Expert Advisory Committee

1.3 Query:

Treatment of expenditure during construction period.

1. A Government of India enterprise, has been formed and registered under the Companies Act, 1956. The main objectives of the company are to plan, investigate, conduct, operate and maintain hydroelectric power stations. The company had sought the opinion of the Expert Advisory Committee of the Institute of Chartered Accountants of India on treatment of capital expenditure on land not belonging to the company and not represented by tangible assets (published in the Compendium of Opinions, Vol. IX, Query No. 1.32, Page IX-81). The Committee has given the opinion, according to the querist, that immovable assets constructed in the project should not be charged to Incidental Expenditure During Construction but should be accumulated in a separate account and thereafter written off to the profit and loss account as recommended in the Guidance Note on Treatment of Expenditure During Construction Period. Though the querist agrees that generally this should be the policy but feels that this general policy may not be applicable in all cases and circumstances and in particular it may not be applicable to the hydroelectric projects. The capital expenditure during construction incurred by the company is not only represented by tangible assets, but may also be represented by intangible assets. Broadly speaking, as per the querist, the expenditure of such nature in the hydroelectric projects can be classified under the following main points: -

(a) Fixed assets created on the land not belonging to the company but the fixed assets are owned by the company.

(b) Neither the fixed assets nor the land on which such assets have been created belong to the company.

(d) Upgrading, widening of certain portion/stretches of the road, culverts etc., to enable the movement of heavy construction equipment. This is normally done only on selected stretches.

(e) Creation of assets on alternative land in lieu of the land given by the government.

The company sometimes gets land free from the state govt./forest department. In lieu of the free land provided for the duration of the project, the company has to get the afforestation done on the alternative land of the govt./forest department.

(f) The amount paid to the government/private agency for submergence of land area, bridges etc. Cost has to be paid for reconstruction of bridges, footpath etc. in lieu of the submergence of the bridges.

2. The querist has informed that the company till now was following the policy to include the expenditure so incurred under the respective heads of account as capital works-in-progress giving a suitable note in the accounts. At the time of completion of the project, all this capital expenditure as well as the expenditure of revenue nature relating to the maintenance during construction (upgrading and widening of the selected patches/points of the roads) were separately identified and allocated along with the incidental expenditure during construction, on the tangible fixed immovable assets excluding land as all the expenditure is indirect cost of construction.

3. Vide the opinion of the Expert Advisory Committee referred to above, the querist states, that instead of showing this expenditure along with individual assets and giving a separate note, the company has started showing this expenditure in a separate head of account under works-in-progress from 1988-89 onwards. The expenditures were shown as expenditure on land not belonging to the company.

4. The view of the querist is that the nature of the expenditure indicated above mostly does not fall within para 10 of the Guidance Note on Treatment of Expenditure During Construction Period, based on which the opinion has been arrived at by the Expert Advisory Committee. The view of the querist in seriatim is as under: -

(a) For the item covered under (a) of para 1, as the fixed assets belong to the company but only the land does not belong to the company, the same should not be treated as the miscellaneous expenditure and/or deferred expenditure. It should be treated as a normal fixed capital expenditure and classified accordingly in the fixed assets schedule. Only a note should be given in the balance sheet that these fixed assets belong to the company but the land on which the assets have been created does not belong to the company. This type of expenditure is sometimes necessary because though the permission is given to create the assets but the title of land is not transferred to the company, particularly in the state of Jammu & Kashmir, where except for the residents of Jammu & Kashmir and the govt., nobody has a right to own any land. If such cases are required to be treated as per para 10 of the guidance note, then the entire cost to the company, running into hundreds of crores, may have to be written off to revenue within five years, whereas the total sale value itself may be only a few hundred crores. According to the querist, various assets in the balance sheet will not be appropriately depicted.

(b) As regards fixed assets created on land where neither the assets nor the land belongs to the company, the company is paying to the Central Government/State Government department either to upgrade the facility so that it can meet the requirement of the project in those remote areas or to provide additional specific facilities to the company. Generally, two types of expenditures are incurred in this regard, viz., (i) on construction power (ii) roads/communication. The amount is paid so that electricity board can lay the lines for supply of construction power. The amount is also paid for upgrading and widening of the road required for the project. The company feels that amount paid for supply of the construction power and upgrading of roads and bridges should be an appropriate charge as indirect cost of the construction and it will not be correct to treat the expenditure as deferred. These should be written off in the year of completion of the project as the company has got hardly any utility thereafter. To write off this expenditure in five years in operational account does not appear to the querist to be a correct accounting treatment in such cases.

(c) The company sometimes has to pay part of the maintenance expenses for construction power, road and communication etc. Mostly this expenditure is incurred when the road is blocked due to heavy rains in the monsoon period. The querist has further clarified that this expenditure is generally independent of the two types of fixed assets mentioned in (a) and (b) above and is of the nature of development repairs and maintenance expenses. The querist feels this should be charged to incidental expenditure during construction which is prepared in lieu of the profit and loss account in the year in which the same is incurred.

(d) The expenditure on widening of selected points and/or upgrading of road can also be treated as a normal maintenance expenditure during construction as it involves only very small points/stretches. The querist has further clarified that this expenditure is generally independent of the two types of fixed assets mentioned in (a) and (b) above and is of the nature of development repairs and maintenance expenses.

(e) As regards creation of assets on alternative land is concerned, this expenditure normally relates to afforestation and resettlement of the land oustees, since afforestation has to be done in lieu of the land to be taken by the company and, similarly, the expenses for resettlement of oustees is to be borne for the land taken by the company. The querist feels that these expenses should be classified under the cost of the land as the company has incurred this expenditure for the acquisition of land.

