ltd for the year 2006-07. The company had three branches located at Chennai, Delhi and Mumbai. The audit of branches in Chennai, Delhi were looked after by the company auditors themselves. The audit of Mumbai branch had been done by another auditor M/s Vasan & Co, a local auditor in Mumbai. The branch auditor had completed the audit and had given his report too. After this, but before finalisation, the company auditor wanted to visit Mumbai branch and have access to the inventory records maintained at the branch. The management objects to this on the grounds of the company auditor is transgressing the scope of audit areas agreed.

The Auditor of a company has certain statutory rights under the Companies Act, which can not be restricted by the company or the directors. Such rights include right to visit the branches in India and right to access records of the company.

The fact that the branch is audited by another auditor cannot be a reason for restricting the statutory auditor from visiting the branches. The auditor enjoys independence in deciding the nature, extent and timing of audit procedures to be carried out. In the given question, the company cannot say there is any transgression of the scope of audit. Hence, the company is not justified in saying so.

2(b): AB & Associates, the auditor of Ajanta Ltd refused to deliver the Books of Account of the company, which were given to them for the purpose of audit, as the audit fees is not paid to them in full.

The provisions of auditors lien state that the books of account should come to the auditor in the normal course and that he cannot resort to unfair means to secure the books of account on lien.

He can exercise lien on those books on which the work was carried out for which remuneration was receivable. Board of directors should pass a resolution to that effect and deliver the books of account to the auditor. The auditor in the given case is not justified in refusing to return the books of account with him on the ground that audit fees is not paid in full. Since the books of account were still with him it indicates that the books of account pertain to the current year. Fees for the current year becomes payable after the completion of the audit. Current year books cannot be retained for non payment of fees of an earlier year.

2(c): Mr A was appointed as auditor of X Ltd for the year ended March 31, 2008 in the AGN held on August 16, 2007. Mr A had indebted to the company for a sum of Rs 2,500 as on April 1, 2007, the opening date of the accounting year which had bee subject to his audit. Upon learning that he might be appointed as the auditor, he repaid the amount on August 14, 2007. Mr B, a shareholder complained that the appointment of Mr A as auditor was invalid and he incurred disqualification under Section 226 of the Indian Companies Act 1956 and his independence had been vitiated in relation to the accounting year of his audit. The Section 226 states any indebtedness of an amount exceeding Rs 1,000 as a disqualification to be appointed as an auditor.

In the given question, the auditor has repaid the amount before he was appointed as auditor of the company. As on the date of his appointment, he does not have any disqualification.

An auditor is appointed at the AGM from the conclusion of one AGM to the completion of the next AGM and not for the year ended March 31, 2008. Therefore the contention of Mr B is invalid.

2(d): The financial controller of AS Ltd refuses to provide for proposed dividend in books of accounts for the year ended March 31, 2007 on the ground that it is pending approval of shareholders in Annual General Meeting to be held on September 16, 2007.

The Section 205 dealing with dividends requires that the dividends be proposed by the board of directors and declared at the AGM by the shareholders. The dividends declared by the shareholders cannot be more than the dividends as proposed by the board of directors

Once the board of directors propose dividends, the same is to be declared by the shareholders. Such dividends are to be paid out of the profit made by the company for the year ended March 31, 2007. Therefore, it is proper to make the provision for such dividends.

Declaring of dividends is an event occurring after on the date of the balance sheet, which confirms a situation existing as on the date of balance sheet.

AS 4 on events occurring after the date of balance sheet classifies such events as adjusting events and non-adjusting events. Declaring of dividends is an adjusting event, for which a provision is to be made in the accounts. For the same reason proposed, dividends merely appear as a provision (item no 9 under the head current liabilities and provisions) and not as a current liability. It assumes the nature of a current liability once the dividends are declared at the AGM. Therefore, the contention of the financial controller is not justified.

HINDU-MENTOR

Bos/Ancmnet/Srvc-tax/227/41/2007 August 3, 2007

Sub: Guidelines to the students appearing in Professional Competence Examination and Final

Examination to be held in November, 2007

Professional Competence Examination

Paper 5: Taxation, Part –II Service Tax and VAT

It is clarified that in Part –II : Service Tax and VAT of Paper 5 : Taxation, students will not be tested on

specific questions covering individual taxable services.

Final Examination (Old Course)

Paper 8 : Indirect Taxes

It is clarified that in respect of taxable services covered in the syllabus of Paper 8 : Indirect Taxes, students

will be examined only in respect of the following taxable services:

.. Intellectual Property Services

1. Franchise services

2. Intellectual property services

.. Financial services

3. Banking & other financial services

4. Credit rating agency’s services

5. Stock broking services

.. Transport of goods services

6. Goods transport agency’s services

7. Courier services

8. Mailing list compilation and mailing services

9. Transport of goods by air services

10. Clearing and forwarding services

11. Cargo handling services

12. Customs house agent’s services

13. Storage and warehousing services

14. Transport of goods through pipeline or other conduit

15. Transport of goods in containers by rail by any person, other than government railway

.. Professional Services

16. Practising chartered accountant’s services

17. Management or business consultancy services

18. Consulting engineer’s services

19. Scientific and technical consultancy services

20. Technical testing and analysis services

21. Market research services

22. Opinion poll services

23. Public relations services

.. Real estate & infrastructure services

24. Construction services in respect of commercial or industrial buildings or civil structures

25. Construction services in respect of residential complexes

26. Architect’s services

27. Real estate agent’s services

28. Site preparation and clearance, excavation, earthmoving and demolition services

29. Interior decorator’s services

.. Business services

30. Business auxiliary services

31. Business support services

32. Manpower recruitment or supply agency’s services

Director of Studies

Q: What is a weather derivative?

