preliminary and pre-operative exp

[yoganand l]

can some one give me a list of diff. between preliminary and pre-operative expenditure.

also provide me some data about the accounting treatment of the same.

 

yogan.

[Manoj Mishra]

Prelimanary expenses are those expenses which is incurred before and in relation to the incorporation of company and preoperative expenses are those exp. which are incurred before the company commences/starts its actual operation.

 

professional and govt fees, acquisition of assets etc before the incorporation are prelim expenses.

 

expenses in acquisition and installment of assets, expenses incurred on recruiting/retaining employee etc after the incorporation but before commencement of business operations are the pre-operative exp.

 

Prelimanary exp are capital exp always but pre-operative exp. may or may not be capital exp.

 

Please correct me if I am wrong.

 

Regards,

CS Manoj Mishra   

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[csarengarajan]

Please refer section 35D of Income tax act 1961  provides amortization of preliminary expenses. The following are preliminary expenses. Other than the following expenses are treated as pre-operative expenses. The same may be capitalised once the corporate start commence the production activities.

 

 (a) Expenditure in connection with -   (i) Preparation of feasibility report;

(ii) Preparation of project report;

(iii) Conducting market survey or any other survey necessary for the business of the assessee;

(iv) Engineering services relating to the business of the assessee :

Provided that the work in connection with the preparation of the feasibility report or the project report or the conducting of market survey or of any other survey or the engineering services referred to in this clause is carried out by the assessee himself or by a concern which is for the time being approved in this behalf by the Board;

(b) Legal charges for drafting any agreement between the assessee and any other person for any purpose relating to the setting up or conduct of the business of the assessee;

(c) Where the assessee is a company, also expenditure -  (i) By way of legal charges for drafting the Memorandum and Articles of Association of the company; 

(ii) On printing of the Memorandum and Articles of Association;

(iii) By way of fees for registering the company under the provisions of the Companies Act, 1956 (1 of 1956); 

(iv) In connection with the issue, for public subscription, of shares in or debentures of the company, being underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus; 

(d) Such other items of expenditure (not being expenditure eligible for any allowance or deduction under any other provision of this Act) as may be prescribed.

(3) Where the aggregate amount of the expenditure referred to in sub-section (2) exceeds an amount calculated at two and one-half per cent - (a) Of the cost of the project, or

 Hope this will give clear picture about preliminary and pre operative expenses

 

Contrary views solicited.

 

Regards

 

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csarengarajan
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[csarengarajan]

Only pre operative expenses will be capitalised . The preliminary expenses mentioned in section 35D will be amortized as per the provisions of Income tax act, 1961

 

Regards

 

[csarengarajan]

The reproduction of section 35D is as follows. Kindly go through the same for  accounting treatment   Section 35D AMORTISATION OF CERTAIN PRELIMINARY EXPENSES. (1) Where an assessee, being an Indian company or a person (other than a company) who is resident in India, incurs, after the 31st day of March, 1970, any expenditure specified in sub-section (2), -  (i) Before the commencement of his business, or  (ii) After the commencement of his business in connection with the extension of his industrial undertaking or in connection with his setting up a new industrial unit,  the assessee shall, in accordance with and subject to the provisions of this section, be allowed a deduction of an amount equal to one-tenth of such expenditure for each of the ten successive previous years beginning with the previous year in which the business commences or, as the case may be, the previous year in which the extension of the industrial undertaking is completed or the new industrial unit commences production or operation. Provided that where an assessee incurs after the 31st day of March, 1998, any expenditure specified in sub-section (2), the provisions of this sub-section shall have effect as if for the words "an amount equal to one-tenth of such expenditure for each of the ten successive previous years", the words "an amount equal to one-fifth of such expenditure for each of the five successive previous years" had been substituted. (2) The expenditure referred to in sub-section (1) shall be the expenditure specified in any one or more of the following clauses, namely :-  (a) Expenditure in connection with -   (i) Preparation of feasibility report;

(ii) Preparation of project report; (iii) Conducting market survey or any other survey necessary for the business of the assessee; (iv) Engineering services relating to the business of the assessee : Provided that the work in connection with the preparation of the feasibility report or the project report or the conducting of market survey or of any other survey or the engineering services referred to in this clause is carried out by the assessee himself or by a concern which is for the time being approved in this behalf by the Board; (b) Legal charges for drafting any agreement between the assessee and any other person for any purpose relating to the setting up or conduct of the business of the assessee; (c) Where the assessee is a company, also expenditure -  (i) By way of legal charges for drafting the Memorandum and Articles of Association of the company;  (ii) On printing of the Memorandum and Articles of Association; (iii) By way of fees for registering the company under the provisions of the Companies Act, 1956 (1 of 1956);  (iv) In connection with the issue, for public subscription, of shares in or debentures of the company, being underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus;  (d) Such other items of expenditure (not being expenditure eligible for any allowance or deduction under any other provision of this Act) as may be prescribed. (3) Where the aggregate amount of the expenditure referred to in sub-section (2) exceeds an amount calculated at two and one-half per cent - (a) Of the cost of the project, or

