Amortisation of Preliminary Expenses

Facts of the case:
A Company following AS used to amortize the preliminary expenses over a period of 5 year.

Issue/Query:
While transitioning to IND AS, can company fully amortize the remaining preliminary expenses in opening reserves or same treatment needs to followed i.e. amortization over of remaining life

Response:
While transitioning to Ind AS, the company has to derecognise the unamortised preliminary expenses and recognise the difference in retained earnings.

The company shall disclose the amount recognised in retained earning separately as error in previous GAAP in the statements reconciling previous GAAP amounts and Ind AS amounts.

Basis for Response:
Paragraph 56 of Accounting Standard (AS) 26 Intangible Assets states as under:
“In some cases, expenditure is incurred to provide future economic benefits to an enterprise, but no intangible asset or other asset is acquired or created that can be recognised. In these cases, the expenditure is recognised as an expense when it is incurred. For example, expenditure on research is always recognised as an expense when it is incurred (see paragraph 41). Examples of other expenditure that is recognised as an expense when it is incurred include:
Expenditure on start-up activities (start-up costs), unless this expenditure in included in the cost of an item of fixed asset under AS 10. Start-up costs may consist of preliminary expenses incurred in establishing a legal entity such as legal and secretarial costs, expenditure to open a new facility or business (pre-opening costs) or expenditures for commencing new operations or launching new products or processes (pre-operating costs);
Expenditure on training activities;
Expenditure on advertising and promotional activities; and
Expenditure on relocating or re-organising part or all of an enterprise.”

Therefore, preliminary expenses must be recognised as an expense when incurred in accordance with AS 26. The company has instead deferred the recognition of preliminary expenses over a period of 5 years. Therefore, the company has made an error in application of Accounting Standards.

Paragraph 69 of Ind AS 38 Intangible Assets provide a similar guidance. Therefore, the company cannot recognise preliminary expenses as an asset under Ind AS.

Paragraph 10 of Ind AS 101 states as under:
“Except as described in paragraphs 13-19 and Appendices B-D, an entity shall, in its opening Ind AS Balance Sheet:
Recognise all assets and liabilities whose recognition is required by Ind ASs;
Not recognise items as assets or liabilities if Ind ASs do not permit such recognition;
Reclassify items that it recognised in accordance with previous GAAP as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity in accordance with Ind ASs; and
Apply Ind ASs in measuring all recognised assets and liabilities.”

Therefore, the company shall derecognise the unamortised balance of preliminary expenses in its opening Ind AS balance sheet.

Paragraph 11 of Ind AS 101 states as under:
“The accounting policies that an entity uses in its opening Ind AS Balance Sheet may differ from those that it used for the same date using its previous GAAP. The resulting adjustments arise from events and transactions before the date of transition to Ind ASs. Therefore, an entity shall recognise those adjustments directly in retained earnings (or, if appropriate, another category of equity) at the date of transition to Ind ASs.”

Therefore, any adjustment resulting from derecognition of unamortised preliminary expense shall be recognised in retained earnings.

Appendix A of Ind AS 101 First-time Adoption of Indian Accounting Standards defines Previous GAAP as under:
“The basis of accounting that a first-time adopter used for its statutory reporting requirement in India immediately before adopting Ind ASs. For instance, companies required to prepare their financial statements in accordance with Section 133 of the Companies Act, 2013, shall consider those financial statements as previous GAAP financial statements.”

The company shall consider the financial statements prepared in accordance with Accounting Standards notified under Companies (Accounting Standards) Rules, 2006 as the previous GAAP financial statements. Therefore, the company has made an error in application of previous GAAP.

Paragraph 26 of Ind AS 101 states as under:
“If an entity becomes aware of errors made under previous GAAP, the reconciliations required by paragraph 24(a) and (b) shall distinguish the correction of errors from changes in accounting policies.”

Therefore, the company shall disclose the amount recognised in retained earnings on derecognition of preliminary expenses separately as error in application of previous GAAP in the statements reconciling previous GAAP amounts and Ind AS amounts.