1.2 Query: Accounting treatment of disposal of construction plant and machinery and other assets procured for construction purposes after the completion of the project.
1. A public sector corporation registered under the Companies Act, 1956, is engaged in planning, investigation, construction, operation and maintenance of hydroelectric power projects at different parts of the country. The construction period ranges between 4-10 years and each project involves heavy capital outlay. Some of the individual projects may even cost Rs. 1,500 to 2,000 crores. The construction projects also involve a lot of development of infrastructure and also construction of dam, water conductor system, tunnel, electro-mechanical equipment like Generator, Turbine, Gates, Penstocks etc. In the process of construction, the corporation engages thousands of suppliers for supply of millions of tonnes of cement, steel and other construction materials, equipment spares etc. A substantial portion of work including material supply lasting over 6-10 years involves huge accounting work like maintenance of accounts, reconciliation of accounts within the corporation, reconciliation of accounts with various parties etc. The final bills of major contractors are normally received after one year of the commissioning of the project and involve settlement of deviation, extra items etc., and hence it is not possible to completely close the construction account immediately on commissioning of the project in view of difficulties and volume of work. Support of computerised systems is not fully available due to inaccessibility of areas where the project has to be constructed. The corporation also procures construction equipment of substantial value and of different type and nature for its construction requirement and is either given temporarily on hire charges to the contractor or on non-recoverable charges. These equipments are also used in departmental work.
2. The hire charges to be recovered are based on the principles fixed by Central Water Commission in their guidelines on the subject including the depreciation to be charged. The project estimates sanctioned by Government also provide that construction equipment so procured will be adjusted partly as cost of special tools and plants and balance as receipt and recoveries on capital account.
3. Normally, the corporation sets up 3 generating units in a project and these units are commissioned within a gap of 3 to 9 months. The project is declared commercially operative after stabilisation and the 3rd unit is commissioned. Even after the declaration of commercial operation of project, a number of construction works are carried out at the project. These works are such, which are not necessarily to be completed at the time of start of generating units and can be carried out within a reasonable period after the start of the generating units. Some of the important works in this regard relate to stabilisation of hill near the dam, power house and other works.
4. In view of continuation of some of the capital works and time taken for settlement of final claims of contractors and disputes, arbitration etc., project accounts closing and completion takes a lot of time. The capital account of the project normally takes 2-3 years for final completion, though capitalisation of works is completed on the basis of actual expenditure incurred plus the estimated liability which can be determined at that time.
5. The construction plant and equipment procured for construction activities, after completion of the construction, is disposed of in the following manner: -
(i) Transfer to other construction projects of the corporation;
(ii) Transfer to operating units of projects, if required;
(iii) Disposal to other government departments, agencies and public sector undertakings, if required;
(iv) Disposal by tender/auction etc.
6. In the case of disposals mentioned at (i) and (ii) of para 5, normally there is no problem as the equipment is transferred at the book value and there is no difference between the book value and the transfer price (depreciation in the accounts on construction equipment is charged in accordance with the provisions of the Companies Act). However, the querist has doubts about other cases as these involve transfer/sale on profit or loss. The querist’s view is that the profit earned on the disposal of construction plant and equipment should not be charged to profit and loss account but taken to Incidental Expenditure During Construction (IEDC) which is prepared in lieu of profit and loss account during construction period. This IEDC forms a part of works-in-progress and is shown under Fixed Capital Expenditure in the balance sheet of the corporation. (A copy of the balance sheet has been sent by the querist for the perusal of the Committee). The corporation, the querist asserts, has been following this practice consistently for the last 10 years in view of the following reasons: -
(i) The construction plant and machinery is specifically purchased for the construction requirement of the project and, therefore, the profit or loss on the disposal of the same should be charged to construction account only.
(ii) Profit on the sale of assets should not be taken to profit and loss account as it will unnecessarily inflate the profit of the corporation without any normal business or revenue activity and simultaneously increase the capital cost of the project.
(iii) In the view of the querist, the increase in the capital cost will not be in accordance with the guidelines of preparation of project cost estimates by CWC/CEA as well as Government sanction.
