Query No. 9

Subject:        

    Accounting for orchid plants.¹

A. Facts of the Case

1. A public limited company is engaged in the manufacture of calcined petroleum coke. As a part of diversification exercise, the company set up a  floriculture  division  for  growing  orchid  plants/cut-flowers  within  its existing campus.

2. The orchid plants are being grown in orchidarium for sale of orchid cut flowers as well as the plants themselves. Orchidarium is a generally referred term for orchid farm. An orchidarium can be of any size. The company has several orchidariums ranging from around 20,000 sq. ft. in size to 1,50,000 sq. ft. in size. Orchidarium has large tanks, normally of concrete  and  occasionally  of  plastic,  from  which  water  and/or  various chemicals,  such  as,  insecticides,  pesticides,  fungicides,  fertilisers,  etc., are  sprayed  through  an  extensive  system  of  pipes  using  high  pressure hoses and multi-nozzle sprays with delivery being through high pressure pumps.

3. The company imports plants of various sizes from different countries. These  plants,  depending  on  their  size,  are  then  planted  in  specially designed earthen pots in sizes varying from 3’’ to 10’’ and using planting media consisting of specially prepared charcoal, brickbats, coconut husk, etc.  These  pots  are  then  placed  in  a  shade  house  called  ‘orchidarium’, which is covered on top, having sides of half height with plastic nets of 30% to 70% light cutting capacity. Pots are placed on specially designed wooden/steel  benches  in  long  rows,  holding  3  to  6  pots  in  each  row, depending on  the  size  of  the  pots.  Depending on  the  age  of  the  plants when imported, the flowering starts within 9 months to 15 months.

4. Most of the plants imported by the company are of the plantlet size, i.e., approximately 6’’ to 9’’. They start flowering after around 12 months and reach maturity after about 3 to 3.5 years. Only when the plants reach maturity or near maturity, the quality of flowers produced is suitable for exports. Prior to that, even though the plants are producing flowers, they are smaller in size and are not of exportable quality.

5. The original plants imported, do not produce any flowers, but new shoots keep coming out which produce the flowers. Every 2-3 years, the dormant  shoots  are  either  destroyed  or  are  used  for  generation  of  new plants. In certain cases, the plants grow by developing shoots in which case it is vegetatively sub-divided. From one plant, 2, 3 or 4 new plants can be produced which again start the cycle of flowering after 9 to 12 months and taking 3 to 3.5 years to mature.

6. Unless the farm is attacked by any deadly viruses or bacteria which kill the plants or because of quarantine or phytosanitary requirements the plants have to be destroyed, the plants keep on multiplying and growing. The  company  has  not  had  any  attack  of  even  the  mildest  kind  of  any bacteria  or  virus.  Every  farm is  to  quarterly  report  its  activities  to  the Government of India, Quarantine and Phytosanitary Department, which sends its inspectors and the farm gets its approval. The company had no problems of any kind so far, as it followed the best ‘farm management practices’.

7. As  with  most  natural  growing  products,  the  orchid  flower  is  also weather related  product and  the best  yields are  during the  period from July to December and the period January to June provides less production. The yield also depends very much on the weather pattern; if cold persists, the production drops. The pattern of growing and exporting countries is also  changing  over  the  last  several  years  mainly  on  account  of  new countries emerging in the third world which can grow quality products at far  cheaper  costs. Weather  also  plays  an  important  role,  as  a  result  of which countries, like  India, Singapore, Thailand, Malaysia,  Israel, etc., having  similar  winter  climate  as  Europe  has  in  summer,  can  grow  the flowers  in  winter  to  meet  the  peak  season  demand  of  the  developed countries of Europe and USA in winter.

8. The  company  has  been  importing  orchid  plants  since  1994.  The company debited  the  CIF  value  of  imports  together  with  customs  duty and clearing charges thereon to capital work-in-progress during the years 1996-97, 1997-98 and 1998-99. The cost of imported fertilisers/insecticides used for growth of the plants was also debited to capital work-in-progress in the aforesaid accounting years. The company is of the view that upon completion  of  the  first  phase  of  the  project  the  above  costs  should  be capitalised.

