Tangible Fixed Assets in Forensic Accounting – Importance | Facts | Case Analysis

In forensic accounting, "Tangible Fixed Assets" refer to long-term physical assets that a business owns and uses in its operations to generate income. These assets include buildings, machinery, vehicles, furniture, and equipment. They are characterized by their physical substance, meaning they can be seen and touched. In the context of forensic accounting, the evaluation of tangible fixed assets is crucial as they can be involved in various financial irregularities

Table of Contents

1. Why are Tangible Fixed Assets Important?
2. Fast Facts – Before Decoding
3. How to Decode?
4. Case Analysis – Case of Bhushan Steel Limited Substantial Investment in Plant and Machinery Which Never Existed

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1. Why are Tangible Fixed Assets Important?

“Assets are economic resources.

Anything – tangible or intangible that is capable of being owned,

controlled or used to produce value and

that is held to have positive economic value

is considered an asset – tangible fixed assets”.

The analysis of Fixed Assets being Property, Plant and Equipment (PPE) assumes greater importance in case of an entity where substantial amount is invested in the fixed assets.

The object is to find out whether the amount of investment shown in the books of account as fixed assets, is really genuine and all such fixed assets do exist basically, in the conditions and shape, which has been purchased by an entity and all these fixed assets have the economic value equivalent to the amount invested by an entity.

In the forensic accounting investigation, the critical verification of major amount of each and every item of fixed assets (such as land, building, plant, machineries, furniture, fixtures equipment, vehicles, etc.) is very important and desirable to find out that all such investment in fixed assets is genuine, actual and not inflated. Fixed assets, are normally a one-time investment activity and it involve the deployment of huge funds/borrowings, and therefore, could be used for the purpose of diversion or siphoning of the funds, by overstating or inflating the actual amount of investments. Apart from examination of fixed assets, investment is actual and genuine, the critical examination that all such investments in fixed assets have been made in the normal course of business, is also equally relevant in forensic accounting investigation. This is based on concept of reality versus perception.

It is common to inflate the so-called investment shown in the property, plant and equipment, as higher than actual amount of investment, helps in inflated assets- resulting into higher net worth- which result into inflated financial position and on the other hand funds are also taken away from the business. The higher amount of borrowings from banks or financial institutions (on the basis of such inflated investment in fixed assets) is another advantage. Thus, multiple purposes are served by showing enhanced or inflated or sometimes even bogus investments in fixed assets.

Therefore, in forensic accounting investigation relating to fixed assets – the centre of analysis is examination and evaluation of:

• the nature of business and the various types of fixed assets held,
• the volume of sales and the amount of investment in plant & machinery,
• the nature of sales and the types of fixed assets in which investment is made,
• the overall amount of investment in fixed assets and economic benefits drawn from such investment in fixed assets,
• the financial position of an entity during the recent past and period of investment,
• existing capacity utilization and further, investment in plant and machinery,
• profit margin and the amount of investment etc.

Therefore, analysis and verification of investment in fixed assets, is important in forensic accounting investigation, as investment made in fixed assets, if not giving economic benefits to the entity, the purpose and object of such investment need to be looked into, to find out any early warning signs, red flag, diversion of funds, misstatement of details in financial statements, etc.

2. Fast Facts – Before Decoding

Property, Plant and Equipment, earlier known as fixed assets are tangible items, which are held for use in the production or supply of goods or services or for administrative purposes. In order to fall within the definition of fixed assets, apart from above criteria, it is further required that such tangible items should be expected to be used during more than one period. The cost of an item of property, plant and equipment is recognized as an asset, if and only if:

• it is probable that future economic benefits associated with such items will flow to the entity; and
• the cost of an item can be measured reliably

Accordingly, after initial investment in PPE, any subsequent cost incurred is also added to the cost of fixed assets, provided, if above two conditions are satisfied.

Major spare parts and standby equipment which are expected to be used for more than one period, also forms part of plant and machinery.

Certain items of PPE may not directly increase the future economic benefits of an entity but may be necessary for an entity to obtain the future economic benefits from other assets. These assets also form part of PPE, for example, environmental compliance-related equipment in a chemical manufacturing unit.

