Preliminary expenses treatment
This query is : Resolved
20 October 2009
Dear Experts
This is with regard to a partnership firm which is already established. They are starting a new project for which estimates are made for preoperative expense (Upfront fee, Interest during construction etc..) The project financials were made for the purpose of term loans.
The treatment shown in the financials :
- The preliminary expense was amortised over a period of 5 years and shown in the P&L account. The unwritten off portion of the preliminary expense was shown in the asset side of the balance sheet.
But, the bank disagrees with this:
The reason : In ur case u have already formed the partnership wherein u may not be in a position to take up the TL upfront fees and interest on the TL during construction/modification/ renovation. These items are required to be charged to ur P & L only. pls recalculate the CMA data after charging these items to the P & L only.
Dear experts, Can you provide light on what can be done now? Is it allowable in the balance sheet or not?
If not, how can the accounting be complete? and Will it not inflate the other assets?
Kindly provide some light on this - my email umahcc@gmail.com
Thanks a ton
Uma
This is with regard to a partnership firm which is already established. They are starting a new project for which estimates are made for preoperative expense (Upfront fee, Interest during construction etc..) The project financials were made for the purpose of term loans.
The treatment shown in the financials :
- The preliminary expense was amortised over a period of 5 years and shown in the P&L account. The unwritten off portion of the preliminary expense was shown in the asset side of the balance sheet.
But, the bank disagrees with this:
The reason : In ur case u have already formed the partnership wherein u may not be in a position to take up the TL upfront fees and interest on the TL during construction/modification/ renovation. These items are required to be charged to ur P & L only. pls recalculate the CMA data after charging these items to the P & L only.
Dear experts, Can you provide light on what can be done now? Is it allowable in the balance sheet or not?
If not, how can the accounting be complete? and Will it not inflate the other assets?
Kindly provide some light on this - my email umahcc@gmail.com
Thanks a ton
Uma
20 October 2009
Strictly, preoperative expenses are revenue in nature and should normally be written off as such in the profit and loss account.
If, however, a huge time lag separates the setting up of the plant and machinery and other infrastructure and the actual commencement of production due to some valid and compelling reasons, the same can be accumulated as Project implementation expenses to be apportioned and added to the cost of respective assets on completion of the project.
But for tax purposes, pre-operation expenses qualify as revenue expenditure because they qualify for deduction the moment the business is set up and one need not wait till the actual commencement of production to be eligible for claiming them as expenses, no matter whether there is a revenue stream or not.
Coming back to accounts, there must be a compelling reason to justify accumulation as deferred revenue expenditure.
If, however, a huge time lag separates the setting up of the plant and machinery and other infrastructure and the actual commencement of production due to some valid and compelling reasons, the same can be accumulated as Project implementation expenses to be apportioned and added to the cost of respective assets on completion of the project.
But for tax purposes, pre-operation expenses qualify as revenue expenditure because they qualify for deduction the moment the business is set up and one need not wait till the actual commencement of production to be eligible for claiming them as expenses, no matter whether there is a revenue stream or not.
Coming back to accounts, there must be a compelling reason to justify accumulation as deferred revenue expenditure.
20 October 2009
Dear Mr.Chakrapani
Thanks for your immediate response.
If a portion is amortised in the p&l account for 5 years,where will the remaining unwritten off amount appear? Can you pls clarify.
Kind regards
Uma
Thanks for your immediate response.
If a portion is amortised in the p&l account for 5 years,where will the remaining unwritten off amount appear? Can you pls clarify.
Kind regards
Uma
20 October 2009
The remaining portion may be shown in the balance sheet (assets side- last item) as "preoperative expenses a/c pending for amortization.
20 October 2009
Hello again
True. We have shown it in the assets side of Balance sheet. But the bank doesnot allow this to be shown in the balance sheet. They only suggest to write off in the p&L.
Is there an allowability clause on the preliminary expense?
I donot understand how accounts can tally without the balance shown in the balance sheet?
Kind regards
Uma
True. We have shown it in the assets side of Balance sheet. But the bank doesnot allow this to be shown in the balance sheet. They only suggest to write off in the p&L.
Is there an allowability clause on the preliminary expense?
I donot understand how accounts can tally without the balance shown in the balance sheet?
Kind regards
Uma
10 August 2024
The treatment of preliminary expenses and related costs, such as interest during construction, involves several accounting and regulatory considerations. Here's a detailed guide on the treatment and how to address the bank's concerns:
### **1. Treatment of Preliminary Expenses**
#### **Accounting Standards (AS 26)**
- **Preliminary Expenses:** According to **Accounting Standard 26 (AS 26)**, preliminary expenses should not be capitalized. They should be treated as revenue expenses and written off in the year they are incurred. This is because preliminary expenses do not meet the criteria for recognition as intangible assets and thus should not be included on the balance sheet as assets.
- **Amortization:** The amortization of preliminary expenses over five years is not permissible under AS 26. Preliminary expenses must be fully expensed in the Profit & Loss Account in the year they are incurred.
#### **Income Tax Act**
- **Section 35D:** Under Section 35D of the Income Tax Act, preliminary expenses can be amortized over a period of five years. However, this provision applies to businesses starting up or expanding and does not permit preliminary expenses to be capitalized on the balance sheet. For tax purposes, you can claim amortization, but this is not the same as capitalizing these expenses on the balance sheet.
