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Discussions on Accounting Issues
Views of the Accounting Standards Board on certain accounting issues raised recently in the Newspapers.
1. Designs, Drawings and Product Development, brand, trademarks - tangible or intangible?

The Board presumes that the items given under this issue are of the nature of 'assets' and the issue relates only to the classification thereof.

The Board noted that Accounting Standard (AS) 10, 'Accounting for Fixed Assets', deals both with tangible and intangible assets which are of the nature of fixed assets. In respect of designs and drawings the relevant paragraphs of the standard are as below:

"16.4 Know-how in general is recorded in the books only when some consideration in money r money's worth has been paid for it. Know-how is generally of two types.

(i) relating to manufacturing processes; and

(ii) relating to plans, designs and drawings of buildings or plant and machinery.

16.5 Know-how related to plans, designs and drawings of buildings or plant and machinery is capitalised under the relevant asset heads. In such cases depreciation is calculated on the total cost of those assets, including the cost of the know-how capitalised Know-ho related to manufacturing processes is usually expensed in the year in which it is incurred.

16.6 Where the amount paid for know-how is a composite sum in respect of both the types mentioned in paragraph 16.4, such consideration is apportioned amongst them on a reasonable basis".
The Board also noted the definition of 'intangible asset' given in the Guidance Note on Terms Used in Financial Statements', as follows:

"Asset which does not have a physical identify, e.g. goodwill, patents, copyright etc.

Accordintly, brands and trademarks are intangible in nature.

Insofar as product development is concerned, Accounting Standard (AS) 8, Accounting for Research and Development, which deals with expenditure incurred on research and developemnt may be relevant. According to AS8, research and development has been defined as below:
    (i) Research is original and planned investigation undertaken with the hope of gaining new scientific or technical knowledge and understanding

    (ii) Development is the translation of research findings or other knowledge into a plan or design for the production of new or substantially improved materialsm, devices, products, processes, systems or services prior to the commencement of commercial production".
As per AS 8, in case the research and development expenditure is decided to be deferred on the basis of the criteria laid down in paragraph 9 thereof, deferred research and development expenditure should be separately disclosed in the balance sheet uner the head 'Miscellaneous Expenditure (Paragraph 16).

The Institute of Chartered Accountants of India has recently issued Accounting Standard (AS) 26, Intangible Assets, which will come into effect in respect of expenditure incurred on intangible items during accounting periods commencing on or after 1.4.2003 and will be mandatory in nature from that date for the following:
  1. Enterprises whose equity or debt securities are listed on a recognised stock exchange in India, and enterprises that are in the process of issuing equity or debt securities that will be listed on a recognised stock exchange in India as evidenced by the board of directors' resolution in this regard.

  2. All other commercial, industrial and business reporting enterprises, whose turnover for the accounting period exceeds Rs. 50 crores.

In Respect of all other enterprises, the Accounting Standard will come into effect in respect of expenditure incurred on intangible items during accounting periods commencing on or after 1.4.2004 and will be mandatory in nature from that date.

On AS 26 becoming mandatory for the concerned enterprises, AS 10 shall be withdrawn. This standard specifically deals with intangible assets and according to this standard. 'intangible asset' has been defined as below:
    "An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purpose".
Paragraph 7 of AS 26 further gives the examples of intangible items as below:
    "Enterprises frequently expend resources, or incurliabilities, on the acqusition, development, maintenance or enhancement of intangible resource such as scientific or technical knowledge, design nd implementation of new processes or system, licences, intellectual property, market knowledge and trade-marks (including brand names and publishing titles). Common examples of items encompassed by these broad headings are computer software, patents, copy rights, motion picture films, customer lists, mortage servicing rights, fishing licences, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketting rights. Goodwill is another example of an item of intangible nature which either arises on acquisition or is internally generated."

    On the basis of the above, it may be noted that designs drawings, product development brand and trademarks are intangibles, although at present, as per AS 10, designs and drawings cost may have to be added in thecost of the relevant assets.
2. Books, Marketing Know - how - tangible or intangible?
The Board noted paragraph 9 of AS 26 which is reproduced below:

"Some intangible assets may be contained in or on a physical substance such as a compact disk (in the case of computer software), legal documentation (in the case of a license or patent) or film (in the case of motion pictures). The cost of the physical substance containig the intangible assets is usually not significant. Accordingly, the physical substance containing an intangible asset, though tangible in nature, is commonly treated as a part of the intangible asset contained in or on it".

On the basis of the above, the Board noted that while ordinarily books are tangible as having a physical identity, books with high technical content may be of the nature of intangibles. Similarly, on the basis of the definition of "intangible asset and and paragraph 7 of AS 26, quoted in Issue No 1 above, marketing know-how is also intangible.
3. Moulds - Tangible or Intangible

The Board is of the view that moulds are tangible, in view of the fact that these are not intangibel in nature as per the definitions of Intangible assets reproduced in Issue No 1. above.
4. Property Time Sharing Units - Fixed Assets or Investments?