A: It's a financial instrument that seems like an insurance policy but is more like an option. Most weather derivatives are based on how much the temperature goes above or below 65 degrees. But weather derivatives can be based on anything measurable.

Q: An example of weather derivative

A: A ski area could pay a $250,000 premium to collect, say, $100,000 for every inch of snow this winter under the "strike" amount of 100 inches. This is like a "put" option. The ski area is out the premium whether or not snowfall is inadequate. Or, it could enter into a "swap" with another party, paying no premium and getting $100,000 for every inch under 100 and paying $100,000 for every inch over. Increased ticket sales in good winters would cover the cost.

There is also a "call" option where the ski area receives a premium of $250,000 and pays $100,000 for every inch over the strike 100 inches, again assuming higher revenue with heavy snowfall.

Q: Why would anyone assume financial risk by taking the other side?

A: Some are speculators. They believe they understand the probabilities of weather and are willing to wager just as a football fan might bet against a football team because he believes the quarterback is injured. But most parties take the other side of a weather derivative because they also are hedging. Cities, for example, might want to hedge against heavy snowfall because of the cost to clear the streets.

Q: What makes a weather derivative different than other derivatives?

A: All derivatives are used to hedge against bad news. Airlines use derivatives to protect against soaring jet fuel prices. Derivatives are commonly used to avoid fluctuations in interest rates or foreign currencies. What makes weather derivatives unique: They are not derived from anything with an underlying value.

Q: How big is the weather derivatives market?

A: Not very. The first wasn't sold until 1997. It has grown to $12 billion and there are signs that some small companies are interested. Last June, the Rock Garden in London became the first restaurant to hedge against the cool weather that keeps customers from populating its outdoor tables. Aquila predicts $50 billion in weather derivative contracts by 2005, while the value of all derivatives traded worldwide is $100 trillion.

Q: Are there problems with weather derivatives?

A: Small fortunes can ride on weather instruments that are fallible. Gauges have gone unfixed for years. The National Weather Service sometimes moves instruments, and we've all seen rainstorms that hit on one side of the street but not the other. Unlike insurance, which spreads premiums and risks over time, derivatives are one-shot, risky deals that create big winners and losers in a hurry. It looks ripe for lawsuits, but traders say that hasn't been the case. Also, financial markets need simplicity to trade in large blocks, but weather derivatives usually need to be customized to individual needs.

Computing the income chargeable to tax as per the provisions of the Income-Tax Act, 1961 is the first step in tax compliance. The natural sequence thereafter would be filing the return of income and awaiting approval of the tax authorities in respect of the income returned by means of an assessment order.

Section 139 (1) enjoins on all corporate and partnership firms to file return of income whether or not they have income or loss. In the case of other assessees i.e., individuals, HUFs etc., the return of income has to be filed only if the income exceeds the prescribed basic limit.

This write-up discusses the scrutiny procedure prescribed by the Central Board of Direct Taxes (CBDT) for the current financial year and the related issues.

Legal provisions

As per Section 143 (1) if any tax or interest is due, an intimation is required to be issued to the assessee. Similarly, where there is any refund due on the basis of return filed by the assessee, an intimation is required to be issued by the Assessing Officer (AO). The time limit for giving intimation is one year from the end of the financial year in which the return was filed. For example, for the assessment year 2006-07 if the return is filed on June 5, 2007, the time limit for giving intimation under Section 143(1) is available up to March 31, 2009.

Where the AO believes that the claim of loss, exemption, deduction, allowance or relief in the return is inadmissible or if he considers it necessary to ensure that the assessee has not understated his income, a notice under Section 143 (2) would be issued for verifying the books of account and other relevant documents and evidences. The culmination of this exercise would be scrutiny assessment envisaged in Section 143(3).

The time limit for service of scrutiny notice is 12 months from the end of the month in which the return was filed by the taxpayer. The time limit for completing the assessment is 21 months from the end of the assessment year in which the return was first assessable.

For the assessment year 2007-08 if the return is filed after June 1, 2007 the time limit for completing scrutiny assessment would expire after December 31, 2009. The time limit for issuing intimation under Section 143(1) for non scrutiny cases, however, is available up to March 31, 2010 (i.e.2 years from the end of the financial year in which the return was filed).

The CBDT instruction

The CBDT has given norms for current fiscal for selection of cases meant for scrutiny.

For corporates: All banks and public Sector undertakings are liable for scrutiny. Also, all NSE-500 companies and BSE-A group companies listed in Bombay Stock Exchange as on March 31, 2007, are covered. Companies in Delhi, Mumbai, Chen nai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad paying book profit tax under Section 115 JB on the book profit of Rs 50 lakh and above are liable for scrutiny. In the case of companies in other places the monetary limit for book profit is Rs 25 lakh.

All non-banking financial corporations and investment companies having paid up capital of Rs 10 crore are covered. Companies who have amalgamated and seeking set off of loss under Section 72 A are also to be scrutinised. Where the fresh capital introduced is Rs 50 lakh during the year such assessees are liable for scrutiny assessment.

