Query No. 2

Subject:

Applicability of Accounting Standard (AS) 26, Intangible Assets¹

A. Facts of the Case

1. A limited company is engaged in stock broking business and is registered with the Securities and Exchange Board of India (SEBI). It is one of India’s leading stock broking outfits and a subsidiary of a listed private sector bank.

2. The querist has stated that the turnover of the company for the year ended 31st March, 2003, is above Rs. 50 crore. The company is a broker on the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The querist has informed that while the BSE broking activities are handled through two ‘stock exchange cards’ for which the company has paid a purchase consideration of Rs. 4 crore, the NSE activities are carried out after placing the requisite security deposit amount. NSE is a corporatised and mutualised exchange and BSE is moving in that direction.

3. The querist has informed that the amount paid by the company towards acquisition of stock exchange cards has been accounted for and disclosed as ‘Fixed asset’ till March 2003. However, the company has not charged any depreciation on the same till date.

4. The querist has stated that with effect from 1.4.2003, Accounting Standard (AS) 26, ‘Intangible Assets’, issued by the Institute of Chartered Accountants of India, is mandatory for specified class of enterprises in respect of transactions related to intangible items entered into on or after 1.4.2003. The company in question belongs to the said specified class of enterprises. He has further informed that no depreciation has been charged on the cards so far. However, as per the requirements of paragraph 63 of AS 26, the company has estimated the useful life of the BSE cards at 10 years and proposes to depreciate the cards accordingly including for past years’ difference in line with paragraph 99 of AS 26 on transitional provisions.

5. The querist has further informed that BSE is in the process of demutualisation and conversion of the exchange into a corporate entity. As part of the process, which has been mandated by SEBI, BSE will become a corporate and will issue two distinct rights to brokers. One right will be the membership right which entails the member to become a shareholder of the stock exchange and hence is entitled to benefits that accrue to a shareholder of the stock exchange. The other right is the right to trade, which enables the broker to carry out trades on the stock exchange. Based on this background, BSE proposes to convert the existing cards into membership/trading rights. The rights can be obtained by placing a security deposit with the stock exchange which is refundable once the member ceases to be a member. It is expected, based on market reports, that BSE will assign a value of Rs. 65 lakh for the rights and the existing card-holders will be credited with the deposit of Rs. 65 lakh and the cards will be cancelled automatically. The amount of Rs. 65 lakh, presently (upto 28th February 2004) is the consideration that is payable by anyone who wishes to obtain both membership rights and trading rights. As per the querist, post corporatisation, the membership right is transferable and the trading right has to be surrendered to the stock exchange.

6. The company holds two cards of BSE at a value of Rs. 4 crore. Based on paragraph 5 above, it will be credited with a deposit amount of Rs. 1.30 crore and the existing cards will be cancelled.

B . Query

7. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether the stock exchange cards/rights can be treated as an intangible asset.

 

(b) Would it be fair to conclude that the life of the card is not 10 years but infinite and hence only the test of impairment is to be carried out. Is it also valid to state that the life of the card is construed to be too short at 10 years since the company has the right to use the card even after 10 years? (The querist has referred to paragraphs 63, 64, 68 and 72 of AS 26.)

 

(c) Is it fair that even though the cards are depreciated over a period of 10 years, there is also an impairment of the asset (card) despite the fact that the company is a profit making company? It is to be noted that the main business of the company is stock broking and the same contributes most of the revenues/profits of the enterprise.

 

(d) As a corollary to (c) above, since the company’s revenues and profits originate from the stock broking business, is it fair to state that market values of the membership rights do not affect the carrying cost of the cards/membership right and hence ‘the value in use’ is more than the carrying cost and, consequently, no impairment is necessary?

C. Points considered by the Committee

8. The Committee notes from the facts of the case that the query relates to the two cards of BSE, which the company presently possesses,and their possible impairment in view of the impending corporatisation of the stock exchange. The opinion of the Committee given hereafter is, therefore, restricted to this issue only.

