1.  Accounting of promotional/ marketing items

Enquiry:

With regard to pharmaceutical manufacturing companies, your clarification is required about the accounting of promotional/ marketing items that are left undistributed at year end e.g., fridge, air-conditioner, watches, drafting pads etc. Some pharmaceutical companies are classifying these items as their current assets under stores and spares heading. Is this treatment correct? Or should these undistributed items be expensed out as well in the year of purchase, being non asset?

It is important to note that there are no written terms and conditions. These items are distributed as gifts to doctors under implied consideration that they will refer the medicine of pharmaceutical company to their patients.

Opinion:

The Board would like to highlight that the enquired matter has been deliberated by the International Financial Reporting Interpretations Committee (IFRIC) in its meetings and the IFRIC decision based on IAS 38 ‘Intangible Assets’ is as under:

“Paragraph 5 of IAS 38 states that IAS 38 applies to expenditure on advertising activities. Accordingly, the Committee concluded that if an entity acquires goods solely to be used to undertake advertising or promotional activities, it applies the requirements in paragraph 69 of IAS 38. Paragraph 69 requires an entity to recognise expenditure on such goods as an expense when the entity has a right to access those goods. Paragraph 69A of IAS 38 states that an entity has a right to access goods when it owns them. The entity, therefore, recognises expenditure on those goods as an expense when it owns the goods, or otherwise has a right to access them regardless of when it distributes the goods.”

In explaining the rationale for the requirements in paragraph 69, paragraph BC46B of IAS 38 states that goods acquired to be used to undertake advertising and promotional activities have no other purpose than to undertake those activities. In other words, the only benefit of those goods for the entity is to develop or create brands or customer relationships, which in turn generate revenues. However, applying IAS 38, the entity does not recognise internally generated brands or customer relationships as assets.

IFRIC decision on the enquiry can be accessed in the IFRIC update at:
http://www.ifrs.org/news-and-events/updates/ifric-updates/september-2017/#8

In view of the IFRIC decision, the Board has accordingly concluded that in the enquired scenario the promotional and marketing goods (refrigerators, air conditioners etc.) should be recognised as an expense in the statement of profit of loss, in accordance with IAS 38. The expense should be recorded when the pharmaceutical company has right to access to those goods, regardless of when those promotional and marketing goods are distributed to the doctors.

(April 20, 2018)

2. Change of amortisation method of Intangible Asset

Enquiry:

Para 3.4 of Revised AFRS for SSEs requires the Company to amortize the asset using straight line method, however our client, a Small Sized Company, was previously amortizing using written down value method of amortization.

a) Will it be mandatory for the Company to restate its opening balance sheet to account for the impact as required under para 22.2(d), or it may not be required?

Opinion:

Paragraph 3.4 of Section 3 ‘Intangible Assets’ and paragraph 22.2 of Section 22 ‘Transition to the Accounting Standards for SSEs’, referred in your enquiry, are reproduced below for reference:

3.4     “An entity shall allocate the amortizable amount of an intangible asset over its useful life using straight line method. The amortization charge for each period shall be recognized as an expense, unless another section of this standard requires the cost to be recognized as part of the cost of an asset such as inventories or property, plant and equipment.”

22.2    “An entity shall in its opening balance sheet as of its date of transition (beginning of the earliest period presented in financial statements) to this Standard:

a) Recognize all assets and liabilities whose recognition is required by to this Standard;
b) Not recognize items as assets or liabilities if to this Standard do not permit such recognition;
c) Reclassify items that it recognized under its previous financial reporting framework as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity under to this Standard; and
d) Apply to this Standard in measuring all recognized assets and liabilities. (emphasis is ours)

The financial effect of above actions should be reflected in opening balance sheet by adjusting the amount of retained earnings as at the date of transition.”

Measurement is defined in the Framework of the Revised AFRS for SSEs as follows:

“Measurement is the process of determining the monetary amounts at which an entity measures liabilities, assets, income and expenses in its financial statement. Measurement involves the selection of a basis of measurement. Two common bases are: Historical cost and Fair value.

The measurement base most commonly adopted by entities in preparing their financial statements is historical cost.”

With regard to the enquiry, no change in the measurement basis of the intangible, i.e. historical cost shall be required on the adoption of AFRS for SSEs. Further, the change in the amortization method from the reducing balance method to straight line method, mandated on the adoption of AFRS for SSEs, is a change in the accounting estimate. The effect of change in accounting estimate shall be recognised prospectively in accordance with paragraph 19.6 of Section 19 ‘Accounting Policies, Changes in Accounting Estimates and Errors’.

