Query No. 31
Subject: Accounting treatment of payment made for acquiring ‘right of use’ of land.[1] A. Facts of the Case
1. A public sector company engaged in refining, transportation and marketing of petroleum products has a vast network of underground pipeline for transportation of crude oil and petroleum products. For the purpose of laying the pipeline, the company acquires ‘right of way’, i.e., right of use in land (ROU) under which such pipeline is to be laid. The right is acquired under the Petroleum and Minerals Pipelines (Acquisition of Right of User in Land) Act, 1962, and vests absolutely with the company free from all encumbrances.
2. Though the ownership of the land under which the pipeline is laid continues with the land owner, the pipeline remains the property of the company. The company also has perpetual and absolute right to enter the land under which pipeline has been laid for the purpose of maintaining, examining, repealing, altering or removing any such pipeline or for doing any other acts necessary for any of the aforesaid purposes or for the utilisation of such pipeline. This right is also endorsed in land records. This right enables the company to lay one or more pipelines, optical fibre cable for communication, etc. The company acquires this right over 18 meter wide piece of land throughout the entire pipeline route. The land owner cannot construct any permanent structure or plant any tree on this piece of land, though he can raise seasonal crops. As per the querist, the compensation payable for the ROU is ten percent of the market value of the land which is determined by competent authority. Competent authority is appointed by the central government by gazette notification.
3. As per the accounting policy of the company, the cost of ROU is capitalised and shown separately under the head ‘Land’ and no depreciation is charged. This treatment is based on the premise that ROU is an independent fixed asset as this right is absolute and perpetual as per the Petroleum and Minerals Pipelines (Acquisition of Right of User in Land) Act, 1962. Even when the life of the existing pipeline is over, this right can be utilised to lay another pipeline without any additional compensation for ROU. The company discloses the accounting policy in this respect under the heading ‘Land’ in the ‘Statement of Significant Accounting Policies’ as below:
“Cost of Right of Way for laying pipelines is capitalised.”
4. According to the querist, during the audit of annual accounts for the year 1998-99 under section 619(4) of the Companies Act, 1956, the government auditors have opined that since the expenditure is not represented by any specific or tangible assets, as recommended under paragraph 10 of the ‘Guidance Note on Treatment of Expenditure during Construction Period’ issued by the Institute of Chartered Accountants of India, the following accounting treatment should have been followed:
5. Paragraph 10 of the ‘Guidance Note on Treatment of Expenditure during Construction Period’ referred to above states the following:
“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 a 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”.”
6. The querist has stated that the government auditors have given their observation based on an opinion issued by the Expert Advisory Committee of the Institute of Chartered Accountants of India (query no.1.32, Compendium of Opinions, Volume IX).
7. According to the querist, the company is of the opinion that the facts and circumstances of the present case are different from those to which paragraph 10 of the ‘Guidance Note on Treatment of Expenditure during Construction Period’ (as well as the opinion of the Expert Advisory Committee referred to above) apply. It is true that as in the case of items covered by paragraph 10 of the Guidance Note, in the case of ROU also, the ownership of land does not vest in the company. However, unlike the items covered by said paragraph, in the case of ROU, the company has an absolute and perpetual right to enter the land for doing any act necessary for laying the pipeline, its maintenance, etc.
B. Queries
8. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether the accounting policy regarding the treatment of such expenditure is appropriate or whether it requires any modification.
(b) (i) Whether the classification of expenditure on acquisition of ROU as a separate item under ‘Land’ and non-provision of depreciation thereon are correct, or
(ii) whether the amount paid for acquiring ROU should be capitalised along with the cost of pipeline as an incidental expenditure and depreciated accordingly, or
(iii) whether this expenditure should be considered as capital expenditure indicating clearly that it is not represented by any asset owned by the company and written off over the approximate period of its utility or over a relatively brief period not exceeding five years, whichever is less, or
(iv) whether such expenditure should be directly charged to revenue.
C. Points Considered by the Committee
9. The Committee notes the following definitions of the terms ‘Assets’ and ‘Fixed Asset’ as given in the ‘Guidance Note on Terms Used in Financial Statements’ and Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’ respectively:
“Assets
Tangible objects or intangible rights owned by an enterprise and carrying probable future benefits.”
“6.1 Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business.”
10. The Committee notes that the ROU vests in the company the right to lay underground pipeline and to enter the land for the purpose of maintaining, examining, repealing, altering or removing any such pipeline or for doing any other act necessary for any of the aforesaid purposes or for the utilisation of such pipeline. The Committee is of the view that as the pipeline facilitates transportation of crude oil and petroleum products, ROU carries probable future benefits and thus meets the definition of an asset. Further, since the ROU is not held for sale in the normal course of business of the company but is intended to be used for the purpose of facilitating the transportation of raw material and finished products, this right is in the nature of a fixed asset.
11. The Committee notes paragraph 3.2 of the Accounting Standard (AS) 6, ‘Depreciation Accounting’ which defines ‘depreciable assets’ as below:
“3.2 Depreciable assets are assets which
(i) are expected to be used during more than one accounting period; and
(ii) have a limited useful life; and
(iii) are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.”
As the ROU acquired by the company is perpetual in nature, it does not satisfy condition (ii) above. Thus, the right is in the nature of a non-depreciable asset.
12. The Committee notes that according to the government auditors, the expenditure on acquiring the ROU is covered by paragraph 10 of the ‘Guidance Note on Treatment of Expenditure during Construction Period’. The said paragraph deals with expenditure incurred by an enterprise on certain items where the enterprise has neither the legal ownership nor such other control over those items as would make it probable that future benefits from those items would flow to the enterprise. The ROU, on the other hand, gives absolute and perpetual rights to the company. The Committee is, therefore, of the view that the nature of ROU is different from that of items covered by the aforesaid paragraph.
13. Considering the nature of rights acquired under the ROU, the Committee is of the view that the expenditure on acquiring the ROU should be shown under the head ‘Land’ with an appropriate description. The nature of this item (viz., that it is perpetual but does not bestow upon the company the ownership of land) should also be explained by way of a note to the balance sheet.
D. Opinion
14. On the basis of above, the Committee is of the following opinion on the issues raised in paragraph 7:
(a) The accounting policy followed by the company for the treatment of cost of ROU is correct.
(b) (i) The classification of cost of ROU as a separate item under the head ‘Land’ and non-provision of depreciation thereon are correct. However, the nature of the ROU (viz., that it is perpetual but does not bestow upon the company the ownership of land) should also be explained by way of a note to the balance sheet.
(ii) See (a) & (b)(i) above.
(iii) See (a) & (b)(i) above.
(iv) See (a) & (b)(i) above.
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[1] Opinion finalised by the Committee on 23.10.1999.
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