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Query No. 4
Subject:
Capitalisation of borrowing costs.1
A. Facts of the Case
1. A company was incorporated in 1996 under the Companies Act, 1956, to conduct
various educational and consulting programmes. The company plans to construct a
training institute-cum-corporate office and had applied to a state development
authority for allotment of 20,000 sq.m. of land on ‘as is where is basis’ on
lease for a period of 90 years commencing from the date of execution of the
lease deed.
2. The company received a letter dated March 16, 2002, from the state
development authority confirming reservation of approximately 20,000 sq. m. of
land at a premium of Rs.170 lakh and the first installment equivalent to 10% of
the total premium was paid by the company on April 16, 2002.
3. The company received a letter of allotment dated April 24, 2002 from the
state development authority whereby the company was required to deposit
allotment money equivalent to 20% of the total premium before June 23, 2002,
with an option to pay the entire balance of the premium immediately or in twelve
half-yearly installments at an interest of 14% per annum payable at the end of
each half year. The first installment was due on December 22, 2002 and the last
installment is due on June 23, 2008. The total installments to be paid aggregate
to Rs. 230.79 lakh (including reservation/allotment money) which includes total
interest of Rs. 60.79 lakh. The allotment money of Rs. 34 lakh was paid by the
company on June 23, 2002.
4. The company received a letter dated October 22, 2002 from the state
development authority confirming finalisation of the lease plans and the
following amounts that are to be paid by the company in respect of the lease of
land:
Rs.(in
lakh)
Lease
rent,
if
paid
one
time
46.75
Lease
rent,
if
paid
per
annum
4.25
Stamp
Duty
31.41
The lease deed was executed on July 20, 2004 and possession of the land was
obtained on July 26, 2004.
5. On August 7, 2002, the company filed an application with a bank requesting
for a term loan of Rs. 560.18 lakh towards cost of land and construction of the
building in phase I and phase II. The total cost of the project is estimated at
Rs. 800.25 lakh and the term loan from the bank is proposed to be utilised as
follows:
Rs.(in
lakh)
Cost
of
land
119.00
Others 15.75
Construction
of
Building
–
phase
I 242.55
Construction
of
Building
–
phase
II
182.88
Total
560.18
The
balance
cost of
the
project
of
Rs.
240.07
lakh
is
proposed
to
be financed
by
internal
accruals
and
by
the
promoters
of
the
company.
Construction of
phase
I
was
proposed
to
be
completed
by
March
2004
and
phase
II
by
December
2004.
6. On May 7, 2003, the company received a letter from the bank confirming its
willingness to provide a term loan of Rs. 400 lakh at an interest of 12% per
annum payable monthly. The loan is repayable in forty-eight equated monthly
installments commencing from May, 2004 to April, 2008. The term loan of Rs. 400
lakh is proposed to be utilised in proportion to the cost components as stated
in paragraph 5 above. The loan processing fee of Rs. 4 lakh was paid by the
company on May 9, 2003. Till date, the company has not drawn the term loan of Rs.
400 lakh.
7. Upto March 31, 2004, the company has paid Rs. 68.87 lakh to the state
development authority towards premium for the leasehold land and Rs. 26.98 lakh
towards interest on the unpaid balance of premium and the total consideration of
Rs. 95.85 lakh has been recorded in the books
of account as capital advance under ‘Fixed Assets’. The loan processing fee of
Rs. 4 lakh has also been recorded as capital advance under ‘Fixed Assets’. The
company proposes to capitalise the consideration of Rs. 95.85 lakh (including
interest) and loan processing fee of Rs. 4 lakh on the date of possession of the
leasehold land.
8. During the year ended March 31, 2005, the company has paid an additional
installment of Rs. 29.96 lakh (including interest of Rs. 9.68 lakh) to the state
development authority towards premium for the leasehold land and annual lease
rent of Rs. 4.25 lakh. The company proposes to capitalise the consideration of
Rs. 29.96 lakh (including interest) and annual lease rent of Rs. 4.25 lakh as at
March 31, 2005.
B. Query
9. The querist has raised the following issues for the opinion of the Expert
Advisory Committee:
(i) Whether acquisition of land will be termed as a qualifying asset within the
meaning of paragraph 3 of the Accounting Standard (AS) 16, ‘Borrowing Costs’,
issued by the Institute of Chartered Accountants of India. The company has
contended that land is an integral part of the project for construction of a
training institute-cum-corporate office and should be a qualifying asset within
the purview of AS 16 even though construction of the project has not yet
commenced.
(ii) Whether the company can capitalise the interest of Rs. 26.98 lakh that has
been paid upto March 31, 2004 and Rs. 9.68 lakh that has been paid after March
31, 2004, in respect of unpaid premium on land even though the company has not
obtained any loan from the bank or from any other source as at March 31,
2004 or even thereafter.
