1.25 Query: Accounting treatment of expenditure during construction period.
1. A public limited company, having an overseas collaborator, was incorporated in February 1994 for the manufacture of an industrial product. The company commenced commercial operations on 30th June, 1994. The company’s closing date for its books of account is 31st March, 1995. The company has incurred the following expenditure during its construction period:
* Technical know-how fee * Feasibility Study * Interest cost directly allocable to fixed assets * Interest cost not allocable to fixed assets * Raw material consumed for trial runs * Power and fuel * Employee costs * Travelling and conveyance * Miscellaneous expenses * Audit fee * Professional expenses * Depreciation * Research and development and other administration expenses.
2. As per the querist, the Institute of Chartered Accountants of India in its ‘Guidance Note on Treatment of Expenditure During Construction Period’ has divided the above and other expenses that may be incurred during the construction period into finance expenses, preliminary expenses, project expenditure, expenditure related to construction etc. In the said Guidance Note, the Institute has also suggested the accounting treatment which should be followed in this regard, which, as per the querist, in most cases is the capitalisation of expenditure incurred. However, the company has been advised by their collaborators that the accounting treatment acceptable to them, overseas, would be to defer the entire expenditure incurred during the construction period and amortise the same to the profit and loss account over a period of three to five years.
3. The querist has sought the opinion of the Expert Advisory Committee on the appropriateness of the above accounting treatment suggested by the company’s collaborators which the company would like to follow; and whether such accounting treatment would result in an audit qualification.
Opinion February 8, 1995
1.The Committee notes that as per the ‘Guidance Note on Treatment of Expenditure During Construction Period’, issued by the Institute of Chartered Accountants of India, the expenditure, other than direct capital expenditure, which may be incurred by a new project during its construction or pre-production period may be broadly of three types, viz.,
(a) expenditure which arises due to the corporate nature of the enterprise, e.g., formation expenses, share issue expenses, audit fee, filing fee and AGM expenses etc;
(b) indirect expenditure which is related or incidental to the construction work, e.g., expenditure on preparation of project reports and conducting feasibility studies, interest on borrowings for capital expenditure for the construction period, administration and office expenditure related or incidental to the project, depreciation, expenses on test runs etc; and
(c) indirect expenditure not related or incidental to the construction work, e.g., expenditure on recruitment and training of production and sales staff, advertisement of the product, etc.
2.The Committee notes that the general principle of capitalisation of expenditure in case of fixed assets, which is also relevant to expenditure incurred during construction period, has been aptly summarised in Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India. Para 21 of the said Standard lays down that the cost of construction to be capitalised “should comprise those costs that relate directly to the specific asset and those that are attributable to construction activity in general and can be allocated to specific asset”. Accordingly, in the view of the Committee, the indirect expenditure which is related or incidental to the construction work, as stated in 1(b) above, is capitalised as part of the cost of the project assets since this expenditure is necessarily incurred in relation to construction activity. The expenditure as stated at para 1(a) above, which is incurred irrespective of the construction work, and at 1(c) above is not in any manner attributable to the construction of project assets and hence normally should be immediately expensed. However, during the construction stage, such expenditure is treated as deferred expenditure and charged to the revenue over a period of 3-5 years after the project is ready for the commercial production. Since the facts of the query about the various expenses as given in para 1 of the query do not contain the relevant details, the company should ascertain to which of the three categories an item of expenditure listed in the said para of the query belongs keeping in view the nature of expenditure, e.g., in case the professional expenses include architect’s fees for construction of a building, it clearly belongs to the second category and should be capitalised as a part of the cost of the building. On the other hand, if professional expenses include consultant’s fees related to formation of the company, it falls under the first category, which is to be treated as deferred revenue expenditure.
3. On the basis of the above, the Committee is of the opinion that various expenses enumerated by the querist at para 1 of the query should be accounted for, in accordance with their nature, as recommended in the ‘Guidance Note on Treatment of Expenditure During Construction Period’, issued by the Institute of Chartered Accountants of India. It would not be appropriate to treat all such expenses as deferred revenue expenditure. In case the company treats all expenses as such, the auditor should determine its effect on the truth and fairness of the financial statements being audited by him and make appropriate qualification in his report. ______________________________
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