QURIES ON AS-26. (1) Accounting for the profit arising from a sale and lease-back transaction.

Transcription

1 QURIES ON AS-26 (1) Accounting for the profit arising from a sale and lease-back transaction. 1. A company registered under the Companies Act, 1913, is carrying on the business of banking. Its operations are subject to the provisions of the Banking Regulation Act, and the Reserve Bank of India Act. The company has invested sizeable amounts in acquiring movable and immovable assets for the use of its branches and administrative offices. The cost of the movable fixed assets, comprising safe deposit lockers, air-conditioners, computers, gensets, motor-vehicles and other furniture & fixtures, as on was Rs.6.50 crores as against the written down value of Rs.2.52 crores (a copy of the annual reports of the company for the financial year has been submitted by the querist). As per the querist, the estimated present market value of these movable fixed assets is more than Rs. 5 crores. 2. The querist has stated that the company has a proposal by which a major part of the movable fixed assets of the company would be sold to a leasing company and taken back on a 5 year lease on payment of monthly/quarterly lease rentals. By virtue of the sale, the company would be able to book a profit of about Rs crores which, in the view of the querist, would be outside the ambit of taxation since section 41(2) of the Income-tax Act, 1961, has been deleted with effect from the assessment year (the balance in the block of assets is sufficient to cover the sale proceeds of these assets). The rentals paid during the lease period would be debited to the profit and loss account. The assets, as per the querist, would revert back to the company on the expiry of the lease period on payment of the residual value which is estimated to be 1%. The company, as per the querist, intends to use the profit generated from the proposed scheme of sale and lease-back for meeting the provisioning requirements in respect of non-performing assets, as per the prudential accounting standards, stipulated by the Reserve Bank of India (RBI) for the commercial banks, beginning from the financial year The querist has sought the opinion of the Expert Advisory Committee on the following issues: (a) (b) Whether the company can take to the credit of its profit and loss account, the profit accruing to it under the scheme of sale and lease-back, as stated at para 2 above? If yes, whether the profit so credited can be used for making the provision in respect of non-performing assets, as per the prudential accounting standards of the RBI?

2 (2) Amortisation of goodwill, trade marks and copyrights purchased. 1. A company has spent a substantial amount on purchase of goodwill, trade marks and copyrights, of which 95 % of the amount has been spent on the purchase of trade marks and copyrights. Schedule XIV to the Companies Act, 1956, does not give any rate of depreciation for these assets. 2. In the opinion of the querist, based on prudent accounting principles, these intangible assets should be amortised in the financial records over their useful estimated economic life as may be best determined by the management of the company. However, the company is not willing to amortise these intangible assets in the financial records on the contention that these are permanent in nature and do not require any amortisation. 3. The querist has sought the opinion of the Expert Advisory Committee that in case of nonamortisation of the intangible assets in question, does the auditor need to give a note in the financial accounts and, if yes, does the auditor give a note in the Notes to the accounts and refer to it in the report or a note should be given in the auditors report? (3) Accounting treatment of technical know-how A. Facts of the Case 1. An industrial engineering company is engaged in the manufacture of earthmoving equipment for supply to various core sectors of the economy. 2. According to the querist, right from its inception, the company has been having collaboration agreements with earthmoving equipment manufacturers in various countries. These collaboration agreements relate to know-how comprising drawings and designs and training of personnel for manufacture of various earthmoving equipments. The terms and conditions usually provide for a lumpsum amount payable in instalments, viz., first instalment at the time of receipt of designs and drawings and subsequent instalments after a certain period of time. The company at no point of time had any occasion to have a collaboration agreement relating to plant and machinery. 3. The company was incorporated in 1964 and commenced its commercial production from Upto the financial year , the payment for technical know-how was exhibited under the head Miscellaneous Expenditure in the balance sheet and amortised over a period of time. From to , the entire expenditure towards technical know-how was charged off to profit and loss account. During the financial years and , the expenditure incurred on technical know-how was capitalised as a tangible asset and exhibited under the schedule of Fixed Assets and depreciation charged at 16.67%. The querist has stated that based on the observations of the government auditors, from the financial year onwards, the company switched back to carry forward of such expenditure under the head Miscellaneous Expenditure and its amortisation at the rate of 16.67%. As per the querist,

