Enquiry:
We would like to draw your kind attention towards a general issue related to Capitalization of Deferred Revenue Expenditure (Preliminary Expenses). According to para 69 (a) of International Accounting Standards-38 (IAS-38) Intangible Assets:-
QUOTED
“68 Expenditure on an intangible item shall be recognized as an expense when it is incurred unless:
a) it forms part of the cost of an intangible asset that meets the recognition criteria( see paragraphs 18-67); or
b) The item is acquired in a business combination and cannot be recgonised as an intangible asset. If this is the case, it forms part of the amount recognized as goodwill at the acquisition date (see IFRS 3).
69 In some cases expenditure is incurred to provide future economic benefits to an entity, but no intangible asset or other asset is acquired or created that can be recognised. In the case of the supply of goods, the entity recognizes such expenditure as an expense when it has a right to access those goods. In the case of the supply of services, the entity recognizes the expenditure as an expense when it is receives the services. For example, expenditure on research is recognized as an expense when it is incurred (see paragraph 54), except when it is acquired as part of a business combination. Other examples of expenditure that is recognized as an expense when it is include:
(a) Expenditure on start-up activities (i.e. start-up costs), unless this expenditure is included in the cost of an item of property, plant and equipment in accordance with IAS 16, Start-up costs may consist of establishment costs such as legal and secretarial costs incurred in establishing a legal entity, expenditure to open a new facility or business (i.e. pre-opening costs) or expenditure for starting new operations or launching new products or processes (Ice, preconditioning costs).”
UNQUOTED
Under the light of the above paragraph, it is not allowed to capitalize the preliminary expenditure in the period it is incurred.
According to the Section 25 of the Income Tax Ordinance, 2001, pre-commencement expenditures are allowable a tax expense for the purpose of calculating Taxable Income.
QUOTED
“25. Pre-commencement expenditure.- (1) a person shall be allowed a deduction
for any pre-commencement expenditure in accordance with this section.
2) Pre-commencement expenditure shall be amortized on a straight line basis at the rate specified in Part III of the Third Schedule.
3) The total deduction allowed under this section in the current tax year and all previous tax years in respect of an amount of pre-commencement expenditure shall not exceed the amount of the expenditure.
4) no deduction shall be allowed under this section where a deduction has been allowed under another section of this Ordinance for the entire amount of the pre-commencement expenditure in the tax year in which it is incurred.
5) In this section- pre-commencement expenditure means any expenditure incurred before the commencement of a business wholly and exclusively to derive income chargeable to tax, including the cost of feasibility studies, construction of prototypes and trial production activities , but shall not include any expenditure which is incurred in acquiring land or which is depreciated amortized under section 22 or 24.”
UNQUOTED
Based on the above paragraph, we are of the opinion that in the financial statements the Deferred Revenue Cost should be capitalized, for the reason that in case the incremental laws conflicts with the local laws, the local laws will prevail.
Opinion:
The financial reporting framework as applicable in Pakistan comprises of IASs/ IFRSs, Companies Ordinance 1984 and notifications issued by SECP as explained in ICAP Circular No. 7 of 2007. The relevant extracts of the circular is as follows:
The Professional Standards and Technical Advisory Committee in its 56th meeting held on September 10, 2007 also reviewed the following draft of the Statement of Compliance to be included in the financial statements of companies other than MSEs and SSEs:
“These financial statements have been prepared in accordance with approved accounting standards as applicable in Pakistan. Approved accounting standards comprise of such International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board as are notified under the Companies Ordinance, 1984, provisions of and directives issued under the Companies Ordinance, 1984. In case requirements differ, the provisions or directives of the Companies Ordinance, 1984 shall prevail.”
It is clear from reading the above that financial reporting framework as applicable in Pakistan does not include Income Tax laws. Further, under Section 25 of the Income Tax Ordinance, 2001, pre-commencement expenditures are allowable only as tax expense for the purpose of calculating Taxable Income.
The Committee is of the opinion that there is no ambiguity in the accounting treatment of preliminary expenses in IASs/ IFRSs and Companies Ordinance 1984 and these should not be capitalized.
(March 19, 2014)