1.31 Query: Accounting treatment of advance against depreciation to be recovered through tariff.
1. A public sector company, registered under the Companies Act, 1956, is engaged in construction and operation of hydroelectric power projects. The power generated by the company is supplied to various States/State Electricity Boards (beneficiaries) at the rates which are notified by the Government of India separately for each generating station. The amount to be recovered from beneficiaries on account of sale of power is based on the Tariff Notification issued by the Government of India. The tariff is actually fixed and notified by the Government of India and mainly based on the expenses incurred by the company and includes an element of depreciation/advance against depreciation and a fixed percentage of return on equity included in the project cost with a provision of incentive for higher machine availability and more generation than the designed energy and disincentive for lower machine availability and less generation in the generating station. The query pertains to the accounting treatment of ‘advance against depreciation’ recoverable through tariff.
2. According to the querist, the amount of depreciation to be recovered against sale of energy is the:
(a) depreciation at the rates notified by the Central Government from time to time, or
(b) ‘advance against depreciation’, not exceeding 1/12 of the loan amount limited of actual loans liability of the year as per the approved financial package less the depreciation recovered for the year.
3. The method of adjustment of advance against depreciation is not specified. However, total depreciation and advance against depreciation charged through tariff shall not exceed 90% of the approved capital cost. The intention of advance against depreciation is to partly make available resources to discharge the loan repayment liabilities within specified limits.
4. The full amount of depreciation including advance against depreciation as stated above and the interest on loans termed, as ‘capital charges’ are recoverable from beneficiaries in 7884 hours/year of operation. The payment of capacity charges below the level of 7884 hours/year shall be on pro-rata basis. The capacity shall be calculated on monthly basis and denominated in Rs./KW/month. For availability level above 7884 hours/year, the company will get incentive.
5. Advance against depreciation is quite uncertain because of loan repayment schedule for the project and there may not be any advance against depreciation after 8 to 10 years depending upon the terms of the loan.
6. Relevant part of depreciation policy of the company is reproduced below:
“Depreciation is charged on straight line method as per rates prescribed under the Electricity (Supply) Act, 1948 as notified from time to time. In respect of assets, where rate has not been laid down under the aforesaid Act, depreciation is provided on straight line method as per rates prescribed under the Companies Act, 1956.
Depreciation on fixed assets is provided from the year following that in which the assets become available for use.”
7. The company feels that taking credit of ‘advance against depreciation’ (amount in excess of the depreciation recoverable through tariff) to the profits of earlier years which may be offset against depreciation in the subsequent years in the tariff calculation shall not be a sound accounting practice. Also, the amount of advance against depreciation is not a regular, fixed and similar amount for each year and, therefore, it may not be recognised as a regular revenue income. The company is of the view that the excess of advance against depreciation recovered/recoverable through tariff (para 2 (b)) over the amount of depreciation charge for the year being the amount calculated as per Para 2 (a) above and as taken in tariff calculation may be shown by way of reduction from the sales in profit and loss account to be named as ‘Advance against future depreciation’ as depicted below:
Sale of Power xxx
Less: Advance against future depreciation xxx ___ Net sales xxxThe contra will be shown as ‘Capital Reserve’ in the schedule of ‘Reserve & Surplus’. This will also avoid unnecessary inflating of sales during initial years of project life and inflating of sales in the later years. In the year in which the depreciation/advance against depreciation recoverable through tariff is less than the amount of depreciation charge (amount calculated as per para 2 (a) above), the amount equivalent to the short fall may be transferred from ‘Advance against future depreciation’ to the extent available in the account. By following the proposed accounting, the effect of non-provision of depreciation in the accounts during first year of commercial operations (as per depreciation policy of the company in line with the Electricity Supply Act) shall automatically be neutralised in case of newly commissioned projects.
8. The querist has sought the opinion of the Expert Advisory Committee whether the accounting treatment as mentioned above is correct? If some other accounting is suggested, the same may be mentioned.
Opinion March17,1998
1. The Committee notes that Notification dated January 12, 1995, issued by Government of India, Ministry of Power, lays down with regard to advance against depreciation as below:
“2.6 the annual capacity charges shall be computed on the following basis, namely:
Explanation: I The total of depreciation including advance against depreciation, charged through the tariff shall not exceed 90 per cent of the approved capital cost during the life of the project.”