3 the company adopted this policy as it considered prudent to do so. As per the querist, the company follows a uniform policy of amortising expenditure incurred on technical know-how over a period of 6 years on technical assessment. 4. The querist has informed that during the course of audit of accounts for the year , the statutory auditors were of the view that the accounting policy followed by the company (viz., Expenditure incurred on purchase of technical know-how fee is amortised over a period of six years on technical assessment ) was not in consonance with paragraph 16.5 of Accounting Standard (AS) 10, Accounting for Fixed Assets, which states that know-how related to manufacturing processes is usually expensed in the year in which it is incurred. 5. According to the querist, the company s contention is that there is enough flexibility in-built in accounting for technical know-how as could be noticed from published annual reports of leading industrial establishments read with the opinion of the Expert Advisory Committee contained in Volume VI (Query No. 1.26), paragraph 9.7(a) of the revised Guidance Note on Treatment of Expenditure During Construction Period, (which was issued after AS 10 became mandatory) and Accounting Standard (AS) 6, Depreciation Accounting. 6. The relevant portion of paragraph 9.7(a) of the Guidance Note referred to above reads as under : 9.7 (a)... If, on the other hand, the technical know-how which is supplied relates to productive facilities and processes, the value would have to be treated initially as an item of deferred revenue expenditure to be amortised in suitable instalments after the commencement of production, preferably over a period not exceeding 3 to 5 years after the commencement of production The querist has stated that in view of the above, the company is of the opinion that the cost incurred on know-how is required to be matched with the income arising out of sale of equipment produced using such know-how. This criterion does not support the view of charging off the cost in the year of incurrence and hence accounting it as deferred revenue expenditure and amortising it over a number of years is a sound accounting practice. 8. The querist has also drawn attention to the following definition of depreciable assets contained in Accounting Standard (AS) 6: Depreciable assets are assets which (i) are expected to be used during more than one accounting period; and (ii) have a limited useful life; and (iii) are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business. 9. According to the querist, technical know-how being in the nature of a tangible asset fulfils all the three criteria and hence, can be construed as a depreciable asset. Accordingly, since its life exceeds a year, it may not be correct to expense the same in the year in which the cost is incurred as this would result in a mismatch between revenue and cost. The querist has stated that this practice is common with many companies, keeping in view the decision of Ahmedabad High Court in the case of Elecon Engineering Co. Ltd. [1974] [96 I.T.R. 673 (Guj.)] which was later confirmed by the Supreme Court. The querist has argued that the law applicable regarding accounting for fixed assets under the Income-tax Rules would apply mutatis mutandis under the Companies Act also. In addition, as per Accounting Standard (AS) 6, Depreciation Accounting, the definition of depreciation includes amortisation of assets whose useful life is predetermined. Hence, amortisation of cost of technical know-how as a depreciable asset is permissible which would also enable the same to be included as an item of fixed assets under Schedule VI to the Companies Act, 1956.

