Accounting and taxation treatment of the expenses incurred for a mobile application

The world now being at the peak of the smart phone era, many business enterprises are getting a mobile application for their business promotion, trying to make the business experience with their enterprise easier. Mobile phones being the most handy and portable devices, with easy access to the internet all the time are serving their purpose very well.  Since the enterprises do not specialize in accounting and taxation matters they are unable to show a proper accounting treatment of the expenses incurred for the application.

This article is focused on the accounting and taxation treatment of the expenses incurred on intangible assets such as mobile application and websites etc.

As specified in Accounting Standard 26 an intangible asset is an identifiable non-monetary asset, without physical substance held by a business enterprise as a supplement for generating revenue over a period of time.
Since the benefit of expenditure incurred on the mobile application and websites help in revenue generation and growth of the business over a period of time the mentioned expenditure should not be debited in the statement of profit and loss account in the first year itself rather the expenditure should be capitalized and amortized over a period of time taking into consideration the provisions of Accounting Standard 26.

The question now arises about which expenditure should be capitalized?
When the enterprise outsources the contract for the creation of the intangible asset then the amount paid to the outsourced company should be capitalized.
However, when the enterprise itself creates a department for the creation the intangible asset then the sum of all the expenses such as
a)licensing fees,
b) salary paid to the employee,
c)amount paid for buying the domain
d)expenditures that are directly attributable to the generation of the asset
should be capitalized.

Capitalization is an accounting method to delay the recognition of expenses by recording the expenses as long term assets. Capitalizing expenses is beneficial to the enterprise for the purpose of acquiring assets with long term life span so that the cost can be spread over a specified period of time. Companies take the expenses incurred today and deduct them over a long term to eliminate an immediate negative affect against revenues. 

The next thing to be done is that the capitalized amount needs to be amortized over the useful life of the asset, so that we get the benefit of the expenditure from the taxation point of view over a period of time.
Amortization is the systematic allocation of the depreciable amount of an intangible asset over its best estimate of the useful life. There is a rebuttable assumption that the useful life of an intangible asset cannot be more than 10 years. There are a number of factors that need to be considered while deciding the useful life of an intangible asset- However given the history of rapid changes in technology and computer software the mentioned intangible assets are susceptible to technological obsolescence. Therefore the useful life will be short.

The amortization method should be such that it reflects the pattern in which the economic benefits are felt by the business. However if that pattern cannot be determined reliably the straight-line method can be used. The amortization charge of each period should be treated as an expense which hits the statement of profit and loss bringing down the net profit of the business for each subsequent financial year.

Here is an illustration for better understanding of the mentioned case-

While incurring the expenditure we would credit bank and debit the intangible asset, creating a ledger of the intangible asset in our books.
Let us consider an intangible item is appearing in the balance sheet of the A Ltd. at Rs 10 lakhs as on 1/04/2013 the given item was acquired on 1/04/2012 for Rs 12 lakhs and was available for use as on that date. However now it is determined that the useful life of the asset is 5 years, hence now the enterprise is required to amortize the asset full over the remaining useful life of the asset i.e. 4 years at the rate of 2.5 lakhs per year.

Subsequent expenditure:
Enterprises may incur considerable cost in modifying existing mobile application or software systems. Subsequent expenditure on software after its purchase or its completion should be recognized as an expense when it is incurred.
However if the following conditions are met, the subsequent expenditure should be added to the carrying amount for amortization over the years-
(a) it is probable that the expenditure will enable the software to generate future economic benefits in excess of its originally assessed standards of performance; and
(b) the expenditure can be measured and attributed to the software reliably

What if the expenditure incurred on the intangible asset does not generate the estimated revenue?

This would be a situation of impairment of the asset i.e. the capitalized amount of the asset needs to be written down to the recoverable amount. Impairment: an asset is impaired when its carrying amount exceeds its recoverable amount. That reduction in the value of the asset is called impairment loss. This impairment loss would be recognized immediately as an expense in the statement of profit and loss.

It is very important for companies to follow proper accounting and taxation guideline as prescribed by the law to avail the maximum benefit on tax payments.

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