A. Facts of the Case
1. A company has three business units engaged in the business
of manufacture and sale of paints, speciality chemicals and
adhesives. The manufacturing facilities, viz., effluent treatment plant,
electrical substations, roads, fire fighting facilities, weighbridge,
canteen, etc., which are shared by all the three business units, are
situated at a common site taken on lease by the company.
2. During the year, the company has divested its speciality
chemical business (henceforth referred to as ‘divested business’)
on a going concern basis for an agreed composite consideration.
As per the terms of the sale agreement, a portion of the undivided
land on which the manufacturing facilities of the divested business
are situated, is being bifurcated for transfer to the purchaser.
Certain shared facilities located on the portion of land so bifurcated,
will also have to be transferred to the purchaser as a part of the
aforesaid divestment. Due to the above divestment, the company
will have to acquire/construct similar shared facilities at the site for
its continuing businesses. Management estimates that such cost
of acquisition/construction will be significant.
3. The querist has suggested two possible accounting treatments
for the costs to be incurred for acquisition/construction of such
new shared facilities:
(A) Cost to be incurred for acquisition/construction of the
new shared facilities for use by the continuing businesses
should be adjusted against profit on sale of the divested
business.
(B) The sale of existing shared facilities should be recognised
in the books of account as sale and acquisition/
construction of the new shared facilities should be
recognised as fixed assets.
4. The querist has given the following arguments in favour of
treatment ‘A’ as mentioned in paragraph 3 above:
• It would be an appropriate reflection of the substance of
the transaction since the need for the new facilities has
been triggered due to sale of the divested business and
the consideration paid by the buyer for the divestment
reflects the economic value of the facilities being
transferred as a part of the divested business.
• It would reflect the true economic value of the transaction
and is in line with the ‘matching concept’ which is a
fundamental accounting concept, and will therefore, not
be in diversion with Accounting Standards and Generally
Accepted Accounting Principles (GAAP).
• The facility to be constructed will not result in any
incremental revenue generation to the continuing
businesses.
5. The querist has given the following arguments in favour of
treatment ‘B’ as mentioned in paragraph 3 above:
• Sale of the existing shared facilities and acquisition/
construction of new facilities should be considered as
independent transactions. Consequently, fixed assets sold
off should be adjusted against the block of fixed assets
and new assets should be capitalised when acquired/
constructed.
• The new acquired/constructed assets will have their own
useful lives as against the existing assets that are almost
fully depreciated. In accordance with Accounting Standard
(AS) 10, ‘Accounting for Fixed Assets’, issued by the
Institute of Chartered Accountants of India, the cost of
acquisition/construction of new assets should be
capitalised.
• The costs to be incurred for acquisition/construction of
the new shared facilities are associated with the continuing
businesses of the company. These expenditures relate
to future conduct of the company’s business and are not
expenditure associated with business divestment.
Accordingly, such expenditures are to be recognised on
the same basis as if they arose independently of the
aforesaid divestment. Such accounting treatment is in
line with paragraphs 80 and 81 of International Accounting
Standard (IAS) 37, ‘Provisions, Contingent Liabilities and
Contingent Assets’.
B. Query
6. The querist has sought the opinion of the Expert Advisory
Committee as to which of the above mentioned accounting
treatments, is the most appropriate accounting treatment for costs
to be incurred for construction/acquisition of shared manufacturing
facilities due to divestment of speciality chemicals business unit
that are to be used in future by the continuing business units of
the company.
C. Points considered by the Committee
7. The Committee restricts itself to the issue raised by the querist
in paragraph 6 above and has not considered any other issue that
may arise from the facts of the case.
8. The Committee notes that the company in question has
disposed of its speciality chemical business on a going concern
basis for an agreed composite consideration. The disposal of the
business comprises, inter alia, disposal of certain fixed assets of
the company. The Committee notes paragraphs 25 and 26 of
Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, which
state as follows:
“25. Fixed asset should be eliminated from the financial
statements on disposal or when no further benefit is
expected from its use and disposal.
26. Losses arising from the retirement or gains or losses
arising from disposal of fixed asset which is carried at
cost should be recognised in the profit and loss
statement.”
9. The Committee is of the view that the above treatment on
disposal of fixed assets equally applies to the disposal of a group
of fixed assets. Accordingly, the items of fixed assets disposed off
in the sale transaction of divestment of the business are eliminated
on disposal and the gains or losses arising on disposal are
recognised in the profit and loss statement. The Committee is of
the view that the divestment of the business and the acquisition/
construction of the new facilities for continuing businesses are
independent transactions as these are not part of any exchange
transaction of divestment and acquisition of the facilities. Thus,
the cost incurred for acquisition/construction of the new facilities
for use by the continuing businesses should be recognised as
fixed assets.
D. Opinion
10. On the basis of the above, the Committee is of the opinion
that the second option mentioned by the querist in paragraph 3, is
correct, i.e., the gain or loss on sale of the divested business unit
should be recognised in the profit and loss account and the cost
incurred on the new acquisition/construction of shared facilities
should be recognised as fixed assets.
1Opinion finalised by the Committee on 9.8.2007. |