B. Queries

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

C. Points considered by the Committee

10. The  Committee  observes  that  the  query  relates  to  accounting  for regenerative resources. The main facts that emerge from the query are as below:

(i) The plants are imported in the plantlet size of 6’’ to 9’’.

 

(ii) The shoots generated from the plants are used for generation of new plants.

 

(iii) The  plants  start  flowering  after  12  months  of  age  and  reach maturity after about 3 to 3.5 years of age. While flowers are sold  domestically immediately after they start flowering,  the exportable quality of flowers is achieved when the plants are 3 to  3.5  years  of  age.  Presumably,  the  company  is  selling  the flowers in domestic as well as export markets.

 

(iv) Besides the flowers, the plants themselves are also sold.The Committee notes that there appears to be some contradiction in the facts as stated in paragraphs 4 and 5; whereas it appears from paragraph 4 that the imported plants produce flowers, on a perusal of paragraph 5,it appears that they do not produce flowers and only produce shoots. The Committee’s opinion is based on the presumption that the imported plants produce flowers.

11. The Committee notes that it is a well accepted principle of accounting that a fixed asset is held with the intention of using it for the purpose of producing goods. The Committee notes from the facts of the query that the orchid plants are being grown to use them commercially by selling their produce, viz., flowers, although some plants are also sold. Therefore, the Committee is of the view that the orchid plants are of the nature of a fixed  asset.  Since  the  plants  are  likely  to  be  grown  in  batches,  an identifiable batch will be considered as a fixed asset.

12. The Committee is of the view that in case of orchid plants, the stage of  commercial  production  should  be  considered  to  have  reached  when the  plants  begin  to  produce  that  much  quantity  of  flowers,  of  quality suitable for the intended market (i.e., domestic/export), which is feasible to  be  exploited  commercially.  In  other  words,  the  plants  should  be considered to have reached the stage of commercial production when the quantity of flowers produced therefrom is such that it can be sold in the intended market, even though the production might not have reached its peak. From the facts of the query, it appears that such stage is reached when  the  plants  are  of  the  age  of  about  12  months  even  though  the exportable quality is produced at the age of about 3 years. Apparently, the flowers are initially sold in the domestic market and exported later.

13. The  Committee  also  notes  that  it  is  a  well  accepted  principle  of accounting  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. Since the cost of fertilisers/insecticides incurred till the  stage  of  commercial  production  is  a  directly  attributable  cost  of bringing the plants to their working condition for their intended use, i.e.,to make them fit for bearing flowers, it should be capitalised as part of the cost of orchid plants. However, any such expenditure incurred after the commencement of commercial production should be treated as revenue in nature.

14. The Committee is of the view that costs incurred on infrastructure facilities  for  setting  up  of  the  orchidarium  as  mentioned  in  paragraph 9(c) above are of capital nature and should be capitalised separately as fixed asset in accordance with Accounting Standard (AS) 10, ‘Accounting for  Fixed  Assets’,  issued  by  the  Institute  of  Chartered  Accountants  of India. These facilities should be capitalised when they are ready for their intended  use.  Depreciation  should  be  provided  in  accordance  with Accounting Standard (AS) 6, ‘Depreciation Accounting’. The depreciation charged upto the commencement of commercial production would be of the nature of indirect expenditure related to the development of orchid plants  and  should  be  capitalised  as  cost  of  orchid  plants.  However, depreciation on these facilities after the commencement of commercial production would be of revenue nature.

