A. Facts of the
Case
1. A public sector
company engaged in
passenger and cargo transportation entered into an agreement
for purchase of an aircraft to be delivered in August 1996 at an agreed
consideration. The delivery of the aircraft was delayed due to labour strike at
the manufacturer’s factory by about 3 months
and the same
was delivered in
November 1996. The delay in the delivery of the said
aircraft resulted in loss of revenue from planned commercial operations and
loss of net cash flow to the company. The company also incurred cost by way of
interest payments on advances made towards the
purchase price which
was capitalised. The company claimed compensation from the
manufacturer on these grounds.
2. The
manufacturer rejected the company’s claim to reduce the price of the aircraft on the ground that
the delay was excusable because of the labour strike and the company was not
entitled to any compensation as per the purchase agreement. The price of the
aircraft was strictly governed by the formula based on charging values
(indices) as per the terms of the purchase agreement.
3. After considerable
negotiations, in view
of the long
standing relationship between the manufacturer and the company, the
manufacturer agreed to compensate the company up to Rs. 10.7 crore in the form
of operational support credit whereby the company was entitled to purchase any
spare parts (not necessarily to be used for the same aircraft) supplied by them
free of cost
to the extent
of credit allowed. Accordingly, the company was not entitled for any refund
of the amount. The company was liable
to make the
full payment of
the aircraft as
agreed vide the purchase agreement.
4. According to
the querist, considering that the said operational credit was neither a
discount, nor a rebate allowed in purchase consideration, but was the
compensation for loss of revenue due to the late delivery of the aircraft, the
company did not reduce it from the cost of the aircraft and capitalised the
total agreed consideration of the aircraft in accordance with paragraph 9 of Accounting
Standard (AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of
India.
5. The company
considered the said
operational support credit
as compensation for loss of revenue in the form of a right to purchase
spare parts manufactured by
the vendors (not
necessarily to be
used for the same aircraft) free of cost, which if otherwise
purchased would have to be paid for.
Hence, full amount
of operational support
credit was recognised as
income in the
statement of profit
and loss in
the year
1996-97.
6. According to
the querist, the government auditors raised this issue in their preliminary
comments on the accounts of
the company for the year
1996-97 but after
considering the above
facts dropped the
said comment while giving their final comments.
7. According to
the querist, the auditors for the subsequent year, i.e., the year 1997-98, were
of the view that the amount of the said operational credit should have been
reduced from the cost of the aircraft instead of crediting it to the statement
of profit and loss and qualified their audit report indicating over-statement
of cost of the aircraft and excess provision of depreciation.
B. Queries
8. The querist
has sought the opinion of the Expert Advisory Committee on the following
issues:
(a) Whether the
company was justified in crediting the amount of the said
operational support credit
to the statement
of profit and loss and not
adjusting it against the total cost of the aircraft.
(b) If answer to
(a) above is in the negative, whether the treatment suggested by the auditors in paragraph 7 above for the year
1997-98 is correct.
C. Points
considered by the Committee
9. The
Committee notes that the basic issue in the query relates to the accounting treatment of
operational support credit
given by the manufacturers on purchase of aircraft.
The Committee presumes that the capitalisation of interest cost upto the date
of delivery of the aircraft was in accordance with the provisions
of
AS 10.
10. The Committee
notes paragraph 9.1 of Accounting Standard (AS)10, ‘Accounting for Fixed Assets’, which provides as below:
“9.1 The cost of an
item of fixed asset comprises its purchase price, including import duties and
other non-refundable taxes or levies and any
directly attributable cost
of bringing the
asset to its
working condition for its intended use; any trade discounts and rebates
are deducted in arriving
at the purchase
price. Examples of
directly attributable costs are:
(i) site preparation;
(ii) initial delivery and handling costs;
(iii) installation cost, such as special foundations for plant;
and
(iv) professional fees, for example fees of architects and engineers.
The cost of
a fixed asset
may undergo changes
subsequent to its acquisition or
construction on account
of exchange fluctuations, price adjustments, changes in
duties or similar factors.”
11. The Committee is
of the view that as a matter of accounting principle, if the operational
support credit is
received in mitigation
of the extra costs of the aircraft incurred and
capitalised by the enterprise, on account
of the specific events which gave rise to the credit, and
its utilisation by way of acquisition
of spares is
reasonably certain in
future, the same should be adjusted in the cost of the
aircraft. However, if the credit is for the
loss of revenue
consequential to delay
in delivery of
aircraft, the same should be
credited to the statement of profit and loss provided its utilisation by way of
acquisition of spares is reasonably certain in future.
12. The Committee
notes from the facts of the case that the company claimed compensation from the
manufacturer on the grounds of (i) loss
of revenue from the planned commercial operations and (ii)
interest on advances made towards
purchase price consequential
to delay in the
delivery of the aircraft, which was capitalised as a part of the cost of the
aircraft. The Committee is of the view that to the extent the amount of
operational support credit can be attributed to the cost actually incurred
or
borne by the company consequential to delay in
the delivery of the said aircraft, viz., interest cost, the
same should first be treated as recovery of that part of
the cost and adjusted
to the cost of
the aircraft and the balance of the operational support
credit, if any, should be credited to the statement of profit and loss as
recovery of loss of revenue consequential to delay in the delivery of the
said aircraft. The Committee is, however, of the view
that the aforesaid
credit could be
recognised in the
year 1996-97 in case the right to receive the same was first
established during that year provided it was reasonably certain that the
company will utilise it in future. In case, it was not
reasonably certain, its recognition should have
been postponed to
the period in
which its utilisation
becomes reasonably certain.
D. Opinion
13. On the basis of
the above, the Committee is of the following opinion on the issues raised in
paragraph 8:
(a) Insofar as the operational support credit relates to loss of revenue consequential to delay in delivery, the company is justified in crediting the amount of the said operational credit to
the statement of profit and loss provided the utilisation of the credit by way
of acquisition of spares is reasonably certain in future and it is in excess of
the additional interest payment incurred and capitalised as a part of the cost of the aircraft, which should be
adjusted against the cost of the aircraft. The aforesaid credit could be recognised in the year 1996-97 in case the right to
receive the same was first established in that year provided its utilisation by way of acquisition of spares was reasonably certain in future. In case utilisation of the credit was not reasonably certain, the
credit should have been recognised as an income or adjusted against the cost of the aircraft as the case may
be, in the period in which the utilisationthereof becomes reasonably certain.
(b) Please refer
to paragraph (a) above.
1
Opinion finalised by the Committee on 19.8.2001.