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Accounting treatment of expenditure on Stamp duty and registration fees for increase in authorised capital

Written By Admin on Sunday, 21 September 2014 | Sunday, September 21, 2014

Case Study

A.        Facts of the Case

1.            A  company  was  incorporated  under  the  Companies  Act,  1956  as   a  private  limited
company.  The  company  is  registered  as   a  non-banking  financial  company  (‘NBFC’)  (non- deposit  accepting)  as   defined  under  section  45-1A  of the  Reserve  Bank  of India  (‘RBI’)  Act, 19 3 4.  The company is primarily engaged in the business of lending for purchase of equipments.

2.          The details of share capital of the company as  at 31“ March, 2013 are as follows:

Authorised share capital (70,00,000 equity shares of Rs.  l0/- each)             Rs.  7,00,00,000
Issued, subscribed and paid-up capital                                                         Rs.  6,48,00,000
(64,80,000 equity shares of Rs.  l0/- each)

The  company  has  not issued  shares  or  other securities  at premium  and  hence,  does  not have securities premium account.

The  company has  received  share  application money of Rs.  55,62,55,000.   To be  able  to  allot further equity shares,  the  shareholders  of the  company,  have  approved  increase  in authorised share   capital  to   Rs.   75,00,00,000/-.   The   company   has   incurred   an   expenditure   of  Rs. 47,60,000  (Rs.  34,00,000  towards stamp duty and Rs.  13,60,000 towards registration fees paid to the Registrar of Companies) for the said increase in authorised share capital.

Post increase in authorised capital, the Board of Directors of the company has passed a resolution for allotment of 5,56,25,500  equity  shares  of the  company  of Rs.  l0/- each  at par amounting to  Rs.  55,62,55,000.

3.           The  issue  relates  to  accounting treatment of the expenditure  of Rs.  47,60,000  incurred by the  company  for increase  in  authorised  capital. Relevant legal/accounting requirements

4.           The  querist  has  stated  that  the  following  technical  literature  merits  consideration  to
determine  the  appropriate  accounting  treatment  for  stamp  duty  and  registration  fee  incurred
by the  company  for increase  in  authorised  share capital:

>Section  78  of the  Companies  Act,  1956  permits  the  use  of securities  premium account,
inter alia,
(a)        in writing off the preliminary expenses of the company, and
(b)        in writing off the expenses of any issue of shares or debentures of the company.

>As per Accounting Standard (AS) 26,  ‘Intangible Assets’,

“6.1     An  intangible  asset  is  an  identifiable  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.”

“5.  Exclusions  from   the   scope   of  an   Accounting  Standard  may  occur  if certain activities  or  transactions  are  so  specialised that they give rise to accounting issues  that may need to be dealt with  in  a  different way.  Such  issues  arise  in  the  expenditure on   the   exploration   for,  or   development   and   extraction   of,   oil,  gas   and   mineral deposits   in   extractive   industries   and in   the   case   of  contracts   between   insurance enterprises   and   their  policyholders.   Therefore, this   Standard   does   not   apply   to expenditure  on  such  activities.  However,  this  Standard applies  to  other  intangible assets   used   (such  as   computer  software),  and   other  expenditure (such   as   start-up costs),   in   extractive   industries  or  by   insurance   enterprises.  Accounting issues   of specialised  nature  also  arise  in  respect  of accounting  for  discount  or  premium relating to   borrowings   and   ancillary  costs   incurred  in  connection  with  the  arrangement  of borrowings,   share   issue   expenses   and   discount   allowed   on   the   issue   of  shares. Accordingly, this Standard does not apply to such items also.” (Emphasis supplied by the querist.)

> As per the Guidance Note on Terms Used in Financial Statements:

“15.08 Share Issue Expenses

Costs  incurred  in  connection  with  the   issue   and   allotment  of  shares.   These include  legal  and  professional  fees,  advertising  expenses,  printing  costs,  underwriting commission, brokerage, and also expenses in connection with the issue of prospectus and allotment of shares.”

