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Pre-operating expense
03-06-2007, 12:45 PM
Post: #1
Pre-operating expense
Good day to everybody, I just want to ask based on the the New Accounting Standards, what is the proper way or treatment for pre-operating expense. Thanks a lot[)]
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03-06-2007, 05:57 PM
Post: #2
 
Dear,

There is no concept of DEFERRED COST for listed companies either in Fourth Schedule to the Companies Ordinance, 1984 or in the IFRSs. Before the recent change in Fourth Scehdule to the Companies Ordinance, 1984, Companies were used to recognise various expenses as deferred cost including the pre-operating expenses. The provisions of the said schedule regarding Deferred Cost were contrary to the requirements laid down by the IFRSs, therefore the SECP has revised this schedule to create hormony between two legislations/guidelines.

IAS 38 deals with the recognition of Intangible Assets and has laid down a primary ciriteria in paragraphs 21, 22, 24 and then in paragraph 57 thereof. However, deferred cost has nothing to do with the concept of intangible asset and none of these paragraphs of IAS 38 render us to account for the Pre-operating Expenses as intangible asset.

Therefore, no listed company can defer the Pre-operating Expenses. These have to be charged to Profit and Loss account.

Care must be taken to conclude that such pre-operating expenses are not the costs qualifying for capitalization in Property, Plant and Equipment under paragraphs 16 and 17 of IAS 16. Pre-operating expenses are not the capital expenditure and as such do not qualify for capitalization under IAS-16 as well.

However, for your appropriate guidance I must quote Paragraph 17 (e) of IAS-16 which deals with capitalization of TRIAL RUN PRODUCTION EXPENSES or COST OF TESTING. These costs are incurred while checking that the asset capitalized is functioning properly and are recognized after dedcuting the net proceeds from selling any items produced such as samples produced while testing such asset.

Normally such TESTING COSTS or TRIAL RUN COSTS can arise only if some revenue is also arising therefrom against the production made during such testing or trial run. However, in some cases, although very rare, there are testing costs without any revenue. In these cases such costs will also be capitalized.

Companies must not take benefit of paragraph 17 (e) of IAS 16 to capitalize the operational losses form first year's operation caused by excessive depreciation and financial costs arising from newly capitalized assets declaring them the TRIAL RUN COSTS or TESTING COSTS. Auditors must be vigilant enough to stop or report such malpractices. I have seen an annual report of a textile company for the year 2005 where huge amounts have been capitalized under this provision as TESTING COST/TRIAL RUN COST to show the profits and auditors have failed to point out this matter in their report. I cannot quote its name here due to legal reasons. Authorities must see and check such cases. IAS 16 clearly mentions that such TESTING would produce samples only and in my view it is the essence of testing or trial run.

Still, if pre-operating expenses include some cost of testing or trial run expenses, these could be capitalized as a component of the cost of the related assets under IAS 16.

In all other cases, PRE-OPERATING EXPENSES have to be charged to profit and loss account.

Status of Unlisted companies is still not clear. Section 234 of the Companies Ordinance,1984 requires all companies to follow IFRSs but Fifth Schedule to the Companies Ordinance, 1984 (applicable to unlisted companies) provides the disclosure requirements that are quite different from IFRSs. Further, section 234 itself exempts the companies other than listed or the subsidiaries of listed companies to attach CASH FLOW STATEMENT and STATEMENT OF CHANGES IN EQUITY as a component of financial statements. This is not understandable as these both are the basic components of the financial statements as per IAS 1. However, the Institute of Charterd Accountants of Pakistan and Securities and Exchnage Commission both are working on this area an we hope that Fifth Schedule to the Companies Ordinance, 1984 would be shortly amended to bring it in line with IFRSs. ICAP has also currently issued Accounting Standard for Medium and Small enterprises that also provides the requirements similar to IFRSs in many areas.

Until then, as per my views, Unlisted Companies should also endevour to follow the IFRSs in true spirit.

Hope your querry has ben adequately replied.

Thanks.

Kamran.
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03-06-2007, 06:01 PM
Post: #3
 
Dear,

I gave you response in Pakistan's perspective. If you are from abroad, be informed that there is no such provision in IFRSs to defer the Pre-operating Expenses and these have to be expensed out in profit and loss account. However, if some of these expenses relate to testing of the newly installed asset then you have to follow paragraph 17 (e) of IAS 16.

Best regards,

Kamran.
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03-06-2007, 06:07 PM
Post: #4
 
Dear,

You must also see what your local laws require, if you are not from Pakistan as i do not know what is the requirement of your legislature at Phillipines. You must know that local laws always override/overrule the international standards and requirements.