(iii) Whether the company can capitalise the loan processing fee of Rs. 4 lakh
that was paid on May 9, 2003, if the loan is drawn after March 31, 2004. In the
event the existing offer of term loan is cancelled and a fresh loan is drawn
from another bank, whether the loan processing fee that was paid on May 9, 2003,
can be deferred/capitalised and amortised over the period for which the loan
remains unpaid.
(iv) Whether the company can capitalise future interest in respect of unpaid
premium on land that is paid after the loan is drawn and also after completion
of construction of the project.
(v) On possession of the leasehold land, the company proposes to capitalise the
premium on leasehold land for Rs. 230.79 lakh
(including interest of Rs. 60.79 lakh). Whether the company can capitalise
unpaid interest in respect of premium on land irrespective of whether such
payments are proposed to be made in future through internal accruals or after
the loan is drawn.
(vi) The company proposes to defer all payments in respect of annual lease rent
of Rs. 4.25 lakh till completion of the project and capitalise such rent under
the head ‘Building’. Whether such capitalisation is permitted keeping in view
the ‘Guidance Note on Treatment of Expenditure During Construction Period’,
issued by the Institute of Chartered Accountants of India.
(vii) Whether the stamp duty of Rs. 30.41 lakh paid on registration of leasehold
land can be capitalised as value of leasehold land.
The company has contended that the issues referred to in paragraphs (i) to (v)
above should be capitalised as they are in conformity with AS 16.
C. Points considered by the Committee
10. The Committee notes the definition of the term ‘qualifying asset’ as per AS
16 and paragraph 16 thereof as reproduced below:
“A qualifying asset is an asset that necessarily takes a substantial
period of time to get ready for its intended use or sale.”
“16. The activities necessary to prepare the asset for its intended use or sale
encompass more than the physical construction of the asset. They include
technical and administrative work prior to the commencement of physical
construction, such as the activities associated with obtaining permits prior to
the commencement of the physical construction. However, such activities exclude
the holding of an asset when no production or development that changes the
asset’s condition is taking place. For example, borrowing costs incurred while
land is under development are capitalised during the period in which activities
related to the development are being undertaken. However, borrowing costs
incurred while land acquired for building purposes is held without any
associated development
activity do not qualify for capitalisation.”
11. The Committee is of the view, on the basis of the above, that the land
acquired by the company cannot be considered as a qualifying asset within the
meaning of AS 16 since no development work thereon is being undertaken. The
argument that acquisition of land is an integral part of the project of
construction of the corporate office and training institute is not valid since
each asset necessary for the project should be considered separately for the
purpose of deciding whether it constitutes a ‘qualifying asset’ within the
meaning of AS 16. ‘Land’ and ‘Building’ in any case are considered separate
assets.
12. The Committee notes from paragraph 1 of the Facts of the Case that the
company has acquired the land on lease for 90 years. The Committee
is of the view that in respect of the lease agreements for long periods, e.g.,
90 years, it is generally expected that either the lease period would be
extended or the title will pass to the lessee at some agreed amount. Therefore,
in substance, the lease of land for a period of 90 years amounts
to transfer of the significant rights of ownership in the land to the lessee and
thus, it should be shown as a ‘fixed asset’ in the books of the lessee along
with proper disclosures about the nature of lease, term of lease period, etc.
Further, with regard to stamp duty paid on registration of leasehold land, the
Committee notes paragraph 9.1 of Accounting Standard (AS) 10, ‘Accounting for
Fixed Assets’, issued by the Institute of Chartered Accountants of India, which,
inter alia states as follows:
“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;…”
In this context, the Committee also notes the following extracts from paragraph
9.6 of the ‘Guidance Note on Treatment of Expenditure During Construction
Period’, issued by the Institute of Chartered Accountants of India:
“9.6 …In addition to the actual cost of land, various expenses may be incurred
in connection with the land which should also be capitalised. These expenses
would include the following:-
(a) Legal costs, stamp duties and fees, etc.
…”
From the above, the Committee is of the view that stamp duty paid on
registration of leasehold land is a cost directly attributable to the
acquisition of land and accordingly, should be capitalised as a part of the cost
of land.
D. Opinion
13. On the basis of the above, the opinion of the Committee on the issues raised
by the querist in paragraph 9 is as follows:
(i) Acquisition of land cannot be termed as a qualifying asset within the
meaning of AS 16.
(ii) to (v) In view of the answer at (i) above, these questions do not arise.
(vi) Annual lease rent paid in respect of land cannot be capitalised as part of
the cost of ‘building’.
(vii) Stamp duty paid on registration of leasehold land should be capitalised as
a part of the cost of land.
1 Opinion finalised by the Committee on 15.3.2005
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