Fictitious Assets

Fictitious assets are expenses presented as assets.

Preliminary expenses are an example of this asset.

The presentation is for disclosure purposes.

What’s the Fictitious definition?

Fictitious means unreal or not true.

Fictitious assets are

• Not real
• Represents miscellaneous expenditures recorded in books
• Not tangible
• Doesn’t have any realizable value

So, the name itself indicates that those assets are fake.

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Fictitious Assets Infographic Summary

Access the summary from the table of contents below

Let’s understand the following terms first.

1. Asset
2. Miscellaneous Expenditure
3. Quick Recap of the Golden Rules of Accounting

The above terms are basic.

So, good knowledge about these basics helps an easy understanding of fictitious assets.

Asset:

An asset is a property or resource that provides future benefits. It can be either tangible or intangible. These assets drive the entity’s operational activities and help advance business operations, so they help ensure the success of any business.

Miscellaneous Expense:

The word miscellaneous means items from varied or different sources. As such, these expenses comprise different categories. The details of all such categories are below:

• Preliminary expense,
• Deferred Revenue Expenditure (Such as Advertising or Marketing expenses, Promotional Expenses),
• Loss (Profit and Loss Debit balance)
• Underwriting Commission
• Discount on Securities issued
• Loss on Debt Securities

Note: Please refer below for a detailed understanding of each of these terms

Quick Recap of Golden Rules of Accounting:

Do you remember the Second and Third Golden Rules of Accounting?

The second rule (Real Accounts) is “Debit what comes in and credit what goes out.“

The third rule (Nominal Accounts) is “Debit all the expenses and losses, and credit all incomes and gains.”

Also Read: Understanding Wasting Asset (Fixed Asset)

Understanding the logic behind recording expenses as fictitious assets:

Now, we know the above three terms and will see the logic behind the treatment of fictitious assets.

If incurring a Miscellaneous Expense provides a benefit that lasts for more than one accounting period, it’s inappropriate to amortize it in the same year. These expenses, like assets, provide future benefits over a period of time.

Further, these expenses have a significant quantitative value. If you write off these high-value expenses completely in the same year against the earnings, you distort the net income in the financial statements.

It’s time for a fictitious asset example in this context:

ABC Company spent a considerable amount on promotions during the year, which helped consumers learn about the company. Because of this continuous advertising spending, ABC Company has a good reputation and relationship with consumers, so there are higher chances of purchasing its products. There’s no guarantee that sales will increase immediately, but it will happen over time.

This huge expense provides enduring benefits, and the company shall amortize it over time.

Recording in the books of accounts:

While recording journal entries in the books of accounts, debit all assets with a corresponding credit to the bank (for cash transactions) or credit to a liability (for non-cash transactions). So, all the GL accounts with debit balances are on the assets side of the balance sheet. This presentation of GL with a debit balance under Assets and GL with a Credit balance under Liabilities is to ensure the double-entry bookkeeping. It’s based on the principle that every debit shall have a corresponding credit.

What if the entities do not follow this principle? The balance sheet does not tally. Assets will not be equal to Liabilities. So, this expense having a debit balance is good to present under the asset side, but not along with the liabilities side.

Note: The basis for all these is the golden rules of accounting: debiting the expenses and crediting the liability or cash, depending on whether it’s a cash or credit transaction.

Also read: Test of details.

Example

Let’s see an example to get a holistic picture of this concept.

A large construction company is in the pharmaceutical business. It’s one of the most successful and a leader in its industry, with a profit of $10 billion. However, due to an earthquake, the company has incurred a massive loss of $16 billion in one of its primary generating plants.

This business loss is not normal. It is an abnormal loss that is part of the ordinary course of business. Can we consider this abnormal loss a Fictional asset?

From the analysis below, let’s see why this loss is a Fictitious asset.

The loss is very high and equals 1.6 times the annual profits. The entity needs to recognize the losses in the Statement of Profit and Loss as a debit against the income per the Nominal Account Rules. However, this loss can’t be recognized in the same year because of its abnormal nature. Further, the loss incurred will distort the company’s income if recognized in one year. Additionally, it’s not a transaction that impacts one business’s financial year, which will impact the business over a couple of years and take time for the business to recover.