For non-corporates: If the fresh capital introduced exceeds Rs 50 lakh in respect of cases in Delhi, Mumbai, Chennai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad are liable for scrutiny. In respect of other places the monetary li mit for fresh capital introduction is Rs 10 lakh for scrutiny selection.

Where the unsecured loans introduced during the year exceeds Rs 25 lakh, such case is also covered. All market committees and statutory bodies are liable for compulsory scrutiny. Professionals with gross receipts of Rs 20 lakh or more but the income returned is less than 20 per cent are liable for scrutiny of their cases.

Common to all taxpayers

The following criteria apply for all the taxpayers regardless of their status.

All search and seizure cases and surveys conducted under Section 133 A.

Cases where deduction under chapter VI-A exceeds Rs 25 lakh.

Cases were the CIT or ITAT has confirmed addition or disallowance of Rs 5 lakh or above in an earlier year and the identical issue arising in the current year.

All cases in which the appeal is pending before CIT or pending before ITAT in respect of appeal preferred by the Department relating to addition or disallowance of Rs 5 lakh and the identical issue arising in the current year.

Charitable trusts claiming exemption under Section 11 with gross receipt exceeding Rs 5 crore in 8 cities viz Delhi, Mumbai, Chennai, Kolkata, Pune, Hyderabad, Bangalore and Ahmedabad. For other places the monetary limit is Rs 1 crore.

Educational institutions, hospitals (being non profit organisations) with aggregate receipt exceeding Rs 10 crore (including corpus donations) in 8 cities and Rs 5 crore in other places. However, it will not apply to those which are su bstantially financed by the Government.

All cases where the total value of International Transactions for the year exceeds Rs 15 crore.

Stock brokers and commodity brokers where the brokerage exceeds Rs 1 crore.

Stock brokers and commodity brokers including sub-brokers if the bad debt claim is Rs 5 lakh. For corporates, if the bad debt claim is Rs 10 lakh or more it will be liable for scrutiny.

All cases where deduction under Sections 10A/10B/10BA/10AA exceeds Rs 25 lakh.

Contracts (other than transporters) whose contract receipt exceeds Rs 1 crore and the income declared is less than 5 per cent of gross contract receipts.

Loss from house property if more than Rs 2.50 lakh.

Investment in property is more than 5 times the gross income (including agriculture and other exempt incomes).

Short-term capital gains covered under Section 111A and long-term capital gains exceeding Rs 25 lakh.

Sale of property as per AIR return but no capital gain declared in the return of income.

Commission paid during the year if more than Rs 10 lakh.

Real estate business with gross turnover of Rs 5 crore.

Business of hotels/tour operators with gross turnover exceeding Rs 5 crore but the net profit is less than 0.05 per cent.

All cases where depreciation claimed at the rates of 80 per cent and 100 per cent is more than Rs 25 lakh.

All cases where the net agricultural income is more than Rs 10 lakh.

Deduction under Sections 80-IA (4), 80-IB, 80-IAB, 80-IC, 10(23C), 10A, 10AA, 10B or 10BA is claimed for the first time. All returns filed in response to notice under Section 148 shall be liable for scrutiny.

Some issues

While above the parameters set for selection of cases for scrutiny is welcome, there is no general exemption or relief from scrutiny for admitting higher income by the taxpayers.

For example, if the taxpayer admits 30 per cent more than the previous year income still he can be subjected to scrutiny assessment if any transaction therein is covered by the above-said criteria. Indiscriminate issue of Section 148 notice and thereby subjecting the taxpayer to scrutiny assessment is possible. Necessary safeguards have to be introduced for preventing its misuse.

Currently, even exempted entities and taxpayers with below taxable income do not get exemption certificate from AO without going through the rigours of approval from the Joint Commissioner. While justification of such bureaucratic measures remains on one side, the difficulties of the small assessees require objective consideration.

At present, approval of scrutiny draft orders by the higher authorities delays the completion of assessment and causes hardship to the taxpayers. The AO who is empowered to make assessment in law must be permitted to complete the assessment without procedural bottlenecks. The administrative delay could be reduced by fixing the responsibility on the AOs wholly and solely for completing the scrutiny assessments.

If the AO chooses a case for scrutiny deviating from the norms fixed by the Board then the assessee can challenge the selection of case by means of a writ. There is no provision within the statute book for preventing the AO from proceeding further. However, even after the completion of assessment it could be challenged. Favourable decisions could be found in Nayana P. Dedhia vs Asst. CIT (86 ITD 398); Bombay Cloth Syndicate vs CIT (214 ITR 210) and CIT vs Savoy Enterprises Ltd (211 ITR 192). Contrary decision could be found in Setalvad Brothers vs M.K.Meerani, Addtl. CIT (253 ITR 530)

What are books of account?

In a recent case, the Madras High Court concluded that P&L account and balance-sheet are not books of account as contemplated under the I-T Act.  

T. C. A. Ramanujam

Computation of business income under the income-tax law has to be made on the basis of 'books of account'. This law has been in operation since 1992, but surprisingly there was no definition of the term " till 2001. Finance Act, 2001 introduced the definition through Section 2(12A). The definition, which took effect from June 1, 2001, reads thus:

"Books or books of account includes ledgers, day-books, cash books, account-books and other books, whether kept in the written form or as print-outs of data stored in floppy, disc, tape or any other form of electro-magnetic data storage device". This is an inclusive definition.

