Restructuring of Partnership into Private Company

[wsafca]

Dear all

An unregistered partnership business was in place.

It was converted into Private limited company.

Total assets were taken at ---------Rs. 100,000,000
Total liabilities were taken at ----Rs. 20,000,000

What could be the possible treatment of the resultant capital receipts?

Is it correct if the company show it as the financing by the directors?

(Partners of the partnership business and the shareholders of the current company are same and they are also the directors?

Paidup share capital ----------------- Rs. 1,500

Regards

Waqas Shabbir

[kamranACA]

Dear

They should draft and finalize a "Business Transfer Agreement" that should be registered and signed by both parties i.e. "partners of AOP" on one hand and the private limited company on the other hand.

This business transfer agreement should include all details regarding transfer and valuation of assets and liabilities and will mention the disposal of NET WORTH i.e. excess of assets over liabilities being transferred.

Such disposal can be either in form of ordinary shares to be issued to the partners of the AOP (promotors of the company as well) or in the form of a combination of ordinary shares and loan notes. If the later disposal is decided, the repayment schedule of loan notes should also be agreed and made part of the "Business Transfer Agreement".

The safest and legal way is to revalue the assets (even re-assess the liabilities) before transfer to the Company so that the requirements of Capital Issue Rules, 1996 may also be fullfilled and it is ensured that shares are not being issued on an excessive value. For such revaluation independent valuer will be used whose report will also be required to be certified by a firm of CAs (Capital Issue Rules, 1996).

This will also benefit the shareholders (AOP partners) as they will probably get the shares of higher amounts unless the assets are found to be impaired.

I hope this will provide a roadmap. (For such advice I charge at least a quarter of 100K; just kidding).

Regards,


KAMRAN.

[Star]

Dear,

You have wrote following in the third last para of your post;

"For such revaluation independent valuer will be used whose report will also be required to be certified by a firm of CAs (Capital Issue Rules, 1996)."

My understanding is given below;

As per Rule 8(iv) of Companies (issuance of share capital) Rules, 1996, the report of independent valuer is not required to certify from firm of CAs. Exact wording is given below;

"certificate from a practising Chartered Accountant shall be obtained to the effect that the above mentioned conditions have been complied with."

It is clear from the wording of Rules that CAs is only required to certify that the (four) conditions mentioned in Rule 8 have been fulfilled. One of them is independent valuation by valuer (under discussion)

Report of independent valuer (register with Pakistan Engineering Council) is itself a certification which may not require recertification from CAs.

CAs are only required to ensure that valuation has been made by registerd valuer and written report exists for the valuation made.


Regards,


*

[kamranACA]

Dear Star

Thank you for raising this point. I wrote the above post in probably 2 minutes and did not check the exact wording of Companies (Issue of Capital) Rules, 1996. However, now I must answer the point raised by you so that no one is left with misdirection due to this difference of opinion you posted.

For issuance of shares against consideration other than cash the rules prescribe conditions (as you have mentioned). However, these all conditions strictly pertain to revaluation of assets and nothing else. I again say there is no other condition but to have the assets revalued. Let me post below these 4 conditions by mentioning exact wording of rule 8.

QUOTE

A company may issue shares for consideration otherwise than in cash subject to the following conditions, namely;--

(i) The value of assets shall be determined by a consulting engineer registered with Pakistan Engineering Council and borne on the panel of at least two financial institutions as a Valuer;

(ii) the value of assets taken over shall be reduced by depreciation charged on consistent basis;

(iii) the goodwill and other intangible assets shall be excluded from the consideration; and

(iv) certificate from a practicing Chartered Accountant shall be obtained to the effect that the above mentioned conditions have been complied with.

UNQUOTE

Let me discuss it to elaborate what I said and why I said.

There are in total 4 conditions out of which the first 3 (i to iii) strictly pertain to the scope of the work to be undertaken by the Independent Valuer.

The condition (iv) states that a practicing CA (a firm) has to certify that the condition from (i) to (iii) have been fulfilled. This means practicing CA has to certify that-

- the value of assets has been determined by consulting engineer (the independent valuers);

- the consulting engineer was registered with Pakistan Engineering Council current to the date of his appointment and valuation;

- The consulting engineer was borne on the panel of at least two financial institutions as a Valuer;

- The Valuer has reduced his valuation of assets (being taken over) by depreciation charged on consistent basis. (Rest assured this is Valuer’s work; if you doubt, please check such valuation reports issued for this specific purpose);

- The Valuer has excluded all intangible assets and goodwill etc from his valuation; (again rest assured this is for Valuer’s attention and not for any body else's).

So my brother, the certificate of practicing CA will cover nothing but

1. THE WHOLE SCENARIO OF VALUATION

This includes evidence of correct selection and appointment on the basis of conditions stipulated in rules (condition (i) of Rule 8).

