1.36 Query
Accounting treatment of fixed assets used in projects outside India.
1.A Government of India company undertakes projects mainly abroad in all the fields of telecommunications. The projects are mainly in under-developed and developing countries. The duration of the projects for consultancy projects is normally one year and for turnkey projects in one to three years. After completion of the respective projects the capital assets are disposed off in the country of the project itself. In most of the cases, after the completion of projects, the used assets are either sold at throw-away prices or at no price. In some of the cases, the company has to pay for the disposal of scrap. Normally, these assets cannot be brought to India.
2. The company has assets of the following types, abroad: -
(a) Vehicles: This includes cars, jeeps, pick-ups, trucks, tractors and trolleys.
(b) Plant and Machinery: This includes construction machinery like cranes, compressors, dumpers, generators, excavators, water pumps, cable drum, jackets, transformers, cable laying equipments, capacitors, imbalance and motors, wrapping machines, insulation testers, jack hammers, asphalt cutter and rollers, rotter engines, etc.
(c) Furniture & Fixtures: This includes office furnitures like tables, chairs, sofa sets, dinning tables, air conditioners, carpets, photocopier, typewriters, EPABX, telephone instruments, etc.
3.These assets are used for a particular project and after completion of the project, the assets are to be disposed off as these cannot be brought to India.
4.The company, since its inception in 1978, has followed the accounting policy of debiting the assets to the ‘Project Execution Expenses’. At the year end the residual value of these assets is included in ‘Closing Work in Progress’ which is shown under the head ‘Other Current Assets’, depicting it as ‘Capital Assets’.
5.The residual value is worked out on the basis of life of the assets, assuming it as three years since the project life is maximum three years. Thus, one third of the original value of the asset is charged each year. In case of disposal of the asset, the sale value, if any, is shown as other income.
6. The above accounting treatment has been accepted in the past by the auditors and the same has also been accepted by the Income-tax Department considering the nature of the business of the company.
7.In the audit of the accounts of 1988-89, the auditors have advised to review the accounting policy in respect of these assets. They have expressed the view that for the above-mentioned foreign project assets also, the company should follow the same practice as is being done for Indian assets since the above-mentioned accounting treatment is in contradiction to Schedule VI to the Companies Act, 1956. It has been clarified by the company that considering the nature of the business of the company and the fact that assets can be used only in the country where the project is being executed, the assets are of the nature of ‘Current Assets’ only. However, to segregate them from other current assets, the same are being shown under ‘Other Current Assets’ as ‘Capital Assets’ only. The querist has also stated that the auditors have no observation on the life of the asset as such, i.e., three years on the basis of project life. Further, the company is maintaining Capital Assets Register for these depicting situation of the assets, etc.
8. The querist has further stated that assets being treated as current assets of the company, their residual value is being translated at closing rate of exchange. The auditors have pointed out that if the assets at foreign projects are also treated as fixed assets, the same should be translated at the historical cost.
9.In view of the above, the querist has sought the opinion of Expert Advisory Committee as to whether the accounting policy relating to the assets at foreign projects, as presently followed by the company, is in order or not.
Opinion March 29, 1990
1.The Committee notes paragraph 3.34 and 6.05 of the ‘Guidance Note of Terms Used in Financial Statements’, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India, which define the following terms:
“3.34 Current Assets
Cash and other assets that are expected to be converted into cash or consumed in the production of goods or rendering of services in the normal course of business.
6.05 Fixed Asset
Asset held for the purpose of providing or producing goods or services and that is not held for resale in the normal course of business.”
2.The Committee is accordingly of the view that the assets referred to in paragraph 2 of the query are in the nature of fixed assets and not in the nature of current assets.
3.The Committee also notes paragraph 8, 8.4 and 8.5 of the Accounting Standard (AS) 7 on ‘Accounting for Construction Contracts’, issued by the Institute of Chartered Accountants of India, which recommend as below:
“8. Cost to be Accumulated for Constructions Contracts
8.4 Costs incurred by a contractor can be divided into:
(i) Costs that relate directly to a specific contract;
(ii) Costs that can be attributed to the contract activity in general and can be allocated to specific contracts;
(iii) Costs that relate to the activities of the contractor generally, or that relate to contract activity but cannot be related to specific contracts.
8.5 Examples of costs that relate directly to a specific contract include:
(i) site labour costs, including supervision;
(ii) materials used for project construction ;
(iii) depreciation of plant and equipment required for a contract;
(iv) costs of moving plant and equipment to and from a site;”
4.The Committee is accordingly of the view that depreciation on assets referred to in paragraph 2 of the query should have been debited to the ‘project execution expenses’ account.
5.The Committee also notes paragraph 8, 9 and 10 of the ‘Guidance Note on Accounting for Depreciation in Companies’ issued by the Research Committee of the Institute of Chartered Accountants of India, which recommend as below:
“8. A question may arise as to whether it is obligatory on a company to provide for depreciation only on the basis mentioned in Section 205 (2) read with section 350 and Schedule XIV of the Act or whether these bases can be considered as indicating the minimum deprecation which must be provided by the company, insofar as the accounts of the company are concerned and insofar as it is required to exhibit a true and fair view of the state of affairs of the company as on a given date and of the profit or loss for the year.
9. The Committee is of the view that in arriving at the rates at which depreciation should be provided the company must consider the true commercial deprecation, i.e., the rate which is adequate to write off the asset over its normal working life. If the rate so arrived at is higher than the rates prescribed under Schedule XIV the company should provide depreciation at such higher rate but if the rate so arrived at is lower than the rate prescribed in Schedule XIV, then the company should provide depreciation at the rates prescribed in Schedule XIV, since these represent the minimum rates of depreciation to be provided. Since the determination of commercial life of an asset is a technical matter, the decision of the Board of Directors based on technological evaluation should be accepted by the auditor unless he has reason to believe that such decision results in a charge which does not represent true commercial depreciation. In case a company adopts the higher rates of depreciation as recommended above, the higher depreciation rates/ lower lives of the assets must be disclosed as required in Note no. 5 of Schedule XIV to the Companies Act, 1956.
10. This view is supported by the Department of Company Affairs and it has clarified that “the rates as contained in Schedule XIV should be viewed as the minimum rates, and, therefore, a company will not be permitted to charge depreciation at rates lower than those specified in the Schedule in relation to assets purchased after the date of applicability of the Schedule. If, however, on the basis of bona fide technological evaluation, higher rates of deprecation are justified, they may be provided with proper disclosure by way of a note forming part of annual accounts.2.”
6. The Committee is accordingly of the view that the Board of Directors of the company should determine the commercial life of the fixed assets used in the projects on the basis of bona fide technological evaluation and provide depreciation accordingly.
7. The Committee is also of the view that the fixed assets used for the purpose of foreign projects and purchased in foreign currency should be incorporated in the books of account at the rate prevailing at the original date at which these assets were acquired keeping in with the historical cost concept. Such cost should be further adjusted in accordance with the requirements of Part I of Schedule VI to the Companies Act, 1956, insofar as they relate to acquisition of a fixed assets from a country outside India. Depreciation will accordingly be charged on the cost so arrived at.
8.The Committee is therefore, of the opinion that the accounting treatment followed by the company in respect of the assets for foreign projects is not correct and is in contradiction to the provisions of Schedule VI to the Companies Act, 1956.
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2Circular No. 2/89, dated March 7, 1989 |