> As per the Guidance Note on Audit of Miscellaneous Expenditure:

“I4.  Preliminary   expenses   are   the   expenses   relating   to   the  formation   of  an enterprise.   For example,   in   the   case   of a   company,   preliminary  expenses   would normally include the following:

(a)        Legal cost in drafting the memorandum and articles of association.
(b)        Fees for registration of the company.
(c)         Cost  of printing  of the  memorandum   and  articles  of association  and statutory books of the company
(d)        Any   other   expenses   incurred  to   bring  into   existence   the   corporate structure of the company.”

“Expenses Related to Subscription or Issue of Shares

20.   Expenses   related  to   subscription   or  issue   of share   include  commission   or brokerage on underwriting or subscription  of shares or debentures,  discount allowed on  issue of shares or debentures.

“24.  Other expenses  on  issue  of shares  or debentures,  such  as fees of the  managers  to the issue, fees of the registrars to the issue including mailing and handling charges, fees of the advisors to  the issue,  advertisement expenses,  expenses  on printing and supply of prospectus  and application forms,  expenses  on printing of share/debenture  certificates, etc.,   should  be   verified  with reference   to  supporting  documents  such   as   invoices, agreements,  etc.’

(Emphasis supplied by the querist)

> As  per  paragraph  8.7.4  of the  Guidance  Note  on  the  Revised  Schedule  VI  to  the Companies Act,  1956, dealing with ‘Other non-current assets’:

“The   Revised   Schedule   VI  does   not   contain   any   specific   disclosure   requirement for   the unamortized  portion  of expense  items  such  as   share  issue  expenses,  ancillary borrowing  costs and discount or premium relating to borrowings.  The Old Schedule VI required these items to be included under the head “Miscellaneous Expenditure”. As  per  AS   16   Borrowing  Costs  ancillary borrowing  costs   and   discount  or  premium relating  to  borrowings  could  be  amortized  over  the loan  period.  Further,  share  issue expenses,  discount  on  shares,  ancillary  costs-discount-premium on  borrowing,  etc., being  special  nature  items  are  excluded  from  the  scope  of AS  26 Intangible Assets (Para  5).  Keeping  this  in  view,  certain  companies  have  taken  a  view  that  it is  an acceptable practice to amortize these expenses over the period  of benefit,  i.e.,  normally 3   to 5   years.  The  Revised  Schedule  VI does  not  deal  with  any  accounting  treatment and    the   same     continues    to     be     governed    by    the    respective    Accounting Standards/practices. Further,  the  Revised  Schedule  VI  is  clear  that  additional  line items  can  be  added  on  the  face or  in  the   notes.  Keeping  this  in  view,  entity  can disclose  the  unamortized  portion  of such expenses  as  “Unamortized  expenses”,  under the  head  “other  current/non-current  assets”, depending  on  whether  the  amount  will be amortized in the next 12 months or thereafter.”

> As  per  an  EAC  opinion  (Volume  XI,  Query No.  3.1)  regarding  classification of share issue expenses:

“3.   The  Committee  is  of the  view  that,  in  general,  all  expenses  incurred  directly  in relation to a public issue should be considered as public issue expenses.  In other words, public issue expenses are  those  expenses  which  would not have  been  incurred had  the public  issue   not  been made,   e.g.,   Registrar ’s   Processing   Charges,   expenses   on printing and distributing ofa application forms, prospectus,  etc.  Further,  in  the  view of the Committee, public issue expenses would be those which are incurred between the decision  to  make  the  public  issue  and  completion of all necessary formalities  with regard to the issue.” (Emphasis supplied by the querist.)

