1.15  Query:    

Accounting treatment of expenditure during construction period.

1.  A public sector company has a running refinery with a capacity of 9.0 million tonnes per annum. The hydrocracker project of the company for upgrading the heavy ends into middle distillates such as LPG, diesel, MS etc., at a cost of Rs. 757.24 crores, was approved by the Government of India. This project mainly consists of the following facilities:

2. As per the querist, the above stated facilities have been commissioned in phases and capitalised during the year 1992-93 and 1993-94 on the basis of the extant capitalisation accounting policy of the company, which is as under:

“The assets are to be capitalised when they are mechanically completed (duly supported by completion certificate) and are ready for use, notwithstanding the fact that the use of the facilities may be delayed for want of input such as gas, raw-material product etc. However, if the facilities are closely linked with other related facilities/plants, former facility cannot be considered as ready for use till other later facilities are ready for use. In such cases all the related facilities can be capitalised only after they all become ready for use.”

3. As per the querist, after the commissioning of the facilities, depreciation and other expenses such as salaries, repairs and maintenance, gas for operation of turbine sets, chemicals etc. have been charged to revenue during 1992-93 and also subsequently during 1993-94. Further, gas required, for the operation of turbine sets, is purchased from another company. The terms for the supply of the gas provide for fixed charges for 80% of the agreed quantity of gas to be supplied by the supplier company and in case consumption of gas exceeds this level, the charges at the agreed rate should be levied.

4. The querist has stated that after the initial start up and commissioning of gas turbines, it was expected that the electricity generated by the turbines will be used by the hydrocracker/hydrogen unit and other facilities which were to be commissioned in March 1993. However, the hydrocracker/hydrogen unit could not be commissioned in time to use the electricity generated by the turbines with the result that there was no bulk demand for the electricity generated by the turbines. Some quantity of electricity, of course, was consumed in the main operation unit of the refinery and some electricity was also consumed in the construction of hydrocracker unit. The bulk of the balance electricity, however, had to be supplied to the State Electricity Board free of cost because of the common grid. As per the querist, turbine sets had to be kept running since fixed charges, in any case, were payable to the gas supply company. Besides, steam was also generated from waste heat recovery system of the turbines. The steam so generated also had to be vented without much use for want of demand from hydrocracker/hydrogen unit as these units could go into operation much later as indicated above, i.e., hydrogen unit on 30.9.1993 and hydrocracker unit on 1.12.1993.

5.A question has arisen whether cost and other allied expenses incurred for the generation of electricity from the date of commissioning of the turbines to the date of commissioning of hydrogen/hydrocracker plant could be treated as ‘construction period expenses’ and capitalised with the cost of hydrocracker/hydrogen unit. Similarly, how the running expenses of the other units which have been capitalised and their expenses charged to revenue should be treated, till the date of commissioning and capitalisation of hydrogen/hydrocracker unit.

                                                                                   Opinion                               June 14, 1994

1.  The Committee notes that as per para 12 of ‘Guidance Note on Treatment of Expenditure During Construction Period’, issued by the Institute of Chartered Accountants of India, cost of construction of a plant etc. is capitalised when the related assets are complete and ready for commercial production, i.e., production in commercially feasible quantities in a commercially practicable manner is possible. However, from the accounting policy of the company, as stated at para 2 of the query, it is not clear whether ‘mechanically completed and ready for use’ means ‘ready for commercial production’. The Committee presumes that by ‘mechanically completed and ready for use’ the company means ‘ready for commercial use’. The Committee is accordingly of the view that the accounting policy of the company may be reworded to make it clear.

2. The Committee notes paras 13.2 to 13.4 ‘Guidance Note on Treatment of Expenditure During Construction Period’, issued by the Institute of Chartered Accountants of India, which read as follows:

“13.2    In the normal course, the interval of time between the date a project is commissioned and is ready for production and the date when commercial production actually begins should be very brief. However, several factors sometimes operate to make this interval of time very prolonged and this is especially so in India because of the multifarious list of regulations to be complied with before commencing production as well as the acute shortage of basic materials and services. For example, the fact that certain licences may have not been obtained in time from a Government or local authorities may hold up commercial production. In other cases, the plant may be commissioned and completed and may be ready in all respects to commence production, but there may be delay in obtaining the power line or the water supply. Sometimes, one project is linked to another in such a way that it relies on the latter for its supply of raw materials. This is particularly the case with the chemical and process industries. For example, a fertiliser plant may be established as part of a large petro-chemical complex. One of the essential raw materials for making fertilisers may be derived from the petro-chemical complex. In such a case, even if the fertiliser plant is complete in all respects and is commissioned for commercial production, it cannot actually commence production until the petro-chemical complex has been completed. It will thus be appreciated that circumstances can arise in which the interval of time between the completion of the plant and its readiness for commercial production and the time when commercial production actually commences will be very prolonged indeed.  During such an interval of time, it is inevitable that the normal running expenses will continue to be incurred.

13.3     Having regard to consideration outlined in paragraph 12 which deals in some detail with the date or commencement of commercial production, it would follow that all expenses of a revenue nature incurred after the date when the plant is completed and commissioned and is ready for commercial production or, to put it differently, all expenses of a revenue nature incurred after the date when the business has been set up or established would have to be charged to the profit and loss account and can no longer be capitalised, even though commercial production has not actually commenced. There is no reason to depart from this principle even in a case where there is a prolonged interval of time between the date of setting up or establishing a business and the date on which it actually commences commercial production.

13.4     If commercial production is considerably delayed, the problem which would arise is that there would be no income during the period of such delay while, on the other hand, the expenditure of a revenue nature incurred during this period would have to be charged to the profit and loss account as mentioned above. If the period of delay in commencing commercial production is extremely prolonged, the only possible concession which may be made is that the expenditure incurred during this period can be treated as deferred revenue expenditure, to be amortised over a period not exceeding 3 to 5 years after the commencement of commercial production. This procedure is not, however, recommended as a matter of general policy or practice, but may be resorted to only in those exceptional cases where fairly heavy revenue expenditure is incurred during a prolonged period of delay in commencing commercial production. In any case, it would be completely wrong to treat such expenditure as capital expenditure since it does not add in any way to the value or cost or utility of the plant and other manufacturing facilities which have already been constructed but which have remained idle due to delay in commencing commercial production.”

3.  On the basis of the above, the Committee is of the opinion that the revenue expenditure incurred for running of turbine sets, as stated in para 2 of the query, can not be capitalised as a part of the cost of construction of hydrocracker/hydrogen unit, except to the extent of the cost of electricity consumed in construction of hydrocracker unit. The same should be the treatment of running expenses of other capitalised units. It would be completely wrong to capitalise such expenditure, since it does not add in any way to the value or cost or utility of the hydrocracker/hydrogen units. Such expenses should normally be charged to the profit and loss account for the relevant period.

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