4 B. Query 10. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting practice followed by the company, i.e., amortising the cost of technical know-how procured for manufacturing processes, preferably over a period of 3-6 years, meets the requirements of company law/accounting practice. C. Points Considered by the Committee 11. The Committee is of the view that the manner of treatment of an item of expenditure in the books of account of an entity should be decided on the basis of the relevant accounting principles and practices rather than on the basis of the relevant tax provisions which might have been enacted to fulfil different objectives. 12. The Committee notes from the facts of the query that the technical know-how comprising drawings and designs and training of technical personnel, referred to in paragraph 2 of the query, relates prima facie to the process of manufacture of various earthmoving equipments and does not relate to plans or designs for plant and machinery. 13. The Committee further notes that paragraph 16.7 of Accounting Standard (AS) 10, Accounting for Fixed Assets, states as under: 16.7 Where the consideration for the supply of know-how is a series of recurring annual payments as royalties, technical assistance fees, contribution to research, etc. such payments are charged to the profit and loss statement each year. The Committee observes that the payment for the technical know-how is a lumpsum amount, though payable in instalments over a period of years and is not in the nature of recurring payments as envisaged in paragraph 16.7 of AS 10. Therefore, paragraph 16.7 of AS 10 is not applicable in the present case. 14. The Committee further notes that paragraph 16.5 of the aforesaid Accounting Standard states as under:... Know-how related to manufacturing processes is usually expensed in the year in which it is incurred. In the opinion of the Committee, the wording of the above paragraph is such that it merely describes a prevalent accounting practice rather than laying down a specific accounting treatment for the item in question. Also, the use of the word usually in the above-mentioned paragraph indicates that AS 10 recognises that there are situations where expensing of such costs is not considered appropriate. 15. The Committee also notes opinion 1.26 contained in the Compendium of Opinions, Volume VI, issued by the Committee, referred to in paragraph 5 of the query. 16. The Committee further notes that the accounting treatment of expenditure incurred on know-how related to productive facilities and processes has been discussed in the Guidance Note on Treatment of Expenditure During Construction Period issued by the Institute of Chartered Accountants of India. Paragraph 9.7(a) of this Guidance Note states as follows:... the consideration, if any, which is paid separately for the value of the technical know-how supplied by the contractors, would have to be accounted for, depending on the nature of the technical know-how which is supplied. If the technical know-how which is supplied by the contractors relates to the construction of the plant, it may be added to the value of the plant.... If, on the other hand, the technical know-how which is supplied relates to productive facilities and processes, the value would have to be treated initially as an item of deferred revenue expenditure to be amortised in suitable instalments after the commencement of production, preferably over a period not exceeding 3 to 5 years after the commencement of production. Any consideration paid separately to the contractors for

5 training the technicians of the purchasing company would have to be treated also as deferred revenue expenditure The Committee is of the view that though the Guidance Note lays down the accounting principles described in paragraph 9.7(a) in the context of projects under construction, these principles would also apply to enterprises which are already engaged in commercial activities. (4) Accounting for acquisition of a trademark A. Facts of the Case 1. Company K is a private limited company engaged in the business of organizing tours and other related travel services. In June 2001, K entered into various agreements with company T and its principal shareholders and directors, viz., M and A. These agreements relate to the following: (i) Brand agreement Under this agreement, K obtained an exclusive license to use T s trademark (the mark is pending registration and is in the name of T in Mumbai under the Trade and Merchandise Marks Act, 1958) for a period of five and a half years with an exclusive option to acquire the trademark earliest at the expiry of three years, i.e., earliest on June 30, 2004, at a consideration contingent upon future earnings. (ii) Website and domain name agreement Under this agreement, K obtained an exclusive license to use T s domain name ( domain name ) for a period of 15 months with an exclusive option to purchase the domain name at the closing date, i.e., September 30, 2002, at a predetermined price. (iii) Consultancy agreement Under this agreement, M has been appointed as a consultant for a period of three years, for a pre-determined compensation. In case the closing date for K to exercise its option to acquire the trademark is extended to year four and/or year five, the consultancy agreement would also be extended for the similar period but no consideration would be payable for the extended period. (iv) Non-compete agreement with M and A : Under this agreement, A has agreed not to compete with K s business for a period of five years from July 1, 2001, and M has agreed not to compete for a period of five years from the date of purchase of the trademark by K.

