1.6 Query: Accounting treatment in respect of expenditure on development of software in a contract for design, development and supply of package of systems.
1. A company is engaged in the manufacture of electronic products and systems whose objectives as per Memorandum of Association are as follows:
“Carry out all kinds of business relating to research, development, pilot production, manufacture, buying, selling, importing, exporting – items, equipment, apparatus, instrument-components, instruments and systems for communication. The Company shall also be entitled to carry on all or any of the following objects as being incidental or ancillary to the attainment of the above objectives.
To manufacture, buy, sell, exchange, install, work alter, improve, manipulate, prepare for market, import or export and otherwise deal in all kinds of plant, machinery, apparatus, job substances, materials and things necessary or convenient for carrying on any of the business whom the company is authorised to carry on or usually dealt in by persons engaged in such business”.
2. The company has undertaken to execute an order for supply of training simulator package for power plants in association with an overseas party. The company and the overseas party together have executed joint undertaking in favour of the customer for the successful performance of the package. The stages involved are:
(a) Purchase of software, software tools and receiving training from foreign associate.
(b) Carry out further development work on the software supplied to the company by the foreign associate, to add additional required features to the system.
(c) Demonstrate the developed software to the customer.
(d) Dismantle the integrated system after its acceptance by the customer.
(e) Deliver the accepted system at customers’ site in knocked down condition.
(f) Assemble and prove the system of the requirements of the customer.
3. The querist has stated that the delivery schedule covers a period of 36 months and hence it involves a decision on the accounting treatment to be given in each yearly accounts with regard to the payments made to the overseas party towards purchase of software, software tools, receiving the training, expert engineering guidance, expenditure by the company on further developing the software including related salaries and overheads; and valuation of work-in-progress at the end of each accounting year.
4.The broad details of the expenditure incurred are as under:
Rs. in lakhs
5. The company’s accounting policy regarding deferred revenue expenditure states that “The cost of software and other expenses aggregating to a sum of above Rs.50 lakhs and wholly identifiable to a project or product is amortised over a period of 3 to 5 years based on the technical estimates.”
6. The querist has stated that the amounts paid to overseas party towards software, training etc., are exclusively for the system under reference. Since they are incurred in connection with a specific order, one view is that it is expedient to charge off the expenditure in the year in which it is incurred rather than treating the same as deferred revenue expenditure. The other view is that it is to be treated as deferred revenue expenditure.
7. The querist feels that the skills and expertise acquired in respect of the software development will have their value only when they are finally integrated with the hardware and make the total system functional. As the skills acquired under software are invisible, they may not fall within the meaning of inventories and hence need not be considered while valuing work in progress.
8. The opinion of the Expert Advisory Committee is sought on the following issues:
(i) Whether the amounts paid to the overseas party for puachase of software, software tools, receiving training and expert engineering guidance are to be charged off to the revenue in the period (s) as and when incurred or are to be treated as deferred revenue expenditure and amortised over a period of three years?
(ii) Whether the valuation of work-in-progress as at the end of each year is to be based only with reference to the expenditure incurred on hardware alone or the expenditure incurred on the software development is also to be considered as an item of work in progress particularly keeping in view the definition of inventories as comprising tangible property only?
(iii) What could be the right method of accounting for the costs incurred on hardware and software till their integration and successful execution of the system, when only the income is recognised? Till then, the expenditure in respect of software, tools, models and training charges would have no realisable value as they are incurred for acquiring the particular skill and not related to the acquisition of a tangible asset?
(iv) The best possible accounting in respect of the expenditure incurred in each year and for the valuation of the inventories to ensure prudence, matching costs with revenue and conservatism as at the end of each year may be suggested.
Opinion April 19, 1996
1. The Committee notes that the company has undertaken a specific order which will take 36 months to be executed, to supply training simulator package for power plants. The Committee is therefore of the view that it is a customer specific contract. It appears that the software developed by the company is in accordance with the customer’s requirement and therefore will not have general applications. Accordingly, in the view of the Committee the accounting principles should broadly be the same as that in case of long term construction contracts.
2. The Committee notes that the query relates to primarily costing aspects, therefore, it has not gone into the question of revenue recognition in respect of the contract.
3. The Committee is of the view that costs incurred by the company should be divided into:
(1) Costs that relate directly to the specific order. Examples of costs that may relate directly to a specific order include: -
i) Purchase of software.
ii) Software tools.
iii) Receiving training from foreign associates specific to the order.
iv) Developmental work on the software that is directly related to the order.
v) Salaries and overheads which relate directly to the execution of the order.
(2) Costs that can be attributed to the performance of the order in general and can be allocated to specific order.
These costs should form part of the work-in-progress and should be carried forward to the next year. To the extent they do not properly form part of the work-in-progress, they should be expensed.
4. The Committee is also of the view that if current estimates of total cost and revenue of the package being developed indicates a loss, provision should be made for the entire loss.
5. Based on the above, the Committee is of the following opinion on issues raised at para 8 of the query:
(i) & The costs incurred on purchase of software, software tools, receiving (ii)(a) training and expert engineering guidance to the extent forming part of the work-in-progress as per the principles laid down in para 3 above should be carried forward to the next year. The costs which do not so form part of the work-in-progress should not be carried forward.
(b) If the expenditure incurred on hardware is only in connection with the package in question which has no alternative use, it should be charged to the package, and written off over the life of the contract, i.e., three years. If it is general purpose hardware having alternative use, it should be written-off over the life of the hardware concerned.
(iii) Please see (i) and (ii) above.
(iv) Please see paras 4 and 5 (i) and (ii) above. ___________________________
|