Also Read: Contingent Assets

Factors to Consider:

Management deemed this loss unforeseen and decided to recognize the loss over the next five years based on the above reasons. We need to determine the period of amortization of such a loss as per the following considerations:

1. The company will be able to complete the plant construction within the next six months.
2. The company will be able to revive the business within a year
3. Profits will start normalizing from the 2nd year of the revival
4. Insurance Claims received for this loss are $11 billion.

So, Management decided to recognize the remaining $5 billion loss equally over the next five years to ensure a uniform distribution.

Runners Insight:

The factors that require consideration vary with the facts of the scenario, the industry in which the entity operates, internal factors like a revival of business, financial stability, and external factors like insurance claims receivable. The above considerations in the above example provide a holistic understanding of the Management thought process. Thus, the entity needs to study all these factors before recognizing these losses as fictitious assets or miscellaneous expenditures and determining the amortization period for such losses.

How to Record a Journal Entry for Fictitious Assets?

Let’s understand how to record the Journal entry for the Fictitious assets in this scenario.

Recording the Abnormal Loss as Fictitious assets in the year when a loss occurs. So, the GL accounts which are part of this transaction are:

1. Plant & Machinery Loss of $16 Billion

2. Insurance Claim of $11 Billion

3. Abnormal Loss of $5 Billion

Recording Business Loss

According to modern accounting rules, when assets increase, you debit the account; when assets decrease, you credit the account in the journal entry.

(Being the business loss relating to the Earthquake recorded)

The Loss GL, which needs to be amortized over the period, will be named based on its nature. There isn’t any formula to derive the GL account description, and ensuring the GL name reflects its nature is a good practice. We can describe this scenario as an abnormal loss and group it under fictitious assets.

Entry to record the Insurance proceeds

Runners Insight:

Note that insurance claims require a nominal fee to be paid along with an application for processing. If such charges exist, we need to consider them expenses, and the disbursement amount will be reduced accordingly.

Abnormal Loss Amortization

The abnormal loss is shown as Non-Current Assets under the grouping of Fictitious Assets. Every year, the abnormal loss is written off as decided by the Management over the next five years. The entry will be

(Being Abnormal Loss amortized)

Let’s consider a different example. Assume that the company found the confiscation of property worth $1 million. The loss here is negligible in comparison to the company’s net profits. So, writing off the entire loss in the same financial year is advisable instead of recognizing it under fictitious assets.

Advantages:

Accounting of Fictitious assets results in spreading the expenditure or loss throughout the period until its impact falls. Thereby, the annual net income isn’t distorted.

Ensures following of the Matching concept of recording the expenses against the related income

Disadvantages:

Determining the total costs that need to be considered for a Fictional asset isn’t easy. It involves understanding the nature of the transaction and industry proficiency.

Fictitious assets increase the balance sheet value due to deferred expenses or abnormal losses, which are not representative of the entity’s asset value. There will be an unnecessary increase in non-real asset balances.

Frequently Asked Questions:

What are Fictitious assets?

Fictitious assets are not real and do not represent any real value. For example, it’s common practice to present a capital loss as a fictitious asset and amortize that loss over time. One example of a fictitious asset is preliminary expenses.

Do Fictitious assets realize cash when sold?

Fictitious assets are nothing but expenditures that are recorded as assets. They do not represent any value. So, the answer is no.

What’s Fictitious Meaning?

Fictitious meaning doesn’t require an in-depth analysis. We can take the fictitious definition in the literal sense. So, fictitious means unreal or fabricated (an asset in this context).

Are Fictitious assets the same as intangible assets?

These two assets are not the same. However, neither has physical existence. Intangible assets provide financial value. For example, intangible assets such as copyrights offer the owner intellectual property rights, such as ownership over books or musical works. Fictitious assets are imaginary assets. Therefore, fictitious assets are different from intangible assets.

Is Preliminary expense a capital expenditure?