The Memorandum explaining the amendment, mentions that the passing of the Information Technology Act, 2000 necessitated the insertion of this definition in the I-T Act, 1961. A new Section 2 (22AA) was also brought in to define "document", as including electronic record as defined in Section 2(1)(t).

Books of account are prescribed by Rule 6F of the I-T Act. The proviso to this Rule grants exemption from the requirement of maintenance of books of account if the gross receipts from the profession do not exceed Rs 60,000. Section 44AA makes it obligatory for every person carrying on business or profession to maintain books of account if the income, turnover or gross receipts exceeded the prescribed limits. Failure without reasonable cause to maintain books may attract penalty under Section 271A read with 273B.

P&L account

Since the definition is inclusive and not exhaustive, the question of what constitutes books of account arises. If a profit and loss (P&L) account is maintained and credits are found in such an account, can we consider the same to be books of account? This is an interesting issue and not merely academic. It was taken up for detailed consideration by the Madras High Court in CIT vs Taj Borewells (291 ITR 232 Madras).

Taj Borewells did not maintain books of account since the gross receipts were below Rs 5 lakh. The partners of the firm had brought in Rs 5,25,00 as investments. The assessing officer (AO) did not accept the claim about the investment by partners. He concluded that the amount represented the undisclosed income of the firm and added the same under Section 68 of the I-T Act.

The Income Tax Appellate Tribunal (ITAT) annulled the addition and the department took up the matter in appeal before the Madras High Court. .

The Madras High Court quoted with approval the definition given in Ramanatha Iyer's Advanced Law Lexicon. The definition in the Lexicon appears wider than the in the tax law. A book containing a monetary transaction, according to the Lexicon, would attract the definition of books of accounts under the Indian Evidence Act.

Striking features

The High Court observed that books of account will mean any book which formed an integral part of a system of book keeping employed in any particular business and included the ledger and the books of original entry. After explaining the object behind the making of a P&L account, the court observed that the balance-sheet listing the assets and liabilities and equity accounts of the company is prepared "as on" a particular day and the accounts reflected the balances that existed at the close of business on that day. The court took note of earlier precedents on the subject and held:

"We can safely conclude that the profit and loss account and the balance-sheet are not books of account as contemplated under the provisions of the Act."

The court referred to three striking features in this case:

Since there are no books of accounts, there can be no credits in such books;

It is the first year of assessment of the assessee;

The Explanation offered by the assessee firm was not rejected and only the explanation offered by the partners was.

Hence, the High Court concluded that it was not a fit case for making addition under Section 68 of the Act. The judgment will have far-reaching ramifications both under tax law and company law.

(The author is a former Chief Commissioner of Income-Tax.)

NOW THIS IS REALLY CONFUSING - TALKING ABOUT CONTROLLING DOLLAR INFLOWS ON ONE HAND .... AND ... READ THE ARTICLE BELOW WHICH HAS COME IN FINANCIAL EXPRESS TODAY!!!!!

New Delhi, Aug 9 Foreign institutional investors (FIIs) and mutual funds may get to invest in debt paper that is below investment grade (aka junk bonds). The government is planning to create a separate segment for such instruments, in effect hiking the present ceiling of $4.7 billion on FIIs investing in Indian paper.

At present, FIIs can invest up to $3.2 billion in government securities and $1.5 billion in corporate bonds, which are mostly above investment grade. The Centre wants to specify a separate cap for debt papers with sub-investment grades.

The finance ministry has discussed the proposal with the Securities and Exchange Board of India (Sebi). An official familiar with the issue said the Reserve Bank of India (RBI) was not against the proposal. The proposal is, nevertheless, still at a preliminary stage and would be formalised only after wider consultations, the official said.

The move is expected to deepen and widen the debt market while at the same time enabling smaller firms, which do not possess top-notch investment ratings, attract FII funding.

The government feels that permitting investment in sub-investment grade securities would put in place one crucial link that is missing in the Indian debt market. It would enable FIIs to invest in bonds that are comparatively riskier but offer higher returns.

Various agencies such as Icra, Crisil, Care and Fitch rate securities. For instance, on the Crisil scale, bonds carrying the BBB (-) rating or better are considered above investment grade.

One leading analyst, however, said the government’s proposal might not necessarily be a favourable move. “It’s a risky proposition and not consistent with our philosophy in the financial sector. We should not allow exposure to unrated bonds,” said the executive director of a major rating agency, who did not wish to be identified.

When you travel around the world nowadays, it's not uncommon to find that there is a marked preference for a particular currency say the USD. Let us have a look into as to how this scenario developed.

Overview
During the eighteenth and nineteenth centuries, the British pound reigned as the world's reserve currency but in the twentieth century, the US dollar took over this title.
Dollarization is a generic term that can fall into three categories:

1. Official Dollarization: The dollar is the only legal tender; there is no local currency. Examples of this can be seen in Panama, El Salvador and Ecuador. For example, since independence in 1903, Panama has only used the U.S. dollar. Surprisingly, the U.S. government does not have to provide approval for another country to use its currency as legal tender.
2. Semi-Dollarization: A country will use both its own currency and the U.S. dollar interchangeably as legal tender. Lebanon and Cambodia are good examples of this.
3. Unofficial Dollarization: For many countries in the developing world, the dollar will be widely used and accepted in private transactions, but it is not classified as legal tender by the country's government.

Why is the U.S. dollar the currency of choice?
One of the major reason is stability of the currency. The U.S. dollar has never been devalued, and its notes have never been invalidated. Business is easier to conduct when a stable currency is used.