6 2. The querist has provided a synopsis of the brand agreement which states as follows: (i) Under the brand agreement, K has paid a non-refundable fee of Rs. 67 for the exclusive use of the trademark for a period of five and a half years. If K exercises its right to acquire the trademark by June 30, 2004, (earliest date for exercising the option to acquire the trademark), the license period shall stand appropriately shortened. On K exercising its right to acquire the trademark, T will execute a deed of assignment in favour of K transferring legal ownership rights of the trademark to K. (ii) T has represented that the use of trademark during the license period will result in K earning certain profits in year one, two and three. Based on the profits earned, K will make payments to T in accordance with the formula set out in the brand agreement. Till such time K does not exercise its right to acquire the trademark or declines to acquire the trademark, these payments are advance payments for both K and T and would be adjusted against consideration payable for the acquisition of the trademark,if the option to purchase the assets from T is exercised by K. (iii) If the estimated profits from the use of trademark during year one, two and three are not achieved, then the closing date for K to exercise its option to acquire the trademark is extended to year four and/or year five. It is pertinent to note that no minimum guaranteed price has been agreed for purchase of the trademark. (iv) In case K chooses not to acquire the trademark, T is obliged to return all amounts paid as advances towards acquisition of the trademark by K. In addition to the above, under the following circumstances also, K would be entitled to a refund of advances made for the trademark: (a) If the business from use of the trademark incurs a loss in any year till K exercises its option to acquire; (b) If T, M or A commit a breach of any provision of any of the above agreements; and (c) M suffers from any mental or physical incapacity within one year of the date of the agreement. (v) Till the time the option to acquire trademark is exercised by K, K has only the right to use the trademark and cannot be the legal owner or have ownership rights. The ownership rights continue to be vested with T during the license period.

7 (vi) Pending the decision to acquire the trademark, K has agreed to make advance payments towards acquisition of trademark at regular intervals as follows: Date of payment Amount (Rs.) Remarks June 30, Unconditional payment June 30, Unconditional payment September 30, 2002 September 30, 2003 September 30, /- x 165+/- x 164+/- x Based on the audited profits from use of trademark for the year ended June 30, 2002 Based on the audited profits from use of trademark for the year ended June 30, 2003 Based on the audited profits from use of trademark for the year ended June 30, 2004 ( x would represent the difference between the profit represented by T and actual profit). In addition to the above, separate considerations are being paid under website and domain name agreement, consultancy agreement, and non- compete agreement. (vii) In addition to the above payments, K shall also pay per cent per annum from July 1, 2001, to the actual date of payments or up to June 30, 2004, whichever is earlier, only if it acquires the trademark. 3. According to the querist, there can be two methods of accounting and disclosure of the brand agreement in the books of K. The querist has described the two methods as Option A and Option B. 4. The querist has stated that the accounting treatment under Option A would be as follows: (i) License Fees To amortise the license fee under the brand agreement over the period of the agreement. (ii) Advance payments towards acquisition of trademark

8 To account for and disclose as advances recoverable until such time K exercises its option to acquire the trademark or declines to acquire it. (iii) Trademark To capitalise only after K purchases them, i.e., from the date of purchase as per the agreement and thereafter amortise over their respective useful lives. (iv) Disclosure in notes to accounts (a) Under this option, no note would be included in the accounts with reference to Schedule VI (Note (g)) to the Companies Act, 1956, which mandates that any reference to benefits expected from the contracts to the extent not executed shall not be made in the balance sheet but shall be part of directors report. (b) There is no commitment on capital account as it is an option available to K. (c) Under this option, the balance payments are not a contingent liability since the contracts entered into do not cast any liability on K. The liability arises only at the time when K exercises its option to acquire the trademark. 5. As per the querist, the following is the rationale for following Option A: (a) Obligation of K to pay the advances arises when the use of trademark of T during the license period results in K earning profits, i.e., the obligation to pay advances is contingent in nature. (b) T is obliged to return advances paid by K in the event that K chooses not to acquire the trademark. (c) K has been legally advised that above agreements are exclusive and independent of each other and that its right to use the trademark is independent of its right to acquire the trademark. (d) All legal titles are not transferred in favour of K on July 1, The legal title would be transferred only after the option to acquire the same is exercised. The option cannot be exercised before June 30, (e) The legal effect of the agreements is not to bring about a transfer of all the risks and rewards to K. The exploitation of the benefits of the trademark is by virtue of the brand agreement. (f) The cost of acquisition cannot be ascertained reliably until the exercise of the option as the consideration will be dependent on the future profits earned.

