Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.4  Query:       

Treatment of capital expenditure on tangible assets not belonging to the

company and not represented as company’s assets.

 

1.  A Government of India enterprise, formed and registered under the Companies Act, 1956, has set up a captive power plant of 270 MW capacity at Korba to supply an uninterrupted power to their aluminum plant at Korba. The operation and maintenance of the plant is entrusted to A Ltd. As per an agreement entered into, A Ltd. will manage the plant on actual cost basis plus their fee for the same. The company does not have facilities of transportation, handling and storage of coal, handling and storage of oil, treatment of water, township infrastructure etc. Accordingly, A Ltd. permits the use of these facilities installed at A Ltd.’s Power Station, which is situated at the same place, on terms and conditions mutually agreed to.

 

2. The querist has informed that till the year 1991-92, the company was depreciating the asset-value paid for Rs.22.68 crore as per normal depreciation rules applicable. In 1992-93, it was found that A Ltd. was depreciating these assets in their books in as much as these are their own assets and the contribution received as consumer contribution from the company was treated in their books as capital subsidy taken to capital reserves. Therefore, the treatment was reviewed by the company and the depreciation charged upto 1991-92 was reversed in 1992-93 accounts and a decision to amortise the same over the life of the plant was taken. Therefore, the relevant entry was duly passed in the books of account amortising the asset value over a period of 20 years (25 years of life with effect from 1988-89, the year in which commercial operation started less the expired life of the asset upto 1992-93).

 

3.The above view of the querist is based on the classification of the expenditure as fixed assets created on the land and neither the fixed assets nor the land belong to the company, and also keeping in view para 10 of the ‘Guidance Note on Treatment of Expenditure during Construction Period’ issued by the Institute of Chartered Accountants of India, which is reproduced below:

 

            “10.     Capital expenditure not represented by assets

 

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 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’.” (Emphasis supplied by the querist)

 

4.  According to the querist, the matter falls within para 10 of the Guidance Note.

           

5. According to the querist, there seems to be no valid objection for disclosing the same in the balance sheet under the general heading of ‘capital expenditure’ subject to two conditions. The first condition, viz., the specific item of capital expenditure in the balance sheet should clearly indicate the expenditure as not represented by any assets owned by the company, is fully satisfied and met. But while complying with the second condition, the capital expenditure has been written off over the remaining period of its utility without considering the brief period not exceeding five years which is lesser than the life. The company has taken this decision in view of the following:

 

(a) The nature of the common assets are such that these are not detachable from the main operation and the utility of the same is shared by both the plants. While A Ltd. has provided depreciation as per the Companies Act, as the owner of these assets, it would not be equitable that the company writes off this expenditure for a period not exceeding 5 years, differently treating the same asset. It is to be noted that substantial expenditure of Rs. 22.68 crore has been incurred for acquiring these assets.

(b) The acquiring of the assets for common use and keeping useful services out of it and keeping the ownership/title with A Ltd., is a unique transaction strictly not falling within the purview of para 10 of Guidance Note and therefore it should not be equated and matched with the general guidelines shown thereunder.

 

(c) The suggestion of classifying such expenditure in the balance sheet as ‘Capital Expenditure’ without writing off to revenue under heading miscellaneous expenditure or deferred revenue expenditure is also felt not applicable in as much as the fixed asset cannot be depreciated twice contrary to the company law provisions, that is, once by A Ltd. and then again in the company books, without undergoing any transfer of asset.

(d) The company has also thought it prudent to write off the expenditure for a period exceeding five years and not to load the revenue receipt of the company and to strike a balance between cost and profit commensurate with the life of the asset which will render sustained generation/operation till its life.

6. The querist has further informed that while commenting on the audited accounts of the company for the year 1993-94, the CAG has noted that the company has not followed the Guidance Note for treatment of capital expenditure not represented as company’s assets and has agreed to accept the company’s assurance to have this examined by the Institute of Chartered Accountants of India. In this context, the observation of CAG, management replies and supplementary replies/assurances to CAG have been submitted by the querist for the perusal of the Committee.

 

7.  The querist has sought the opinion of Expert Advisory Committee as to whether the action taken by the company to treat this expenditure as capital expenditure not represented by company’s assets and write off the same over a period of 20 years, in view of the foregoing reasons in support thereof, is proper.

                                                                             Opinion                                       April 7, 1995

 

1. At the outset, the Committee wishes to point out that it has examined only the matter of accounting for expenditure incurred by the company for using the facilities provided by A Ltd. and not any other accounting treatments indicated in the fact of the query. For arriving at its opinion the Committee has relied upon the facts supplied by the querist which are reproduced in the query portion.

 

2.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’, as reproduced at para 3 of the query.

 

3. The Committee notes that the expenditure on assets not owned by the company and created on land not owned by the company has been shown in the balance sheet under the head ‘Fixed Assets created on land and neither the Fixed Assets nor the Land belong to the company’. As regards the arguments advanced by the querist, at para 5 of the query, in support of the company’s decision to write-off the capital expenditure over a period exceeding five years, the Committee notes from the facts of the query that A Ltd. is the sole owner of the assets concerned and not the joint owner with the company in question. Accordingly, the capital expenditure incurred by the company is not represented by the assets and, therefore, the accounting treatment thereof would be governed by para 10 of the above mentioned Guidance Note. It may be added that since the expenditure is not represented by an asset belonging to the company, it cannot be considered to be having an economic life.

 

4. On the basis of the above, the Committee is of the opinion that the capital expenditure not represented by assets has been correctly classified as ‘Capital Expenditure’ in the balance sheet. The Committee is further of the opinion that the amount of capital expenditure should not be written-off over a period of 20 years but should be written off as recommended in the Guidance Note, i.e., over the appropriate period of utility or over a relatively brief period not exceeding five years, whichever is less.

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