1.52     Query

Depreciation as an Element of Cost for Calculation of Work-

In-progress in Contract Accounting vis-à-vis Compliance of

Sections 205 and 350 of the Companies Act, 1956.

Ours is primarily a contracting company engaged in the execution of large industrial and civil construction projects on turn-key basis including design, supply and erection.  We are maintaining separate accounts for each project.  Generally each project takes 2 to 3 years for completion and problem arises as to how to arrive at figures of actual profit on uncompleted projects.  Generally in contract accounting profit on uncompleted projects is calculated on the basis of estimated work-in-progress certified by some qualified valuer of the client and only some percentage of profit earned is taken into account.

However, in our company the work-in-progress is compiled by actual cost incurred plus the profit/surplus allocated on the following basis: -

            Extent of job completed                                             Percentage of profit to

                                                                                          be taken into account

                        Upto 25%                                                No profit

                        Above 25% till                                     80% of the estimated profit i.e.

                        Completion                                             Actual cost incurred

                                                                                     -------------------------  x 80% of

                                                                                     Total estimated cost

                                                                                     Estimated profit.

                        On completion of the job                          100% of the profit.

Depreciation on the fixed assets e.g. plant, vehicles, furniture, etc. used at project site is also taken into account in valuing the work-in-progress as direct expenses of that project.

A Profit & Loss Account for each project is prepared and work-in-progress valued as above is shown on the credit side as income while depreciation and other expenses under various heads are shown on the debit side as expenditure.

 While conducting audit for the current year, our auditors pointed out that by including the amount of depreciation on project site fixed assets in the value of work-in-progress, we are making no provision for the depreciation to that extent.  According to them we are neutralising the effect of depreciation booked on fixed assets by including the amount of depreciation on project site fixed assets in the work-in-progress which is shown as income in Profit and Loss Account.  However, we feel that depreciation on the fixed assets employed for a specific project is an element of cost for that project and since ours is a contracting business, every expense related to the project is a part of our work-in-progress.  In order to comply with the provisions of the Companies Act, we are providing for depreciation as laid down in the Companies Act, and it is shown in the Profit and Loss Account on the expenditure side.  It is immaterial as regards the provisions of the Companies Act, whether the depreciation is added to work-in-progress or not because it is merely our method for deriving the value of work-in-progress.

We also emphasised that while calculating work-in-progress of uncompleted projects, factory overhead expenses are added to the prime cost.  Such factory overhead expenses include depreciation on factory building and plant and machinery.  Similarly in our case while calculating work-in-progress of uncompleted jobs, we include depreciation on fixed assets employed on that job to the other direct expenses.  But the auditor did not agree with our clarification.

 You are requested to kindly let me have your esteemed opinion whether the depreciation provided by us is in full compliance with the provisions of the Companies Act, 1956.

                                                  Opinion                                                                                    April 5, 1979

The Committee is of the opinion that in valuing closing stocks of finished goods or work-in-progress consistent method of valuation should be adopted.  Depreciation is an element of cost and can be taken to value the work-in-progress at the end of the year as any other element of cost or expenditure.  Merely because a part of depreciation pertaining to work-in-progress is taken into account for stock valuation, it cannot be stated that the depreciation on fixed assets has not been provided in accordance with the provisions of the Companies Act, 1956.

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