1.48 Query: Capitalisation of the engineering overheads.
1. A government company is formed by an Act of Parliament, for the construction and running of warehouses throughout the country. The construction of godowns is carried out by the company’s own Engineering Wing. This consists of: -
i) A construction cell headed by an executive engineer level officer to directly supervise the work at different sites in its jurisdiction. At the different construction sites, assistant engineers and junior engineers are posted. There are 15 such construction cells at present.
ii) The circle offices headed by superintending engineer to oversee the construction quality and pace of progress. There are 4 such offices, each of which have been allocated 3/4 construction cells.
iii) An Engineering Wing headed by chief engineer level officer stationed at the head office to supervise the entire engineering activity on all India basis.
2. The cells incur expenditure on the construction of warehouses, minor capital projects and maintenance of the existing godowns. The salaries and other revenue expenditure at the construction cells is allocated by way of engineering overheads to the respective works in proportion to the value of work done. The expenditure on maintenance of the existing godowns is, however, not allocated. Thereby these revenue expenses are capitalised along with the completed works. The expenses of the Circle Offices and the Chief Engineer’s office at head office are also allocated to the respective works by way of engineering overheads.
3. The proportion of the engineering overheads of the cells to the value of work done at the respective construction cells varied from cell to cell, depending upon the distribution of work amongst the cells. The average of percentage of overheads of the cells to the value of work done on an all India basis was around 14.63%.
4. Due to some dis-proportionate distribution of work amongst the various construction cells the percentage of engineering overheads to the works outlay varied to a significant extent from the year 1987-88. As a result, the revenue expenses at each construction cell to the extent these exceeded the all India average (of engineering overheads percentage) were treated as abnormal and charged to the revenue.
5. The entire exercise of charging of engineering overheads to the revenue was being done at the head office. Once a godown was constructed and completed, the same would be handed over to the Commercial Wing for commissioning and putting to use the godowns for warehousing purpose. Depreciation would be charged on the godowns from the date the same were commissioned by the Commercial Wing.
6. The corporation has Regional Offices situated at state capitals to supervise the running of warehouses. From the year 1990-91, these Regional Offices have been entrusted with the responsibility of maintaining the fixed assets register in respect of the godowns as are constructed and handed over to them by the construction cells. The Regional Offices are now required to capitalise the godowns in their books and to charge depreciation thereon.
7. The querist has further informed that the organisation in question and all other organisation in the warehousing industry are reaching a stage where the construction activity is on the downward trend. Consequently, the engineering costs consisting of direct and indirect costs would undergo a radical change in the inter-se ratio. While the overhead percentage in the previous years was within 20% approximately, during the year 1990-91 it has crossed 31% and if this trend continues, by the end of this decade, the quantum of overheads would be at par with the capital outlay. The querist feels that the relevant existing accounting principles need to be reviewed to ensure that
(i) There is responsibility of overhead percentage to be applied to the direct cost;
(ii) The inflationary situation is taken note of;
(iii) The cost of godown, when procured from alternative source, should not be at variance with the self-construction cost;
(iv) The rate of increase in the overhead percentage applied to the direct cost should not rise beyond the increase in the inflationary rate as this excess could be attributed to the higher margin of earnings of the executing contractors;
(v) The staff cannot be retrenched.
8. The advice of the Expert Advisory Committee has been sought on the following: -
(a) The mode of capitalisation of the godowns at the Regional Offices.
(b) Any alternative method more appropriate to ensure an equitable mode of capitalisation for godowns handed over during the course of the year.
(c) Whether a fixed percentage of overheads would be an acceptable form of capitalisation, wherein at the year end the excess/shortfall based on actual percentage computed could be given a revenue effect through Profit and Loss Account. Alternatively, adoption of the previous year’s all India average percentage for purpose of transferring of the assets during the course of the year and adjustment of difference based on current year’s overhead percentage computation through the revenue account.
Opinion February 11, 1992
1. The Committee notes that the accounting principle for determination of the cost of a self-constructed fixed asset, has been laid down in para 21 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India. According to the said paragraph, “the cost of self-constructed fixed asset should comprise those costs that relate directly to the specific asset and those that are attributable to the construction activity in general and can be allocated to the specific asset.” Thus, all direct costs and relevant indirect costs should be included for arriving at the cost of construction of the self-constructed warehouses.
2. The Committee also notes the peculiar circumstances under which the company is operating, viz., declining construction activity over the years, while increasing costs (due to inflation) are unavoidable as the organisation cannot scale down its infrastructure for construction of godowns, e.g., it cannot retrench workers. Due to these reasons, excessive indirect costs, which are of the nature of idle capacity costs, are being incurred. The Committee is of the view that such excessive indirect costs can be charged to the profit and loss account instead of capitalising the same as cost of construction of warehouses. The Committee is further of the view that such excessive indirect costs can be arrived at by determining a normal overhead absorption rate on the basis of the normal level of construction activity. The normal level of activity can be determined keeping in view various factors, such as, the existing facilities for construction of godowns available with the company in question, past experience etc. The normal level of construction activity can be expressed in appropriate terms, for example, number of working hours etc.
3. On the basis of the above, the Committee is of the opinion that the relevant indirect costs should be absorbed in the cost of construction of godowns by using the following formula:
Relevant indirect costs of construction Actual construction activity = _________________________________ X during the year Normal construction activity
The indirect costs which cannot be absorbed may be charged to the profit and loss account. Basis of absorption of indirect costs on the basis of all India average may not be proper in the opinion of the Committee. _________________________________ |