Query No. 22 Subject: Accounting for development
and leasing of industrial estate.1
A. Facts of the Case
1. A government company is engaged, inter alia, in the business of developing industrial estates and housing plots. The company acquires land and incurs development expenditure like expenditure on construction of roads, drainage system, sewerage system, installation of electric lines, transformers, water supply, etc. The expenditure incurred on such development activities is debited to ‘Land Development Account’. The expenditure incurred on acquisition of land is debited to 'Land Account'. The company gives the industrial plots to entrepreneurs on long term lease for a period of 60 years. The company receives the lease premium at the beginning of the lease period. Lease premium is not refundable during the period of lease. However, lease is transferable by lessee to any other entrepreneur with the consent of the company. A nominal lease rent of Re. 1 per annum is charged from the lessees during the period of lease. The company also recovers service charge at the rate of two percent of the lease premium every year towards maintenance of the industrial estate. Service charges and lease rent are shown as income on accrual basis in the respective years.
2. In the first phase, the industrial estate was leased out during the period from financial year 1996-97 to the financial year 1998-99. All the plots in the first phase were leased out for a period of 60 years. During the financial years 1996-97 and 1997-98 the company accounted for the proportionate lease premium (1/60th) in respect of respective leased plots as income and the balance lease premium was shown as a liability under the head ‘Current Liabilities' as 'Lease Premium Received in Advance'. The leasehold land was shown under the head ‘Fixed Assets’. The land development expenditure was carried forward under the head ‘Capital Work in Progress’ under the broad head ‘Fixed Assets’. No depreciation/amortisation was provided on the Land Development Expenditure upto the financial year 1997-98.
3. At the time of the finalisation of accounts for the year 1998-99, the statutory auditors insisted that the Land Development Expenditure should be amortised during the operative period of lease. The company accordingly amortised the proportionate (1/60th) expenditure and included the same under the head ‘Depreciation’. The proportionate 'Land Development Expenditure' relateable to lease premium accounted for as income in earlier years was also reduced from the ‘Land Development Expenditure’ and was charged to profit and loss account under the head ‘Prior Period Adjustments’. The balance in ‘Land Development Expenditure Account’ was carried forward and included in ‘Fixed Assets’. The investment in land was shown as an asset in the ‘Fixed Assets’ without any amortisation in view of the fact that the ownership of the land remains with the company.
4. The company has undertaken the second phase of industrial estate development. Some of the plots in the second phase are being leased out for a period of 99 years and some for a period of 66 years. The lease premium for 99 years period is proportionately higher than that of the lease premium for 66 years’ lease.
5. The company has also undertaken a housing project. Under this project the company will develop the land, internal roads, provide drainage and sewerage and water supply tanks and the plots will be leased out for a period of 99 years.
6. The company allocated salaries of certain staff members engaged in the execution of industrial estate/housing project for the financial year 1998-99 on the basis of estimated time spent as determined by the superintending engineer of the company. In respect of projects under execution, the proportionate salary based on estimated time spent was charged to respective projects (Work in Progress Account). However, in respect of the projects which are only in preliminary stages, the proportionate salary was charged to the profit and loss account. Other expenditure that the company was unable to allocate on the project was charged to the profit and loss account.
B. Queries
7. The querist has sought the opinion of the Expert Advisory Committee on the following issues: (a) Whether the accounting system followed by the company in respect of the lease premium and development expenditure relating to land is correct.
(b) What is the other alternative available to the company.
(c) Whether the development of industrial estate can be treated as a construction project. If yes, whether all expenditure on development including land cost can be charged to project even though the plots might be leased out for long period and ownership remains with the company.
(d) Whether the same accounting system as for industrial estate can be followed for housing projects in which plots will either be leased out or outrightly sold.
(e) Whether it would be prudent to account for income from the project in the year of completion of the project.
(f) In cases where the company leases out the plots for different periods and collects the differential lease premium, how should the cost of land/development expenditure (which is same per square metre for plots leased out for different periods) and revenue over the period of lease be apportioned keeping in mind the accrual and matching concept.
