Query No. 26

Subject:

Accounting for expenditure on distribution of mementos to

employees during construction period. ¹

A. Facts of the Case

1. A company is a Government of India undertaking, incorporated in 1975 under the Companies Act, 1956. One of its objectives is to set up thermal/hydro-power plants in the country for supply of bulk power to various State Electricity Boards / successor entities.

2. The querist has stated that during the construction stage of a project, the company accounts for the expenditure on employee remuneration and benefits as incidental expenditure during construction. In case of projects which are partially under operation and partially under construction, the expenditure on employee remuneration and benefits is analysed and as far as possible, identified with operation or construction activities and accounted for accordingly. Further, such expenses that are common to revenue and capital activities are allocated in the proportion of sales to accretion to capital work-in-progress and charged to the profit and loss account or the statement of incidental expenditure during construction, as the case may be. In the case of expansion projects, only the expenditure directly attributable to the construction/ expansion activities is capitalised, keeping in view the provisions of paragraph 16.2 (b) of the Guidance Note on Treatment of Expenditure during Construction Period, issued by the Institute of Chartered Accountants of India.

3. At one of the projects where new units are being set up for expansion of generating capacity, mementos were distributed to all the employees, whether engaged in operations, construction or other common services/functions, on the occasion of synchronisation of a new generating unit ahead of the schedule. Synchronisation is a major milestone preceding the readiness for commercial operations. The expenditure on the mementos was capitalised as incidental expenditure during construction. The government auditor while reviewing the accounts observed that the expenditure is not directly attributable to the construction of the unit and should have been charged to revenue.

4. The company is of the view that the expenditure on distribution of mementos on the occasion of synchronisation ahead of schedule is an additional expenditure directly related to the construction of the unit. Synchronisation before schedule results in significant benefits to the company in terms of cost reduction and shorter project construction schedule. The mementos were distributed to the employees to enhance employee morale and team spirit.

B. Query

5. The querist has sought the opinion of the Expert Advisory Committee on the issue as to whether capitalisation of the expenditure on the mementos distributed to all the employees of the project on synchronisation of unit, as indirect expenditure related to construction activity, is in accordance with the Guidance Note on Treatment of Expenditure during Construction Period.

C. Points considered by the Committee

6. The Committee, while expressing its opinion, has considered only the issue raised in paragraph 5 above and has not touched upon any other issue arising from the Facts of the Case, such as, accounting policy of the company in respect of expenditure during construction period, as indicated by the querist in paragraph 2 above.

7. The Committee notes that the Guidance Note on Treatment of Expenditure during Construction Period allows the capitalisation of only those expenses which are incurred during the construction period and which are related to or are incidental to construction activities directly or indirectly. The Committee notes that the nature of these expenses is such that these are generally incurred in connection with the construction activity and had these expenses not been incurred, construction activity would not have proceeded/ accomplished. In this regard, the Committee notes that paragraph 5.2 of the said Guidance Note, which deals with ‘indirect expenditure incidental and related to construction’, inter alia states as follows:

  “5.2 The following list of some of the possible items of expenditure which would qualify for inclusion under this heading is by no means exhaustive but is merely illustrative of the type of expenditures which are discussed in this paragraph:—

(a) Expenditure on employees who are either assigned to construction work or to supervision over construction work including salaries, provident fund and other benefits, staff welfare expenses, etc.”

8. The Committee notes from the above, particularly, the expenditure on employees as contained in clause (a) of paragraph 5.2 of the Guidance Note as reproduced above that the nature of the expenses to be capitalised, is such that these expenses are generally part of a formal plan or an informal practice of the organisation to provide such benefits to its employees and are relatable to the construction activity, i.e., these expenses directly or indirectly benefit the construction activity and are responsible for bringing the asset to its working condition. Accordingly, in the view of the Committee, if the giving of mementos to the employees is pursuant to a formal plan or an informal practice of the company to provide incentive to the employees for early completion of the construction activity, or the expenditure directly or indirectly benefits the construction activity, the cost of these mementos should be capitalised as then, these would be attributable to the cost of bringing the asset under construction to its working condition for its intended use. However, if these mementos are not a part of any formal plan or an informal practice as stated above, and are given only as an after-thought, i.e., as an award/reward to the employees for meeting the target, i.e., synchronisation of the unit ahead of schedule, the cost thereof cannot be attributed to bringing the asset under construction to its working condition for its intended use, and hence, the same should not be capitalised. Further, in case the cost of the mementos is to be capitalised on the aforementioned basis, it should be capitalised only to the extent of such benefit given to the employees who are engaged in the construction activity. In this regard, the Committee notes from the Facts of the Case that the company has distributed the mementos to all employees, whether engaged in operations, construction or other common services/functions.

D. Opinion

9. On the basis of the above, the Committee is of the opinion that the capitalisation of the expenditure incurred on mementos distributed to the employees would be in accordance with the Guidance Note on Expenditure during Construction Period only if it is part of a formal plan/informal practice of the organisation to provide incentives to the employees for achieving certain construction activity ahead of schedule, or it directly or indirectly benefits the construction activity. In case it is to be so capitalised, it should be capitalised only to the extent such expenditure is related to the employees engaged in the construction/expansion activity, as discussed in paragraph 8 above.