Querist’s analysis

5.           As per the literature quoted above, it is permissible to amortise share issue expenses over a period of 3 to  5   years.  A  company  has  also  an  option  to  write  off expenses  on  issue  of shares against  the   securities  premium  account.  However,  none  of the  aforesaid  literature makes specific  reference  to  expenditure  incurred  on  increase  in  authorised  share  capital  and whether such expenditure is a part of share issue expenses. The querist’s analysis is as  follows:

> One   argument  is   that  the   increase   in   authorised  capital  happens  before   issuance   of shares  and  should  not be  regarded  as  share  issue  expenses.  However,  the  purpose  of increasing  authorised  share  capital  of a  company  is  solely  to  enable  the  company  to issue  shares to that extent.  There is  no  other reason  why  any  company  would  increase its  authorised share  capital.  Thus,  the  benefit from  incurring  expenditure  on  increase  in authorised  capital  arises  when  the   company  issues   shares.   To  properly  reflect  this cost-benefit relationship, expenditure  on  increase  in  authorised share capital should be regarded as part of share issue expenses.

In the given case,  the nexus of increase in authorised capital with issue of shares is  even clearer than is  the  case  generally.  The  test  (laid  down  in  the  EAC  opinion  referred to  above)  for determining whether an  expenditure  is  a  part of share  issue  expenses  is whether  it would have been  avoided  if the  share  issue  had  not been  made.  This  test  is satisfied in the present case:

>   Further  equity  shares   could  not  have   been   allotted  without  increasing  the authorised  share  capital  as  the  company’s  issued  capital was  nearly equal  to  its authorised share capital.

>   Share   application  money  was  received  first  and  the   increase   in  authorised share  capital was effected later.

>   The  expenditure  was  incurred  after the  company  had  fir me d  up  its  decision  to issue shares.

Thus, it is clear that the company would not have incurred this expenditure had the share issue not been made.

6.  On the basis  of the above analysis, the querist believes that the  expenditure incurred by the company  for  increase  in  authorised  share  capital  should  be  treated  as  part  of share  issue expenses.

> If expenditure on increase in authorised capital is treated as part of share issue expenses, it would be a  logical corollary that pending issue of shares, the same should be regarded as  an  asset.  What are   the  future  economic  benefits  from  this  asset - can  capacity  to issue  shares  be  regarded  as a  future economic benefit ?

> If shares   are   issued   only  for  a   part  of  the   increase   in  authorised  capital,  should  a proportionate  part of the relevant expenditure  for such  increase be  carried as  an  asset? The  current  accounting practice  does  not  seem  to  support  an  affir mati  veanswer to  the

B.        Query

7.   On the basis of the above,  opinion of the Expect Advisory Committee is  sought by the querist on whether the  company can treat the whole of the expenditure incurred on increase  in authorised capital as  ‘share issue expenses’.

C.        Points considered by the Committee

8.   The  Committee  notes  from the  Facts  of the  Case  that  the  company has  received  share application  money  in  excess  of the  authorised  share  capital  and  subsequently  increased  its authorised share capital and made allotment of shares.  The Committee notes that the query raised is in relation to  expenses  (stamp  duty  and  registration  fee)  incurred  for increase  in authorised share capital of the company.  Accordingly, the Committee has  examined only that issue and has not examined any other issue arising fiom the Facts of the Case, such as,  accounting for expenses incurred on allotment and other share issue expenses,  etc.  Further, the opinion of the Committee expressed, hereinafter, is only from accounting point of view and not from legal viewpoint.

9.    The Committee notes that the querist has argued that the expenses incurred on increase in authorised  share  capital  can  be  considered  as  share  issue  expenses  as  in  the  extant  case,  the shares  against the  excess  share  application money received  can be  issued  only after  increasing the   authorised  share   capital.  Accordingly,  the  Committee  has   fir st  analysed  whether  these expenses can be termed as  ‘share issue expenses’.  In this respect, the Committee notes paragraph 5   of  Accounting   Standard   (AS)   26,   ‘Intangible   Assets’,   notified  under   the   Companies (Accounting Standards) Rules, 2006 (as reproduced in paragraph 4 above), which states that this Standard does not apply to accounting for share issue expenses.  The term ‘share issue expenses’, however,  has  not been  defined in AS  26.   The  Committee  further notes  that the  term has  been defined in the Guidance Note on Terms Used in Financial Statements which provides as under:

“Costs  incurred in connection with the  issue  and  allotment of shares.  These  include legal    and    professional    fees,    advertising    expenses,    printing   costs,    underwriting commission, brokerage, and also expenses in connection with the issue of prospectus and allotment of shares.”

