3. The querist has stated that though Accounting Standard (AS) 16, ‘Borrowing Costs’, is applicable w.e.f. 01.04.2000, there were no borrowing costs in the year 2000-2001. The expansion activities were financed from the internal accruals of the company till May 2001 and no working capital borrowing was raised during this period. The first borrowing was raised in June 2001 in the form of Export Packing Credit (EPC). Subsequently, some of the borrowings were specifically taken for expansion activities with 3 to 5 years tenure and some were taken against working capital limit. These financing activities were co-ordinated centrally from the corporate office. The outstanding general borrowed funds (not identified with any qualifying assets) as on 31st March, 2002 and 31st March, 2003 are as follows:

i) 8.6% Non-convertible Redeemable As on As on 31.3.2003 31.3.2002 Taxable Bonds 300.00 300.00 (Rs. in crore)

ii) Short Term Borrowings:

(Secured by hypothecation of raw materials, finished

Commercial Paper — 196.37

Total: 756.10 634.24

4. According to the querist, the company had incurred interest of Rs. 23.49 crore and Rs. 44.18 crore on the above borrowings during the year 2001-02 and 2002-03, respectively. The above borrowings were partly used for financing of expansion activities and partly used to meet working capital requirements. In order to allocate borrowing costs on general borrowed funds that are attributable to acquisition/construction of fixed assets, the company considered the following paragraphs of AS 16:

"12. To the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation should be determined by applying a capitalisation rate to the expenditure on that asset. The capitalisation rate should be the weighted average of the borrowing costs applicable to the borrowings of the enterprise that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs capitalised during a period should not exceed the amount of borrowing costs incurred during that period."

"14. The capitalisation of borrowing costs as part of the cost of a qualifying asset should commence when all the following conditions are satisfied:

           (b) borrowing costs are being incurred; and

(i) The capital expenditure incurred during each year on cash basis.

(ii) The cumulative capital expenditure at the end of each year including the capital expenditure incurred prior to availment of borrowings which was met out of internal resources but excluding the borrowing costs allocated to capital assets.

(iii) The cumulative capital expenditure for each year including the borrowing costs allocated to capital assets in the previous years and also including the capital expenditure incurred prior to availment of borrowings which was met out of internal resources.

(iv) The cumulative capital expenditure at the end of each year starting from the date of availing first borrowing and including the borrowing costs allocated to capital assets in the previous years.

 

6. The querist has stated that relying on paragraph 15 of AS 16, the capital expenditure on the qualifying assets was considered at average of opening and closing cumulative capital expenditure of a particular year including the borrowing costs. The capital expenditure for the financial years 2001-02 and 2002-03, the cumulative capital expenditure upto the end of these years and cumulative borrowings at the end of the years are given below:

(a) Capital expenditure for the year on 2001-02 2002-03 (Rs. in crore) aluminium and power segment 802.35 392.54

(b) Cumulative capital expenditure on aluminium and power segment 1414.08 1806.62

(c) Cumulative capital expenditure on total expansion 2678.25 3130.70

(d) Borrowings at the end of the year 756.10 634.24

From the above, the querist has stated that it may be observed that the cumulative capital expenditure was mostly met from internal resources. Also, while the cumulative capital expenditure went up gradually, the borrowings fluctuated from time to time considering the cash requirement. Sometimes, the borrowings reached their peak to meet dividend or debt redemption pay out, having no co-relation with cumulative capital expenditure.

7. According to the querist, assets like wagons and mobile equipments, which are ready for their intended use at the time of purchase, were excluded from such qualifying assets for allocation of borrowing costs. Also, capital expenditure on small projects and remaining part of mines and alumina expansion were excluded for allocation of borrowing cost considering its materiality.

8. As per the querist, if alternative (i) at paragraph 5 is considered, the allocated borrowing costs being more than the total borrowing costs, the whole of interest expense for 2001-02 is to be capitalised, whereas, in 2002-03, a part of the borrowing costs is to be capitalised. But if alternatives (ii), (iii) or (iv) at paragraph 5 are considered, the whole of the borrowing costs for the years 2001-02 and 2002-03 are to be capitalised even though the borrowings are both for capital expenditure and working capital requirements.