In view of the above, the Committee is of the view that restatement on account of this point is not required under paragraph 22.2(d) of Revised AFRS for SSEs.

(March 20, 2017)

3.  Query on subsequent cost of Intangible Asset

Enquiry:      

Para 5.10 of AFRS for MSEs and SSEs allowed capitalization of expenditure on intangible asset subsequent to its completion, subject to certain conditions. With effect from July 01, 2015, Company is required to comply with Revised AFRS for SSEs, wherein no such para is included, however, para 3.6 in the Revised AFRS for SSEs provide guidance on capitalization of website costs.

Company owns the Job posting website, which is in operation for more than 5 years. Costs incurred during the operational period, subsequent to initial completion, meeting the criteria given under para 5.10 of AFRS for MSEs and SSEs (previously applicable), were also being capitalized by the Company.

a) Whether or not the guidance in para 3.6 of Revised AFRS for SSEs can be applied to capitalize the costs incurred on intangible asset subsequent to its completion?

b) If not allowed, should previously capitalized costs be de-recognized under the requirement of para 22.2b of Revised AFRS for SSEs?

Opinion:

Section 3, Intangible Assets, of the Revised Accounting and Financial Reporting Standard for Small-Sized Entities (the Revised AFRS for SSEs), outlines the accounting and reporting requirements for the intangible assets. Paragraph 3.6 (as stated below) provides guidance for the accounting of website related costs:

3.6     “Website costs are categorized into five basic stages that are planning stage (stage 1), application and infrastructure development (stage 2), the graphical design development (stage 3), content development (stage 4) and operating (stage 5). Costs incurred in stage 1 and stage 5 are always expensed however costs incurred from stage 2 to 4 can be capitalized if it fulfills the criteria of development asset discussed in preceding paragraph, particularly (d) above”.

Considering the above requirements of paragraph 3.6, the Committee is of the view that the cost incurred subsequent to the initial recognition of the website can be capitalized, only, if it relates to the three eligible stages for capitalization i.e. application and infrastructure, graphical design and/ or content development. Costs incurred at planning and operating stages are always expensed.

In relation to second part of the query, the Company should consider the requirements mentioned in section 22, Transition to the Accounting Standards for SSEs, when it adopts the Revised AFRS for SSEs for the first time for the preparation of the financial statements.

Relevant paragraph of section 22 is reproduced below:

22.2    “An entity shall in its opening balance sheet as of its date of transition (beginning of the earliest period presented in financial statements) to this Standard:

• • Recognize all assets and liabilities whose recognition is required by to this Standard;
  • Not recognize items as assets or liabilities if to this Standard do not permit such recognition;
  • Reclassify items that it recognized under its previous financial reporting framework as one type of asset, liability or component of equity, but are a different type of asset, liability or component of equity under to this Standard; and
  • Apply to this Standard in measuring all recognized assets and liabilities.

The financial effect of above actions should be reflected in opening balance sheet by adjusting the amount of retained earnings as at the date of transition.”

In accordance with the requirement (b) above, the Committee is of the view that previously recorded intangible asset should be re-assessed for recognition as per the criteria outlined in section 3 of the Revised AFRS for SSEs, and the items not fulfilling the criteria should be derecognized from the opening balance sheet and charged to the retained earnings, i.e., restatement would be required.

  (March 14, 2017)

4. Transfer of rights of Hospital Rooms

Enquiry:      

The object of the public unlisted company (“the Company”) is to establish, purchase construct and maintain hospitals, nursing homes and other allied health care facilities. The Company is categorized as medium-sized company and in pursuance of SRO 23(1)/ 2012 dated January 16, 2012 (previously SRO 860(I) I 2001 dated August 21, 2007) requires being compliant with the Accounting and Financial Reporting Standards (AFRS) for Medium-sized Entities (MSEs);

• The Accounts revealed that the Company disposed of its ‘Land’ during the years ended June 30, 2011, 2012 and 2013 and recorded / accounted for gains as ‘Profit on sale of Patients’ Rooms’. Details of which are as under, figures are fictitious:

Years	2011	2012	2013
Land (disposed of)	120 M	20M	100M
Profit on Sale of Patients’ Room	2M	0.5 M	0.3M