(b) Where the assessee is an Indian company, at the option of the company, of the capital employed in the business of the company,  the excess shall be ignored for the purpose of computing the deduction allowable under sub-section (1). Provided that where the aggregate amount of expenditure referred to in sub-section (2) is incurred after the 31st day of March, 1998, the provisions of this sub-section shall have effect as if for the words "two and one-half per cent, the words "five per cent had been substituted. Explanation : In this sub-section, -  (a) "Cost of the project" means -  (i) In a case referred to in clause (i) of sub-section (1), the actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the business of the assessee commences; (ii) In a case referred to in clause (ii) of sub-section (1), the actual cost of the fixed assets, being land, buildings, leaseholds, plant, machinery, furniture, fittings and railway sidings (including expenditure on development of land and buildings), which are shown in the books of the assessee as on the last day of the previous year in which the extension of the industrial undertaking is completed or, as the case may be, the new industrial unit commences production or operation, in so far as such fixed assets have been acquired or developed in connection with the extension of the industrial undertaking or the setting up of the new industrial unit of the assessee; (b) "Capital employed in the business of the company" means -  (i) In a case referred to in clause (i) of sub-section (1), the aggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the business of the company commences; (ii) In a case referred to in clause (ii) of sub-section (1), the aggregate of the issued share capital, debentures and long-term borrowings as on the last day of the previous year in which the extension of the industrial undertaking is completed, or, as the case may be, the new industrial unit commences production or operation, in so far as such capital, debentures and long-term borrowings have been issued or obtained in connection with the extension of the industrial undertaking or setting up of the new industrial unit of the company; (c) "Long-term borrowings" means -  (i) Any moneys borrowed by the company from the Government or the Industrial Finance Corporation of India or the Industrial Credit and Investment Corporation of India or any other financial institution which is for the time being approved by the Central Government for the purposes of clause (viii) of sub-section (1) of section 36 or any banking institution (not being a financial institution referred to above), or (ii) Any moneys borrowed or debt incurred by it in a foreign country in respect of the purchase outside India of capital plant and machinery, where the terms under which such moneys are borrowed or the debt is incurred provide for the repayment thereof during a period of not less than seven years. (4) Where the assessee is a person other than a company or a co-operative society, no deduction shall be admissible under sub-section (1) unless the accounts of the assessee for the year or years in which the expenditure specified in sub-section (2) is incurred have been audited by an accountant as defined in the Explanation below sub-section (2) of section 288, and the assessee furnishes, along with his return of income for the first year in which the deduction under this section is claimed, the report of such audit in the prescribed form duly signed and verified by such accountant and setting forth such particulars as may be prescribed 570 . (5) Where the undertaking of an Indian company which is entitled to the deduction under sub-section (1) is transferred, before the expiry of the period of ten years specified in sub-section (1), to another Indian company in a scheme of amalgamation, -  (i) No deduction shall be admissible under sub-section (1) in the case of the amalgamating company for the previous year in which the amalgamation takes place; and  (ii) The provisions of this section shall, as far as may be, apply to the amalgamated company as they would have applied to the amalgamating company if the amalgamation had not taken place. (5A) Where the undertaking of an Indian company which is entitled to the deduction under sub-section (1) is transferred, before the expiry of the period specified in sub-section (1), to another company in a scheme of demerger, - (i) No deduction shall be admissible under sub-section (1) in the case of the demerged company for the previous year in which the demerger takes place; and (ii) The provisions of this section shall, as far as may be, apply to the resulting company, as they would have applied to the demerged company, if the demerger had not taken place.   (6) Where a deduction under this section is claimed and allowed for any assessment year in respect of any expenditure specified in sub-section (2), the expenditure in respect of which deduction is so allowed shall not qualify for deduction under any other provision of this Act for the same or any other assessment year.

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[yoganand l]

take an eg. of a power project. it takes six years to complete the entire process. for a 100mw hep, it might cost around 600 cr.; no P&L Account would be prepared till actual production of power takes place and the same is sold.

 

now can this 600 cr. be considered pre-operative ??

 

yogan.

[csarengarajan]

other than preliminary expenses all are considereed as pre operative expenses

[csarengarajan]

the same to be considered as pre operative expenses and to be capitalised once the company starts operation

 

regards

 

[ravi p]

You can refer to the guidance note" expenditure during construction" issued by Institute of Chartered Accountants of India for accounting of the pre-operative expenses.  I have also attached below the article published in Business line the same which might be useful for you to understand the accounting treatment.