15. The Committee is of the view that expenditure on personnel engaged in floriculture division till the cut-off date should be capitalised only if they are either assigned to development of orchid plants or involved in supervision  over  their  development.  The  expenditure  to  be  capitalised should be restricted to the additional expenditure as a result of undertaking the floriculture project. Expenditure relating to training of personnel for performing activities other than development of plants, e.g., plucking of flowers, marketing, etc., or expenditure on employees who are appointed ahead of the date of production but whose work involves no connection, direct  or  indirect,  with  the  work  of  development  of  orchid  plants,  for example,  employees  of  the  sales  department,  publicity,  etc.,  is  of  the nature of indirect expenditure not related to development of orchid plants. Such expenditure should be written-off to revenue since the company has

a running business and is preparing a profit and loss account.

16. The Committee notes that sale proceeds of flowers grown, if any, during the period orchid plants are not ready for commercial production, i.e., till they are of the age of about 12 months, is of the nature of income during pre-production period and should be deducted from the indirect expenditure relating to the development of orchid plants. In other words, such income should be reduced from the capitalised cost of the orchid plants.  Therefore,  the  treatment  given  by  the  company  to  such  sale proceeds is incorrect.

17. The unplucked flowers which are mature for plucking at the end of the accounting year may be valued at their net realisable value provided their sale is assured under a forward contract or where market exists and there is negligible risk of failure to sell; otherwise, these should be valued at ‘nil’. For  this purpose, events occurring after the  balance sheet date may also be referred to.

18. The Committee notes that no rate of depreciation has been specified for orchid plants in Schedule XIV to the Companies Act, 1956. Therefore, the Committee is of the view that the expenditure capitalised as ‘orchid plants’ should be depreciated over their estimated useful life. Useful life of the plants is the estimated life from the date they become ready for commercial production till the date their produce becomes so small that it becomes economically unviable. In respect of infrastructure facilities as  mentioned  in  paragraph  9(c)  above,  the  Committee  notes  that  these would  be  covered  under  different  heads  of  fixed  assets. Therefore,  the rate  of  depreciation  should  be  determined  according  to  the  respective nature of an individual item.

19. The  Committee  refrains  from  expressing  an  opinion  on  the  issue whether the company will be eligible for deduction u/s 81 IA and 81 I, as in accordance with the Advisory Service Rules, the Committee answers queries involving application of accounting and auditing principles and not  queries  which  involve  purely  interpretation  of  law.  However,  the Committee observes that section 81 has been omitted from the Income- tax Act, 1961.

D. Opinion

20. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9:

(a) (i)  The expenditure referred to should be capitalised under the head ‘orchid plants’.

 

 

(ii) Cut-off date for capitalisation of plants should be taken to be the date when the plants reach about 12 months of age if intended for domestic market and about 3-3.5 years, if intended to be sold only in the export market.

 

(b)  The cost of fertilisers/insecticides till the cut-off date (as stated in (a) (ii) above) should be capitalised with the cost of ‘orchid plants’ and depreciated accordingly. Any such expenditure after the cut-off date should be charged to revenue.

 

(c) The  cost  of  infrastructural  facilities  incurred  to  bring  the concerned facilities to their working condition for their intended use should be capitalised as a separate fixed asset. Thereafter, these should be depreciated over their useful lives.

 

(d)  Salaries,  perquisites  and  other  related  expenses  of  personnel engaged in horticulture division should be capitalised only to the extent specified in paragraph 15 above.

 

(e) No  issue  has  been  raised  by  the  querist.  However,  the  sale proceeds from sale of flowers till the cut-off date, if any, should be  reduced  from  the  cost  of  ‘orchid  plants’.  Therefore,  the treatment given by the company is incorrect.

 

(f) The unplucked flowers which are mature for plucking at the end of the accounting year may be valued at their net realisable value provided their sale is assured under a forward contract or where market exists and there is negligible risk of failure to sell; otherwise, these should be valued at ‘nil’. For this purpose, events  occurring  after  the  balance  sheet  date  may  also  be referred to.

 

(g) The rate of depreciation should be worked out on the basis of the useful life of the assets concerned for the purposes of the Companies Act, 1956. The Committee refrains from expressing its opinion on issues related to Income-tax Act, 1961, in view of the reasons explained in paragraph 19 above.

¹Opinion finalised by the Committee on 14.4.2001.