1.5       Query

Treatment of deferred revenue expenditure.

1. A company with a turnover of Rs. 90.00 crores has commenced marketing of a new product which is quite different from its existing products. It is estimated that the company will have a turnover of around Rs. 7 crores from this product. The brand name under which these goods are to be marketed is owned by this company. In order to create brand image and to launch this new product the company carried out an extensive special initial advertisement campaign at a cost of Rs. 50 lacs. The annual budget for this product is expected to be about Rs. 5 lacs thereafter. The annual expenditure of the company on advertisement is around Rs. 75 lacs in respect of other current products. It is expected that the benefit of this special campaign would be available for 5 to 7 years.

2. The company proposes to treat this expenditure as the deferred revenue expenditure as it is of the opinion that the company will have benefit of this expenditure over quite a long period.

3. The opinion of the Expert Advisory Committee has been sought on the following questions:

(i) Whether the company is correct in considering this initial expenditure incurred on launching extensive specialadvertisement campaign which has lasting benefit as deferred revenue expenditure and not writing-off the entire expenditure to profit and loss account in the year in which it is incurred.

(ii) What should be the reasonable period-5 years or 7 years- over which this expenditure should be written-off, if it is to be treated as deferred revenue expenditure?

(iii) Will it make any difference, if the company was altogether a new company not doing any other business?

                                                  Opinion                                                            January 13, 1987

1.The Committee notes that the term Deferred Revenue Expenditure has been defined in para 4.5 of the Guidance Note on terms used in the Financial Statements, issued by the Institute of Chartered Accountants of India, as the Expenditure for which payment has been made or liability incurred but which is carried forward on the presumption that it will be of benefit over a subsequent period or periods .

2.The Committee also notes that para 10.1 of the Statement on Auditing Practices, issued by the Research Committee of the Institute of Chartered Accountants of India has recommended the treatment of deferred revenue expenditure. The relevant extract of the said para is as below:

If a future period will receive benefit from the outlay, the proper portion of the deferred charge should appear on the balance sheet. Unless some value can be determined as flowing into the future, there is no justification for not writing off the item immediately. The fact that the amount spent is large, should not by itself affect the decision.

(b) Is there proper authority for the outlay and the deferral of the write off? This will be determined through the vouching process.

 

(c) What is reasonable period for amortising the expenditure? In some cases the time involved will be related directly to some other account, as in the case of debenture discounts and debenture issue expenses. In other cases, it may be influenced by tax laws, e.g., preliminary expenses can be written off over 10 years for income-tax purposes (Section 35D of the Income-tax Act, 1961). In many instances, such as deferred advertising, plant rearrangement, research and development costs, etc., the period has to be arbitrarily decided by the management, and the auditor should satisfy himself that it is not unreasonable.

 

3. On the basis of the above, the opinion of the Committee on the issues raised by the querist in para 3 of the query is as follows:

(i) The special advertisement expenditure incurred to launch a new product, the value of which is expected to flow into the future, can be treated as deferred revenue expenditure.

 

(ii) Regarding the period of write-off of the said advertisement expenditure which is treated as deferred revenue expenditure, the Committee is of the opinion that the management of the company should exercise its judgement and determine that period on the basis of the period expected to benefit from the said expenditure. The auditor should satisfy himself that the period so determined is not unreasonable keeping in view the circumstances of the case. 

 

(iii) The Committee is of the opinion that the nature of the said expenditure will not change if it is incurred by a new company not doing any other business. Thus, in such a situation also the special advertisement expenditure incurred to launch the product, which is expected to benefit future periods, should be treated as deferred revenue expenditure. In this context, the Committee draws the attention of querist, to the following relevant extracts of paras 6.1, 6.2 and 6.3 of the Guidance Note on Treatment of Expenditure During Construction Period, issued by the Research Committee of the Institute of Chartered Accountants of India.

 

6.1This heading refers to various items of indirect expenditure incurred by a project during its construction period, which are not related either directly or indirectly to the work of construction, but which are incurred mainly in preparation for the work which will be undertaken after the project commences commercial production.      

 

6.2 Expenses will also be incurred in connection with the salaries of employees who are appointed ahead of the date of production but whose work involves no connection, direct or indirect, with the work of construction, for example, employees of the sales department, publicity and public relations departments, etc. The concern may also engage in advance publicity campaigns in the press and otherwise in order to popularise itself and its products, well in advance of the date it goes into production.

 

6.3 Indirect expenses of the type discussed in this paragraph cannot be regarded as part of the incidental cost of construction because as explained above, they are not related either directly or indirectly to the work of construction. At the same time, since these expenses are incurred during the preproduction period, they cannot be written off to revenue. The only alternative, therefore, is to treat such expenses as deferred revenue expenditure to be carried forward on the balance sheet under the general heading of Miscellaneous Expenditure. They should, however, be written off to revenue as soon as possible after the commencement of commercial production and, in no case, should the period of such write-off extend beyond a reasonable period of time-say three to five years, depending upon circumstances.

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