1.9  Query

Treatment of expenditure incurred on removal

of overburden from limestone quarries.

1.The manufacturing unit of a company was set up in 1946 in Bihar. The plant is placed approximately 40 Kms. away from the nearest rail head. The capacity of the plant was gradually raised, through phases of expansion and modernisation, to the present level of 4.02 lac tonnes per annum. The company has embarked on a programme of modernisation and expansion to attain a present day viability level of 1 million tonnes per annum and convert from wet process to dry process in order to bring down its cost of production and improve its competitiveness in the market.  The plant obtains its present requirement of limestone from its own quarries located in close vicinity. On account of its geological character, the limestone mines have a high content of overburden which considerably increases the mining operations.

2.The company sets its annual budget separately for limestone raising and cement production. Men and machines utilised for limestone raising and cement production are entirely different and various expenses incurred on these activities are separately booked in the company’s books of account.

3.Before limestone can be raised from mines, overburden has to be removed and the mines kept ready for limestone raising. For optimum utilisation of men and machines even if limestone is not required for current operation, these are deployed in removing the overburden so that mines are ready for exploitation in future. In past, the company has charged these expenses incurred on removal of overburden in mines to be used in future as revenue expenditure in its profit and loss account.

4.The present practice followed by the company results in distortion in company’s financial statements on account of the fact that expenses which will result into benefit in the future period are charged to current period. This results into a high limestone per tonne cost. It is also against the matching concept of mercantile system of accounting which is followed by the company.

5.The company proposes to treat the expenditure on removal of over-burden in its mining area which is going to be exploited in future as a deferred revenue expenditure as the company is of the opinion that it will have benefit of this expenditure in future period.

6.The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a) Whether the company is correct in considering the expenditure incurred on removal of overburden in the area, which is not going to be exploited during the current period, as deferred revenue expenditure and not writing off the entire expenditure to the profit and loss account in the year in which it is incurred.

(b) Since, on the basis of mining plan already prepared by the company of all the mines, the quantum of limestone available in particular mine can be predicted fairly accurately, will it be in order for the company to write back the expenditure incurred on over-burden removal in past and treat it as deferred revenue expenditure on per tonne limestone raised out of these areas?

(c) Will it make any difference, if the company was a new company which has just started its activity? 

                                                                                                        Opinion                                                   March 29, 1990

1.The Committee notes that it is a generally accepted accounting principle of valuation of a fixed asset that apart from its purchase price, all directly attributable costs of bringing the asset to its working condition for its intended use are also included to arrive at the original cost of the asset.

2.The Committee is of the view that since limestone can be extracted from the quarries only after the removal of overburden, the expenditure incurred on removal of overburden is directly attributable to bringing the quarry in its working condition. Therefore, the said expenditure should be capitalized to the cost of limestone quarries. Thereafter, a composite depletion rate can be applied to the cost of quarry and the expenditure on removal of overburden so capitalized. For example, say the cost of the quarry ‘X’ is Rs. 1,00,000.00 and the quantum of limestone available in the quarry is predicted to be 10,000 tonnes. Say, the expenditure on removal of overburden is Rs. 25,000.00. Accordingly, Rs. 25,000.00 should be capitalized to the cost of the quarry and the depletion rate per tonne shall be calculated as under:

                        Rs. 1,00,000.00 + Rs. 25,000.00

                        ---------------------------------------       ==  Rs. 12.50 per tonne

                                    10,000 tonnes

3.The Committee also notes a situation where, in a quarry:

a) over burden is completely removed from a part of the area (fully developed area);

b) over burden is partially removed from another part of the area (partially developed area); and

(c) over burden is not removed at all from the remaining part of the area (undeveloped area);

and the operation of extraction of limestone is begun from the fully developed areas even before the overburden is completely removed from the entire quarry. The Committee is of the view that in such a situation the following accounting treatment should be followed:

(i) The cost of the quarry should be apportioned among the three areas mentioned above on the basis of limestone available in each area.

(ii) The expenditure on removal of overburden in those areas should be capitalized to the cost so apportioned.

(iii) Since limestone can be extracted only from the fully developed areas, the depletion on account of extraction of limestone from such areas should be calculated on the cost of the area apportioned as in (i) above together with the expenditure as per (ii) above capitalized to such area.

(iv) The cost of the partially developed area alongwith the expenditure on removal of overburden capitalized, should be transferred to the cost of the fully developed area as and when overburden is completely removed from the area.

(v) Until overburden is completely removed from partially developed area, the costs referred to in (i) and (ii) above should be accumulated and no depletion is required to be charged.

(vi) Since the expenditure incurred on removal of overburden from the area mentioned in (vi) above may be different from the areas developed earlier, it is desirable that the company maintains separate records in respect of separate areas on suitable technical operational centre-wise.

The above accounting treatment is illustrated by an example below:

Operational centres ‘C’ and ‘D’ comprise 20% and 30% of the total area respectively and no work has been done during the years 1989 and 1990 on these two centres.

In the accounts for the year 1989, the accounting should be as follows:

In the accounts for the year 1990, the accounting should be as follows:

* Centre B has been fully developed during the year and hence it has been shown under ‘Fully developed Areas’.

4.The Committee notes paras 11 and para 12 of Accounting Standard (AS) 5 on ‘Prior Period and Extraordinary Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India, which state, as below:

“11. A change in an accounting policy should be made only if the adoption of a different accounting policy is required by statute or for compliance with an accounting standard or if it is considered that the change would result in a more appropriate preparation or presentation of the financial statements of an enterprise.

12. Any change in an accounting policy which has a material effect should be disclosed. The impact of, and the adjustments arising from such change, if material, should be shown in the financial statements of the period in which such change is made to reflect the effect of such change. Where the effect of such is not ascertainable, wholly or in part, the fact should be indicated. If a change is made in the accounting policies which has no material effect on the financial statements for current period but which is reasonably expected to have a material effect in later periods, the fact of such change should be appropriately disclosed in the period in which the change is adopted.”

5. The Committee is accordingly of the following opinion in respect of the issues raised by the querist in para 6 of the query:

(a) The expenditure on removal of overburden should be capitalised in the manner suggested in paras 2 and 3 above. Since this will involve a change in accounting policy of the company, the change should be disclosed in accordance with the recommendations given in para 12 of AS-5.

(b) The company can write back in the current year the expenditure incurred on removal of overburden in the past and give the treatment recommended in paras 2 and 3 above. The adjustments arising out of such write back should be disclosed in accordance with recommendations given in para 12 of AS-5.

(c) The treatment suggested in paras 2 and 3 above will be applicable to a new company as well.

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