Query No. 40 Subject: Cut-off date for capitalisation of construction cost.1
A. Facts of the Case
1. A company incorporated under section 25 of the Companies Act, 1956, organises fairs/exhibitions in order to achieve its objective of promoting India’s trade. During the year 1998-99, the company entrusted the work of construction of a new hall to CPWD which was completed in all respects in November, 1998, including structural work and electrical installations.
2. As the hall was ready for commercial use, the company started letting out the same from November, 1998 which generated rental income of Rs. 169.33 lakh and Rs. 419.64 lakh in the years 1998-99 and 1999-2000 respectively.
3. As the hall was put to commercial use from November, 1998, the expenditure of Rs. 9.97 crore incurred on the construction of the hall was capitalised with effect from November, 1998, to depict true and fair view of the state of affairs of the company. The formal completion certificate of the hall is, however, still awaited from CPWD.
4. The government auditors are of the view that since the completion certificate of the hall is awaited from CPWD the expenditure incurred on the construction of the hall should be shown as ‘Capital Work-in-Progress’ in the annual accounts of the company after deducting the income generated from the project during construction period. Accordingly, the rental income of Rs. 588.97 lakh from the letting out of the hall upto 31.3.2000 should be deducted from the construction cost of the project.
5. According to the querist, the audit observation is based on the ‘Guidance Note on Treatment of Expenditure During Construction Period’ issued by the Institute of Chartered Accountants of India. The company’s contention is that the hall was ready for commercial use in November, 1998 and that issuance of completion certificate by CPWD has no relevance to the actual completion of work because such certificates are issued only after rectification of all the defects by the contractors and settlement of final bills by CPWD. As per the querist, the said Guidance Note referred to by the government auditors deals with treatment of income from miscellaneous sources generated during construction period, whereas, in the case of the company, the purpose of the construction of the hall was to generate rental income. Hence, the company took the view that the Guidance Note referred to above does not apply in the instant case.
6. The government auditors, however, dropped the above observation from their report on the assurance that the matter shall be referred to the Institute of Chartered Accountant of India for expert advise.
B. Queries
7. The querist has sought the opinion of the Expert Advisory Committee as to:
(C) Points Considered by the Committee
8. From the facts of the query, the Committee notes that the basic issue to be decided is the point of time when the capitalisation of the construction cost of the hall should cease.
9. The Committee notes the following relevant extracts of paragraph 12.1 and paragraph 12.2 of the Guidance Note on Treatment of Expenditure During Construction Period:
“12.1 In any project which involves lengthy construction period, it is extremely important to be very specific about the selection of a “cut-off date”, based on the date when the project is officially recognised as being ready for commercial production..........”
“12.2 In several cases, guidance may be available in selecting the official date of commencement of production by reference to the date of the inauguration ceremony as well as by reference to the date which is publicly and officially announced by the company as the date on which it has commenced commercial production. It should be borne in mind, in this connection, that “commercial production” is a term of somewhat wider import than the mere term “production”. Even during a period of test runs and experimentation, a plant may be engaged in actual production, but until the test runs are completed and the plant is properly adjusted on the basis thereof, it may not be said to be ready for “commercial production”. The term “commercial production” refers to production in commercially feasible quantities and in a commercially practicable manner.”
10. On the basis of the above, the Committee notes that the reference to the cut-off date for the purpose of capitalisation is to the date when the asset/project is ready for commercial production rather than the formal completion of the asset/project. In the present case, the asset was actually put to commercial use for which it was intended before the formal receipt of the completion certificate of the asset. The Committee is, therefore, of the view that in the present case the formal receipt of completion of the asset is not relevant since the asset was actually put to commercial use earlier.
11. In this context, the Committee also notes that paragraph 20 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, provides that “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”. The Committee also notes that the intention of the construction of the hall was the generation of rental income from letting out of the same. Therefore, the Committee is of the view that the hall should be construed as ready for its intended use when it is ready to generate rental income. Consequently, the cut-off date for capitalisation of expenditure should be the date when the hall is ready for its intended use and any expenditure incurred or income generated after the cut-off date should be treated as of revenue nature.
12. The Committee also notes that 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). The Committee is of the view that issuance of the completion certificate of the hall by CPWD when the construction of the hall is already complete, is an administrative formality. Even though the certificate of completion has not been issued, in substance, the hall is complete for its intended use when it is ready to be let out for generation of rental income.
13. From the above, the Committee is of the view that the cut-off date for capitalisation of expenditure for construction of the hall should be taken as November, 1998 when the hall was ready and letting out of the hall was started for earning rental income. Accordingly, depreciation should be charged with effect from that date. The rent received would form part of revenue income.
D. Opinion
14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 7:
________ 1Opinion finalised by the Committee on 17.1.2001. |