2. THE VALUATION DETERMINED AND REPORTED BY VALUER

This means to certify that the Valuer has excluded all goodwill and intangible assets from his valuation and that he has taken into account depreciation charge on some consistent basis to reduce the gross value of assets determined by him. (Condition (ii) and (iii)

In my previous post I wrote

“For such revaluation independent valuer will be used whose report will also be required to be certified by a firm of CAs (Capital Issue Rules, 1996).”

I HOPE THERE WAS NOTHING WRONG IN WHAT I MENTIONED EARLIER. HOWEVER, IT WAS NOT TOO ELABORATED SINCE I MENTIONED CAPITAL ISSUE RULES, 1996 FOR REFERING TO ORIIGINAL TEXT. IF YOU FIND SOMETHING, PLEASE LET ME KNOW.


I am sorry for this lengthy post but it was necessary for providing the reasoning.

Regards,



Kamran.

[kamranACA]

Waqas

My earlier advice still prevails.

)

Regards,


KAMRAN.

[Star]

Dear,

Thanks for the early and detailed response. Thats the thing i too meant exactly.

Regards,


*

[kamranACA]

<blockquote id="quote"><font size="1" face="Verdana, Arial, Helvetica, san" id="quote">quote<hr height="1" noshade id="quote"><i>Originally posted by Star</i>
<br />Dear,

You have wrote following in the third last para of your post;

"For such revaluation independent valuer will be used whose report will also be required to be certified by a firm of CAs (Capital Issue Rules, 1996)."

My understanding is given below;

As per Rule 8(iv) of Companies (issuance of share capital) Rules, 1996, the report of independent valuer is not required to certify from firm of CAs. Exact wording is given below;

"certificate from a practising Chartered Accountant shall be obtained to the effect that the above mentioned conditions have been complied with."

It is clear from the wording of Rules that CAs is only required to certify that the (four) conditions mentioned in Rule 8 have been fulfilled. One of them is independent valuation by valuer (under discussion)

Report of independent valuer (register with Pakistan Engineering Council) is itself a certification which may not require recertification from CAs.

CAs are only required to ensure that valuation has been made by registerd valuer and written report exists for the valuation made.


Regards,


*




<hr height="1" noshade id="quote"></font id="quote"></blockquote id="quote">



CAs are only required to ensure that valuation has been made by registerd valuer and written report exists for the valuation made.




Star

I differ in opinion specific to the above stated paragraph in your post.

CAs don't merely have to check that a written report exists.

They have to certify (besides selection and appointment criteria)

- what was required to be included has been included,
- what was required to be excluded has been excluded, and
- whether or not the depreciation has been arrived at on some consistent basis to reduce the gross valuation.

Of course you cannot expect CA to issue a revaluation report at his own.

Regards,


KAMRAN.

[Star]

Dear KamranACA,

You have wrote following in the third last para of your post;

"For such revaluation independent valuer will be used whose report will also be required to be certified by a firm of CAs (Capital Issue Rules, 1996)."

Actually, valuation report is not required to be certified by CAs, they are required to ensure that no intangibel asset has been included in assets valued and if valuation has been made at some earlier date then depreciation has been charged on the revalued amount upto the date of issuance of shares for consideration other than cash.

Certification of valuation report and certificate of CAs to ensure that four conditions have been fulfilled are two separate things.


Cetification of valuation report may include but not limited to ensure that market value has been correctly calculated according to the assumptions actually exist and assumption taken by valuer.

In practical, if valuation has been done by approved valuer, then CAs may not object / change it because they are not required to undertake the audit of market value at the time of certification.

Hope this discussion would be mutually beneficial as well as other members.


Regards,

*

[hshamsi]

@ above

although report is being obtained by a registered valuer who is well aware of the tools and techniques used in valuation, yet CAs are required to certify their report. thy also have right to object the valuation report if thy suggest. (as per Co Issue of Share Capital Rules 1996)

for instance in gratuity calculation, CAs are required to confirm the value of the assets on which the gratuity calculation by the actuary was based. (this is as per my experience and knowledge and also we were told to do so during one of our audit.)

regards.

[Star]

Dear,

you are referring the situation when auditor is required to give opinion on the financial statements by following the Auditing Standards. Auditing standard titled "Using the work of an expert" requires the auditor to verify the assumptions and contents of valution report.

Is certification under capital issue Rules is an audit?


Regards,

*

[hshamsi]

@ above

yes certainly m referring the situation when auditor is required to give opinion on FS under IFRSs and related laws, etc, bt i gave that jst as an example

and of course ISA 620 "Using the work of an expert" requires the auditor to actually verify the assumptions and contents of valuation report.

it goes as under

Evaluating the Work of the Expert
12. The auditor should evaluate the appropriateness of the expert’s work as audit evidence regarding the assertion being considered. This will involve evaluation of whether the substance of the expert’s findings is properly reflected in the financial statements or supports the assertions, and consideration of
i)Source data used;
ii)Assumptions and methods used and their consistency with prior periods; and
iii)Results of the expert’s work in the light of the auditor’s overall knowledge
of the business and of the results of other audit procedures.

13. When considering whether the expert has used source data which is appropriate in the circumstances, the auditor would consider the following procedures
(a) Making inquiries regarding any procedures undertaken by the expert to establish whether the source data is relevant and reliable.
(b) Reviewing or testing the data used by the expert.