9 6. The querist has stated that the accounting treatment under Option B would be as follows: (i) Capitalisation of trademark on July 1, 2001 Capitalise the intangible assets (right to acquire trademark) on July 1, 2001 at Rs. 791 being the estimated consideration payable (including license fees of Rs. 67) by K to T on the trademark achieving the profits represented by T. Thus, the license fee paid as well as the liability towards future payments would all be capitalised. (ii) Amortisation of intangible assets Amortise intangible assets from date of use, i.e., July 1, (iii) Disclosure in the notes to accounts Disclosure of the fact that the consideration payable for the brand acquisition would vary based on profits generated by use of the trademark. 7. As per the querist, following is the rationale for adopting Option B: (a) The agreement, if treated as a whole, despite its form, is in substance the purchase of the trademark. (b) The risks and rewards from the business arising from use of the trademark, i.e., the turnover, related expenditure and profits/losses arising from the use of the trademark belong to K during the period of the license agreement. (c) The business arising from the trademark would operate as a division of K and the business activity of T would cease. (d) The consideration is to be paid much before the option to purchase is exercised. (e) Interest on consideration which remains unpaid (not advances) is payable by K. (f) The profit targets in the agreement represented by T for the three years from July 1, 2001, are approximately three times the amounts payable by K by way of license fee, consultancy fee and non-compete fee to T, M and A. (g) The consideration envisaged between the two parties, i.e., the knowledgeable buyer and the knowledgeable seller has been determined and included in the agreement. Variations dependent on future event will be incorporated based on future developments.

10 (h) There are no developments at this stage to suggest that the option for acquisition of brand is not likely to be exercised. The company has paid Rs. 297 as on June 30, 2002, towards the above agreements. (i) As far as T is concerned, they have parted with their entire business. If the payments are viewed as being only an advance to be repayable by them in the event of non-acquisition of the trademark by K, the transaction may not make any economic sense from their angle. B. Query 8. The querist has sought the opinion of the Expert Advisory Committee on the following issues: (a) What is the appropriate accounting treatment for the trademark - whether Option A or Option B as on June 30, 2002, should be followed? (b) What disclosures would be required in the notes to accounts in respect of brand agreement? C. Points considered by the Committee 9. The Committee notes that the querist has sought the opinion of the Committee only in respect of the accounting treatment of trademark. Accordingly, the Committee restricts its opinion to this issue only. 10. The Committee notes that the company in question, namely, 'K', has acquired from 'T', an exclusive license to use the trademark for a period of 5 and 1/2 years and for this purpose it has paid a non-refundable fee of Rs. 67. The company has also acquired an exclusive option to acquire the trademark earliest at the expiry of 3 years. For this purpose, 'K' has agreed to pay Rs.33 on the date of the agreement and Rs. 197 after one year of signing the agreement as unconditional payments and has also agreed to pay, at the end of 1st, 2nd and 3rd year, amounts based on the estimated profits earned in accordance with a formula set out in the agreement. In case 'K' exercises its right to acquire the trademark these payments are considered as advance payments to be adjusted against the consideration payable for the acquisition of the trademark. In case 'K' decides not to exercise its option to purchase the trademark, the advance payments so made are to be returned to 'K'. The Committee further notes that if the estimated profits from the use of the trademark during years 1, 2 and 3 are not achieved, then the closing date for 'K' to exercise its option to acquire the trademark is extended to year 4 or year The Committee notes that the Institute of Chartered Accountants of India has issued Accounting Standard (AS) 26, Intangible Assets, which came into effect in respect of expenditure incurred on intangible items during the accounting periods commencing on or after and is mandatory in nature from that