The Board noted the definition of fixed assets given in AS 10 as below:

"6.1 Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business".

The Board also noted the following definition of the term 'investments' as given in paragraph 3 of AS 13, Accounting for Investments:

"3 Investments are assets held by an enterprise for earning income by way of dividends, interest, and rentals for capital appriciation, or for to other benefits fo the investing enterprise. Assets held as stock-in-trade are not 'investments'.

The Board is of the view that whether property time sharing units are fixed assets or investments would depend upon the intention for which these are held. In case such units are held with the intention of being used for the purpose of providing services, for example, as a facility to its employees, and are not held for sale in the normal course of business, these should be considered as fixed assets. However, where the intention of holding such units is to earn income by way of capital appreication or for similar benefits to the investing enterprises, these would be considered as investments.
5. Project Under Sale - Fixed Asset or Current Asset?

The Board noted paragraph 24 of Accounting Standard (AS) 10, Accounting for Fixed Assets, which is reproduced below:

"24 Material items retired from active use and held for disposal should be stated at the lower of their net book value and net realisable value and shown separetely in the financial statements".

In view of the above, the Board is of the view that project under sale if its was originally treated as a fixed asset would continue to be a fixed asset would continue to be a fixed asset even if it is under sale and will not, therefore, be classfied as a current asset.

The board is also of the view that if an enterprise is a dealer of projects, then the project under sale would be an inventory and will be classified as a current asset.
6. Incentive from State Government - Income or capital subsidy?

The Board noted the following definition of 'Government grants' as per AS 12, Accounting for Government Grants:

"Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transations of the enterprises".

On the basis of the above, the Board is of the view that incentive from State Government is a government grant.

The Board also noted that whether incentive from State Government is an income or a capital subsidy would depend upon its nature as per AS 12. For instance incase the incentive is of the nature of promoter's contribution it would be a capital subsidy. However, if it is related to revene, it would be recognsed as income in accordance with the requirements of AS 12.
7. Loss on sale of investments is deducted directly from Investment Reserves - Whether unusual accounting?

The Board noted that Clause 3 (xii)(a) of Part II of Schedule VI to the Companies Act, 1956, requires as follows:
    "Profits or losses on investments showing distinctly the extent of the profits or losses earned or incured on account of membership of a partnership frim to the extent not adjusted from any previous provision or reserve.

    Note: Information in respect of this item should also be given in the balance sheet under the relevant provision or reserve account".
The Board also noted paragraph 34 of AS 13, Accounting for Investments, which requires as below:
    "On disposal of an investment, the difference between the carrying amount and net disposal proceeds should be charged or credited to the profit and loss statement".
The Board also noted that the 'Preface to the Statements of Accounting Standards', issued by the Institute of Chartered Accountants of India, states in paragraph 4.1 as follows:
    "Efforts will be made to issue Accounting Standards which are in conformity with the provisions of the applicable laws, customs, usages and business environment of our country. However, if due to subsequent amendments in the law, a particular Accounting Standard is found to be not in conformity with such law, the provisions of the said law will prevail and the financial statements should be prepared in conformity with such law".
In view of the above, the Board is of the view that as perclause 3 (xii) (a) of Part II of Schedule VI to the Act, it is permissible, until such time as amendments are made to Schedule VI, to adjust loss on sale of investments against investment reserve only to the extent it was created by a debit to profit and loss account in earlier years and excess of loss should be charged to the profit and loss account.
8. A company transferred Land from "Fixed Assets" to "Current Assets" at market price and adjusted the excess value under "Capital Reserves" instead of "Revaluation Reserve". In subsequent years, the value was writen down gradually as" decline in market value" - whether unusual accounting?

The Board noted that in respect of this issue, the following are the possible treatments on the basis of facts and circumstances of each case:

A. In case the intention of the enterprises is to become a dealer of the asset which was hitherto treated as a fixed asset, it is permissble to transfer such assets to current assets.

With regard to the valuation of such assets, the following alternatives are available:
  1. Ordinarily, fixed assets reclassified as current assets should not be valued at market price which is higher than the carrying amoung of the said assets. Accordingly, assets reclassified as current assets should be valued at their carrying amoung appearing in the balance sheet or at the net reasliable value whichever is lower. In this case, no appreciation would be recognised either in the capital reserve or the revaluation reserve.

  2. It would be appropriate to value assets which were hitherto classified as fixed assets at their market price in order to determine the correcm profit on sale of such assets in the ordinary course of business. The excess of market value over the carrying amount at the date f reclassification can be transferred to revaluation reserve.

