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Pre-operating

Sanjay (SO) (24 Points)

10 July 2011

hey,

As per IFRS if the company is in pre-operating phase, the expenses should be charged below the operating line item. But if in the pre-operating phase the business gained a pre-operating surplus. And is the preoperating gain distributable to the shareholders???How is this treated by IFRS???

For e.g

A Ltd came on operation from 1 June 2011, during the period it has an pre-operating expenses $ 20,000 and interest income $ 30,000 from the bank(deposited by the shareholder as an investment). How do we treat it in accordance with IFRS/IAS???And is the preoperating gain distributable to the shareholders???

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2 Replies

CA Sachin Rastogi (Audit/IFRS Manager) (338 Points)
Replied 11 July 2011

Dear Sanjay

This is a case of internally generated intangible assets. You need to first decide that whether this preoperating expenses were there in the 'Research phase or Development Phase'. As per IAS (International Accounting Standard) 38 Para 54 and 55 - Expenditure during the 'Research Phase' of the project should be expensed as incurred based on the reason that during research phase an entity is unable to demonstrate that these expenditure will results in future economic benefits. Thus, it doesn;t qualified to be recognised as intangible assets. (Read the relevant paras for further understanding of Research and Temporary Phase).

With regards to the temporary income on the bank deposits, it will be treated as normal interest income and should not be netted off with the above impairment loss on writing offf the prelim expenses. Further, these are to be treated below the GP line in the income statement.

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Desperado (Cost And Management Accountant) (129 Points)
Replied 12 July 2011

Dear,

Apart from the original query, it is worth mentioning in response to Sachin's view that no company can defer the Pre-operating Expenses. These have to be charged to Profit and Loss account.

However, 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 deducting 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.

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.

AS FAR AS THE QUERY IS CONCERNED, it should be noted 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 / profit of the pre commencement period will be taken to the balance sheet after the operation is started.