From the above, the Committee notes that share  issue  expenses  are  costs  incurred in connection
with the issue and allotment of shares.

10.  The Committee also notes that the querist has cited the view expressed by the Committee in one of its  opinion (refer paragraph 4  above),  wherein the  Committee had expressed the view that public issue expenses are those expenses which would not have been incurred had the public issue not been made,  e.g.,  Registrar’s processing charges,  expenses  on printing and distributing of application forms, prospectus, etc.  Further, the Committee had expressed the view that, public issue expenses would be those which are  incurred between the decision to make the public issue and completion of all necessary  formalities with regard to  the  issue.  The  Committee wishes  to point out that in the cited query, the issue of enhancing the authorised capital was not raised.  The Committee  is  of the view  that  increase  in  authorised  share  capital  is  an  independent  process which  does  not necessarily  lead  to  issue  of shares.  The  need  to  increase  the  authorised  capital and to incur expenses for increasing the same would not have arisen had the additional allotment of shares  was within the  limits of existing authorised capital.  Accordingly, the  Committee is  of the view  that  the expenses  incurred  on  increase  in  authorised  share  capital  are  distinct  and separate  from the expenses  incurred on share  issue.  Additionally, the Committee is  of the view that accounting depends  on the nature  of expense  and the  fact that the  share  application money was  received before  increase  in authorised  share  capital will not change  the  nature  of expense. Further, increase  in authorised  share  capital  does  not represent issue  of additional share  capital and  only sets   a   limit  for  the  paid  up   capital  of  a   company  at  any  given  point  of time. Accordingly, the   Committee  is   of  the  view  that  the   expenses   incurred  on  increasing  the authorised share capital cannot be termed as  ‘share issue expenses’.

11.        As  regards  the  issue  relating  to  accounting  for  the  expenses  incurred  on  increase  in
authorised capital, the Committee notes the following paragraphs of AS 26:

“6.2    An asset is a resource:
(a)  controlled by an enterprise as a result ofpast events; and
(b)  from which future economic benefit sare expected toflow to the enterprise.”

“56.  In  some  cases,  expenditure  is  incurred  to  provide  future  economic  benefit sto  an enterprise,  but  no  intangible  asset  or  other  asset  is  acquired  or  created  that  can  be recognised. In  these  cases,   the  expenditure  is  recognised  as   an  expense  when  it  is incurred.  ...”

From the  above paragraph of AS 26, the  Committee notes that if an expenditure does not result into acquisition of an  asset,  it should be  recognised  as  an  expense  as  and when  incurred.   The Committee also notes that the amount spent towards increase in authorised share capital does not give rise to any resource controlled by the  enterprise.  In fact,  such expenses  are  only permitting the company to  enhance the  limit for the paid-up capital of the  company which does  not ensure any flow  of funds  to  the  company.  Accordingly,  it does  not meet the  defini t i onof an  asset,  as reproduced above.  Thus,  the  amount aggregating to Rs.  47,60,000 incurred towards  stamp  duty and fees paid to the Registrar of Companies should be recognised as  expense in the statement of profit and loss as per the requirements ofparagraph 56 of AS 26.

D.        Opinion

12.  On the basis  of the above,  the  Committee is  of the  opinion that the  expenditure incurred by the company towards increase in authorised share capital (stamp duty and registration fee paid to  the Registrar  of Companies)  cannot  be  considered  as  share  issue  expenses  and  should  be treated as expense and charged off in the statement of profit and loss, as  discussed in paragraphs 10 and  11 above.

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