In most cases, fixed assets and intangible assets are purchased at a certain price and the accounting is fairly straight forward. Purchase of an asset on credit gives rise to a financial liability when the asset is delivered. The buyer makes the payment to the seller and relinquishes the financial liability. However, more complex contracts are emerging, where the payments could be contingent upon one or more variables. This is generally referred to as contingent consideration.
Some payments are dependent on the purchasers future activity derived from the underlying asset. For example, a contract for the purchase of a licence may specify that payments are based on a specified percentage of sales derived from that licence. Some payments could depend upon the performance of the asset, for example whether the asset acquired complies with agreed-upon specifications at specific dates in future, such as standard production capacity or a standard performance. Other payments may be dependent on an index or a rate. For example, an operator in a service concession agreement agrees to pay an annual concession fee to the grantor, with the principal amount increasing at the end of each year based on the consumer price index.
The provisions relating to AS 10 Accounting for Fixed Assets, AS 6 Depreciation Accounting and AS 26 Intangible Assets are set out below.
AS 10 Accounting for Fixed Assets
9.1 The cost of an item of fixed asset comprises its purchase price, including import duties and other non-refundable taxes or levies and any directly attributable cost of bringing the asset to its working condition for its intended use; any trade discounts and rebates are deducted in arriving at the purchase price. Examples of directly attributable costs are:
i. site preparation;
ii. initial delivery and handling costs;
iii. installation cost, such as special foundations for plant; and
iv. professional fees, for example fees of architects and engineers.
The cost of a fixed asset may undergo changes subsequent to its acquisition or construction on account of exchange fluctuations, price adjustments, changes in duties or similar factors.
11.2 When a fixed asset is acquired in exchange for shares or other securities in the enterprise, it is usually recorded at its fair market value, or the fair market value of the securities issued, whichever is more clearly evident.
AS 26 Intangible Assets
25. The cost of an intangible asset comprises its purchase price, including any import duties and other taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), and any directly attributable expenditure on making the asset ready for its intended use. Directly attributable expenditure includes, for example, professional fees for legal services. Any trade discounts and rebates are deducted in arriving at the cost.
26. If an intangible asset is acquired in exchange for shares or other securities of the reporting enterprise, the asset is recorded at its fair value, or the fair value of the securities issued, whichever is more clearly evident.
AS 6 Depreciation Accounting
6. Historical cost of a depreciable asset represents its money outlay or its equivalent in connection with its acquisition, installation and commissioning as well as for additions to or improvement thereof. The historical cost of a depreciable asset may undergo subsequent changes arising as a result of increase or decrease in long-term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors.
16. Where the historical cost of an asset has undergone a change due to circumstances specified in para 6 above, the depreciation on the revised unamortised depreciable amount is provided prospectively over the residual useful life of the asset.
Author’s point of view
Neither AS-10 Accounting for Fixed Assets nor AS 26 Intangible Assets provides any clear guidance on how to account for such contingent pricing arrangement for acquisition of fixed assets and intangible assets. Theoretically many views are possible.
View 1.1
The fixed asset and the liability can be measured at cost on date of acquisition. The cost would be the amount paid on the date of acquisition. In the case of fixed assets, based on paragraph 9.1 of AS-10, any subsequent change in the liability or consideration is capitalised to the cost of fixed asset. This can be used by analogy for intangible assets as well. AS 6 is also clear that any such changes to the fixed asset cost are depreciated prospectively. This is not clear in the case of intangible assets; however the same analogy may be used.
View 1.2
A variation of View 1.1 is that any change to the cost of the asset is not included in cost of the asset, but the impact is taken to P&L. This view is supportable as paragraph 9.1 of AS-10 includes price adjustments, which is not the same as contingent consideration. In other words paragraph 9.1 does not clearly deal with accounting for contingent consideration and hence it is arguable that the changes to the liability are included in the P&L.
View 2
On the date the fixed asset or intangible asset is purchased, the control is transferred to the buyer and consequently a debit to fixed asset or intangible asset and a credit to liabilities would arise equal to the fair value of the contingent payment. Paragraph 11.2 of AS 10 and paragraph 26 of AS 26 support this view, though those paragraphs apply to consideration by way of shares or securities.
The core issue would then be whether the remeasurement of the liability on account of changes in the consideration should be recognised in the profit or loss or included as an adjustment to the cost of the asset. This is a major issue that is not clear even under International Financial Reporting Standards and is a matter of significant debate in the International Financial Reporting Interpretations Committee (IFRIC).
Paragraph 9.1 requires subsequent changes in cost to be included as cost of fixed assets. However those costs do not include contingent consideration adjustment. Therefore there are supportable arguments that subsequent changes in the remeasurement of liability may be recognised in the profit or loss.
Conclusion
In this article, we have simplified the issue of contingent payments and not taken into consideration the various complex arrangements that may be involved and their impact on accounting. Take for example, the contingent payments based on a quoted index. Under IFRS typically one would make an assessment of whether there is an embedded derivative, and whether that embedded derivative needs to be valued and accounted for separately or not. Indian GAAP does not contain any guidance on this matter. The ICAI should participate in the current discussions of IFRIC on this subject and arrive at an amicable conclusion as this would also be relevant for the purposes of interpretation of Ind-AS.