Unofficial dollarization can be so prevalent in some countries that more U.S. currency is in circulation than local currency. Once this happens, it can be difficult to reverse. Ironically, the very stability that dollarization brings can be a curse to local governments, as they lose the power to control inflation and fiscal policy. However, to many, what is a curse to the government is a blessing to others.

Money is only valuable if it is acceptable. Therefore, the U.S. dollar is not without its problems. For example, $100 bills have a reputation of being vulnerable to counterfeiting. As a result, they also tend to be the ones that are most rejected or discounted around the world. Long gone are the days when bills denominated in $500, $1,000, $5,000 and even $10,000 circulated because money launderers love large bills. This also represents the final attraction of the U.S. dollar: anonymity. While the U.S. dollar is accepted around the world, it's not necessarily tracked well around the world.

Conclusion
This article should have helped unveil some of the mystery of unofficial dollarization. It's a topic that comes up repeatedly with international travelers and business people. Stability, acceptability and anonymity are all reasons why the U.S. dollar has become the world's currency of choice. Despite its popularity, however, don't become too enamored with the U.S. dollar, as no currency has held onto the title of "currency of choice" forever.

The Big Mac Index is an informal way of measuring the purchasing power parity (PPP) between two currencies As stated in the Economist, it "seeks to make exchange-rate theory a bit more digestible".

· The Big Mac Index was introduced by The Economist in September 1986

· The index also gave rise to the word burgernomics.

It is based on the principle that the rate between two currencies should naturally adjust so that a sample basket of goods and services should cost the same in both currencies.

In the Big Mac Index, the "basket" in question is considered to be a single Big Mac sandwich as sold by the McDonald's fast food restaurant chain. The Big Mac was chosen because of the high degree of standardization of the BIG MAC burger across many countries around the world, with local McDonald's franchisees having significant responsibility for negotiating input prices.

Hence the index enables a comparison between many countries' currencies. Some menu items are market specific, which would hinder a comparison, if used. Still other menu items are specially priced, such as the dollar menu in many U.S. restaurants consisting of sandwiches and other items that cost $1.

The Big Mac PPP exchange rate between two countries is obtained by dividing the price of a Big Mac in one country (Home currency) by the price of a Big Mac in another country (foreign currency). This value is then compared with the actual exchange rate; if it is lower, then the first currency is under-valued (according to PPP theory) compared with the second, and conversely, if it is higher, then the first currency is over-valued.

For example, suppose the price of a Big Mac is $2.50 in the United States and Rs.100 in India; thus, the PPP rate is 2.50/100= 40. If, the actual USD rate is 1$ = Rs. 45 then USD is under-valued (40<45)>

The burger methodology has limitations in its estimates of the PPP. In many countries, eating at international fast-food chain restaurants such as McDonald's is relatively expensive in comparison to eating at a local restaurant, and the demand for Big Macs is not as large in countries like India as in the United States.

Social status of eating at fast food restaurants like McDonald's, local taxes, levels of competition, and import duties on selected items may not be representative of the country's economy as a whole. In addition, there is no theoretical reason why non-tradable goods and services such as property costs should be equal in different countries: this is the theoretical reason for PPPs being different from market exchange rates over time. Nevertheless, the Big Mac Index has become widely cited by economists.

MORE WHEN WE DO THE TOPIC IN THE CLASS!!!!!!

So the much awaited credit policy is out and our Reddy "garu" has pulled out some surprises (although not nasty ones).Let us look at some of the fall outs of the policy announced yesterday:

• RBI has told the corporates, banks etc to be "vigilant and well prepared" to deal with higher volatility on the rupee dollar front - which means--- guys I am not going to put too much effort into restricting rupee appreciation - so you guys take care of yourself
  
• This is a good sign ... I have long been of the opinion that too much protection is being given to the exporters - while this was necessary in the early stages of the development - it should have been stopped once our FX reserves touched 200 bnUSD. Moreover the exporters of our country have been pampered to the hilt and should now realise that they should grow up.
• CRR hiked by 0.50 bps to 7%
• This move will suck out close to Rs.13500 crores out of the system - not a major cause of concern for treasuries - because the liquidity floating around in the system is estimated to be around Rs. 1 lac crores. The bond yields reacted yesterday - but this was only a reaction to the announcement and is likely to settle down today. We have seen that the excess liquidity in the system was arising primarily due to the fact that deposits were growing rapidly while advances was showing a declining trend. This coupled with the RBI pumping rupee to support the dollar led to huge liquidity float in the system. Of course the banks will now have to make the effort of pushing advances and reduce costs on borrowings i.e. deposits.
  
• Ceiling of Rs.3000 crores on reverse repo discontinued:
• With the removal of this ceiling the call rates will now gravitate towards this rate which is presently at 6%
• Long term repos to be introduced:
• I have mentioned in my lectures that the short term yield curve is characterised by a zig zag pattern owing to volatility and unpredicability in the short run. With the introduction of 14 day and 28 day repos we might see some smoothening of this segment of the yield curve.
• GDP growth at 8.5%
• This growth has primarily been driven by the services and industrial sector - the farm sector outlook is still uncertain. Like discussed in the class - the RBI is faced with a dilemna of managing a high GDP growth on one hand and reigning inflation on the other.A High GDP together with a monetary system sloshing in liquidity is sure indicator of high inflation in the days to come - this will also result in higher interest rates (this is already indicated by a upward move of the CRR

The coming few months should be interesting as RBI unfolds its plans to tackle the strange situation that India is in now My call - we should see some tightening of the interest rates in the medium term and the RBI is likely to adopt a push pull strategy to control inflation and dollar.