### **2. Bank's Perspective**
The bank's requirement to write off preliminary expenses immediately in the Profit & Loss Account is in line with the standard accounting practice and regulatory norms. Banks generally prefer to see all expenses reflected in the P&L account to present a true and fair view of the company's financial performance and avoid inflating assets.
### **3. Handling the Discrepancy**
To address the bank's concerns and ensure compliance with accounting standards, you should:
- **Write Off Preliminary Expenses:** As per AS 26 and general accounting principles, all preliminary expenses should be written off entirely in the Profit & Loss Account in the year they are incurred. This approach ensures that the balance sheet reflects only current assets and liabilities.
- **Adjust Financial Statements:** Recalculate the financials and adjust them to ensure that preliminary expenses are fully written off in the P&L account. Remove any capitalized preliminary expenses from the asset side of the balance sheet. This adjustment aligns with both accounting standards and the bank's requirements.
- **Impact on CMA Data:** Since preliminary expenses should be fully expensed, the Cost and Management Accounting (CMA) data should also reflect this adjustment. This will impact the financial projections and the loan terms accordingly.
### **4. Accounting Entries**
Here’s how you can adjust the accounting entries:
- **Initial Entry for Preliminary Expenses:**
- Debit: Preliminary Expenses (Asset Side of Balance Sheet)
- Credit: Bank/Cash (Liability Side)
- **Adjustment Entry for Expense Write-Off:**
- Debit: Preliminary Expenses (P&L Account)
- Credit: Preliminary Expenses (Asset Side of Balance Sheet)
### **Summary**
1. **Preliminary Expenses** should be fully written off in the Profit & Loss Account as per AS 26. They should not be capitalized or shown as assets in the balance sheet.
2. **Interest During Construction** and similar costs are typically treated as revenue expenses and should be charged to the P&L account unless they are directly attributable to the creation of a capital asset, in which case they may be capitalized as part of the cost of the asset.
3. **Bank’s Requirement:** The bank’s suggestion to write off these expenses in the P&L account aligns with standard accounting practices and regulatory norms. You should comply with this to ensure accurate financial reporting and meet loan conditions.
By making these adjustments, you will align your accounting practices with the required standards and satisfy the bank’s requirements.
### **1. Treatment of Preliminary Expenses**
#### **Accounting Standards (AS 26)**
- **Preliminary Expenses:** According to **Accounting Standard 26 (AS 26)**, preliminary expenses should not be capitalized. They should be treated as revenue expenses and written off in the year they are incurred. This is because preliminary expenses do not meet the criteria for recognition as intangible assets and thus should not be included on the balance sheet as assets.
- **Amortization:** The amortization of preliminary expenses over five years is not permissible under AS 26. Preliminary expenses must be fully expensed in the Profit & Loss Account in the year they are incurred.
#### **Income Tax Act**
- **Section 35D:** Under Section 35D of the Income Tax Act, preliminary expenses can be amortized over a period of five years. However, this provision applies to businesses starting up or expanding and does not permit preliminary expenses to be capitalized on the balance sheet. For tax purposes, you can claim amortization, but this is not the same as capitalizing these expenses on the balance sheet.
### **2. Bank's Perspective**
The bank's requirement to write off preliminary expenses immediately in the Profit & Loss Account is in line with the standard accounting practice and regulatory norms. Banks generally prefer to see all expenses reflected in the P&L account to present a true and fair view of the company's financial performance and avoid inflating assets.
### **3. Handling the Discrepancy**
To address the bank's concerns and ensure compliance with accounting standards, you should:
- **Write Off Preliminary Expenses:** As per AS 26 and general accounting principles, all preliminary expenses should be written off entirely in the Profit & Loss Account in the year they are incurred. This approach ensures that the balance sheet reflects only current assets and liabilities.
- **Adjust Financial Statements:** Recalculate the financials and adjust them to ensure that preliminary expenses are fully written off in the P&L account. Remove any capitalized preliminary expenses from the asset side of the balance sheet. This adjustment aligns with both accounting standards and the bank's requirements.
- **Impact on CMA Data:** Since preliminary expenses should be fully expensed, the Cost and Management Accounting (CMA) data should also reflect this adjustment. This will impact the financial projections and the loan terms accordingly.
### **4. Accounting Entries**
Here’s how you can adjust the accounting entries:
- **Initial Entry for Preliminary Expenses:**
- Debit: Preliminary Expenses (Asset Side of Balance Sheet)
- Credit: Bank/Cash (Liability Side)
- **Adjustment Entry for Expense Write-Off:**
- Debit: Preliminary Expenses (P&L Account)
- Credit: Preliminary Expenses (Asset Side of Balance Sheet)
### **Summary**
1. **Preliminary Expenses** should be fully written off in the Profit & Loss Account as per AS 26. They should not be capitalized or shown as assets in the balance sheet.
2. **Interest During Construction** and similar costs are typically treated as revenue expenses and should be charged to the P&L account unless they are directly attributable to the creation of a capital asset, in which case they may be capitalized as part of the cost of the asset.
3. **Bank’s Requirement:** The bank’s suggestion to write off these expenses in the P&L account aligns with standard accounting practices and regulatory norms. You should comply with this to ensure accurate financial reporting and meet loan conditions.
By making these adjustments, you will align your accounting practices with the required standards and satisfy the bank’s requirements.
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