The querist has also furnished as illustration of working out advance against depreciation, which is enclosed as Annexure ‘A’.
2. The Committee also notes para 13 of Accounting Standard (AS) 6 on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, which states as below:
“The statute governing an enterprise may provide the basis for computation of the depreciation. For example, the Companies Act, 1956 lays down the rates of depreciation in respect of various assets. Where the management’s estimate of the useful life of an asset of the enterprise is shorter than that envisaged under the provisions of the relevant statute, the depreciation provision is appropriately computed by applying a higher rate. If the management’s estimate of the useful life of the asset is longer than that envisaged under the statute, depreciation rate lower than that envisaged by the statute can be applied only in accordance with the requirements of the statute.”
3. The Committee notes from the facts of the query that as per the querist the relevant statute for providing depreciation in respect of the company in question for accounting purpose is the Electricity (Supply) Act, 1948 and the various notifications issued thereunder in this regard. The Committee has not specifically gone into the question of the applicability of the said Act to the company in question since it involves a matter of interpretation of law only and as per Rule 2 of the Advisory Service Rules, it is prohibited to reply on such matters. The Committee’s opinion given hereafter is on the presumption that the aforesaid Act is the relevant statute applicable to the company.
4. The Committee is of the view that the advance against depreciation is allowed with the objective of enabling the electricity company to recover depreciation higher than hat as would be allowed as per the rates of depreciation applicable as notified by the Central Government from time to time for the purpose of fixation by electricity tariff so that the company may be able to generate internal resources for the payment of loans. The Committee further notes from the facts of the query that this advance against depreciation will be adjusted in later years when the depreciation at rates fixed for tariff purposes exceed the advance against depreciation. In other words, the advance against depreciation is basically a timing difference.
5. The Committee notes that as per the accrual basis of accounting “revenue is recognised as it is earned”[para 2.5(i) of the Guidance Note on Accrual Basis of Accounting, issued by the Institute of Chartered Accountants of India]. The Committee further notes that where revenue, or a part thereof, received/receivable, during a particular period, is to be adjusted in future, to that extent the revenue received/receivable is not considered as earned, but is treated as revenue received in advance. The Committee is, accordingly, of the view that in the present case that part of the tariff, which arises because of inclusion of advance against depreciation, should be treated as revenue received in advance since the said advance will be adjusted in later years against the depreciation.
6. On the basis of the above, subject to the presumption stated in para 3 above, the Committee is of the opinion that advance against depreciation may be shown as a deduction from the sale of power as suggested by the querist in para 7 of the query. It should not be shown as a capital reserve but as income received in advance in the balance sheet.
Annexure A
ILLUSTRATION OF WORKING OUT ADVANCE AGAINST DEPRECIATION
(Rs. In Crores) I 1. Assumed Project cost as : 1000.00 2. Equity component : 280.00 3. Loan component : 720.00
Schedule repayment of loan: 1st Year : 40.00 2nd Year : 50.00 3rd Year : 150.00 4th Year : 50.00 Rate of Depreciation : 3% with no depreciation in 1st year of commercial operation.
II Provision for advance against depreciation 1/12th of the Loan amount i.e. 1/12th X Rs. 720 Crores = 60 Crores 1st Year: Actual repayment of Loan : Rs. 40 crores Depreciaiton : NIL
2nd Year: Repayment of Loan : Rs. 50 crores Deprecation : Rs. 30 crores Actual repayment of Loan less Depreciation = 20 Crores
3rd Year: Repayment of Loan : Rs. 150 crores Depreciation : Rs. 30 crores Actual repayment less Depreciation : Rs. 120 crores
Effectively the advance against depreciation will be an annual amount not exceeding 1/12th of the loan amount and limited to actual loan liability of the year less depreciation recovered through tariff (the depreciation to be recovered through tariff is presumed to be reduced as either depreciation is allowed or advance against depreciation is allowed). Therefore, advance against depreciation allowed to the Company will be as under:
Alternatively, in 2nd year and 3rd year no depreciation will be allowed and only advance against depreciation amounting to Rs. 50 crores and Rs. 60 crores will be allowed in the tariff calculation. __________________________________
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