Preliminary Expenses are Capital items. Recognizing the total preliminary expense in the statement of profit and loss distorts the total income for the year. Further, the benefits arising from such expenses last for more than one year. As such, the preliminary expense is recognized as an asset.

Is Goodwill a Fictitious asset?

Goodwill is an intangible asset that derives its value when an entity acquires another business. It’s the price for the trust and reputation built over time.

How about an example?

Small Company has been in the Footwear business for more than a decade. Consumers like Small Company products, which are another name for quality products.

Big Company is a Multi-National Conglomerate and wants to acquire the “Small Company”.

The book value of Small Company Net assets (Assets after reducing the liabilities) is $10K. However, the Market price is $15K. The difference between the Market value and Book Value equals $5K. Payment of an excess price over and above the book value results in recording Goodwill in the books.

After buying the Small Company, the Big Company sells all its products under the brand name of the Small Company because of its quality. So, the Big company earns more profits. That’s how a big company makes money by buying the goodwill (business of a small company).

However, the fictitious assets are deferred expenditures and do not have any realizable value.

Can we classify fictitious assets under Current Assets or Non-current Assets?

Presentation of Fictitious assets is at the end under the assets side (after the Current and Non-Current Assets Section).  However, we can present it under Current or Non-current assets to adhere to any legislative requirements based on the amortization period of those assets.

Note: While calculating any financial ratios, there is no need to consider fictitious assets.

Are preliminary expenses an asset?

Preliminary Expenses are not assets. However, due to their debit balance, we need to recognize them as fictitious assets under the non-current category for accounting convenience.

Can we determine the amortizing period for such expenses?

This is very subjective and depends on the actual benefit. The business context is crucial in determining the period, so there is no predefined formula.

Are Fixed Assets and Fictitious Assets the same?

The answer is no. The nature of both assets is different. A fictitious asset is a deferred expenditure, but not a real asset. It’s just a different accounting treatment.

What are the Examples of Non-Fictitious Assets?

Sometimes, it’s best to learn in the reverse order. Non-fictitious assets are assets that either have a physical existence, like plants and machinery, land, buildings, etc., or that do not have a physical existence, like goodwill, copyright, patent, etc.

Similar to Non-Fictitious assets, these Fictional assets will also be charged to the income statement as amortization.

Understanding the Miscellaneous expenses which are grouped under Fictitious asset:

1. Preliminary Expenses

The word Preliminary means initial. So, we consider all initial expenses before forming any entity as preliminary expenses. Normally, these expenses involve legal fees, Auditor fees, printing, and stationery expenses.

Before the entity became legal, it incurred all these preliminary expenses. These are one-time and will not be recurring in nature. An entity does not need to pay legal fees for its formation every year. Amortizing all these expenses in the first year of operations is not appropriate. It distorts the company’s income statement. Further, these expenses result in the very existence of a company, so they should be spread over time. Hence, these are accounted as Fictional assets.

Note: Promoters or initial members who want to establish a business are the representatives of the Entity. These personnel incur expenditures on behalf of the entity. Once an entity exists, it assumes all such expenses relating to its business.

2. Deferred Revenue Expenditure (Such as Advertising or Marketing expenses, Promotional Expenses)

Deferred revenue expenditures are not capital expenses but provide benefits that extend beyond one accounting period. These expenses arise in the current period, but the business expects to receive related benefits in future periods.

According to the Matching Concept, the business amortizes these expenses over the periods in which it earns the related revenue.

What does Capital nature here mean?

Businesses treat expenses to prepare fixed assets for use as capital expenditures. These expenses do not fall under deferred revenue expenditures and do not represent fictitious assets.

How about an example of deferred revenue expenses?

For example, assume that Amazon plans to have “Great Sale days” in the Jan, 20NY (Next year). Great sale days are the days when Amazon offers products at discounted prices. Customers intend to buy more products on those days.

So, Amazon incurred huge advertising expenses by filming an ad shoot with a celebrity on January 20CY (Current Year) to have a big reach to its customers. The company spent $10 million on expenses.

Even though the expenses are incurred in 20CY, these relate to 20NY. They should be recorded in 20NY to match against the corresponding revenues. So, this deferring of costs ensures that the financial information does not comprise any misstatements.

