1.12 Query:   

  Accounting treatment of expenditure incurred

after cut-off date of capitalisation.

1. A Government of India company had taken up a project for setting up a phenol plant. The project, a chemical manufacturing unit, involves a capital investment of about Rs. 120 crores. The project expenses were capitalised taking 8.3.88 as cut-off date for commencement of commercial production.

2. The company has entered into a technical collaboration agreement with M/s. Universal Oil Products Co. Ltd. (UOP), USA, for rendering services for basic process know-how, basic engineering and commissioning. This agreement did not cover any services to be rendered after setting up/commissioning the plant.

3.The services to be rendered by UOP have been spelt out in the agreement as follows:

                        (i) To observe and approve the preparation of the plant for operation;

(ii) To advise the company in the initial operation of the plant;

(iii) To instruct the operators of the company;

(iv) To specify operating conditions and data collection and evaluation process; and

(v) To advise laboratory test procedures related to the operation of the plant.

All these activities were regarded as services in connection with preparation, setting-up and commissioning of the plant.

4.            The fees payable are as follows:

The fee payable under (a) and (b) above was remitted in the year 1982-83 and capitalised.

5. The plant was capitalised in the financial year 1987-88, taking 8.3.88, as mentioned above, as the date on which the guarantee was proved, after successful trial runs of the plant.

6. The fees for commissioning services, including inspections and supervision charges, was payable to UOP in terms of the mandays spent by each expert for the purpose. The fees payable to UOP in US Dollars in respect of mandays spent upto the date of capitalisation (cut-off date) was capitalised applying the exchange rate ruling as on the cut-off date, in the year 1987-88. The amount due was, however, not paid for want of the Government approval.

7. The services of the US experts who were responsible for setting up and commissioning the plant were utilised until the plant completed trail run operations satisfactorily. Though the plant was taken to have proved the guarantee on a particular day during the commissioning and trial run operations, some of the foreign technicians remained in the plant for a few more days only to ensure that the commissioning of the plant has been properly done and there were no failures or defects in the setting-up of the plant and the plant had achieved the designed level of synchronisation and stabilisation. Being a large plant system of a highly sophisticated and also hazardous nature, some of the technical experts had to watch and supervise the performance level for a few more days even after the “Cut-off date”, so as to ensure that the plant has been properly set up and commissioned. The cut-off date for commercial production itself was decided upon later after due technical assessment. During this brief period of the stay of the foreign technicians after the cut-off date for commercial production, their services were mainly in observing and ensuring all aspects of the plant performance and no services were rendered in the matter of regular production.

8.The total mandays utilised for the commissioning activities were 3320, out of which 192 mandays were after the cut-off date.

9. As mentioned above, the plant was capitalised as on 8.3.88 in the year ended 31.3.88. The fees payable to the US collaborators for transfer of technical know-how and for their expert technicians for services rendered upto 8.3.88 as also the fees payable to the foreign technicians for the period of their stay after 8.3.88, for 192 mandays was also capitalised as part of the plant cost and provided for as a liability. The amounts payable to the foreign collaborators for the period upto 8.3.88 and for the extended period of services beyond 8.3.88 for 192 mandays provided for as stated above could not be remitted to them before 31.3.90, pending various Government approvals. The rupee equivalent of the liability as provided for while capitalising the fees on 8.3.88 had increased consequent to exchange variation as on 31.3.90. Therefore, the liability in terms of rupees for the whole amount of fees payable (for the services upto 8.3.88 as capitalised initially in 1988-89 and for services for 192 mandays capitalised in 1989-90) were translated at the prevalent exchange rate as on 31.3.90 and the increase in liability resulting therefrom was also added to the cost of the plant and provided for as on 31.3.90.

10. The view taken by the company was based on the following considerations:

(a) The foreign collaborators/technicians were engaged for setting up and commissioning of the plant and not for commercial operations of the plant.

(b) The foreign technicians actually rendered services only in setting-up and commissioning the plant and proving the guarantee and satisfactory trial runs.

(c) While the cut-off date for plant capitalisation was determined as 8.3.88 based on the plant performance, the presence of the foreign technicians was retained for a few more days after the date only to ensure that the plant was properly commissioned and there were no failures or defects in plant synchronisation, and stabilisation especially since the plant was a large sophisticated system of hazardous nature. As no services were rendered for regular operations of the plant, no part of the fees was revenue expenditure.

(d) The payment of fees could not be made pending receipt of necessary approvals and the increase in liability in foreign exchange at any time due to variation in currency rates in respect of the plant cost capitalised will also go to increase the cost of the plant. The accounts of the company for the year ended 31.3.90 were drawn up as above.

