Query No. 6 Subject: Accounting treatment of interest earned on funds received from government for acquisition of fixed assets.[1] A. Facts of the Case
1. A public sector company is engaged in the manufacture of cement in its factories situated in various states. Due to severe power cuts faced by some of the cement manufacturing units, the company decided to procure diesel generating (DG) sets to partly cater to the need for power. To finance the acquisition of the DG sets, the government of India sanctioned Rs. 29 crore consisting of Rs. 14.5 crore as equity and Rs. 14.5 crore as loan. The amount was to be kept in ‘no lien account’ and was to be used exclusively for acquisition of DG sets.
2. The Government of India released Rs. 25 crore on 10.3.1995 and Rs. 4 crore on 5.11.1996, both comprising 50% equity and 50% loan. The process of placement of orders for procurement of DG sets started thereafter. During the intervening period, the loan amount of Rs. 14.50 crore was invested temporarily in short-term deposits instead of in a current account. The equity portion of Rs. 14.50 crore was also kept in a separate short-term deposit bank account.
3. The querist has stated that in relation to the loan portion, net interest debited to work-in-progress (i.e., interest payable to Government of India less interest earned on short-term deposit of the said loan amount) was as below:
According to the querist, as per the recommendations contained in the ‘Guidance Note on Treatment of Expenditure During Construction Period’, issued by the Institute of Chartered Accountants of India, the above amount of net interest was treated as a financing cost and debited to capital work-in-progress to be capitalised later on when the DG sets were actually received and capitalised.
4. The equity portion of Rs. 14.50 crore, which was temporarily invested, also earned the following amount of interest:
The above interest was included under ‘Miscellaneous Income’ and reduced from the ‘Corporate Office Overheads’.
5. As per the querist, the above treatment of interest earned on equity portion was commented upon by the government auditors during the course of audit of the accounts of the company for the year 1996-97. The observations of the government auditors are reproduced below:
“A fund of Rs.29 crore was released by the government of India (Rs. 25 crore on 10.3.1995 and Rs. 4 crore on 5.11.1996) specifically for the purchase of DG sets to be installed at various units of the company. The above funds were released in the shape of 50% plan equity and 50% interest bearing plan loan. In terms of the sanction letters, these funds were to be kept in no-lien account and were to be utilised for the purpose for which it was sanctioned. Accordingly, the company put these funds in short term deposits fetching interest at prescribed rates and simultaneously started the process of purchasing DG sets. Since then the company is allocating net interest expenditure (capitalisation of interest on loan) to capital work in progress being the expenditure during construction period. The company is crediting the interest income on short term deposits to the extent of loan portion of the funds only whereas interest income on short term deposits on equity portion of funds has been taken to revenue income. In terms of paragraph 1.4 read with paragraph 17.11 of Chapter 34 of Compendium of Guidance Notes Vol. I, 4th Edition, issued by the Institute of Chartered Accountants of India, this should have been credited to the capital work-in-progress on the same basis as the interest income on loan portion of the funds has been credited. This is so because the funds were sanctioned specifically for the purchase of DG sets and as such any expenditure/income on account of interest therefrom during construction period should be debited/credited to the capital work-in-progress.
This has resulted in overstatement of other income to the tune of Rs. 114,24,815 for the year and consequently understatement of loss to that extent for the current year whereas overstatement of capital work in progress to the tune of Rs. 234,29,471 (as per details below) and overstatement of other income for prior periods and understatement of accumulated losses to the extent of Rs. 120,04,656:
6. The management in its reply to the said observation contended that had the interest earned on equity portion been credited to capital work-in-progress, the capital work-in-progress would have had a negative balance right from the first year, i.e., (-) Rs. 2.33 lakh for 1994-95, (-) Rs. 13.13 lakh for 1995-96 and (-) Rs. 5.26 lakh for 1996-97. This was because of the fact that procurement action for DG sets was in process and no payment was made to the supplier during the aforesaid period. The payment process started during 1997-98 only. The management also contended that the above interest earning was not on account of investment of surplus funds and had this amount been taken to normal cash credit accounts of the company which had debit balances of more than Rs. 50.35 crore during the above period of three years, the interest charges on cash credit balances would have reduced, resulting in a reduction of revenue expenditure.
7. Considering the above replies, the government auditors issued their final comment as under:
“Profit and Loss Account - Other Income (Schedule - 12)
Interest on Others - Rs. 135.28 lakh
This includes interest income of Rs. 114.25 lakh accrued on short term deposit of funds amounting to Rs. 1450 lakh received from Government of India as equity specifically for purchase of DG sets.”
B. Queries
8. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether interest earned on short term deposit of equity amount should be credited to capital work-in-progress to be capitalised on acquisition and capitalisation of the DG sets and if so, what accounting treatment would be given when net effect of the interest expense accrued and interest earned on loan as well as interest earned on equity capital, became negative.
(b) Whether interest earned on short-term deposit of equity should be taken as ‘Miscellaneous Income’ of the company and reduced from the ‘Corporate Office Overheads’.
C. Points Considered by the Committee
9. The Committee notes that the querist has not specified whether the terms of sanction of the funds by the government for acquiring the DG sets contain any stipulations regarding the utilisation of the interest earned on short-term deposit of moneys received from the government. The Committee’s opinion, therefore, is based on the presumption that the terms of sanction do not contain any such stipulation.