Best regards,

Kamran.
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03-13-2007, 03:30 PM
Post: #5
 
Comprehensive reply Mr. Kamran. It was very useful for me too.

Mahmood Chaudhry
ACA, ACCA
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03-17-2007, 05:08 PM
Post: #6
 
Thank you Mahmood Sahib.

Kamran
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08-29-2007, 07:36 PM
Post: #7
 
Dear Kamran Sahib,

With reference to the above discussion, what would be the treatment of the pre incorporation expenses in respect of a private limited company which has not yet started any trade. The company has acquired some assets but for the financial year ended it had no trading activity nor had any other source of income.

As per my understanding the profit and loss account would be drawn once the trading is started. In absence of any stream of income, would it be appropriate to charge such expenses to Profit & Loss account? If yes, would it not be in contravention of matching principal? And if no, do we have the option to categorize such expenses as deferred cost and amortize once the revenue stream is operational?

Looking forward for your professional guidance.

Regards,
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08-30-2007, 04:36 PM
Post: #8
 
Dear Mr. Mahmood,

It's nice to see you at the forum after a long time.

ICAP has yesterday issues a circular which I am pasting hereunder

QUOTE

Circular No. 05/2007 August 29, 2007

ALL MEMBERS OF THE INSTITUTE

NOTIFICATION OF ACCOUNTING AND FINANCIAL REPORTING STANDARDS FOR MEDIUM-SIZED ENTITIES (MSEs) AND SMALL-SIZED ENTITIES (SSEs) AND REVISION OF THE FIFTH SCHEDULE TO THE COMPANIES ORDINANCE, 1984

Dear Member

On the recommendation of the Institute of Chartered Accountants of Pakistan (ICAP) the Securities and Exchange Commission of Pakistan (SECP) vide SRO No. 860(I)/2007 dated August 21, 2007 has notified the Accounting and Financial Reporting Standards for MSEs and SSEs issued by ICAP under Section 234(3) of the Companies Ordinance, 1984.

As the above notification also necessitated appropriate amendments to the Fifth Schedule to the Companies Ordinance, 1984, therefore on the recommendation of the ICAP, the SECP vide SRO 859(I)/2007 dated August 21, 2007 has also revised the said Fifth Schedule.

The above documents along with Accounting and Financial Reporting Standards for MSEs and SSEs may be downloaded from ICAP website using the following link

http//www.icap.org.pk/news/notificationsecp.htm

Members are advised to note the above.

Thanking you

Yours truly

Shahid Hussain

Director Technical Services


UNQUOTE

The standard for medium size entities is basically an epitome of the IFRSs in a broad spectrum.

As per my info AFF has currently adopted the practice to draw up the profit and loss account of all such entities for charging up the pre-incorporation expenses and advises the clients not to take up any amount to deferred cost.

I have yet to study the fifth schedule (revised) so I cannot precisely comment on the issue, but I personally feel that no pre-incorporation expense should now be deferred and the companies should draw up profit and loss account even if these are not in operation so far. Any loss will be taken to the balance sheet.

I will come back to you soon after having a look on the pronouncements.

Best regards,

Kamran.
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08-31-2007, 04:38 PM
Post: #9
 
Dear Mr. Mahmood Ch.

Now Fifth schedule (revised) does not allow for or provide for deferring any pre-incorporation expenses as deferred cost.

You will have to draw up the profit and loss account of the private limited company referred by you and the loss will be taken to equity / balance sheet.

As far as matching principle is concerned, Mahmood Sahib, what would you opine about matching the cost with the benefits in this case. Would deferring such expenses and amortising them in three to five years would tentamount to appropriate compliance of matching principle. I think the benefit of incorporating a company and incurring incorporation expenses will go for all the life time of the company in perpetuity and cannot be consumed in (say) three or five years. However, this is a lengthy discussion. We have to do what legislature requires.

No deferred cost could be recognised in any unlisted compny or other concern which comes under the definition of medium size entity.

Hope to see your regular visits to the forum and to have your professional views on various matters raised herein by the members.

Best regards,


Kamran.
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09-07-2007, 06:25 PM
Post: #10
 
Thanks Kamran Sb.

The position has also been clarified through the accounting standards issued by ICAP and notified by SECP. Start up costs can not be capitalized and have to be written off.

Regards,
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01-29-2009, 05:31 PM
Post: #11
 
Dear Kamran

It is great to take some very useful knowledge about this topic, but i can concern about what is the treatment of pre-operating expenses in the light of Income Tax Ordinance 2001, because Income Tax Department wants to deffered pre-operating expenses and amortized it on 3 to 5 year basis

Best regards

Haris
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01-29-2009, 07:59 PM
Post: #12
 
Dear,

During last year, this issue was discussed by me on some other thread the link of which I don't remember as for now.