(f) The compensation paid by the company for creating another bridge/footpath in lieu of the submergence of the bridge is a normal condition/requirement for construction of hydro-electric projects. The querist is of the view that although it may be a normal loss, yet it may be taken as indirect expenditure for the construction of the project and should not form part of capital expenditure not represented by assets. It is a normal indirect expenditure on the project and forms part of IEDC and allocated as cost of the project in terms of the accounting policy.

5. The querist asserts that most of these problems are peculiar and technical for hydroelectric projects. The expenditure on some of these assets involves substantial portion of the project cost. If not properly classified, it may give an incorrect picture of the true position of the project cost itself. The company still feels that the earlier policy followed upto 1987-88 was more correct and appropriate in depicting true and fair view of the affairs of the entities in hydroelectric sector.

6. The opinion of the Expert Advisory Committee has been sought as to the accounting treatment of the items mentioned in para 1(a) to (f) of the query.

Opinion July 6, 1992

1. The Committee notes para 10 of the Guidance Note on Treatment of Expenditure during Construction Period, issued by the Institute of Chartered Accountants of India, which is as under:

“Sometimes, circumstances force a project to incur capital expenditure which is not represented by any specific or tangible assets. For example, a project may have to pay the cost of laying pipelines in order to facilitate the supply of its products or raw materials to or from a seaport, but the Port Trust or other similar authorities may insist that the pipelines belong to them even though the cost thereof is paid by the company. In other cases, a project may have to agree with a local authority to pay the cost or part of the cost of roads to be built by that authority in the vicinity of the project for the purpose of facilitating the business of the project. In this case also, the capital expenditure incurred by the project for this purpose would not be represented by any actual assets, since the roads would remain the property of the relevant State authorities even though the whole or a part of their cost may have been defrayed by the company in order to facilitate its business. In all such cases the expenditure so incurred would have to be treated in the books of account as a capital expenditure. There seems to be no valid objection to disclosing the same in the balance sheet under the general heading of “Capital Expenditure” subject to two conditions. In the first place, the description of the specific item on the balance sheet should be such as to indicate quite clearly that the capital expenditure is not represented by any assets owned by the company. In the second place, the capital expenditure should be written off over the approximate period of its utility or over a relatively brief period not exceeding five years, whichever is less. In fact, having regard to the nature of the expenditure and the purpose for which it is incurred, it is suggested that it would be more appropriate and realistic to classify such expenditure in the balance sheet under the heading of “Capital Expenditure” rather than either, write-off the expenditure to revenue or classify the expenditure under the heading of “Miscellaneous Expenditure” or “Deferred Revenue Expenditure”.

2. The Committee further notes that the opinion of the Expert Advisory Committee, published in the Compendium of Opinions, Vol. IX Query 1.32, Page IX-81, relates to the asset not belonging to the company constructed on the land which also does not belong to the company. Thus, the opinion is not relevant to those assets which belong to the company although constructed on land not belonging to company. The said opinion is also not relevant to other types of expenditures mentioned in the query.

3. In view of the above and the normally accepted accounting principles, the Committee’s opinion regarding the accounting treatment of the items mentioned in para 1 of the query, is as below:

(a) Fixed assets which, though having been built on land not belonging to the company, but are owned by the company, should form part of the relevant head of fixed assets belonging to the company and treated accordingly.

(b) Regarding fixed assets created on land not belonging to the company, which are also not owned by the company, the Committee reiterates its previous opinion (as referred to above), i.e., the expenditure incurred on the construction of such assets should be classified as ‘Capital Expenditure’ in the balance sheet indicating appropriately, the nature of the expenditure including the fact that the assets are not owned by the company. Also, after the commencement of commercial operations, the same should be written off to the profit and loss account over the approximate period of its utility or over a relatively brief period not exceeding five years, whichever is less. Thus, the expenditure may be written off in the year of commencement of commercial production if its utility does not last beyond that year, as indicated by the querist in para 4(b) of the query.

(c) & (d) The share of maintenance expenditure on common facilities as referred to in para 1(c) of the query, and the expenditure on upgrading, widening of certain portion/stretches of the road, culverts etc., as mentioned in para 1(d) of the query, are indirect incidental expenditures on construction of project. These should, therefore, be charged to Incidental Expenditure During Construction Account.

(e) The expenditure incurred on alternative land, as a pre-condition for obtaining the relevant piece of land, should be considered as a part of cost of acquisition of land. Accordingly, this expenditure should be capitalised as cost of land and shown as part of the cost of land in the balance sheet.

(f) The expenditure incurred by way of payment to the government/private agencies for construction of bridges/footpaths etc., in lieu of submergence of bridges etc., although may be a normal condition for such type of projects, yet its treatment would depend on the facts and circumstances of each case. For example-

(i) In case the company also uses such bridges etc., for its own construction/operations purposes, the expenditure would be of the nature of capital expenditure incurred on creation of assets not belonging to the company on the land also not belonging to the company, and, therefore, to be treated as per (b) above.

(ii) In case the construction of bridges etc., in lieu of submergence of the same, is a specific pre-condition for the acquisition of land acquired for the purpose of the project, the expenditure incurred on it should be treated as a part of the cost of acquisition of land.

(iii) In case the bridges etc., are not used for construction/operations purposes of the company or the construction thereof is not a specific pre-condition for acquisition of land for the project, the expenditure incurred in this regard should be treated as incidental expenditure during construction and treated accordingly.

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