1.52 Query: Treatment of Interest on borrowing costs of fixed assets.
1. A company is a central public sector undertaking having its registered office at Ranchi. It is engaged in the business of extraction, production, manufacture and sale of coal, soft coke, hard coke, washed coal and other by-products, viz., coal tar, coal breeze, as well as development of mines falling under its jurisdiction.
2.Apart from projects under revenue, the company has got some projects which are under development. As per company’s accounting policy, during development period, expenditure incurred (net of income) including borrowing costs on these projects are capitalised and are booked to ‘Development Accounts’ by way of transfer from natural heads of income/expense account. When these projects are brought under revenue, such development expenses are amortised in 20 years or life of the project, whichever is earlier.
3. As per the Government guideline and according to the accounting policy of the company, for bringing any development project to revenue account, any one of the following conditions is required to be fulfilled by the project:
1. Two years after touching the coal seam.
2. After achieving 25% production of the rated capacity.
3. The unit should indicate revenue surplus.
4. The company has got a project named “PIPARWAR” which is coming up with Australian collaboration. The estimated cost of the project is Rs. 526 crores with a projected production of 5 million tonnes per annum. Since this project had generated a revenue surplus, the management decided to bring the project under revenue w.e.f. 1.4.1990, though it has the following special features:
(i) The project has got long gestation period which is five to six years.
(ii) The total capital expenditure as on 1.4.1990 was only Rs. 19.74 crores and 73 crores as at 31.3.1991 as against the total cost of Rs. 526 crores.
5. The revenue surplus by the project was possible mainly because of the fact that the production activities in the project could be carried out with some old existing equipments and some hired by the project from the neighbouring company’s collieries. Since the gestation period of the project is long and the capital expenditure incurred so far is negligible in comparison with the estimated total cost of the project, the management wants to capitalise the financing cost relating to borrowed funds attributable to construction or acquisition of fixed assets for the period up to the acquisition of fixed assets. The querist is of the view that this decision of the management is in conformity with para 9.2 of “Accounting For Fixed Assets (AS-10)” issued by the Institute of Chartered Accountants of India.
6. In the facts and circumstances referred above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the aforesaid method of capitalisation of interest on borrowing cost of fixed assets would be well within the accounting principle.
(b) If not, what should be the suitable alternative method of distribution of financing cost relating to the borrowed funds for acquisition of fixed assets.
Opinion February 11, 1992
1. The Committee does not express any opinion on the propriety of bringing the project to revenue account since this matter has not been specifically raised by the querist. The opinion hereunder is restricted to the issues raised in paragraph 6 of the query.
2. The Committee notes paragraph 20 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’ issued by the Institute of Chartered Accountants of India, which is reproduced below:
“20. The cost of a fixed asset should comprise its purchase price and any attributable cost of bringing the asset to its working condition for its intended use. Financing costs relating to deferred credits or to borrowed funds attributable to construction or acquisition of fixed assets for the period up to the completion of construction or acquisition of fixed assets should also be included in the gross book value of the asset to which they relate. However, the financing costs (including interest) on fixed assets purchased on a deferred credit basis or on monies borrowed for construction or acquisition of fixed assets should not be capitalised to the extent that such costs relate to periods after such assets are ready to be put to use.”
3. The Committee also notes paragraph 3.25 of ‘Statement on Auditing Practices’, issued by Institute of Chartered Accountants of India, which is reproduced below:
“3.25 The question often arises as to whether interest on borrowings can be capitalised and added to the cost of fixed assets which have been created as a result of such expenditure. The accepted view seems to be that in the case of a newly started company which is in the process of construction and erecting its plant, the interest incurred before production commences may be capitalised. “Interest incurred” means actual interest paid or payable in respect of borrowings which are used to finance capital expenditure. In no circumstances, should imputed interest be capitalised, such as interest on equity or preference capital at a notional rate. Interest on capital during construction paid in accordance with the provisions of Section 208 of the Companies Act, 1956, may, however, be capitalised as permitted by that section. Interest on monies which are specifically borrowed for the purchase of a fixed asset may be capitalised prior to the asset coming into production, i.e., during the erection stage. However, once production starts, no interest on borrowings for purchase of machinery (whether for replacement or renovation of existing plant) should be capitalised. For an existing business, interest paid for financing a completely new unit or a substantial expansion undertaken by the company may be capitalised. Only the interest on monies specifically borrowed for the new expansion may be capitalised and that only for the period before production starts. Interest payable on fixed assets purchased on a deferred credit basis, should not be capitalised after commencement of production.”
4.The Committee is of the following opinion in respect of issues raised in para 6 of the query:
(a) The company should capitalise the interest attributable to construction or acquisition of fixed assets for the period upto the completion of construction or acquisition of fixed assets.
(b) This does not require any answer in view of (a) above. ___________________________ |