Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 33

 

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 transportation, processing and marketing of natural gas owns about 4000 kms. of pipeline.  The pipeline passes through the land owned by government as well as by private parties. As the outright purchase of land for this purpose is expensive and time consuming and also as the land is required for the limited purpose of laying of underground pipeline and its maintenance as and when required, the company acquires the ‘right of use’ (hereinafter referred to as ‘ROU’) for the purpose of laying and maintenance of the underground pipeline. The acquisition of ROU is governed by the Petroleum and Minerals Pipelines (Acquisition of Right of User in Land) Act, 1962 (hereinafter referred to as ‘P&MP Act’).

 

2. The company has disclosed the cost incurred in connection with the acquisition of ROU in the schedule of fixed assets under the heading ‘Land’ as ‘Right of Use’.  The company has disclosed its accounting policy for ROU as under:

 

“Cost of Right of Use (ROU) of land for laying pipelines is capitalised as land.”

 

3. As per the querist, the government auditors have disagreed with the above accounting policy.  Their observation on the accounting policy is reproduced below:

 

“Fixed Assets Rs. 77,68,76,18,000

 

This includes Right of Use amounting to Rs. 7,55,10,000 in respect of which the company has neither the ownership nor leasehold rights.  It has simply the right to use the land as pleaded in case of GAIL v. MCD.  High Court in its decision had held that the company does not have ownership of land.

 

Accounting policy number 6(f) states that “capital expenditure on the assets the ownership of which is not with the company is charged off to revenue.”

 

In view of the above, the ‘right of use’ should have been charged off to the revenue as deferred revenue expenditure to be amortised within a reasonable period of time.

 

The fixed assets have been overstated by Rs. 7,55,10,000 and revenue expenditure understated and profit overstated by Rs. 7,55,10,000.”

 

4. According to the querist, in its reply to the observation of the government auditors, the company has stated that it has acquired ROU under the P&MP Act. Under the Act, any person authorised by the company in whose name ROU vests, can enter upon the land and lay pipeline or do any other act necessary for the purpose of laying of pipeline.  The owner or occupier of the land cannot construct any building or any other structure, construct or excavate any tank, well, reservoir or dam, or plant any tree on that land.  The owner or occupier of the land also cannot do any act or permit any act to be done which will or is likely to cause any damage in any manner whatsoever to the pipeline.  For the purpose of acquiring the ROU, the company has to pay consideration @ 10% of the market value of the land determined by the competent authority under the Act. The company, in its reply, has also stated that ROU is a capital asset which vests in the company and the company has the right to use the same in the manner for which it has been acquired.  The company has further contended that it would not be correct to treat the same as revenue expenditure or as deferred revenue expenditure. The company has pointed out that in the case of capital expenditure incurred on creating a super-structure or otherwise on assets belonging to others, the right of use of the resultant assets is not restricted to the person making expenditure as in case of ROU acquired under the P&MP Act.  The resultant assets can be used by anyone whereas ROU under the P&MP Act is exclusively with the company.  The company has further stated in its reply that accounting policy 6(f) relates to items such as contribution made by the company for laying approach roads on government land, for laying electricity transmission lines, etc.

 

5. According to the querist, the accounting treatment of cost of ROU as perceived by government auditors is based on the premise that it represents expenditure on assets the ownership of which is not with the company.  As per the querist, ROU differs from the expenditure on assets without any ownership rights (referred to below as ‘the expenditure’) on account of the following reasons:

 

(a) ROU is acquired through a legal process as per the P&MP Act while the expenditure is based on mutual understanding.

 

(b) ROU provides unrestricted right of entry while restricting the use by others, whereas the expenditure does not give the company any legal right to restrict the use by others.

 

(c) ROU provides right of work upon the land, both initially for laying the pipeline and later for any repair work, while the expenditure provides no such right of work.

 

(d) Legal remedies including use of police force are available for any hindrance by the owner or other party for work of the company in the case of ROU while the expenditure provides no such remedy.

 

(e) The actual owner is prohibited to make use of the ROU land for constructing any building or any other structure, to construct or excavate any tank, well, reservoir or dam or plant any tree.  No such restriction is imposed in the case of the expenditure.

 

(f)  In the case of ROU, a declaration is made in official gazette stating that the right of user in the said land shall vest in the name of the company free from any encumbrances while in the case of the expenditure, no such declaration is made.

 

(g) For use of ROU land by any other party, prior approval of the company is essential while in the case of the expenditure, no such prior approval is required.

 

(h) Even for major changes necessitated by the government or otherwise, the company is consulted and its consent is taken while it is not so in the case of the expenditure.

 

B. Queries

 

6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

 

(a) Whether the accounting treatment followed by the company for the cost incurred on ROU is as per the accepted accounting principles.

 

(b) Whether the accounting policy disclosed for the treatment of such expenditure is appropriate or it requires any modifications.

 

(c) Whether the cost incurred on ROU can appropriately be charged to revenue.

 

(d) Whether the cost incurred on ROU can be treated as a deferred revenue expenditure and written off within a period of 3-5 years.

 

(e) In case the answers to issues (a) to (d) are in the negative, what should be the accounting treatment to be followed for the cost of ROU.

 

C. Points Considered by the Committee

 

7. 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.”

 

8. 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.

 

9. 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.

 

10. 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

 

11. On the basis of above, the Committee is of the following opinion on the issues raised in paragraph 6:

 

(a) The accounting treatment followed by the company for cost of ROU is correct.  However, the nature of 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.

 

(b) The accounting policy in respect of cost of ROU is appropriate.

 

(c) No.

 

(d) No.

 

(e)  Not applicable.

________

 

[1] Opinion finalised by the Committee on 23.10.1999.