Please be informed that Corporate Entities don't have to follow ITO 2001 for the preparation of financials. The financial reporting frame-work has to be followed, and in Pakistan this framework is the Companies' Ordinance, 1984, directives issued by SECP, IFRS, local standards fro MSEs and SSEs, legal and non-legal GAAPS etc. ITO 2001 is not included in financial reporting framework, one must understand.

Therefore, while drafting financial statements, adopting accounting policies, making accoutning estimates and considering all recognition and measurement criterias, the corporate entities have to follow the applicable financial reporting framework. To that extent Income tax law has no bearing. It is only relevant while calculating tax liabilities. This is the thing to be understood.

Now, what you have pointed out is a valid observation at its own. However, the presence of such provisio in income tax law depicts the indifferent behaviour we possess at large. So many laws of Pakistan don't match with each other. This is a fact. Some laws even have conflicting issues within their own text. Income Tax Ordinance should have been amended after the relevant amendment of the Companies' Ordinance 1984. If such amendment has not so far been made, it does not provide any room for deviating from the financial reporting framework applicable in Pakistan.

Notwithstanding the above, ITO 2001 no where makes it compuslion to defer such costs and amortise over 5 years. It only provides how such balance would be amortised if it exists in the balance sheet. if no body will recognise such asset, there would be no question of amortisation. I refer you to study section 25 (4) of ITO 2001 for the sake of clarity. It states

"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."

Therefore, it is apparent that deferring of such costs is not even warranted as a compulsion by income tax law.

I think it would be enough for you to understand the issue. However, if you are dissatisfied with the answer, please let me know.


Regards,



KAMRAN.
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02-22-2009, 07:27 PM
Post: #13
 
Dear,

Hi how are u all, i have jes logged my self here, i hope some one could help me with a bit of info i require.

I am an audit trainee in muscat oman, i jes wanted to know according to IFRS wat do i have to do to pre-operating expenses in the first year of the bussiness & if possible you can send me a format of it .

Thanking you
Mahek
Have a good day everyone [)]
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02-23-2009, 03:46 PM
Post: #14
 
Mahek,

Simply expense out in the profit and loss account. Simple entry shall be passed in the books of accounts as

Pre-operating Expensese Dr
Bank Cr.

Then pre-op expenses shall be reported in the profit and loss account.

Regards,

*
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02-23-2009, 05:50 PM
Post: #15
 
Dears,

The unermentioned is a portion of my first post on this thread. You may find it helpful so I am copying it here


QUOTE


Care must be taken to conclude that such pre-operating expenses are not the costs qualifying for capitalization in Property, Plant and Equipment under paragraphs 16 and 17 of IAS 16. Pre-operating expenses are not the capital expenditure and as such do not qualify for capitalization under IAS-16 as well.

However, for your appropriate guidance I must quote Paragraph 17 (e) of IAS-16 which deals with capitalization of TRIAL RUN PRODUCTION EXPENSES or COST OF TESTING. These costs are incurred while checking that the asset capitalized is functioning properly and are recognized after dedcuting the net proceeds from selling any items produced such as samples produced while testing such asset.

Normally such TESTING COSTS or TRIAL RUN COSTS can arise only if some revenue is also arising therefrom against the production made during such testing or trial run. However, in some cases, although very rare, there are testing costs without any revenue. In these cases such costs will also be capitalized.

Companies must not take benefit of paragraph 17 (e) of IAS 16 to capitalize the operational losses form first year's operation caused by excessive depreciation and financial costs arising from newly capitalized assets declaring them the TRIAL RUN COSTS or TESTING COSTS. Auditors must be vigilant enough to stop or report such malpractices. I have seen an annual report of a textile company for the year 2005 where huge amounts have been capitalized under this provision as TESTING COST/TRIAL RUN COST to show the profits and auditors have failed to point out this matter in their report. I cannot quote its name here due to legal reasons. Authorities must see and check such cases. IAS 16 clearly mentions that such TESTING would produce samples only and in my view it is the essence of testing or trial run.

Still, if pre-operating expenses include some cost of testing or trial run expenses, these could be capitalized as a component of the cost of the related assets under IAS 16.

In all other cases, PRE-OPERATING EXPENSES have to be charged to profit and loss account.


UNQUOTE

Rule is to expense out the pre-operating expenses in profit and loss account unless they qualify to make a part of some intangible or tangible asset under specific provisions of any IFRS/IAS.


Regards,


KAMRAN.
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