Fixed assets are known as “Property, Plant and Equipment” in a case where Indian Accounting Standards (Ind AS) applies. Ind AS 16 – Property, Plant & Equipment, deals with the same. Further, as per amendment in schedule III (Preparation of Financial Statements) to the Companies Act, 2013, the “Fixed assets” is replaced with “Property, Plant & Equipment” w.e.f. 11th October, 2018.

2.1 Presentation of Fixed assets details in the Balance Sheet

In case of an entity to which Ind AS does not apply the fixed asset is known as “Tangible Assets”. In case of an entity to which Ind AS applies, the fixed asset is known as “Property, Plant & Equipment”. The classification for the same is required to be presented as under in the balance sheet:

2.2 Separate information

Schedule III to the Companies Act, 2013, requires to provide separate information on the gross and net amount of each class of fixed assets being Property, Plant and Equipment at the beginning and end of the Balance Sheet date. It further requires to separately disclose the amount of addition, disposals, acquisition through business combination and other adjustments, like impairment losses or reversals separately.

2.3 Useful life

Useful life of an asset is defined in terms of asset’s expected utility to the entity. The following factors are taken into consideration, while determining useful life:-

• expected usage,
• expected physical wear and tear,
• technical obsolescence,
• legal limits on use of the asset

2.4 Disclosure of details, if different useful life adopted

With effect from 1st April, 2014, it has further mandated to follow the useful life of fixed assets, as per the schedule II to the Companies Act, 2013. If a company is adopting some different benchmark for useful life other than that prescribed in Schedule II, necessary disclosure is required to be made in the notes to accounts.

2.5 Depreciation

Depreciation is the systematic allocation of the depreciable amount of an asset over its useful life. Accordingly, the amount of depreciation is provided for the use of the assets, as an item of expenditure in the Statement of Profit & Loss. Depreciation is a non-cash item, as it is an allocation of the cost of an asset in the statement of profit & loss, out of the amount of fixed assets. Accordingly, the net amount of fixed assets (after depreciation) is shown in the balance sheet.

Depreciation is calculated on the basis of cost of an asset, less its residual value.

2.6 What is revaluation?

Where there is a change in fair value of the fixed assets, the revaluation model is applied. Fair value is the price that would be received, when an asset is sold. Fair value is not necessarily the market price.

2.7 Fixed asset is a non-current asset

Fixed asset is non-current asset, and accordingly in the balance sheet shown under head non-current assets.

2.8 Derecognition of Property, Plant and Equipment

PPE is derecognized (eliminated) from Balance Sheet when PPE is disposed off or no future economic benefits expected from its use or disposal.

The gain or loss arising from the derecognition of an item of property, plant and equipment shall be the difference between

• Net disposal proceeds, if any, and
• Carrying amount of the item.

The disposal of an item of property, plant and equipment may occur in a variety of ways (e.g. by sale, by entering into a finance lease or by donation). The date of disposal of an item of property, plant and equipment is the date the recipient obtains control of that item in accordance with the requirements of determining when a performance obligation is satisfied in Ind AS 115. Ind AS 116 applies to disposal by a sale and leaseback.

The amount of consideration to be included in the gain or loss arising from the derecognition of an item of property, plant and equipment is determined in accordance with the requirements for determining the transaction price. Subsequent changes to the estimated amount of the consideration included in the gain or loss are to be accounted for in accordance with the requirements for changes in the transaction price in Ind AS 115.

If the entity rents some assets and later ceases to rent them, the asset is required to be transferred to inventories in their carrying amounts as they are now held for sale.

3. How to Decode?

Having explained the importance of tangible fixed assets in forensic accounting investigation and various relevant details about the fixed assets, and information as available in the financial statement in Table given below, how to decode the issues relating to investment in fixed assets is explained.