11. The Government Audit, however, took the view that the per diem fees payable relatable to the stay of the foreign technicians after the date of capitalisation of the plant, viz., 8.3.88, was revenue expenditure and should not have been capitalised. They took the view that the exchange variation in the liability on foreign exchange after the date of commissioning of the plant also should have been charged to revenue.

12. The company has availed the services of UOP technicians under an agreement which provides for services upto the date of commissioning of the plant. No service for day to day running of the plant and commercial activity was contemplated in the agreement. It, therefore, follows that the entire amount payable under the said agreement is of capital nature, including the exchange rate variation upto the date of actual payment.

13. On the other hand, it can also be argued that the cut-off date having been defined and the plant cost capitalised from that date, the per diem fees payable after that date should be viewed as revenue expenditure, since the plant has commenced commercial productions. Similarly, the liability of the company on the cut-off date which was with reference to the rate of exchange prevailing on that date only should be capitalised. The additional amount of liability that has become payable due to exchange rate variation should be treated as revenue expenditure.

14 The Expert Advisory Committee is requested to give its opinion on the accounting treatment to be given in respect of:

(a) The per diem fees payable for the stay of the foreign technicians after the cut-off date, in the above case.

(b) The exchange rate variation after the cut-off date and as on the date of the balance sheet on 31.3.90.

                                                                                Opinion                                  June 14, 1991

1. The Committee notes that para 12.3 of the Guidance Note on Treatment of Expenditure During Construction Period, issued by the Research Committee of the Institute of Chartered Accountants of India, recommends as below:

“12.3 As discussed in other paragraphs of this Note, various expenditures of a revenue nature which are incurred during the construction period are either capitalised as part of the indirect cost of construction, or are carried forward as deferred revenue expenditure, as may be appropriate. However, from the moment the plant is completed and commissioned and is ready for commercial production, all expenditures of revenue nature must be charged to the profit and loss account. It is for this reason that it is so important to determine the “cut-off date” based on the date when the plant is ready for commercial production, with a great degree of precision.”

2. The Committee is of the view that the fees payable to the foreign technicians in respect of the period after the cut-off date for commencement of commercial production cannot be capitalised since such expenditure does not add to the value or utility of the fixed assets; it is incurred merely to ensure that the plant is running smoothly after commencement of commercial production. The cut-off date is determined on the basis that the testing of the operation of the plant and trail-runs are completed and it is satisfied that the plant is set-up and is ready to commence commercial production. If there had been any doubt that there would be problems in the commercial operations of the plant, the cut-off date could have been extended. Once the cut-off date is correctly determined, the expenditure of revenue nature incurred after the cut-off date should be charged to the relevant profit and loss account.

3. The Committee presumes that the satisfactory operation of the plant was ensured while determining the cut-off date and the opinion is given by the Committee in the light of this presumption.

4.The Committee further notes that Accounting Standard (AS) 11, on “Accounting for the Effects of Changes in Foreign Exchanges Rates”, issued by the Institute of Chartered Accountants of India, states in para 24 as below:

“24(a) In case of current assets and current liabilities (other than those related to fixed assets), if the result of conversion at the closing rate is an overall net gain, such gain should not be taken into account and the assets and liabilities should continue to appear in the books at the rates at which they were originally recorded. On the other hand, if the result is a net loss, the current assets and current liabilities should be restated and the loss should be charged in the Profit and Loss Statement.”

(b) In the case of current liabilities incurred for the acquisition of fixed assets, the loss or gain, if material, should be regarded as an adjustment of cost and should be included in the carrying amount of the related fixed assets. If the amount is not material, the loss or gain may be dealt with in the manner described in para (a) above.”

5. On the basis of the above, the opinion of the Committee on issues raised in para 14 of the query is as follows:

(a) The fees payable for the stay of the foreign technicians after the cut-off date should be treated as a revenue expenditure and charged to the relevant profit and loss account.

(b) Since the current liability in respect of the payment outstanding in respect of fees payable for 192 days is of revenue nature, as it does not relate to the fixed asset, the exchanged rate variation in relation to such current liability should be treated as per para 24(a) of AS 11, reproduced at para 3 above.

Fees payable for mandays related to the period prior to cut-off date, viz., 3128 mandays (i.e., 3320-192) is capitalised to fixed assets account. Since the said fees is in relation to acquisition of fixed assets, the exchange variation arising in respect thereof should be capitalised to fixed assets account in accordance with para 24(b) of AS 11 as reproduced above.

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