RUPEE APPRECIATION AND AS 11

The rupee has appreciated 10-11 per cent against the dollar in recent times. Accounting Standard (AS-11) of the Institute of Chartered Accountants of India (ICAI) governs accounting of foreign currency transactions and translations. Those who have long-term loans in dollar such as external commercial borrowings (ECBs) have to book huge gains on account of this fluctuation, when re-stating the balance-sheet. Is this correct?

The rupee appreciation in the past few weeks was very fast and it is difficult to assume that the appreciation will sustain in the long run. How do we proceed to simultaneously comply with the standard and recognise the currency volatility? We have to be prudent while recognising income and booking losses. The gain on account of the appreciation may not be sustainable, and hence is it prudent to recognise the same in the profit and loss (P&L) account? Can it be a good practice, not to recognise the income and pass it on to an exchange risk administration reserve to meet future liabilities? Is AS-11 equipped to meet this scenario?

Prudence is no longer an objective of most accounting framework. Fair presentation is. Therefore, it is important that assets and liabilities are represented at fair values. In the case of forex loan, fair presentation would be to account for the loan at the exchange rate prevailing on the balance-sheet date. As a corollary, the corresponding gain/loss is recognised in the `profit and loss' account (where else can it go?).

It would be incorrect not to recognise the gain, since it would tantamount to creating a secret reserve. It is also not appropriate to suggest that the gain is not being recognised, since exchange rates can cause the reverse moment in the future. What if they do not? Accounting cannot be based on prediction.

Just another point, if the loan was used for financing a fixed asset, then the exchange difference may very well be termed as a borrowing cost under AS-16 and to that extent the same may be capitalised or de-capitalised.

RELATIONSHIP BETWEEN INTEREST RATES AND INFLATION

It is typically a positive relation. In other words, both tend to move either up or down together. However, the caveat is that interest rates will always follow inflation rates or, put simply, when inflation goes up, interest rates go up and when inflation comes down, interest rates tend to fall.

The reason behind this relationship is fairly simple as also complex. Inflation tends to happen when an economy is `overheating' much like what is happening in India now. Of course, inflation also happens when central banks print a lot of money or when macroeconomic policies go bad. However, in this case, let's assume that the central bank and government are largely following `correct' policies. This assumption is necessary because the relation between inflation and interest rates becomes clearer.

Money is the engine of any economy. Let's start from the time when money is cheap or in other words, there is a low interest rate. This is also called `loose money policy'. Because of this cheap money, people borrow to start businesses, invest and so on; the price they pay for the money is interest. Over time, a virtuous cycle gets created where this money generates more money and people tend to become richer.

India is the best case where this has happened in the last few years. Interest rates were low in India and people and companies have borrowed liberally for a variety of things. People bought houses, cars, TV sets and so on and companies built factories, etc. When this happens, economies will typically go through what is known as a boom phase with GDP, incomes, and profits rising rapidly. All this increases the demand for goods and we all know that prices of goods depend on demand and supply. Over time, demand builds and slowly outstrips supply as is happening in India now. When that happens, prices of goods tend to go up and that results in inflation because most of these goods are usually part of a basket that constitutes the Wholesale Price Index or the Consumer Price Index.

To `cool' the economy, central banks will raise interest rates. The intention here is to slow demand and, in effect, decelerate the economy. However, this is a tightrope act because interest rates must be raised just enough to cool the economy but not send it into a recession. When interest rates are increased, money becomes costlier and that is known as `tight money policy'. What the central bank hopes is that when it increases rates, people and companies will borrow less and therefore there will be less purchases and investments. This usually cools the economy. During this cooling period, GDP growth usually slows, companies' profits are reduced and people are less likely to spend. Over time, inflation drops and as it does, the central bank will usually lower interest rates to again kick-start the economy and the cycle continues.

However, it is important to understand that the above explanation is very broad and that there are many factors that go into this sometimes complex relationship.

- The article has been written by Sunil Rongola who is Economist, Murugappa Group. The views expressed are personal and has appeared in Hindu todya

PLEASE DO MAKE SURE TO GO THROUGH THE SECTION ON THE RIGHT TITLED " Articles I would recommend - these are enormously useful for CA Students"


srini

hey guys,
please visit my blog linked : http://www.srininewsblog.blogspot.com

It has a section Hindu business line - mentor - this section often contains interesting news for CA students. e.g. on 16th of July it had the solution of a problem in costing which came in May 2007 solved by Mr. PV Ratnam. It also contained an article as to constitution of audit paper in the finals - keep an eye on this blog

Well so much for the so called ethics, professionalism, laptop toting personnel, cutting edge technology by the so called big 4 ......

Deloitte to Pay $130 Million to Parmalat Shortly

Deloitte had settled with Parmalat to pay US $149 million for its role in the bankruptcy of the Italian dairy company.

Now it is time to pay....Parmalat SpA says that Deloitte have a few days to come up with the money, and apparently Deloitte will pay $130 million as a first installment.

The first signs of the economy cooling down is showing: the runaway growth in bank loans is finally losing some steam. For the first time in 6 years, banks have recorded an absolute dip in loans given to individuals and Corporates.