10. The Committee notes that paragraph 20 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, states as follows:
“20. The cost of a fixed asset should comprise its purchase price and any attributable cost of bringing the asset to its working condition for its intended use. Financing costs relating to deferred credits or to borrowed funds attributable to construction or acquisition of fixed assets for the period up to the completion of construction or acquisition of fixed assets should also be included in the gross book value of the asset to which they relate. However, the financing costs (including interest) on fixed assets purchased on a deferred credit basis or on monies borrowed for construction or acquisition of fixed assets should not be capitalised to the extent that such costs relate to periods after such assets are ready to be put to use.”
11. The Committee also notes that paragraphs nos. 8.1, 15.2 and 17.11 of the ‘Guidance Note on Treatment of Expenditure During Construction Period’, (1993 Edition) issued by the Institute of Chartered Accountants of India, state as follows:
“8.1 It is possible that a new project may earn some income from miscellaneous sources during its construction or pre-production period. Such income may be earned by way of interest from the temporary investment of surplus funds prior to their utilisation for capital or other expenditure or from sale of products manufactured during the period of test runs and experimental production. Such items of income should be disclosed separately either in the profit and loss account, where this account is prepared during construction period, or in the account/statement prepared in lieu of the profit and loss account, i.e., Development Account/Incidental Expenditure During Construction Period Account/Statement on Incidental Expenditure During Construction (Refer to paragraph 14.7). The treatment of such incomes for arriving at the amount of expenditure to be capitalised/deferred, has been dealt with in paragraph 15.2.”
“15.2 From the total of the aforesaid items of indirect expenditure would be deducted the income, if any, earned during the period of construction, provided it can be identified with the project.”
“17.11 During the construction period, a project may earn income from miscellaneous sources, for example, interest income, income from hire of equipment or assets and income from sale of products manufactured during the period of test runs and experimental production. It is recommended that where such income can be identified with the project, it should be deducted from the total of the indirect expenditure so that only the net amount of the expenditure is capitalised or treated as deferred revenue expenditure, as the case may be (paragraph 15.2). In either case, consideration may have to be given to the question of providing for the income tax liability on such income (paragraph 8.2).”
12. From the facts of the query, the Committee notes that even though the first instalment of Rs.25 crore (constituting about 85% of the total amount) was received by the company in March 1995, the DG sets were not procured by it even till March 1997. From the facts of the query and considering the nature of assets to be acquired, it also appears to the Committee that the activities necessary to procure the DG sets were started only after receiving the second and final instalment of Rs.4 crore on 5.11.1996.
13. A question which arises is whether the interest payable on the loan portion and the interest earned on both loan and equity through investment in short term deposits upto the time when the process of acquiring DG sets was started can be said to be ‘attributable’ to bringing the DG sets to their working condition for their intended use. Considering the facts of the query, the Committee is of the view that they cannot be said to be so attributable. This is because, during this period, neither the expenditures for the assets (i.e. DG sets) were being incurred nor the activities necessary to prepare these assets for their intended use were in progress. As such, the interest payable (as well as that receivable) pertaining to this period cannot be said to be attributable to acquisition of DG sets. However, interest payable (as well as interest earned on short term deposits) pertaining to the period after the commencement of the aforesaid activities can be said to be attributable to bringing the aforesaid assets to their working condition for their intended use.
14. The Committee also notes that paragraph 8.1 of the ‘Guidance Note on Treatment of Expenditure during Construction Period’ deals, inter alia, with interest from ‘temporary investment’ of surplus funds prior to their utilisation. Considering the nature of assets to be acquired out of the funds received from the government and the period for which such funds have been invested, the Committee is of the view that the investment of the funds in the instant case cannot be said to be ‘temporary investment’ as contemplated in paragraph 8.1 aforesaid.
D. Opinion
15. On the basis of the above, the Committee is of the following opinion on the queries raised:
(a) The interest payable on loan portion till the time the activities for acquiring the DG sets commenced should have been treated as a revenue expense and thus charged to the profit and loss accounts of the relevant years. The interest income earned through investment of the loan as well as equity portion in short term deposits during this period should likewise have been treated as revenue income for the relevant years and thus credited to the profit and loss accounts of those years. As regards the interest payable as well as interest receivable after the commencement of activities for acquiring DG sets, the Committee is of the opinion that the capitalisation of interest payable on loan portion after adjusting thereagainst the interest earned on short term deposits made out of the said loan amount is proper. The Committee is further of the opinion that interest earned during this period on short term deposits made out of equity portion of funds should also be reduced from the capitalised cost of DG sets. If the net effect of the above becomes negative, it should be transferred to Capital Reserve Account. The Capital Reserve so created should be utilised to reduce the capitalised value of DG sets whenever such balance is available.
(b) The interest earned on short-term deposits made out of equity portion of funds received, pertaining to the period up to the commencement of activities for procuring the DG sets should be taken as revenue income of the company. On the other hand, interest income of the aforesaid nature pertaining to the period after the commencement of the said activities should not be treated as miscellaneous income of the company and not reduced from the corporate office overheads. It should be dealt with as per (a) above.
The readers are advised to refer to Accounting Standard (AS) 16, ‘Borrowing Costs’ which has been issued subsequent to the finalisation of this opinion
[1]Opinion finalised by the Committee on 13.8.1998.
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