11 date for certain enterprises. The Committee is of the view that although on the date of entering into the transaction in question, AS 26 is not applicable, yet it would be appropriate to consider the relevant requirements of the Standard since it lays down specific principles with regard to recognition and measurement of intangible assets which had, hitherto been governed by Accounting Standard (AS) 10, Accounting for Fixed Assets, read with the Framework for the Preparation and Presentation of Financial Statements (hereinafter referred to as the Framework ), issued by the Institute of Chartered Accountants of India, as discussed in paragraph 17 below. 12. The Committee notes the following definitions of the terms intangible asset and asset as per paragraph 6 of AS 26 and the explanation thereto as per paragraph 7 thereof: "An intangible asset is an identifiable nonmonetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes. An asset is a resource: (a) controlled by an enterprise as a result of past events; and (b) from which future economic benefits are expected to flow to the enterprise." "7. Enterprises frequently expend resources, or incur liabilities, on the acquisition, development, maintenance or enhancement of intangible resources such as scientific or technical knowledge, design and implementation of new processes or systems, licences, intellectual property, market knowledge and trademarks (including brand names and publishing titles). Common examples of items encompassed by these broad headings are computer software, patents, copyrights, motion picture films, customer lists, mortgage servicing rights, fishing licences, import quotas, franchises, customer or supplier relationships, customer loyalty, market share and marketing rights. Goodwill is another example of an item of intangible nature which either arises on acquisition or is internally generated." 13. The Committee is of the view that, keeping in view the facts of the case, the right to use the trademark for the business of the company is an intangible asset as it meets the definitions of the terms asset and intangible asset reproduced above. However, in order to consider whether the right to use the trademark should be recognised as an intangible asset, the recognition criteria prescribed in paragraph 20 of AS 26, as reproduced below, are to be considered: "20. An intangible asset should be recognised if, and only if: (a) it is probable that the future economic benefits that are attributable to the asset will flow to the enterprise; and

12 (b) the cost of the asset can be measured reliably." 14. The Committee is of the view that since it is probable that the future economic benefits that are attributable to the right to use the trademark will flow to the enterprise and that the costs incurred to use the trademark can be measured reliably (viz., Rs. 67 paid by the company), the right to use the trademark is an intangible asset to be valued at cost, namely, Rs. 67 and that the same should be amortised over its useful life of 5 ½ years. In case Company K decides to purchase the trademark at the end of the 3rd, 4th or 5th year, the useful life of the right to use the trademark will get shortened accordingly, and the written down value at the time of purchase, if any, should be charged to the profit and loss account. 15. With regard to the right of acquisition of the trademark at the end of the 3rd, 4th or 5th year, as the case may be, the Committee is of the view that while such a right may meet the requirements of the definitions of the terms intangible asset and asset, it does not meet the recognition criteria specified in paragraph 20(b) of AS 26 that the cost of the asset can be measured reliably, since the payments made as advances would be based on profits to be earned in future, even though one may consider that the payments, in substance, amount to acquisition of the trademark as argued by the querist under Option B. Accordingly, the payments made as advances should be treated as advances until it is decided to purchase the trademark. The trademark should be recognised as an asset when the decision to purchase the same is taken. The trademark so recognised should be shown at cost arrived at in accordance with the requirements of AS 26.

13 OPINION GIVEN BY ICAI ON AS -26 (1) Opinion 1. The opinion of the Committee expressed herein is restricted to the specific accounting issues raised in the query. Accordingly, the Committee has not considered the taxation and other aspects of the query. 2. The Committee notes paras 21 and 22 of Guidance Note on Accounting for Leases, issued by the Institute of Chartered Accountants of India, which read as follows: 21. A sale and leaseback transaction involves the sale of an asset by the vendor and the leasing of the same asset back to the vendor. The rentals and the sale price are usually interdependent as they are negotiated as a package and may not represent fair values. 22. If in the case of a leaseback, the rentals and the sale price are established at fair value, there has in effect been a normal sale transaction and any profit or loss is normally recognised immediately. If the sale price is below fair value, any profit or loss is recognised immediately, except that, if the loss is compensated by future rentals at below market price, it is deferred and amortised in proportion to

14 the rental payments over the useful life of the asset. If the sale price is above fair value, the excess over fair value is deferred and amortised over the useful life of the asset. 3. The Committee notes that the abovesaid guidance note, defines the term fair value as follows: Fair Value: The amount for which an asset could be exchanged between a knowledgeable, willing buyer and a knowledgeable, willing seller in an arm s length transaction. 4. On the basis of the above, the Committee is of the following opinion in respect of the issues raised at para 3 of the query: (a) The company should treat the sale and lease back transaction in question, in accordance with para 22 of Guidance Note on Accounting for Leases, issued by the Institute of Chartered Accountants of India, as reproduced at para 2 above. Thus, the treatment would depend upon whether or not the sale price and the rentals under the transaction are at fair values. (b) The question of recognition of profit or loss arising out of the transaction of a sale and lease back is independent of creation of any provision. The provision in respect of nonperforming assets has to be made irrespective of the result of the said transaction. (2) Opinion 1. The Committee notes para 38 of Accounting Standard (AS) 14 on Accounting for Amalgamations, issued by the Institute of Chartered Accountants of India, which is reproduced below:

15 The goodwill arising on amalgamation should be amortised to income on a systematic basis over its useful life. The amortisation period should not exceed five years unless a somewhat a longer period can be justified. 2. The Committee further notes that Accounting Standard (AS) 6 (Revised) on Depreciation Accounting, issued by the Institute of Chartered Accountants of India, does not apply to goodwill as per para 1 thereof. However, it applies to other intangible assets such as patents, copyrights and trade marks since the same are not excluded from the application of the standard as per the aforesaid paragraph. Further, the definition of the term depreciation, includes amortisation of assets whose useful life is predetermined (para 3.1). The definition of the term useful life as per para 3.3 of AS 6 is as below: Useful life is either (i) the period over which a depreciable asset expected to be used by the enterprise; or (ii) the number of production or similar units expected to be obtained from the use of the asset by the enterprise. 3. The Committee also notes with regard to patents, the nature of which is similar to that of copyrights, that Accounting Standard (AS) 10 on Accounting for Fixed Assets, issued by the Institute of Chartered Accountants of India, requires in para 37 as below: The direct costs incurred in developing the patents should be capitalised and written off over their legal term of validity or over their working life, whichever is shorter. 4. The Committee is further of the view that since the nature of trade marks, in substance, is akin to that of goodwill, the accounting treatment thereof should also be the same. Accordingly, trade marks should be written off over a period not exceeding five years unless a somewhat longer period is justified. 5. On the basis of the above, the Committee is of the opinion that: (a) goodwill and trademarks should be written off over a period not exceeding five years unless a somewhat longer period is justified, and

16 (b) copy rights should be written off over their legal term of validity or over their working life, whichever is shorter. In case the company does not amortise the aforesaid intangible assets as suggested above, it would be the duty of the auditor to qualify his report or give an adverse opinion, depending upon the materiality of the amounts involved, whether or not a note stating the non-amortisation of the said assets is included in the notes to accounts. (3) Opinion 18. On the basis of the above, the Committee is of the opinion that the payment for technical know-how comprising of drawings and designs and training of personnel of the nature specified in the query should be treated as deferred revenue expenditure to be separately disclosed in the balance sheet under the head Miscellaneous Expenditure and should be written off preferably over a period of 3 to 5 years as may be decided by the company after taking into consideration the facts and circumstances of the case. The above treatment does not, in the opinion of the Committee, violate the provisions of the Companies Act, 1956 relating to annual accounts. 18. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 8 above: (a) The company should follow Option A subject to the recognition of the right to use the trademark as an intangible asset at Rs. 67 which should be amortised over its useful life as discussed in paragraph 14 above. (b) Disclosures required by AS 26, for example, under paragraph 90, should be made from the date the Standard becomes mandatory for the company. Prior to AS 26 becoming mandatory, disclosures required by AS 10 should be made. --- (4) Opinion 16. On the basis of the above, the Committee is of the view that Option A suggested by the querist should be followed subject to the recognition of the right to use the trademark as an intangible asset.

17 17. As stated in paragraph 11 above, application of the requirements of AS 10 (read with the Framework ) which, prior to AS 26 coming into force dealt with accounting for intangible assets such as patents would, in the present case result in the same accounting treatment as that prescribed in AS 26. For instance, the right to use the trade-mark is an asset as per the Framework, which defines it in a similar manner as that in AS 26, as "a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise". Further, the said right is a fixed asset since it meets the definition of the term fixed asset as per AS 10, according to which a "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". Also, the said right meets the criteria for recognition of an asset as per paragraph 88 of the Framework reproduced below, which are also similar to those prescribed in paragraph 20 of AS 26 and reproduced in paragraph 13 above: "88. An asset is recognised in the balance sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and the asset has a cost or value that can be measured reliably." By the same token, since the right to purchase the trademark does not meet the recognition criteria prescribed in the Framework, as discussed in paragraph 15 above with reference to AS 26, the same cannot be recognised as an intangible asset.