• The afore-referred disposal of land as ‘Sale of the Patients’ Rooms’ was recorded on the basis of a ‘Sale Agreement’ with various individuals at different prices. Salient terms and conditions of the sale agreement are as under:
• The buyer agrees to purchase a patient admission room category (private) from the Company for a price of Rs.— paid within one years in —equal Installments of Rs. —- each, out of which Rs. — has been received as down payment;
• The buyer after making complete payment of the room will own one patient admission room category (private) in the said hospital without the right to own land, roof and bathroom.The sale deed shall be registered with the Registrar and documentation charges shall be borne by the buyer;
• Both the parties agree that 40% of the total monthly admission revenue will be retained by hospital for maintenance and running expenses and 60%will be paid to the buyer by 15 days of every month according to the policy of Company;
• The seller agrees that the buyer will get income of one room from the first phase  of construction of 100 rooms, of all categories, of hospital subject to the condition that the buyer has already paid the total price of the subjected room;
• The buyer is entitled to transfer/ sell the rights of the room(s) only with the consent of the hospital administration and the hospital will have the priority to buy back the room;
• Room will only be used at the discretion of the management of Company for admission of patients as and when required basis without any interruption;
• Board of Directors will be the final authority regarding all matters related to room(s);
• Maintenance of the room(s) will be the responsibility of the hospital’s administration;
• Room rent will be collected and disbursed by the Company ; and
• Both the parties agree that the management of Company shall be indemnified from any sort of litigation, legal proceedings and the buyer shall refrain from such action. The management of Company reserves the right to revoke this deed due to such unhealthy action and room shall be taken over by the Company’s management and cost shall be refunded back after deduction of relevant expenditures;
• The Clauses of the ‘Sale Agreement’ of the patients’ admission rooms indicate that risks and rewards were not fully transferred to the allottees as the control of the patients’ admission rooms remain with the Company. Hence this arrangement may not be considered as a valid sale; and
• No mutation of sale was recorded in respect of sale of patients’ room. Reference to para 2 of the ‘Sale Agreement’, SECP also confirmed that they have not been provided any documentary proof that the ‘Sale Agreement’ is registered with the Registrar of Properties. First, the mutation of the respective property be marked and then process of registration of the ‘Sale Agreement’ can be initiated.
• The Accounts for the years ended June 30, 2011, 2012 and 2013 revealed that there is a reduction in ‘Land’ owing to the sale of constructed private patients’ rooms ( which are not separable from the ‘Land’).

2. In this regard, ICAP is kindly requested to provide technical opinion/ input on the following queries of the Department:

• Whether the Company accounted for the afore-referred transaction in accordance with applicable accounting standards i.e. AFRS for MSEs; and
• If not, please provide the correct accounting treatment in accordance with AFRS for MSEs / lAS / IFRS.

Opinion:  

The Committee considered your enquiry and its views are as follows:

• The Company, being a medium-sized company, is required to comply with the requirements of Accounting and Financial Reporting Standards (AFRS) for Medium-sized Entities (MSEs).
• The terms and condition of Sale Agreement mentioned in point (b) and (c) of the enquiry clearly states that right to own land, roof and bathroom of the patient admission room will not be given to the buyer. Point (f) indicates that the hospital may be retaining control over the rooms which indicate that risks and rewards were not fully transferred to the allottees. In addition, the economic benefit will continue to arise in future in the shape of reimbursement of maintenance.

Based on additional information received, mutation of the sale of patients’ room was not undertaken and there is no information whether sales deeds were registered with the Registrar of Properties. Hence, we concur with your views that it is not a sale of land.

With regard to accounting treatment of this transaction, the Committee feels that the transaction may either be a:

• sale of right to use the room depending on the provisions of the contract, for which recognition and measurement criteria of intangible assets as given in Section 5 ‘Intangible Assets’  may apply; or
• the transaction may also be an operating lease on which provisions of Section 4 ‘Leases’ of AFRS may apply.

The Sales Agreement provided to us does not explicitly explain the terms of contract neither we have all other relevant facts and information to make the judgment of applicability of either of the two options.

Certain provisions of IAS 38 ‘intangible assets’ and IAS 17 ‘Leases’ are not covered in AFRS for MSE, therefore, recognition and measurement requirements as given in respective IFRSs should be used for guidance.

The Committee would also like to draw your attention to the requirements of paragraph 5 and 7 of IFRIC 12 ‘Service Concession Arrangements’ which applies to public-to-private service concession arrangements, and may be used as analogy in this case.

(December 02, 2014)

5.  Membership Card

Enquiry:  

A limited liability company has part of its assets a seat (trading right membership) in one of the stock exchanges in Pakistan. Under what heading this asset shall come under IFRS for disclosure and valuation purpose in the balance sheet of the company. This asset after purchase at cost, can thereafter be shown at fair value representing the current market price of the seat.