    The Board also noted another view that the question of revaluation reserve arises in a situation where a fixed asset is revalued and continues to be a fixed asset. However, incase an asset which was orginally classified as a fixed asset and is now classified as current asset, the excess can be transferred to a capital reserve instead of revaluation reserve.

    In support of this view, it is argued that the nature of revaluation reserve and capital reserve is the same as both cannot be used for distribution of divident. The 'revaluation reserve' is covered by the definition of 'capital reserve' as given in Part III of Schedule VI to the Companies Act, 1956. The relevant paragraph of Part III is reproduced below:

    "The expression 'capital reserve' shall not include any amount regarded as free or distribution through the profit and loss account; and the expression "revenue reserve" shall mean any reserve other than a capital reserve".
For subsequent accounting, the amount arrived at as per above on the date of reclassification would be treated as cost of the current assets for applying AS 2 which requires that inventories should be valued at cost or net realisable value whichever is lower.

B. In case the intention is not to deal in assets which were hitherto treated as fixed assets, but assets are retired from active use and held for disposal, these should continue to be calssified as fixed assets and treated as per paragraph 24 of AS 10 which is reproduced as below:
    "24 Material items retired from active use and held for disposal should be stated at the lower of thier net book value and net realisable value and shown separately in the financial statements".

9. A company capitalises interest cost of holding investments and adds to cost of investment every year, thereby understating interest cost in P&L Account - whether unusual accounting?

The Board noted that paragraph 6 of Accounting Standard (AS) 16 Borrowing Costs, requires as follows:
    "6 Borrowing costs that are directly attributable to the acquisiton, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing cost eligible for capitalisation should be determined in accordance with this Statement. Other borrowing costs should be recognised as an expense in the period in which they are incurred".
The Board noted the definition of 'qualifying asset' as per AS 16, as below:
    "A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale".
The Board further noted the explanation paragraph 5 to the above definition as below:
    "Examples of qualifying assets are manufacturing plants, power generation facilities, inventories that require a substantial period of time to bring them to a saleable condition, and investment properties. Other investments and those inventories that are routinely manufactured or otherwise produced in large quantities on a repectitive basis over a short period of time, are not qualifying assets. Assets that are ready for their intended use or sale when acquired also are not qualifying assets."
In view of the above, the Board is of the view that investments other than investment properties are not qualifying assets and therefore, interest cost of holding such investments cannot be capitalised. Further, even interest in respect of investment properties can only be capitalised if such properties meet the definition of qualifying asset, namely, that it encessarily takes a substantial period of time to get ready for its intended use or sale. Therefore, investment properties that are ready for their intended use or sale when acquired are not qualifying assets. Even where the investment properties meet the definition of 'qualifying asset', for the capitalisation of borrowing costs the other requirements of the standard such as that borrowing costs should be directly attributable to the acquisition or construction of the investment property and suspension of capitalisation as per paragraphs 17 and 18 of AS 16 have to be complied with.
10. A company adjusted diminution in the value of investment directly from Reserves. Thus, effect of this dimunution did not get reflected in the Profit & Loss Account - whether unusual acconting?

The Board noted that Clause 3 (xii) (a) of Part II of Schedule VI to the Act, requires as follows:

"Profits or losses on investments showing distinctly the extent of the profits or losses earned or incurred on account of membership of a partnership firm to the extent not adjusted from any previous provision or reserve.

Note: Information in respect of this item should also be given in the balance sheet under the relevant provision or reserve account".

The Board also noted that paragraph 33 of AS 13, Accounting for Investments, requires as below:

"Any reduction in the carrying amount and any reversals of such reduction should be charged or credited to the profit and loss statement".

The Board also noted that the 'Preface to the Statements of Accounting Standards', issued by the Institute of Chartered Accountants of India, states in paragraph 4.1 as follows:

"Efforts will be made to issue Accounting Standards which are in conformity with the provisions of the applicable laws, customs, usages and business environment of our country. However, if due to subsequent amendments in the law, a particular Accounting Standard is found to be not in conformity with such law, the provisions of the said law will prevail and the financial statements should be prepared in conformity with such law."

In view of the above, the Board is of the view that as per clause 3 (xii)(a) Part II of Schedule VI to the Act, it is permissible, until such time as amendments are made to Schedule VI, to adjust loss on sale of investments against investment reserve only to the extent it was created by a debit to profit and loss accont in earlier years and excess of loss should be charged to the profit and loss account.
11. A company which issued secured premium notes wrote off redemption premium directly from reserves - whether unusual accounting?

The Board noted that section 78, sub-section (2)(d) of the Companies Act, 1956, permits the use of the securities premium in providing for the premium payable on the redemption of any debentures of the company. The Board noted that secured premium notes are of the Nature of debentures. In view of this, the Board is of view that redemption premium can be written off against securities premium but not against general reserves or other similar reserves.
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