1.3       Query

Treatment of depreciation on assets used

during construction period.

The query relates to the treatment of depreciation on cranes and other assets used during construction period of a manufacturing company. These assets are carried forward to the production period, i.e., these will also be used after the production starts. The querist sought the opinion of the Committee on the following:

(i)  Whether depreciation on such assets can rightly be allocated, as part of the expenditure during construction period, to plant and machinery, and whether such depreciation can be justified as a part of the actual cost of plant and machinery.

(ii)  If the answer to (i) above is in the affirmative, whether the cost of the assets (on which depreciation was charged during construction period) should be written down for the purpose of exhibiting the same in the Gross Block after the construction period; because if it is not done the Gross Block would be shown in excess of the actual cost. It may be noted that Schedule VI to the Companies Act requires the original cost and the written down value to be shown separately.

                                    Opinion                                                                                   February 12, 1982

The opinion of the Committee on the above questions is as below:

(i)  Depreciation on the assets actually or indirectly utilised during construction period should be capitalised as a part of indirect capital expenditure. Paragraph 15 of the ‘Study on Expenditure During Construction Period’ issued by the Research Committee of the Institute lays down the principles of allocation of such expenditure to specific asset heads which are summarised in para 17.32 of the study as below:

“The allocation of indirect capital expenditure to specific asset heads would have to be made bearing in mind a few general principles. Such allocation should be made only after the construction work has been completed and no attempt should be made to allocate indirect capital expenditure to specific asset heads while the construction work is still in progress. Wherever possible, specific items of indirect expenditure should be allocated directly to related asset heads. In those cases where such direct allocation is not possible, it will be necessary to have recourse to indirect allocation. Even in such cases, however, care should be taken to exclude from such allocation those assets or groups of assets which have not benefited from any particular item of indirect capital expenditure, as well as those fixed assets to which a particular item of indirect expenditure is not at all related.”

Thus, the amount of depreciation on assets utilised during construction period will become a part of the cost of the specific asset heads ready for production. The enhancement of the cost of the specific asset heads is justified because if the assets (the cranes and other equipments etc.) used during construction period, were not available, the specific asset heads would not have been put in their present location and condition ready for production.

(ii) The original cost of the assets used during construction period and to be used further for production should be written down for the purpose of exhibiting the same in the Gross Block after the construction period. Thus the accounts for the production period would begin with the depreciated value of such equipment, which would then be further depreciated in the normal way. This is supported by paragraph 17-18 of the aforementioned Study which states that if any item of fixed assets used during construction period is retained by the project for use after construction, the residual book value of such assets should be depreciated in the normal way after commencement of production. It is obvious therefore that the value of the Gross Block shown in the balance sheet cannot exceed the actual cost incurred on such assets except in the case of revaluation.

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