 

Also note that, pre-operative expenses are not treated as business related  allowable expenses under Income Tax 1961

 

Expenditure during construction

 

Construction period is the time taken by an entity to complete the civil works, install plant and machinery and be ready to commence commercial production. The entity would incur expenditure during this construction period, both for acquiring the new assets as well as on administration.

Direct and administrative expenses: Cost of tendering for plant and machinery, travel related to inspection and sourcing of equipment, etc., are incidental to acquiring the assets,

While expenditure such as office rent, communication costs, staff costs, etc., which cannot be directly related to acquiring the fixed asset, would constitute administrative expenses.

Guidance note on expenditure during construction: The ICAI has issued a guidance note on treatment of expenditure during construction period.

The guidance note requires all such administrative expenditure during the construction period to be capitalised and apportioned to the fixed assets proportionately. It has been the practice to club all the expenditure as preoperative and disclose it as miscellaneous expenditure on the asset side of the balance-sheet.

Accounting for fixed assets (AS 10): AS 10, dealing with fixed assets, requires all the expenditure incurred in connection with acquiring the fixed assets and incidental to acquiring such fixed assets to be added to the cost of the respective asset. (Paragraph 9 of AS 10). Paragraph 9.3 of AS 10 reads: “Administration and other general overhead expenses are usually excluded from the cost of fixed assets because they do not relate to a specific fixed asset….”

Accounting for borrowing costs (AS 16): AS 16, on borrowing costs, requires the interest attributable to acquiring the qualifying asset to be capitalised and added to the cost of the asset till such time the asset is brought to a usable condition, subject, however, to certain terms and conditions for suspension of such borrowing costs.

Accounting for intangible assets (AS 26): Subsequently, the ICAI came out with AS 26 on intangible assets, effective for financial statements commencing from periods beginning on or after April 1, 2003. This standard requires that the expenditure which does not result in any enduring future economic benefit be written off in the year of incurring the expenditure.

Withdrawal of guidance note

All these years, the guidance note continued to exist. One after the other, the expenditure during construction period formed part of the respective Accounting Standards. The guidance note on expenditure during construction period was finally withdrawn in August 2008.

Implications and changes: Pre-incorporation and preliminary expenditure were amortised over a period of time. Such expenditure, to the extent not written off, was disclosed in the financial statements as miscellaneous expenditure.

All the expenditure, whether incidental to acquiring the assets or administrative in nature, was grouped under preoperative expenditure to be apportioned to the assets on commissioning of the project.

After the issue AS 10, all the expenditure related to acquiring the asset got shifted out from preoperative expenditure and formed part of capital work-in-progress.

Preoperative expenditure was shrunk further with the issue of AS 16, requiring the interest on loans and borrowing costs to be capitalised to the respective asset.

Consequent to the issue of AS 26, the preliminary expenditure is written off totally in the year of incorporation of the company and does not appear in the balance-sheet any more.

The residual portion of preoperative expenditure consisted purely of administrative costs.

AS 26 requires all that expenditure which does not result in future economic benefits be expensed out in the year in which it is incurred. This requirement rendered the guidance note redundant and it was finally withdrawn in August 2008. Expensing out through the profit and loss (P&L) account is understandable if the entity is an existing entity and is going in for expansion.

However, where the entity is setting up the first unit and not gone into operations, it does not have a profit and loss account. The point of contention is, whether the administrative expenditure incurred during the period of construction is to be treated as expenditure incurred and is of the nature of a future economic benefit.

Consolidation of accounts

There is no particular reference to the treatment of expenditure during construction in the Accounting Standards for consolidation, in AS 21.

Paragraph 13 of AS 21 reads as under:

“13. In preparing consolidated financial statements, the financial statements of the parent and its subsidiaries should be combined on a line by line basis by adding together like items of assets, liabilities, income and expenses.”

It requires consolidation on a line by line basis, by adding together like items of assets, liabilities and expenses.

Administrative cost of an entity under construction continues to be a preoperative expense. The nature does not change when it is combined for consolidation purposes.

Though administrative in nature, the salary paid during the period of construction is not a like item of expenditure in consolidation with other entities which have already gone on stream.

If one of the entities does not have a profit and loss account and treats the expenditure as preoperative expenditure, treating the same expenditure as revenue and setting it off against the revenues generated by other operating entities may not be justifiable. Such expenditure should be continued to be shown as preoperative expenditure.

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From: csarengarajan <csaren...@gmail.com>
To: csmy...@googlegroups.com
Sent: Tue, 5 January, 2010 9:51:37 PM
Subject: Re: [CSMysore] preliminary and pre-operative exp

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