1.31     Query

Capitalisation of depreciation on assets used during construction period.

1.It has been observed by the Government auditors, during the audit of the accounts of a company for the year 1988-89, under section 619(4) of the Companies Act, that between the years 1985-86 to 1987-88, the company utilised various assets including DM water plant, boilers, motor vehicles, etc., for executing project work at Cochin (as the project was under construction) and capitalised the depreciation on the assets during such construction period amounting to Rs. 1,082.77 lakhs. The value of the gross block of the assets, as exhibited in accounts on which depreciation upto 31.3.1988 was capitalised, but has not been reduced to the extent of such depreciation vide ‘Guidance Note on Treatment of Expenditure During Construction Period’, issued by the Institute of Chartered Accountants of India (Para 9.4). Consequently, this has resulted in over statement of gross block by Rs. 1082.77 lakhs.

2.The querist has stated that the company exhibits in its schedule of fixed assets, the gross block of the assets (block wise), additions or deductions thereto, the depreciation charged uptodate and the net block. As per Schedule VI to the Companies Act, it is obligatory to state under each head of fixed assets, the original cost, additions, and deductions during the year and the total depreciation written off or provided upto the end of the year and thus, the company fulfils the requirements of the said Schedule. The company also fulfills the requirements of the guidance note referred to by the auditors insofar as it states that after production period starts, total cost of the equipment less depreciation charged during the period of construction should be carried forward to the production period and accounts of the production period would begin with such depreciated value which would then be further depreciated in the normal way. For example, if the asset has been used for two years in construction period and the depreciation rate is 10% per annum on straight line basis, 20% depreciation is charged to expenditure during construction period and when the production period begins, 80% of the value of asset is taken as the opening value of the asset which is further depreciated at 10% per annum during the production period. In the view of the querist, the exhibition made by the company in this regard is correct and is as per the provisions of the Schedule VI.

3.Government auditors have however pointed out that in case of certain assets like plant and machinery, the gross value includes depreciation element of assets used during construction period of the project and the gross value of the assets which were depreciated during construction is also shown at their original value. The total of the column ‘Gross Block’ is thus overstated to the extent of such depreciation charged during construction period which has been capitalised. Correspondingly, the total of the column ‘Depreciation’ is also overstated.

4.It was agreed finalisation of audit report under section 619 (4) of the Companies Act, that the manner of presentation of fixed assets in the fixed assets schedule, followed by the company, will be referred to the Expert Advisory Committee for its opinion.

5.The querist has accordingly sought the opinion of the Expert Advisory Committee as to whether the presentation of fixed assets in the Schedule is correct.

                                                                                             Opinion                                                     September 17, 1990

1.The Committee notes paragraphs 9.4 and 14.3 of the ‘Guidance Note on Treatment of Expenditure During Construction Period’, issued by the Research Committee of the Institute of Chartered Accountants of India, which recommend as below:

                        “9.4      In addition to any local construction work of the nature mentioned in the preceding paragraph, it is most inevitable that the company will purchase various items of fixed assets during its construction or pre-production period. The commonest example of such a purchase would be the purchase of automobiles, transport equipments, furniture and fixtures, and office equipment, etc. Such assets would be required from the very inception of the company even before the company enters its productive stage. It is extremely likely that all or some of the fixed assets purchased during the construction period may be actually or indirectly utilised in the work of construction, in which case the appropriate depreciation charged during the period in which they are utilised in the work of construction should be treated as part of the indirect construction expenditure and dealt with in the manner suggested in paragraph 5 of this Note which deals with the treatment of indirect expenditure during construction. For example, earth-moving equipment, tractors and heavy motorised equipment purchased during the period of construction may be utilised directly for the purpose of construction. To a lesser extent, motor cars and office equipment may also be utilised for the purpose of construction work, though indirectly. If some equipment purchased during the period of construction has been utilised only partly for the purposes of construction, a part of the depreciation thereon, on the basis of suitable proportion, should be capitalised as an indirect expenditure incurred during construction period. Thereafter, the total cost of the equipment purchased during the construction period less the depreciation charged during the period should be carried forward to the production period so that the accounts of the production period would begin with the depreciated value of such equipment, which would then be further depreciated in the normal way. [Emphasis given by the Committee].

14.3 It is suggested that, in a large number of cases it would be appropriate to indicate the following items in the balance sheet under the general heading of “Fixed Assets”:

(a) Fixed assets actually purchased during the construction period less depreciation thereon, which may be described in a separate schedule annexed to the balance sheet (see paragraph 9.4 of this note)-

this would also include………………………”

2.The Committee is of the view that in the schedule of fixed assets for the period in which production begins, the figure of gross block of the fixed assets, which were used in the construction period and on which depreciation has been charged during the construction period and capitalised to fixed assets, should be reduced by such depreciation charged during construction period. Thus, the accounts of the production period will begin with the cost of the assets purchased during the construction period less the depreciation charged during the period, which would then be depreciated in normal way.

3.The Committee is also of the view that the value of gross block shown in the balance sheet can not exceed the actual cost incurred on such assets except in case of their revaluation.

4.Committee is accordingly of the opinion that the company has overstated the gross block of assets by the amount of depreciation charged during the construction period and capitalised to the fixed assets. The presentation of fixed assets, therefore, is not proper in the schedule of fixed assets to this extent.

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