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Query No. 2
Subject:
Accounting treatment of expenditure incurred on licence
fee (including user licences) for SAP
software. 1
A. Facts of the Case
1. A public sector undertaking is engaged in refining and marketing of petroleum products having its marketing network spread throughout the country. During the year 1999-2000, the company decided to implement SAP ERP system in a phased manner so as to cover all its units spread throughout the country over an expected period of 5 to 6 years.
2. Accordingly, the company budgeted for the estimated total expenditure likely to be incurred for implementation of SAP system throughout the company and actions were initiated in this regard.
3. Prior to Accounting Standard (AS) 26, ‘Intangible Assets’, issued by the Institute of Chartered Accountants of India, becoming mandatory w.e.f. 1.4.2003, the expenditure incurred by the company on implementation of SAP software including user licences separately procured under agreement with SAP India (other than the hardware portion) has been charged off as expenditure in the year of incurrence. The querist has also informed that the payment made to SAP India is only towards the user licence fees for the right to use the SAP software and nothing has been paid on account of the cost of the SAP software.
4. The company continued to incur expenditure after 1.4.2003 on consultancy charges and user licences in line with its plan for implementation of SAP system throughout the company in a phased manner as was envisaged at the time of deciding and initialising the implementation of SAP system in the company. The querist has also informed that the payment of consultancy charges is over and above the payment made on account of user licence fees of SAP software to the supplier company. The Annual Maintenance Charges (AMC) being paid to the supplier company is towards maintenance of the software, right to use the latest version of the software and minor upgradation in the software from time to time. Such expenditure incurred after 1.4.2003 was continued to be charged to revenue since the original cost incurred on SAP user licences for the software were already charged to revenue prior to 1.4.2003 as explained in paragraph 3 above. According to the querist, this is in line with the understanding conveyed by paragraphs 58 and 59 of AS 26, which envisage that subsequent expenditure on an intangible asset can be recognised as intangible asset only if the original expenditure has been treated as an intangible asset subject to satisfying the conditions laid down for determining the test of admissibility as an intangible asset. Paragraphs 58 and 59 are reproduced by the querist as below:
“Past Expenses not to be Recognised as an Asset
58. Expenditure on an intangible item that was initially recognised as an expense by a reporting enterprise in previous annual financial statements or interim financial reports should not be recognised as part of the cost of an intangible asset at a later date.
Subsequent Expenditure
59. Subsequent expenditure on an intangible asset after its purchase or its completion should be recognised as an expense when it is incurred unless:
(a) it is probable that the expenditure will enable the asset to generate future economic benefits in excess of its originally assessed standard of performance; and
(b) the expenditure can be measured and attributed to the asset reliably.
If these conditions are met, the subsequent expenditure should be added to the cost of the intangible asset.”
5. The querist has stated that in addition to the expenditure stated in paragraph 4 above, the expenditure incurred on or after 1.4.2003 and also further expected to be incurred for total stabilisation of SAP system in the company is mainly for procuring additional user licences for operating the software as was originally envisaged by the company and the same is required to achieve the originally assessed optimal utilisation envisaged while deciding
to implement the SAP system.
B. Query
6. The querist has sought the opinion of the Expert Advisory Committee with respect to the expenditure incurred for acquiring the user licences for right to use of the SAP software, on the following issues:
(a) Whether the accounting treatment of charging subsequent expenditure on SAP licence fee (including user licences) incurred on or after 1.4.2003 to the profit and loss account is correct in view of the fact that the initial expenditure incurred on SAP software including licence fee prior to 1.4.2003 (i.e., before AS 26 became mandatory) has already been charged to revenue in the year of incurrence.
(b) In case the answer to (a) above is in the negative, what is the suggested accounting treatment for the following:
(i) Expenditure incurred on licence fee for SAP software prior to 1.4.2003 (i.e., before AS 26 became mandatory).
(ii) Subsequent expenditure on user licence fee for the SAP software incurred on or after 1.4.2003, which has already been charged to revenue.
(iii) Whether the adjustments, if any, required to be carried out for the accounting periods prior to 31st March, 2005 are to be reflected as prior year adjustment as per Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’.
C. Points considered by the Committee
7. The Committee notes that the issue raised in the query relates to accounting for the expenditure incurred on purchase of user licences for SAP software. The Committee has, therefore, restricted the opinion only to this issue and has not considered any other issue arising from the Facts of the Case, for example, accounting treatment for Annual Maintenance Contract of the software.