14. The appropriateness and reasonableness of assumptions and methods used and their application are the responsibility of the expert. The auditor does not have the same expertise and, therefore, cannot always challenge the expert’s assumptions and methods. However, the auditor will need to obtain an understanding of the assumptions and methods used and to consider whether they are appropriate and reasonable, based on the auditor’s knowledge of the business and the results of other audit procedures. ( I hope this clarifies my point )

15. If the results of the expert’s work do not provide sufficient appropriate audit evidence or if the results are not consistent with other audit evidence, the auditor should resolve the matter. This may involve discussions with the entity and the expert, applying additional audit procedures, including possibly engaging another expert, or modifying the auditor’s report.

I hope m able to clear my point and of course certification under capital issue Rules is not an audit.

Regards.

[Star]

Dear,

I am still not clear that what is your point of view whether the auditor is required assess the assumptions and contents of valuation report at the time of certification in accordance with the Auditing Standards????


Regards,


*

[kamranACA]

Dear Star and hshamsi,

It has really been a quality discussion which has and will certainly raise very significant aspects.

First of all let me know if any ISA any where describes the word "certification by auditors". I hope it has no where been used. Still, one may have to see ISAs for concluding this fact. Therefore, quite recently the audit firms (and specially the big 4) have changed the formats of their certifications. They have started issuing almost all certificates in the shape of and titled as "auditors' report to the management". However, the law still uses the word certification invariably, mostly without prescribing its format, thereby providing leverage to auditors to draft their certificate/report as they deem fit.

Now coming to the issue in hand, I would like to reiterate that the certificate required to be issued under Rule 8 of Companies (Issue of Capital) Rule, 1996 and the resulting verification by practicing CA has to cover the following broad areas

- the qualification and registration of Valuer etc
- the fact that whether or not all the required assets have been included in valuer’s report
- the fact that whether or not depreciation has been charged on consistent basis to reduce the gross valuation. {I differ on its interpretation with Star}***
- the fact that whether or not the valuer has excluded all the excludable assets (goodwill and intangibles etc) from his report / valuation.

***{Charge of deprecation is not meant for to reduce the value for depreciation subsequent to valuation date. Such valuation is normally done quite nearer to the date of transfer of assets and issuance of shares etc. May I point out that the valuation is always made either on market values or on the basis of replacement values (both of which reflect current fair values of similar un-used/new asset). Therefore, in both cases these valuations have to be reduced by charging depreciation consistently for the period for which asset has already been used, in order to match the values with the current condition of the assets as of the valuation date. This is the sense and purpose of adding this line to the rules, and this is what practicing CA must check and certify.}


I must say the above is the broad outline of the areas to be checked before certification. However, let me also explain that when rule 8 says that practicing CA has to certify that above conditions {i.e. three conditions from (i) and (iii); and not the four conditions} have been met, it provides a very wide ranging scope to such practicing CA.

I may remind that when valuers used to be approved by SBP (instead of PBA) many CA firms were also included in the list of approved valuers. So, many of CAs had been in touch with valuation techniques and its pros and cons and in past used to associate qualified engineers on the panel of their firms as well.

Keeping this in mind or even otherwise, if a situation arises where a practicing CA based upon his experience and knowledge believes that the valuation has been made wrong materially, what will he do? Certainly, people do it, and such voilations are always expected. This is where certification of CA has the greatest relevance. Mind it, this is not merely purposed for ensuring whether all documents are avaialble in file or not. Otherwise, can the Registrar or SECP not check whether or not the conditions have been met, if it has to be based merely on checking whether or not the report is appended with documents being filed?

Should the practicing CA keep quiet by assuming that his obligation is only to confirm that conditions (i) to (iii) have been met (i.e. report is available or not) so he should issue the certificate regardless of how wrongly the valuation of net worth and issuance of shares will it lead to, as a result? I am of strong view that this would be a professional misconduct.

Therefore, in my view, although the certification has to be made about whether or not the conditions are met, but since these conditions include a large amount of aspects which all relate to valuation only, the scope of certification remains unlimited. Accordingly, I feel like endorsing the views given by hshamsi in his post.

Regards,



KAMRAN.

[hshamsi]

@ above

i think wz nt able to effectively communicate my point to Star, m sorry bt i tried to.. n m glad Kamranaca helped clearing my point too, thnx for this, n one more thing m nt 'his' s

regards

Hina Shamsi

[hshamsi]

<blockquote id="quote"><font size="1" face="Verdana, Arial, Helvetica, san" id="quote">quote<hr height="1" noshade id="quote"><i>Originally posted by Star</i>
<br />Dear,

I am still not clear that what is your point of view whether the auditor is required assess the assumptions and contents of valuation report at the time of certification in accordance with the Auditing Standards????


Regards,


*
<hr height="1" noshade id="quote"></font id="quote"></blockquote id="quote">

yes the auditor is certainly required to assess the assumptions and contents of valuation report.