C. Points Considered by the Committee
8. The Committee notes that one of the major considerations governing the selection and application of accounting policies is 'substance over form'. Accounting Standard (AS) 1, 'Disclosure of Accounting Policies', provides that "the accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form” (paragraph 17(b)).
9. The Committee is of the view that in the lease agreements for long periods, e.g., 60 years and 99 years, it is generally expected that either the lease period would be extended or the title will pass to the lessee at some agreed amount. Keeping in view the facts and circumstances of the query as explained above and prevalent commercial practices in India in this regard, in substance, the lease of industrial plots amounts to passing of the significant rights of ownership in the land to the lessee. Thus, it would be in the nature of sale of plots and accounted for, accordingly. In this regard, the Committee also takes note of the requirement of Schedule VI to the Companies Act, 1956 of showing leaseholds as an asset of the lessee. This requirement, according to the Committee, is a recognition of the principle of ‘substance over form'.
10. The cost of land along with development expenditure should be reflected as a current asset. However, any abnormal expenditure e.g., expenditure attributable to abnormal delays, should not be added to the cost of land. Such expenditure should be expensed in the year in which it is incurred. The cost of acquisition of land and the development expenditure thereon should be expensed in the same year in which revenue from the lease of plots is recognised keeping in view the matching principle. In respect of development expenditure yet to be incurred on the project for which no additional revenue is to be received, a provision would be required to be made in the year of recognition of revenue.
11. The Committee notes paragraph 12 of Accounting Standard (AS) 5, 'Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies', which requires that “when items of income and expense within profit or loss from ordinary activities are of such size, nature or incidence that their disclosure is relevant to explain the performance of the enterprise for the period, the nature and amount of such items should be disclosed separately.” The Committee is of the view that in the given case, a disclosure in accordance with the said paragraph would be required so as to clearly bring out the nature and impact of the transactions.
12. The Committee is of the view that the accounting treatment of lease transactions related to an industrial project or to a housing project would be same so long as the nature of the transactions and terms and conditions attached thereto are same.
13. The Committee is also of the view that mere completion of a project does not qualify for recognition of revenue therefrom. In this respect, the Committee notes that Accounting Standard (AS) 9, ‘Revenue Recognition’, lays down the following three conditions for recognition of revenue.
(a) Performance of the act giving rise to revenue. For example, in a transaction involving the sale of goods, performance is regarded as being achieved when the seller of goods has transferred to the buyer the property in the goods for a price, or all significant risks and rewards of ownership have been transferred to the buyer and the seller retains no effective control of those goods to a degree usually associated with ownership.
(b) Measurability of the revenue. For example, in a transaction involving the sale of goods, revenue is not recognised if there is any significant uncertainty regarding the amount of consideration that will be derived from the sale of the goods.
(c) Collectability of the revenue. If, at the time of the performance of the act giving rise to revenue, there is significant uncertainty as to collectability, revenue recognition is postponed.
Therefore, the revenue can be recognised only upon the fulfillment of the above three conditions.
D. Opinion
14. On the basis of the above, the Committee is of the following opinion on the issues raised by the querist in paragraph 7:
(a) The accounting system followed by the company in respect of lease premium and development expenditure relating to the land is not correct.
(b) In the facts and circumstances of the query, the lease of land should be treated as sale. Thus, the whole of lease premium should be recognised as revenue in the profit and loss account in the year in which the three conditions as laid down in AS 9 are fulfilled and the related costs of acquisition of land and development expenditure thereon should be expensed in the same period (please refer paragraphs 10 and 13 above). A disclosure in accordance with paragraph 12 of AS 5 should also be made.
(c) The development of industrial estate is similar to a construction project. The development expenditure should form part of the cost of land and treated as per (b) above.
(d) The accounting treatment for leased plots under the housing project will be the same as recommended above for the industrial estate project provided the terms and conditions applicable to plots leased in the housing project are the same as for industrial estate explained above.
(e) The recognition of income from a project depends on the fulfilment of the three conditions as laid down in AS 9 (please see paragraph 13 above). The recognition of income does not depend on mere completion of the project.
(f) The accounting treatment for 66 years’ lease and 99 years’ lease would be the same as per (b) above.
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