Latest RBI figures reveal that aggregate non-food credit extended by banks declined Rs 30,532 crore between April and June 22 to Rs 18,17,955 crore. Though a slow credit demand is normal in the first quarter which is lean season, for the first time in 24 quarters, banks are seeing their loan portfolio shrink. Significantly, it’s happening at a point when deposits parked in banks are recording the highest quarterly growth of over Rs 1,00,000 crore.

The point to note here is that while the deposits are at a record volume - the loan portfolio is reducing - while this is good as far as the FM is concerned because he is achieving the objective of cooling down an overheated economy - the question is what happens to the banks - they will pay interest on the deposit on one hand while on the other hand the loan portfolio
shrinking.
The central bank has given enought indication that it is not comfortable with the fierce loan growth. Since last year, it has implemented series of rate hikes to cool down the economy and diffuse bubbles in various markets. The monetary actions may be finally showing results.

From the corporates side, the corporates are more inclined to borrow from alternative sources which are available at a relatively cheaper rates. But with global PE funds tripping over their feet to fund indian ventures - mid cap segment is gravitating more towards equity.

And anyway equity markets seem to be in a tizzy and spiralling northwards .....

Interesting ruling for section 54 and 54F of the Income tax act

Special bench of Income Tax Appellate Tribunal vide a significant ruling AIT-2007-205-ITAT affecting investment decision of sellers and buyers of real estate has ruled that exemption under sections 54 and 54F of the Act would be allowable in respect of one residential house only. If the assessee has purchased more than one residential house, then the choice would be with assessee to avail the exemption in respect of either of the houses provided the other conditions are fulfilled. However, where more than one unit are purchased which are adjacent to each other and are converted into one house for the purpose of residence by having common passage, common kitchen, etc., then, it would be a case of investment in one residential house and consequently, the assessee would be entitled to exemption.

• The Special Bench was constituted to decide the following question of law:

“Whether, the phrase “a residential house” used in sub-section (1) of section 54 and 54F means one residential house or more than one residential house independently located in the same building / compound / city?”

• The Revenue contended that exemption under sections 54/54F of the Income Tax Act, 1961 would be available only in respect of investment made in one residential house. On the other hand, the assessee contended that the exemption under the aforesaid sections would be available even if investment is made in the two house properties though distantly located from each other.
• The assessee and her husband were co-owners of a residential flat at “Gulistan” situated at Bhulabhai Desai Road, Mumbai, having 50% share each. In the year under consideration, the said flat was sold for a total consideration of Rs.3.03 crores on 12.8.1984. The share of the assessee in the sale consideration of Rs.3.03 crores on 12.8.1984. The share of the assessee in the sale consideration amounted to Rs.1.515 crores. The assessee re-invested the sale proceeds in purchase of ½ share in these two flats were purchased by the husband of the assessee. The assessee claimed exemption u/s 54 of Rs.76.44 lacs against long term capital gain arising from the sale of her share in the residential flat at Bhulabhai Desai Road, Mumbai. However, the assessing officer was of the view that exemption was available only in respect of investment in one residential house. Accordingly, he restricted the exemption to Rs.47.79 lacs being the investment in the flat at Erlyn Apartment, Bandra. On appeal, the CIT(A) held that exemption was available in respect to investment made in both the flats.

Observations of Special Bench:

· The real controversy is about the true meaning of the expression “a residential house” used by the legislature in sections 54 and 54F of the Act. According to the Revenue, it means, one residential house while, according to the assessee, the word “a” means “any” which in turn means “one or more than one”.

· The word “a” is ambiguous as it has no definite meaning. Various meanings are given to the word “a”. It not only means “one” or “any” but it has various other meanings depending upon the context in which it is to be used. Therefore, the cardinal principle of interpretation cannot be applied and consequently, the intention of legislature has to be discovered by resorting to the aids to the interpretation. One of the rules of interpretation is to find out the context in which such word is used by the legislature.

· The legislature has used the words “a” and “any” with reference to investment of capital gain / sale consideration in certain asset or assets. The legislature was not oblivious regarding the meaning of these two words. The word “any” has been used by the legislature in sections 54B, 54D, 54E, 54EA, and 54EB while the word “a” has been used in sections 54 and 54F of the Act. This clearly shows that the legislature intended different meanings to be given to these two words. A close reading of these sections shows that legislature intended to allow exemption in respect of investment in more than one asset by using the word “any”. Section 54E allows exemption in respect of investment in any specified asset. Explanation 1 to sections 54E defines the “specified asset”. It includes various assets in which investment can be made by the assessee who are eligible for exemption u/s 54E. There is nothing to indicate that investment is restricted to any of the specified assets. Had the legislature intended to restrict investment in any one of the specified assets, it would have used the words “in any one of the specified assets” instead of “in any specified asset”. This clearly shows that the word “any” has been used where the legislature intended investment in more than one asset. Similarly, in section 54EB, the legislature has used the words “in any of the assets specified by the Board”. Similar is the position in section 54EA. Section 54B and section 54D also used the word “any other land” and “any other land and building” respectively. The expression “any other land” is an expression of widest amplitude and, therefore, its meaning cannot be restricted to any one piece of land. On the other hand, the legislature has used the word “a” in sections 54 and 54F. Had the legislature intended for investment in more than one asset, it could have easily used the words “in any residential house”. Superfluous words are not used by the legislature. Different words “a” and “any” have been deliberately used by the legislature to convey different meanings. Therefore, in our humble view, the legislature used the word “a” where it intended investment in one residential house only and used the word “any” where it intended investment in one or more assets.

