1.19 Query: Capitalisation of expenditure incurred on expansion of a project.
1.A company registered under the Companies Act, 1956, is an undertaking of a State Government which has several sugar manufacturing units in the state.
2.One unit was manufacturing sugar at the capacity of 800 T.C.D.
3.The accounts of the unit close on 31st March every year.
4.The unit took-up an expansion project of installing a new sugar plant having a capacity of 2,500 T.C.D., in the accounting year 1988-89 worth Rs. 2,000 lacs. The plant, after expansion and modernisation, was commissioned on 21.3.1990, i.e., in the accounting year 1989-90 ended on 31.3.1990.
5.After commissioning of new sugar plant, it started crushing of sugarcane on 21.3.1990 upto 31.3.1990, it crushed 2,000 quintals cane but due to some inherent technical bottlenecks being new plant and machinery and due to intermittent crushing of cane, the commercial production of sugar could not commence in the said accounting year. The production of sugar started on 4.4.1990, i.e., in next accounting year.
6.The total crushing of cane for the season, which commenced from 21.3.90 and ended on 14.6.90, was 6 lacs quintals and production of sugar from 4.4.90 to 14.6.90 was 50,000 bags. Thus, the crushing commenced in accounting year ended on 31.3.1990 while the commercial production commenced in next accounting year.
7.The querist has sought the opinion of the Expert Advisory Committee on the following issues:
i) In which accounting year the capitalisation of plant and machinery and factory building should be made?
ii) In which accounting year depreciation should be charged?
iii) Whether the capitalisation should be made on the basis of crushing of cane or on the basis of commercial production.
iv) The case laws, if available, may also be quoted.
Opinion December 14, 1990
1.The Committee notes paragraphs 12.2 and 12.4 of the Guidance Note on “Treatment of Expenditure During Construction Period” which recommend as under:
“12.2 In several cases, guidance may be available in selecting the official date of commencement of production by reference to the date of the inauguration ceremony as well as by reference to the date which is publically and officially announced by the company as the date on which it has commenced commercial production. It should be borne in mind, in this connection, that “commercial production” is a term of somewhat wider import than the mere term “production”. Even during a period of test runs and experimentation, a plant may be engaged in actual production, but until the test runs are completed and the plant is properly adjusted on the basis thereof, if may not be said to be ready for “commercial production”. The term “commercial production” refers to production in commercially feasible quantities and in a commercially practicable manner.
12.3 As discussed in other paragraph 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.
12.4 It is important to note in this connection that what is significant for this purpose is the date when the plant is ready for commercial production and not the date when the plant actually commences commercial production. Therefore, if a plant had been completed and commissioned and is ready for commercial production, but the company for some reason or other, does not start commercial production immediately thereafter, the expenditure incurred during this intermediate period must be treated as revenue expenditure and cannot be capitalised. This follows from an important rule, both in accounting principle as well as in economic theory. The rule is that only those expenses should be capitalised as part of the cost of an asset which relate to the acquisition or construction of that asset or which add anything to the value or utility of that asset. When a plant has once been completed and is ready for commercial production, the expenditure incurred during the intervening period of delay in actually commencing commercial production is neither related to the acquisition or construction of the fixed assets nor does it add to the value or utility thereof- consequently, it must be written of as revenue expenditure and cannot be capitalised.”
2.The Committee notes from the facts of the query that although the plant after expansion and modernisation was commissioned on 21.3.1990, but the commercial production of sugar commenced on 4.4.1990 on account of some inherent technical bottlenecks, owing to the new plant and machinery. The opinion of the Committee is based on the fact that the commercial production of sugar could not be started before 4.4.1990 on account of technical bottlenecks and that it was not possible to produce sugar before 4.4.1990 on account of these technical bottlenecks.
3.The Committee is of the view that in the present case, the commercial production could have been commenced on 4.4.1990. The project could be said to be ready for commercial production only when commercial production is technically feasible and in the present case, the commercial production was not feasible till 4.4.1990 on account of technical bottlenecks. Therefore, the plant was ready for commercial production only on 4.4.1990.
4.The Committee is also of the view that intermittent crushing of sugar cane is not, in itself, a sufficient ground for considering that the plant was not ready to commence commercial production.
5.The Committee is of the following opinion in respect of the issues raised in para 7 of the query:
i) Since in the present case, as per the querist, it was not technically feasible to commence commercial production till 4th April, 1990, the plant can be considered to be ready for commercial production on 4th April, 1990. In view of this, expenditure incurred upto 4th April, 1990, should be capitalised.
ii) In view of (i) above, the depreciation will be charged in the profit and loss account from the date the plant was ready to commence commercial production, i.e., in the present case 4th April, 1990. However, depreciation on assets used during construction period should be treated as recommended in the aforesaid Guidance Note.
iii) The capitalisation of expenditure during construction period should be made upto the date the plant is ready for commercial production. The date of crushing of cane is not relevant.
iv) The case laws depend on the facts and circumstances of each case. A reference may be made to the case laws given in para 12.5 of the ‘Guidance Note on Treatment of Expenditure During Construction Period’. _______________________ |