4. Case Analysis – Case of Bhushan Steel Limited Substantial Investment in Plant and Machinery Which Never Existed

This case analysis pertains to Bhushan Steel Limited (Bhusan) – a company listed on NSE and BSE and was part of list of 12 companies selected by Reserve Bank of India (based on large advances from the banks) for insolvency proceedings under the Insolvency and Bankruptcy Code, 2016. Bhushan Steel’s insolvency case was resolved in May 2018. This company was engaged in the business of manufacturing auto grade steels. Addition to fixed assets of Rs. 26,478 crores was made during the period 2013 to 2017. However, the overall increase in revenue was only Rs. 3,227 crores.

In the Box 1, the details of gross block, addition during the year, adjustment/deductions from the gross block and closing gross block for the period FY 2013 to FY 2017 is shown, which are prior to IBC proceedings.

BOX 1

Details of Fixed Assets (Property, Plant & Equipment) – Only Gross Block (Rs. in crore)

Note: Please note that only the details of gross block of fixed assets is provided in the above Box and details of depreciation, net block being not relevant to the issue under consideration, not provided.

Analysis of details of fixed assets of Bhushan Steel’s for the period FY 2013 to FY 2017:

• From the perusal of the gross block of fixed assets, it can be seen that the total block of fixed assets which was at Rs. 18,160 crore as on 1st April 2012, has increased to Rs. 44,638 crore as of 31st March, 2017.
• The net addition during the period of 5 years FY 2013 to FY 2017 is of Rs. 26,478 crore.
• The major break-up of the said addition to gross block of fixed assets pertains to:

1. 1. Plant & Equipment (Rs. 34,147 crore minus Rs. 13,353 crore) = Rs. 20,794 crore
   2. Railway Sliding (Rs. 2,832 crore minus Rs. 209 crore) = Rs. 2,623 crore
   3. Building (Rs. 7,089 crore minus Rs. 4,176 core) = Rs. 2,913 crore

• Thus, out of the total addition to fixed assets of Rs. 26,478 crore, the major addition pertains to plant and equipment of Rs. 20,794 crore. On the basis of information provided for each year, it can be seen that addition inter alia includes certain adjustments on account of borrowing cost/exchange fluctuation which has been capitalised during installation period. The total amount pertaining to such adjustment for the period FY 2013 to FY 2017 comes to Rs. 8,088 crore, out of the total addition of Rs. 20,794 crore to plant and equipment.

Therefore, in forensic accounting investigation the genuineness of investment in fixed assets is required to be examined. As can be seen that out of the total addition to fixed assets of Rs. 26,478 crore, excluding the amount of borrowing cost and exchange fluctuation which is capitalized, the amount of addition is Rs. 18,390 crore (i.e. Rs. 26,478 minus Rs. 8,088 crore) which can be said towards purchases of actual, real new plant & equipment.

For the purpose of forensic accounting investigation of plant and equipment, one need to find out the manufacturing capacity, so as to find out is there any increase in manufacturing capacity as a result of such investment (any addition to fixed assets is in fact an investment) of Rs. 20,794 crore. However, the details of production capacity as well as actual production in terms of quantity were not made available in annual reports. Therefore, the manufacturing sales are being analysed, which indirectly indicates the sales out of the production.

In Box 2, the details of revenue from operation for the year FY 2013 to FY 2017, is provided, as in the forensic audit, the amount of addition to fixed assets needs to be compared with the revenue from operation, as explained in Table 20, under the head “How to decode?”.

BOX 2

Revenue From Operations (Rs. in crore)

Linking of Investment in Plant & Equipment to Revenue from Manufacturing (‘finding the truth’- finding the truth is one of the tools of forensic accounting investigation.)

• As can be seen from the analysis of fixed assets (Box 1) that in plant and equipment addition of Rs. 20,794 crore during the period FY 2013 to FY 2017 was made. As against this, the gross revenue from operations has almost remained same for FY 2013 to FY 2017. It is only in FY 2017, there is minor change in revenue, which has increased by Rs. 1,903 crore as compared to FY 2016.
• The following position of amount of investments in plant & equipment and the resulting total gross revenue from operation, indicates that in the case of Bhushan Steel Limited, the entire resources used in plant & equipment, were washed away:

(Rs. in crore)