|
A. Facts of the Case
1. A Government company (hereinafter referred to as ‘the company’) registered under the Companies Act, 1956, is a wholly owned subsidiary of a listed government company. The shares of the company are not listed with any stock exchange.
2. The company is engaged in activities relating to exploration and production of oil and gas. The company follows the ‘Full Cost’ method of accounting for its oil and natural gas exploration and production activities. The company is holding participating interest (PI) in various oil and gas blocks. The company along with another company (company V) bids to have PI in oil and gas blocks at Mozambique. Company A, which is a 100% subsidiary of the company has acquired through its 100% step-down subsidiary, company B, the PI in oil and gas block in Mozambique. The structure of the Group in respect of acquisitions of participating interest is as under:
3. The steps followed for the acquisition of PI, as stated by the querist, are as under:
-
On 22nd December, 2005, the holding company of ‘the company’ entered into a Memorandum of Understanding (MOU) with company V for cooperation in oil and gas exploration in India and worldwide.
-
On 2nd April, 2008, proposal for farm-in opportunity in offshore exploration block in Mozambique Area was received from M/s N Corporation (Operator).
-
Joint Study and Bidding Participating Agreement was signed in April 2008 by the company and company V, both Indian parties. The Agreement states that the expenditure incurred on the due diligence would be shared equally by these two Indian parties.
-
The bids were invited from four parties for the appointment of financial consultant/advisor. After commercial evaluation, the job was awarded to M/s E. The letter of award was issued on 17th April, 2008 and the scope of work includes the following:
* Facilitating in bidding process.
* Assist in appointing legal and taxation consultants in this regard.
* Carry out financial due diligence.
- Fixed Drop Dead Fees of Rs. 36.00 lakh if for any reason, the transaction does not consummate.
- Success Fees of Rs. 1.50 crore, payable on successful closure of the transaction.
-
The commitment (LOI) is made in India by the Indian parties and payment for services was also agreed to be made in India by the Indian parties.
M/s E made presentation to management on 24th April, 2008, which was considered by the managements of the company and its holding company. The company obtained the internal approvals for bidding.
-
The strategy meet between the company and company V for discussing the strategy for bidding and to acquire a participating interest in oil and gas block in Mozambique currently with M/s N Corporation took place on 25th April, 2008.
-
In this meeting decision to bid and commercial terms were discussed and decided. The querist has pointed out that the bidding could have been possible even without relying on financial advisor’s report.
-
The bid letter was submitted on 30th April, 2008.
-
Negotiations/discussions took place during May to July, 2008. During this period, it was decided that both the parties would acquire 10% each, participating interest in the oil and gas block in Mozambique and sign separate agreements with M/s N Corporation.
-
At this stage, it was also decided that the agreement would be signed through a subsidiary abroad. Hence, the company created a new subsidiary, company B at the Netherlands, which is a step-down subsidiary of the then existing subsidiary of the company, company A. Similarly, company V signed the agreement through its subsidiary company. For creation of company B, the remittance of Euro 18,500, which was required as the minimum share capital, was made from India.
-
The Participating Agreement between company B and M/s N Corporation was signed on 11th August, 2008.
-
The Government of Mozambique (Republic De Mocambique – Ministerio Dos Recurson Minerils Gabinete D Ministro) accorded approval on 19th December, 2008.
-
Amount paid to M/s E (being success fee – the company’s share) was Rs. 74,72,221 (after deducting tax) and the same was released on 31st March, 2009.
4. The querist has stated that the above-mentioned success fee has been treated as revenue expenditure in the books of the company for the following reasons:
(a) The underlying assets (PI) are not in the books of the company. The value of equity shares together with share premium subscribed by the company in its subsidiary, company A, are shown as investment in the books of the company. The PI in Mozambique block is in the books of company B. Hence, it is felt that the success fee incurred in relation to PI cannot be capitalised in the books of the Indian company, viz., the company.
(b) The expenditure on account of success fee is incurred at the bidding process stage before the formation/incorporation of company B (which acquired the PI in Mozambique block). The success fee has relation to bidding process for PI and has no relation to the acquisition of equity shares in company A.