· However, we are in agreement with certain decisions of the Tribunal relied on by the learned counsel for the assessee wherein exemption was allowed in respect of investments in two adjacent or contiguous units converted into one residential house by having common passage / stair case, common kitchen, etc. intended to be used as singly house for the residence of the family. As already observed, the intention of the legislature is that investment should be made in one residential house. So long as the house purchased is one even after conversion, the exemption would be available. On the other hand, if the investment is made in two independent residential houses, even located in the same complex, then, in our opinion, exemption cannot be allowed for investment in both the houses. However, the choice would be with assessee to avail exemption in respect of any one house.

In my earlier blog I had written about a derivative instrument called the credit default swap. The ET on 28th June 2007 carried an article about how banks are offering equity linked notes to woo rich investors. This is a clear indicator of how our markets are maturing in a big way.

Citibank and DSP Merrill Lynch have issued equity linked notes to raise resources. The equity linked notes are basically debt instruments issued at a discount with certain additional payoffs being made on the happening or non happening of certain events. To cite an example A Ltd can issue a debenture at Rs.100 which will be repayable on maturity at 100+3 = Rs.103. It can however contain a rider which says that if the Nifty falls / rises by more than say 30% any time between the date of allotment and the date of redemption the repayment will be say Principal + 20%.

This kind of a product provides capital safety plus the opportunity to participate in a equity rally by the investor, while for the borrower it may enable him to issue such paper at a lesser rate than what he would had to offer on a pure debt instrument. These bonds will be rated and traded on the NSE. However as of right now due to lack of depth and knowledge of the product it is likely to be a OTC product with limited liquidity. However if a number of company (say the index companies) start coming out with such an instrument then it will be quite possible to create a basket derivative of such instruments.

This also means that credit rating agencies in India which have so far been rating predominantly vanilla products will have to gear themselves up to deal with such sophisticated instruments. Like I keep saying - exciting times ahead!!!!!!!!

DERIVATIVES -
AN INTRODUCTION TO CREDIT DEFAULT SWAP

Credit default swap: Two parties enter into an agreement whereby one party pays the other a fixed periodic coupon for the specified life of the agreement. The other party makes no payments unless a specified credit event occurs. Credit events are typically defined to include a material default, bankruptcy or debt restructuring for a specified reference asset. If such a credit event occurs, the party makes a payment to the first party, and the swap then terminates.

Another way of putting it:
The buyer of a credit swap receives credit protection, whereas the seller of the swap guarantees the credit worthiness of the product. By doing this, the risk of default is transferred from the holder of the fixed income security to the seller of the swap.

For example, the buyer of a credit swap will be entitled to the par value of the bond by the seller of the swap, should the bond default in its coupon payments.

Use of CDS by commercial banks
Commercial banks use credit default swaps to manage the credit risk associated with making large loans to their corporate customers. If a borrower defaults on a loan or another predefined credit event occurs, the counterparty providing the insurance purchases the defaulted asset.

Credit default swaps are a very common form of Credit Derivative. The objective in many credit derivatives, including default swaps, is to split market risk from credit risk; doing so effectively reduces a bank's exposure and its risk of loss.

A CDS is often used like an insurance policy, or hedge for the holder of debt . The typical term of a CDS contract is five years, although being an OTC product almost any maturity is possible.

An Example A fund has invested Rs 10 croreds worth of a 5 year bond issued by Risky Corporation. In order to manage their risk of losing money if Risky Corporation defaults on its debt, the fund buys a CDS from Derivative Bank for a notional amount of Rs.10 crores which trades at 200 basis points. In return for this credit protection, the fund pays 2% of 10 crores (Rs. 200,000) in quarterly installments of Rs. 50,000 to Derivative Bank. If Risky Corporation does not default on its bond payments, the fund makes quarterly payments to Derivative Bank for 5 years and receives its 10 crores loan back after 5 years from the Risky Corporation. Though the protection payments reduce investment returns for the fund, its risk of loss in a default scenario is eliminated. If Risky Corporation defaults on its debt 3 years into the CDS contract then the premium payments would stop and Derivative Bank would ensure that the fund is refunded for its loss of Rs. 10 crores Another scenario would be if Risky Corporation's credit profile improved dramatically or it is acquired by a stronger company after 3 years, the pension fund could effectively cancel or reduce its original CDS position by selling the remaining two years of credit protection in the market.

P.S. This is not a technical note but just to give you an idea and introduction as how flexible derivatives can be !!!!

Accounting Standard (AS) 20, ‘Earnings Per Share’ is mandatory in nature, in respect of enterprises whose equity shares or potential equity shares are listed on a recognised stock exchange in India.

An entity which has neither equity shares nor potential equity shares which are listed nee not calculate and disclose earnings per share.

But, if that enterprise discloses earnings per share for complying with the requirements of any statute or otherwise, it should calculate and disclose earnings per share in accordance with AS 20.

Part IV of the Schedule VI to the Companies Act, 1956, requires, among other things, disclosure of earnings per share.

Accordingly, it has been clarified that every company, which is required to give information under Part IV of the Schedule VI to the Companies Act, 1956, should calculate and disclose earnings per share in accordance with AS 20, whether its equity shares or potential equity shares are listed on a recognised stock exchange in India or not.