9. The Committee notes that AS 26 requires an enterprise to recognise an intangible asset if, and only if, certain criteria are met. In this context, the definitions of the terms ‘intangible asset’ and ‘asset’ given in paragraph 6 of AS 26 are of prime importance and are reproduced below:

"An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes."

 

"An asset is a resource:

(a) controlled by an enterprise as a result of past events; and

 

(b) from which future economic benefits are expected to flow to the enterprise."

10. The Committee notes from the above that an item can be classified as an intangible asset only if it fulfills all the three conditions: (a) it is identifiable, (b) the enterprise has control over the resource, and (c) expectation of future economic benefits flowing to the enterprise. The Committee is of the view that based on the information provided by the querist in paragraphs 3 and 4 above the stock exchange cards for which the company has paid a purchase consideration of Rs. 4 crore are intangible assets as they meet the aforesaid criteria.

11. The Committee notes from the information provided by the querist in paragraph 4 above that the useful life of the BSE cards has been estimated by the company at 10 years in accordance with paragraph 63 of AS 26 which requires as below:

"63. The depreciable amount of an intangible asset should be allocated on a systematic basis over the best estimate of its useful life. There is a rebuttable presumption that the useful life of an intangible asset will not exceed ten years from the date when the asset is available for use. Amortisation should commence when the asset is available for use."

The Committee notes from the above that as the future economic benefits embodied in an intangible asset are consumed over time, the cost of the asset should be systematically allocated over the asset’s useful life.For determining the useful life of an intangible asset, various factors such as the expected usage of the asset, the period of control over the asset and legal or similar limits on the use of the asset etc., as indicated in paragraph 64 of AS 26, need to be considered. In this context, the Committee notes that the amortisation method should be in accordance with paragraph 72 of AS 26.

12. The Committee further notes paragraphs 67 and 68 of AS 26, which state as below:

"67. In some cases, there may be persuasive evidence that the useful life of an intangible asset will be a specific period longer than ten years. In these cases, the presumption that the useful life generally does not exceed ten years is rebutted and the enterprise:

(a) amortises the intangible asset over the best estimate of its useful life;

(b) estimates the recoverable amount of the intangible asset at least annually in order to identify any impairment loss

(see paragraph 83); and

(c) discloses the reasons why the presumption is rebutted and the factor(s) that played a significant role in determining the useful life of the asset".

"68. The useful life of an intangible asset may be very long but it is always finite. Uncertainty justifies estimating the useful life of an intangible asset on a prudent basis, but it does not justify choosing a life that is unrealistically short."

13. From the above, the Committee is of the view that an intangible asset may have a useful life longer than ten years but it is always finite. The company should disclose the reasons if the presumption of useful life of 10 years is rebutted and the factor(s) that played a significant role in determining the useful life of the asset. Thus, keeping in view the facts and circumstances of each case, the useful life of an intangible asset has to be determined.

14. With regard to the impairment of the cards, the Committee notes paragraphs 81 and 83 of AS 26 reproduced below:

"81. To determine whether an intangible asset is impaired, an enterprise applies Accounting Standard on Impairment of Assets. That Standard explains how an enterprise reviews the carrying amount of its assets, how it determines the recoverable amount of an asset and when it recognises or reverses an impairment loss."

"83. In addition to the requirements of Accounting Standard on Im pairment of Assets, an enterprise should estimate the recoverable amount of the following intangible assets at least at each financial year end even if there is no indication that the asset is impaired:

(a) an intangible asset that is not yet available for use;and

(b) an intangible asset that is amortised over a period exceeding ten years from the date when the asset is available for use.

The recoverable amount should be determined under Accounting Standard on Impairment of Assets and impairment losses recognised accordingly."