8. The Committee is of the view that prior to Accounting Standard (AS) 26, ‘Intangible Assets’, becoming mandatory, i.e., before 01.04.2003, all fixed assets, whether tangible or intangible, were covered by Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’. AS 10 dealt with assets such as know how, patents, etc., the relevant paragraphs in respect of which were withdrawn when AS 26 became mandatory. In this context, the definition of the term ‘fixed asset’ as per AS 10, contained in paragraph 6.1, is reproduced below:
“6.1 Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business.”
9. The Committee notes from the Facts of the Case that the company has purchased the user licences for SAP software for the purpose of use in the business and not for sale. Therefore, in the view of the Committee, since the user licences have a life longer than one year, the expenditure on purchase of user licences, before AS 26 becoming mandatory, i.e., before 01.04.2003, should have been capitalised as per AS 10 and should have been depreciated/amortised as per the requirements of Accounting Standard (AS) 6, ‘Depreciation Accounting’, over the estimated useful life of the user licences. Since this was not done, this amounts to an error and, accordingly, it comes within the purview of the definition of ‘prior period items’ under Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’. The definition of the term ‘prior period items’ as contained in paragraph 4 of AS 5, is reproduced below:
“ Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.”
10. In view of the above, if the assets (user licences) are existing on the date of the balance sheet, the company needs to capitalise the above-said asset at a value arrived at by capitalising the expenditure incurred with retrospective effect and amortising the same for the past accounting years. The value of the asset so arrived at should be brought into books in the current year by a corresponding credit to the profit and loss account as a prior period item.
11. The Committee further notes the definition of the term ‘intangible asset’, provided in paragraph 6 of Accounting Standard (AS) 26, ‘Intangible Assets’, which is reproduced below:
“An intangible asset is an indentifiable 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.”
The Committee is of the view, on the basis of the above definition, that the user licences purchased are intangible assets. Therefore, the expenditure incurred on the purchase of user licences for SAP software on or after 01.04.2003, should have been capitalised and amortised over their estimated useful life as per AS 26. Since this was not done as above, the company is required to make adjustments as suggested in paragraph 10 above.
12. The Committee does not agree with the contention of the querist that previous expenditure which should have been capitalised but which was expensed can not be capitalised in view of the requirements of paragraph 58 of AS 26 reproduced in paragraph 4 of the Facts of the Case. In the view of the Committee, paragraph 58 of AS 26 is related only to that expenditure which could not qualify to be recognised as an intangible asset as per the requirements of the said Standard, at the time of incurrence and, therefore, was charged as an expense, but later it qualified to be recognised as an intangible asset. Paragraph 58 of AS 26 provides that the expenditure so expensed can not be capitalised as an intangible asset in a later year. Thus, this paragraph does not relate to an expenditure which fulfilled all the conditions for recognition as an intangible asset but was erroneously expensed. Therefore, in the view of the Committee, paragraph 58 is not relevant in the present case.
13. The Committee also does not agree with the contention of the querist that as per paragraph 59 of AS 26, reproduced in paragraph 4 of the Facts of the Case, the subsequent expenditure can not be capitalised as the original expenditure on acquisition was not capitalised. In the view of the Committee, the subsequent expenditure dealt with in paragraph 59 is that expenditure which is incurred on those items which were recognised as assets as per AS 10 or AS 26 in earlier years. Thus, simply because the expenditure incurred initially on acquisition of user licences for SAP software was not capitalised, cannot be an argument for not capitalising user licences acquired subsequently as they meet the recognition criteria for capitalising the user licences as an intangible asset. Accordingly, the Committee is of the view that the further purchase of user licences does not amount to be a subsequent expenditure as contemplated in paragraph 59, as this expenditure amounts to creation of an intangible asset.
14. The Committee notes paragraph 4.3 of the ‘Preface to the Statements of Accounting Standards’ which states that “The Accounting Standards are intended to apply only to items which are material….”. Therefore, the above suggestions are only applicable if the amounts involved are material.
D. Opinion
15. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6 above, subject to the consideration of materiality stated in paragraph 14 above:
(a) The accounting treatment of charging expenditure, on purchase of user licences on or after 1.4.2003, to the profit and loss account is not correct.
(b) Subject to the condition that the user licences exist on the date of the balance sheet, i.e., the user licences have a useful life on the balance sheet date,
(i) expenditure incurred on purchase of SAP software user licences prior to 1.4.2003 should be capitalised as suggested in paragraph 10 above;
(ii) expenditure incurred on SAP user licences, on or after 1.4.2003, should be recognised as an intangible asset as suggested in paragraph 11 above; and
(iii) adjustments required to be carried out for the accounting periods prior to 31st March, 2005, should be reflected as prior period item as suggested in paragraph 10 above.
1 Opinion finalised by the Committee on 27.3.2006 |