Query :- Investor Limited (the company) acquired 1,000,000 equity shares of Rs. 10 each in Investee Limited (investee), for the acquisition date fair value of Rs. 9 million. In the past, Investee Limited had incurred losses, which were attributable to the investee’s venture in a new line of business and exceptional events such as economic recession. Over the period, the line of business has stabilized and started generating profits. In addition, the economic environment has improved significantly. Therefore, the investee expects to generate significant profits in the future periods. However, to write off the past losses, the investee has entered a capital reduction scheme. According to the scheme, it will reduce the face value of each share to Rs. 7 per share and adjust the resulting amount against the past losses.
Investor Limited holds the investment in Investee Limited for long-term purposes. The management of Investor Limited has assessed that despite the past losses, there is none other than temporary reduction in the value of the investment. However, it is evaluating whether it needs to write off a proportionate amount of the investment considering the capital reduction by the investee.
AS 13 Accounting for Investments requires long-term investments to be carried at a cost. However, the provision for diminution will be made to recognize a decline, other than temporary, in the value of investments.
Though AS 13 does not require a company to write off its investments merely for the reason of capital reduction by the investee; however, in a typical scenario, this may be a strong indicator of the other than temporary decline in the value of investment. In the given case, Investor Limited should evaluate these matters thoroughly before reaching a decision.