(c) Though the advisory services of the financial advisers have helped the bidding process, the bidding could have been possible even without these services, i.e., it need not necessarily be an integral part of the acquisition. Hence, as per the querist, relying on one of the recent opinions issued by the Expert Advisory Committee (published as Query No. 19 of Volume XXVI of the Compendium of Opinions) on the subject ‘Capitalisation of certain expenses related to acquisition of an investment’, the success fee has been treated as revenue expenditure. The querist has reproduced the following portion of the opinion for reference:
“The cost of acquisition should include only those direct charges which are incurred ‘on’ acquisition of investment, i.e., the expenses, without the incurrence of which, the transaction could not have taken place such as share transfer fees, stamp duty, registration fees and duties and levies by regulatory agencies and stock exchanges. The expenses incurred ‘before’ acquisition, even though directly attributable to acquisition should not be added to the cost of acquisition of shares as these do not represent the worth of shares acquired.”
5. As per the querist, the government auditors while reviewing the accounts had examined the above treatment given by the company and have decided that this matter be taken up with the Expert Advisory Committee of the Institute of Chartered Accountants of India for specific opinion on the matter.
B. Query
6. Considering the above facts, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the accounting treatment followed by the company is correct.
(ii) If no, then what is the correct accounting treatment.
C. Points considered by the Committee
7. The Committee notes that the basic issue raised in the query relates to accounting treatment of fee, i.e., Fixed Drop Dead Fee and success fee, paid by the company to financial advisors in connection with acquisition of participating interest in oil and gas blocks by the step-down subsidiary company B. The Committee has, therefore, considered only this issue and has not touched upon any other issue that may arise from the Facts of the Case, such as, accounting in the books of the holding company, company A, company V or company B with respect to any expenditure in connection with the acquisition of shares or participating interest, etc.
8. The Committee notes from the Facts of the Case that the company in the instant case has incurred the expenditure on fee to financial advisors for a commercial advantage which is to be availed through its subsidiary company A, in whose books, the investment in company B (which is acquiring the participating interest in oil and gas blocks) would appear. The Committee examines whether this expenditure can be added to the cost of investment in the subsidiary company A as appearing in the books of the company. In this context, the Committee notes paragraphs 28, 29 and 32 of Accounting Standard (AS) 13, ‘Accounting for Investments’, which provide as follows:
“28. The cost of an investment should include acquisition charges such as brokerage, fees and duties.
29. If an investment is acquired, or partly acquired, by the issue of shares or other securities, the acquisition cost should be the fair value of the securities issued (which in appropriate cases may be indicated by the issue price as determined by statutory authorities). The fair value may not necessarily be equal to the nominal or par value of the securities issued. If an investment is acquired in exchange for another asset, the acquisition cost of the investment should be determined by reference to the fair value of the asset given up. Alternatively, the acquisition cost of the investment may be determined with reference to the fair value of the investment acquired if it is more clearly evident.”
“32. Investments classified as long term investments should be carried in the financial statements at cost. However, provision for diminution shall be made to recognise a decline, other than temporary, in the value of the investments, such reduction being determined and made for each investment individually.”
From the above, the Committee is of the view that in the present case, the expenditure on fee paid to financial advisors, cannot be included in the ‘cost of investment’ at the time of initial recognition. Such expenditure also does not become part of the carrying amount of the investment in the shares of company A as the investment is to be carried at cost with only diminution being recognised under certain circumstances.
9. The Committee now examines whether the expenditure on fee to financial advisors can be capitalised as a separate asset. The Committee notes that the term ‘asset’ has been defined in the Framework for the Preparation and Presentation of Financial Statements (the Framework), issued by the Institute of Chartered Accountants of India as “a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise” (paragraph 49(a)). The Committee is of the view that the expenditure on fixed drop dead fee and success fee does not result into a resource controlled by the company and accordingly, it cannot be capitalised as an asset.
10. The Committee further notes paragraph 96 of the Framework issued by the Institute of Chartered Accountants of India, which provides as follows:
“96. An expense is recognised immediately in the statement of profit and loss when an expenditure produces no future economic benefits. An expense is also recognised to the extent that future economic benefits from an expenditure do not qualify, or cease to qualify, for recognition in the balance sheet as an asset.”
From the above, the Committee is of the view that the expenditure on fixed drop dead fee and success fee incurred by the company, which does not meet the definition of an asset as discussed in paragraph 9 above, should be expensed in the statement of profit and loss.
D. Opinion
11. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6 above:
(i) The accounting treatment followed by the company to treat the expenditure incurred on success fee as revenue expenditure is correct.
(ii) Since the answer to (i) above is in the positive, this issue does not arise.
|