If in the above example, these expenses benefit more than one accounting period, we recognize those expenses as fictitious assets over a period.

3. Loss (Profit and Loss Debit balance)

Excess expenditures over income from the operation result in a loss. Losses or expenditures are shown as debit balances in the Balance sheet. Therefore, a Loss is nothing but the profit and loss debit balance.

4. Underwriting Commission

Underwriters are investment bankers who help entities raise securities. The perfect example of an underwriter’s assistance is an IPO. They help issue entities by determining the “securities price.” They also buy surplus securities (which are not subscribed) from the entity and sell those securities in the market.

Note: Every company that goes for IPO might not be successful. In other words, the public/investors might not fully subscribe to the securities. The underwriter provides a guarantee to sell a specific number of securities to the public, and in case of failure, they should buy those securities.

The Underwriting Commission allows such investment bankers to handle the IPO. Those expenses provide benefits for more than a year. That’s because the funds sourced through the IPO will not last just a year. The company uses those funds to expand its business for a period.

Note: The reason for going to an IPO is to mobilize funds at no cost. There will not be any interest that needs to be paid to the investors. Further, the dividend is not mandatory. Additionally, those IPO funds are huge, and the end use is primarily to expand the business operations, which will have benefits that extend for more than a year.

5. Discount on shares issued

Shares are issued at a discount to attract more investors, which is like a profit for the Shareholders. Even if Shareholders pay a price less than the face value, the entity owes the full face value to the holders.

Raising Capital by offering discounts is utilized for the company’s business over time. That does not relate to one period. Hence, amortizing those expenses throughout the application of the capital will be more appropriate.

6. Loss on Debt Securities

Issue of Securities at lower prices than their face value to mobilize more debt, similar to a discount on shares

Fictitious Assets Infographic Summary:

Key Points:

We understood the concept of Fictional assets, along with examples and FAQs. Now, it’s time to put together all the key points.

• Fixed assets (such as Land and Buildings) and Intangible assets (such as goodwill) are real assets, which are different from Fictional assets.
• A fictitious asset is an Expenditure that benefits the business for more than a year and does not realize any value, as it does not represent any value
• A fictitious asset isn’t always a deferred expenditure but can also be a loss. The presentation of such a loss as an asset in the balance sheet is purely for presentation purposes.
• Examples of fictitious assets are deferred revenue expenses, preliminary expenses, and Discounts on shares issued.

Conclusion:

Fictitious assets are fake assets that companies present in the non-current asset section of the balance sheet. They represent expenditures or losses incurred by the business. Typically, the benefits from these expenses extend beyond a single accounting period, so companies recognize them as assets on the balance sheet rather than fully amortizing them in the year the expenses or losses occur. Unlike intangible assets such as goodwill, fictitious assets have distinct characteristics.

Fictitious asset examples:

Examples of these fictitious assets are Preliminary Expense, Deferred revenue expenditure, Profit and Loss Debit balance, Underwriting commission, Discount on shares issued, and Loss on Debt securities

Let’s understand two of the fictitious assets

Preliminary Expenses: meaning and example:

Preliminary expenses mean expenditures incurred during the business kick-off period. Entities incur business expenses before their legal existence. So, such expenses are not fully charged off in the profit and loss account. Accounting Treatment for the same is different.

Entities capitalize preliminary expenses as fictitious assets and amortize them over the estimated life.

Preliminary expenses include legal fees for incorporation, registration charges, Auditor fees, professional charges, logo charges, advertisement or promotional expenses, and any other incidental expenses.

There is no limit on examples of preliminary expenses. To sum up, preliminary expenses are an example of a fictitious asset.

Underwriting Commission:

An underwriting commission is insurance before the issuance of shares or other securities. Underwriters are entities that ensure a minimum subscription for the issuances. Paying a fee to the underwriters reduces the financial risk.

Final words: Therefore, understanding the nature of expense or loss and benefits arising from it is a prerequisite to deciding if those require recognition as fictitious assets or entirely written off in the same year.

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