Expert Advisory Committee
ICAI-Expert Advisory Committee
Options:

Query No. 1

 

Subject:

Treatment of arbitration awards.1

A. Facts of the Case

 

1. During the construction phase, a corporation had executed a number of contracts for construction of a railway line. Arbitration is one of the clauses in the contract agreement. Within the framework of the arbitration clause, some of the contractors had gone in for arbitration against the corporation.The arbitration was settled by the arbitration tribunal appointed for the purpose. The arbitration tribunal had given awards in favour of the contractors which include some awards which are in the nature of compensation and interest like:

 

(i) Loss of overheads

 

(ii) Loss due to idling of machinery

 

(iii) Loss due to non-release of advance

 

(iv) Interest past, pendent-lite and future

 

(v) Interest on losses

 

(vi) Loss of profit2. The government auditors (C&AG) are of the view that the above nature of awards constitute revenue expenses and, therefore, should be charged to the profit and loss account instead of capitalising them. However, in the view of the corporation, the practice of capitalising the above payments is in order based on the arguments stated by the querist hereinafter.

 

3. The querist has drawn the attention of the Committee to paragraph

9.1 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, which states 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.”

 

4. According to the querist, as stated in paragraph 9.1 of AS 10 reproduced above, the cost of a fixed asset may undergo changes subsequent to its acquisition, inter alia, due to price adjustments as these are the costs incurred for bringing the asset to be put into use (emphasis supplied by the querist). As per the querist, the price adjustment would imply any additional amount paid by the corporation in terms of the award, be it for additional compensation or for payments of the nature mentioned above.

 

5. The querist has separately submitted copies of two arbitration awards for a perusal of the Expert Advisory Committee.

 

B. Query

 

6. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee as to whether the amount capitalised by the corporation is in order.

 

C. Points considered by the Committee

 

7. The Committee notes paragraph 9.1 of AS 10 reproduced in paragraph 3 above.

 

8. The Committee also notes paragraph 9.8 of the Guidance Note on Treatment of Expenditure During Construction Period, issued by the Institute of Chartered Accountants of India, which recommends, inter alia, as below:

 

“9.8 During the course of construction of a big project, some losses are bound to occur. To an extent the losses may be treated as normal and added to the cost of the project. For instance, a wall may have to be pulled down and rebuilt. The total cost then can be capitalised. However, to the extent the loss is avoidable and results from inefficiency, mischief or an accident it should not be treated as part of the cost of the project.”

 

9. The Committee notes from paragraph 1 of the Facts of the Case and on perusal of the copies of the arbitration awards that the awards made by the arbitration tribunal against the corporation are in the nature of compensation for certain losses and interest thereon. The Committee is, therefore, of the view that these payments are not of the nature of ‘price adjustments’ but have arisen because of factors which do not appear to be normal to the construction of the project such as non-payment of claims in time, idling of machinery during the period the work remained suspended, losses incurred by the contractors during the period the work remained suspended, etc. Accordingly, in the view of the Committee, these awards cannot be considered to be directly attributable to bringing the assets to their working condition for their intended use. The Committee is further of the view that such compensations do not result in any future economic benefit to the corporation. Thus, payments in respect of the awards cannot be capitalised and should be charged to the profit and loss account.

 

D. Opinion

 

10. On the basis of the above, the Committee is of the opinion that capitalisation of the amount paid in respect of the awards against the corporation is not in order.

 

1 Opinion finalised by the Committee on 15.3.2005