9. The querist has stated that the company is of the view that alternative (i) at paragraph 5 is more appropriate and judicious due to the following reasons:

(i) A significant portion of capital expenditure incurred initially was met out of internal resources only. The company resorted to borrowings in June 2001 after a sizeable expenditure was incurred on the projects. To consider capital expenditure incurred exclusively out of internal resources as expenditure incurred on qualifying asset on a cumulative basis for the purpose of applying capitalisation rate appears to be inappropriate.

(ii) The cumulative capital expenditure upto the relevant year with or without borrowing costs does not have direct correlation with the borrowings and the borrowing costs. On the other hand, the capital expenditure during the year has a direct correlation with the borrowings and the borrowing costs.

(iii) As per paragraph 12 of AS 16, capitalisation rate is to be applied to the expenditure on the asset, which is the guiding factor. Paragraph 15 of the Standard is a guideline, but is not mandatory in the view of the company.

The querist has stated that the illustration given on allocation of borrowing costs, published by the Institute of Chartered Accountants of India in the book "A Reader on Accounting Standards", though exhaustive, covers a period of only one financial year. Thus, limiting the company to consider the capital expenditure for the year only. The auditors are, however, of the view that the alternative (iii) at paragraph 5 is more appropriate.

B . Query

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

(a) Whether the view of the company mentioned at paragraph 9 is appropriate, keeping in view the facts and circumstances mentioned above.

(b) If not, what is the appropriate interpretation of ‘Expenditure on qualifying assets’ and its method of computation.

C. Points considered by the Committee

11. At the outset, the Committee wishes to point out that paragraph 15 of AS 16 is not a guideline as contended by the querist in paragraph 9 (iii) above. It may be mentioned that paragraph 15 is an explanatory paragraph which explains the principles stated in paragraph 14. Thus, once a Standard is specified to be of mandatory nature, the entire Standard is mandatory.

12. With regard to the capitalisation of borrowing costs, in the facts and circumstances of the case, the Committee is of the following view:

(i) For the purpose of application of capitalisation rate, the expenditure incurred prior to raising of the borrowings can not be considered since during that period the expenditure is met by internal accruals and not with the borrowings.

(ii) Subsequent to the raising of borrowings, the followings steps should be followed to compute the borrowing costs in the year 2001-2002:

(a) The expenditure incurred (with reference to cash outflows) on the qualifying assets, which has been met from the general borrowings should be considered. Accordingly, in respect of the expenditure incurred on the qualifying assets during the period, the expenditure met out of internal accruals, based on the best estimate of the management, should be excluded.

(b) The expenditure arrived at above as per (a) above should be given weightage by the period involved in order to arrive at the average expenditure.

(c) On the average expenditure arrived at as per (b) above, capitalisation rate should be applied so as to compute the borrowing cost to be capitalised. This amount to be capitalised should not exceed the amount of borrowing costs incurred during the period.

(iii) For the purpose of determining the amount of borrowing costs to be capitalised in the year 2002-03, the amount arrived at as per

(ii)(a) above in respect of the year 2001-02 and the amount of borrowing costs capitalised during 2001-02 should be considered for application of the capitalisation rate since the entire borrowings in relation to this expenditure remain outstanding unless the borrowings are repaid during this year. Besides this, in respect of the expenditure incurred during 2002-03, the average expenditure should be computed on the lines of (ii) above and on this also capitalisation rate should be applied.

(iv) In deciding which borrowings should be considered for the purpose of arriving at the capitalisation rate, those borrowings should be excluded which were borrowed for a specific purpose (other than the capital expenditure under consideration) unless there is evidence that the same were used for the capital expenditure under consideration. Also, borrowings which, as per the information available with the management, clearly indicate that the proceeds therefrom have been directly used for a specific purpose (other than the capital expenditure under consideration) and, therefore, did not enter the common pool of funds, should be excluded.

13. On the basis of the above, the Committee is of the view that none of the alternatives suggested by the querist in paragraph 5 above are appropriate.

D. Opinion

14. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 10 above:

(a) No, the view of the company mentioned at paragraph 9 above is not appropriate.

(b) Please see paragraph 12 above.

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1 Opinion finalised by the Committee on 27.1.2004.