(iv) The equipment which is surplus to the requirement of construction is not held with the intention of being used for the purpose of producing or providing goods or services in the normal course of business. In this connection, the querist has referred to para 6.1 of the Accounting Standard (AS) 10 on Accounting for Fixed Assets. According to the querist, the profit/loss to be charged to the profit and loss statement in accordance with para 14.2 of the said Accounting Standard (AS) 10 relates to only those fixed assets which are held with the intention of being used for the purpose of producing or providing goods or services. He has stated that the opinion of the Expert Advisory Committee in para 4(ii) under query 1.10 (Treatment of equipment/plant used in construction activities after the completion of the construction period) (Compendium of Opinions- Vol. VIII) that the profit or loss should be charged to the profit and loss account may not be a correct depiction in accordance with normal accounting principle/systems and in terms of para 6.1 and para 14.2 of the Accounting Standard on Accounting for Fixed Asset (AS) 10 in the instant case.
7. The querist has suggested that the Expert Advisory Committee may re-examine the issue in the light of the above facts. Incidentally, the problem has arisen as there is a profit of about Rs. 80 lakhs in one of the construction projects in the sale or disposal of assets during 1990-91 and showing this profit of Rs. 80 lakhs in the profit and loss account does not appear to be correct to the querist in view of the reasons stated above.
8. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the showing of these surplus construction plant and machinery under the ‘Fixed Assets’ is in order in view of para 6.1 of (AS) 10 ‘Accounting for Fixed Assets’.
(ii) If it is not in order to show the surplus construction plant and machinery in the Fixed Assets Schedule, then what would be the proper presentation of the same?
(iii) Whether the profit on sale of surplus plant and machinery should be disclosed in the profit and loss account or in the Incidental Expenditure During Construction Account.
Opinion July 6, 1992
1. The Committee notes that para 6.1 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, provides:
“Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business.”
2. The Committee is of the view that the construction equipment is held for the purpose of producing or providing goods or services which are used by the corporation itself for construction of its own power plants. The fact that the same is being held, for the time being, awaiting disposal, does not change its basic nature. The clause ‘not held for sale in the normal course of business’ excludes inventories from the definition of ‘Fixed Asset’.
3. The Committee further notes para 24 of Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, which states as follows:
“Material items (of fixed assets) retired from active use and held for disposal should be stated at the lower of their net book value and net realisable value and shown separately in the financial statements”.*
4. On the basis of the above, the Committee is of the view that if surplus plant and machinery is not actually disposed off on commissioning of the project then it should appear in the books at the lower of NRV and book value till it is actually disposed off. On its disposal, the difference in the value of the plant and machinery shown in the accounts and the actual amount realised from such disposal should be booked in the profit and loss account for the period in which such disposal takes place. The Committee thus reiterates its earlier opinion contained at query no. 1.10 in Volume VIII of the Compendium of Opinions.
5. On the basis of the above, the Committee is of the following opinion in respect of the issues raised by the querist in para 8 of the query:
(i) The surplus plant and machinery, which has not actually been disposed of at the time of commissioning of the project, should be disclosed at the lower of net realisable value (NRV) and book value under the head ‘Fixed Assets’.
(ii) In view of (i) above, this question does not arise.
(iii) Profit on sale of surplus plant and machinery after commencement of commercial production should be disclosed in the profit and loss account. ______________________________________________________________________________________ *The Committee, however, notes that para 9.5 of the Guidance Note on Treatment of Expenditure During Construction Period, issued by the Research Committee of the Institute of Chartered Accountants of India, inter alia, recommends that, “a more convenient method in practice would be initially to capitalise the full cost of such temporary facilities, services and equipment and, thereafter, to credit against this cost the residual or scrap value at the end of the construction period. In those cases where the temporary facilities and equipment are sold or scrapped or are intended to be sold or scrapped at the end of the construction period, the value to be credited would be the actual or estimated sale value or scrap value.” The Committee is of the view that the aforesaid recommendation visualises taking credit for residual or scrap value of the assets which is not likely to be material in amount and, therefore, would not materially affect the balance of incidental expenditure for the purpose of capitalisation. In any case, since AS 10 is now mandatory, it would prevail over the Guidance Note. ________________________ |