Opinion:    

At the outset, the Committee would like to draw to your attention to the definition of intangible assets as provided in IAS-38 ‘Intangible Assets’, which reads as under:

“An intangible asset is an identifiable non-monetary asset without physical substance”

Also, paragraph 12 of the said IAS states that:

“12  An asset meets the identifiability criterion in the definition of an intangible asset when it:

(a)   is separable, ie is capable of being separated or divided from the entity and sold, transferred, licensed, rented or exchanged, either individually or together with a related contract, asset or liability; or
(b)  rises from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.”

In view of the above, the Committee is of the opinion that trading rights arising from stock exchange membership fall under the definition of intangible asset and, therefore, should be classified as such in the financial statements

With regard to your second question, the Committee would like to make reference to the following paragraphs of IAS-38:

“72    An entity shall choose either the cost model in paragraph 74 or the revaluation model in paragraph 75 as its accounting policy. If an   intangible asset is accounted for using the revaluation model, all the other assets in its class shall also be accounted for using the same    model, unless there is no active market for those assets.

Cost model

74      After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortisation and any accumulated impairment losses.

Revaluation model

• After initial recognition, an intangible asset shall be carried at a revalued amount, being its fair value at the date of the revaluation less any subsequent accumulated amortisation and any subsequent accumulated impairment losses. For the purpose of revaluations under this Standard, fair value shall be determined by reference to an active market. Revaluations shall be made with such regularity that at the balance sheet date the carrying amount of the asset does not differ materially from its fair value.”

It follows from the above that an intangible asset can be carried after initial recognition at revalued amount subject, however, to the condition that an active market exist for such intangible asset. In this context the characteristics of an active market have also been laid down by the IAS-38 which are as under:

“An active market is a market in which all the following conditions exist:

(a)  the items traded in the market are homogeneous;
(b)  willing buyers and sellers can normally be found at any time; and
(c)  prices are available to the public”

The Committee would therefore recommend that the management of the company should assess the existence of an active market in relation to the trading rights (arising from the stock exchange membership) by considering the above referred characteristics of an active market and choose the accounting policy accordingly. In this context the Committee is of the view that the management should also assess the useful life of the Intangible asset to determine whether the same is finite or indefinite in accordance with IAS 38

(March 8, 2008)

6. Recognition of Goodwill of Company’s Brands

Enquiry:  

The examination of annual accounts of a Company for the year ended June 30, 2007 revealed that the company has recognized Goodwill of its Brands of Rs.100,000,000 as intangible assets vide the valuation report given by the valuer  on June 25, 2005. Perusal of the annual accounts of the Company for the previous years revealed that the aforesaid amount is appearing in the accounts of the Company since 2005 which is in contravention to Para 48 of International Accounting Standard (IAS) 38 (Intangible Assets) which states that Internally generated Goodwill shall not be recognized as an asset.

On enquiry, the Company has submitted to this Commission that the Goodwill for its brand recognized in the accounts is not internally generated.  Its brand is a well renowned brand on which the company has incurred substantial advertisement expenses. The company has recognized the asset on the basis of the report of the valuer because the following criteria are met:

• The asset meets the definition of an intangible asset i.e. it is identifiable and controlled by the entity.
• It is probable that future economic benefits that are attributable to the asset will flow to the entity;
• The cost of the asset can be measured reliably.

Moreover, if the brand name is sold in the market, it would fetch the value not below the amount on which the asset has been recognized.

In view of the above, please comment on the appropriateness of the above accounting policy for recognition of goodwill in light of IAS 38. As with the aforesaid treatment the company has inflated the profits of the company by the said amount in the year 2005.

Opinion:  

The Committee would like to draw your attention to paragraph 9 and paragraphs 57-67 of IAS 38 ‘Intangible Assets’ whereby the standard does not prohibit recognition of internally generated “intangible assets”. However, paragraph 63 and 64 (reproduced below) of the Standard specifically prohibits recognition of internally generated “brands” as Intangible assets.

63      Internally generated brands, mastheads, publishing titles, customer lists and items similar in substance shall not be recognised as intangible assets

64      Expenditure on internally generated brands, mastheads, publishing titles, customer lists and items similar in substance cannot be distinguished from the cost of developing the business as a whole. Therefore, such items are not recognised as intangible assets.

In view of the above the Committee reached a conclusion that the value of internally generated “brand” should not have been recognized as intangible asset.

                      (February 8, 2008)