15. The Committee notes that Accounting Standard (AS) 28, ‘Impairment of Assets’, issued by the Institute of Chartered Accountants of India, requires that an asset is impaired when the carrying amount of the asset exceeds its recoverable amount. In this regard, the Committee notes the definitions of the terms ‘Recoverable amount’ and ‘Carrying amount’ given in paragraph 4 of AS 28, and the requirements of paragraphs 6 and 8 thereof, which are reproduced as under:

"Recoverable amount is the higher of an asset’s net selling price and its value in use."

"Carrying amount is the amount at which an asset is recognised in the balancesheet after deducting any accumulated depreciation (amortisation) and accumulated impairment losses thereon."

"6. An enterprise should assess at each balance sheet date whether there is any indication that an asset may be impaired.If any such indication exists, the enterprise should estimate the recoverable amount of the asset."

"8. In assessing whether there is any indication that an asset may be impaired, an enterprise should consider, as a minimum, the following indications:

 

External sources of information

 

(a) during the period, an asset’s market value has declined significantly more than would be expected as a result of the passage of time or normal use;

(b) significant changes with an adverse effect on the enterprise have taken place during the period, or will take place in the near future, in the technological, market, economic or legal environment in which the enterprise operates or in the market to which an asset is dedicated;

(c) market interest rates or other market rates of return on investments have increased during the period, and those increases are likely to affect the discount rate used in calculating an asset’s value in use and decrease the asset’s recoverable amount materially;

(d) the carrying amount of the net assets of the reporting enterprise is more than its market capitalisation;

Internal sources of information

(e) evidence is available of obsolescence or physical damage of an asset;

(f) significant changes with an adverse effect on the enterprise have taken place during the period, or are expected to take place in the near future, in the extent to which, or manner in which, an asset is used or is expected to be used. These changes include plans to discontinue or restructure the operation to which an asset belongs or to dispose of an asset before the previously expected date; and

(g) evidence is available from internal reporting that indicates that the economic performance of an asset is, or will be, worse than expected."

16. The Committee is of the view that in determining whether indication of impairment of the stock exchange cards exists on the balance sheet date, the company should consider the factors stated in paragraph 8 of AS 28. In this regard, the fact that the value of the card will be Rs. 65 lakh may have relevance provided that value represents the market value of the relevant rights including the trading rights. Further, it may also be considered whether merely by corporatisation of the stock exchange, the economic performance of the cards becomes worse than expected and, thereby, the business of the company gets adversely affected. The Committee feels that this may not be so unless there are certain other indicators which are not mentioned in the facts of the case. If the business of the company is not adversely affected, the market value of the cards may not be of much relevance. Accordingly, after considering the other factors stated in paragraph 8 of AS 28, it may be assessed whether indications for impairment exist. The company should determine the recoverable value (i.e., it should estimate the value in use and net selling price) and compare it with the carrying amount of the cards only if the indication of impairment exists. However, in case the company estimates that the useful life of the cards is in excess of 10 years, it should determine the recoverable value and compare it with the carrying amounts of the cards, even if the impairment is not indicated. If the company estimates that its value in use, determined as per the requirements of AS 28, is in excess of its carrying amount, it need not estimate the net selling price of the cards, i.e., the said price would not be relevant.

D. Opinion

17. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7:

(a) The stock exchange cards should be treated as intangible assets in the books of account of the company.

(b) The useful life of an intangible asset has to be determined by considering all the necessary factors but it is always finite as explained in paragraph 13 above.

(c) An intangible asset may be impaired even if it is amortised. Thus, cards may be impaired even if the cost thereof is being amortised over their respective useful lives. However, whether the cards are impaired will have to be determined in accordance with the requirements of AS 28 as discussed in paragraph 16 above.

(d) Carrying cost of the cards is neither affected by their market value nor by their ‘value in use’. ‘Value in use’ has to be determined separately as per the requirements of AS 28 and compared with the carrying cost of the cards to determine whether the cards are impaired. If the ‘value in use’ is more than the carrying cost, the selling prices are not relevant as there is no impairment.

¹ Opinion finalised by the Committee on 5.3.2004