Query No. 28

Subject:

Capitalisation of establishment expenses of Rehabilitation & Resettlement

office after commissioning of the project. ¹

A. Facts of the Case

1. A joint venture between a Government of India enterprise and the Government of Madhya Pradesh was incorporated as a company on 01.08.2000, with 51% stake being held by the former and the rest by the latter, to exploit the hydroelectric potential of the Narmada Basin. The company, having its headquarters at Bhopal, Madhya Pradesh (M.P.), presently has two projects, viz., Indira Sagar Project (ISP) of 1,000 MW under operation and Omkareshwar Project (OSP) of 520 MW under construction. Both these projects are situated in the state of M. P.

2. The querist has stated that ISP is the mother project of the Narmada Basin. It supplies water to three major downstream hydroelectric projects, viz., Omkareshwar & Maheshwar Projects (both in M.P.) and Sardar Sarovar Project in Gujarat. The installed capacity of the project is 1,000 MW, i.e., 8 units of 125 MW each. The project cost of ISP is Rs. 4,277.03 crore.

3. ISP is a multipurpose project, having both power generation and irrigation components. It has a catchment area of 61,642 sq. km. and its reservoir of 913 sq. km. will be the largest reservoir in India. Besides generation of electricity, the project would irrigate an area of 2.70 lakh hectares covering 564 villages, provide drinking water to downstream areas and enable production of an additional 4.00 lakh tons of food grains and 10.55 lakh tons of other crops. Other benefits of the project include annual production of approximately 1,500 tons of fish from the reservoir, creation of jobs through development of tourism and establishment of Industrial Training Institute (ITI), etc.

4. The queist has further stated that the work of Rehabilitation & Resettlement (henceforth referred to as R&R) of the Project Affected Families (PAFs) of the project is being carried out by the R&R office situated at Khandwa. The work of R&R office includes, inter alia, land acquisition, preparation and payment of land compensation awards, development of infrastructure at various resettlement sites and transportation of PAFs to these sites. As per the approved cost estimate of ISP, the entire expenditure incurred on the R&R activities is chargeable to the dam of ISP and is to be capitalised therewith. A total number of 249 villages are covered in the submergence area of the project, out of which 75 villages are being fully submerged and the balance 174 villages are being partially submerged. In addition to these, some more villages being submerged / families affected by the back waters of the reservoir are also to be resettled. The original cost estimate for R&R was Rs. 1,160 crore which was later revised to Rs. 1,570 crore vide the Cabinet Committee on Economic Affairs (CCEA) clearance dated 28.03.2002. The total proportionate establishment expenditure pertaining to R&R works of ISP incurred on R&R office from 24.08.2005 to 31.03.2006 works out to Rs. 6.43 crore which has been transferred to Incidental Expenditure During Construction (IEDC) and thus got capitalised in the annual accounts of 2005-06 of ISP, as the project is fully operational.

5. The first unit of ISP was commissioned on 13.01.2004 and the remaining seven units were commissioned on different dates thereafter. Though the first unit was commissioned on 13.01.2004, a substantial amount of civil, electrical and hydro-mechanical work, apart from R&R work was yet to be completed. Even after the commissioning of the last unit (i.e., 8th unit) on 30.03.2005, some of these works were still incomplete. Accordingly, the company has been preparing both profit and loss account and IEDC account since 2003-04 because the construction activities of the project were being carried out simultaneously with the operation of the commissioned units. The capitalisation of the project expenditure has been carried out in stages and at different times. All the units of ISP were commissioned by 30.03.2005 and the rated capacity of 1,000 MW was achieved on 24.08.2005.

6. The querist has stated that though the rated capacity of 1,000 MW was achieved on 24.08.2005, the total expenditure incurred till that date was only Rs. 3,786.89 crore as against the estimated project cost of Rs. 4,277.03 crore. The unspent amount of Rs. 490.14 crore is on account of balance civil, electrical and finishing works of dam and power house, pending claims of various contractors and remaining R&R works as well as the balance expenditure on compensatory afforestation and catchment area treatment.

7. Though the dam has been raised to its maximum height of EL 262.13 M, the Hon’ble High Court, Jabalpur has ordered that the water level may be maintained at or below EL 255 M, due to the fact that R&R work of many villages in submergence area has not yet been completed.

8. The querist has stated that the comments of the Comptroller and Auditor General of India (C&AG) on this issue during the audit of the company for the year ended 31.03.2006 were as follows:

“All the generating units of ISP were commissioned by 30.03.2005 and the rated capacity of 1,000 MW was achieved on 25.08.2005. As the project was complete and fully operational by this date, all the revenue expenditure and income should have been booked in the Profit and Loss Account. However, net revenue expenditure of Rs. 642.53 lakh incurred by R&R Division, Khandwa, in respect of ISP from 25.08.2005 to 31.03.2006 were transferred to IEDC and capitalised instead of charging to Profit & Loss Account.

This has resulted in understatement of revenue expenditure and overstatement of profit for the year by Rs. 642.53 lakh.”

9. As per the querist, the company’s reply to the above comments of C&AG was as follows:

“The office of R&R Division, Khandwa is doing only the work of land acquisition and related activities and is not engaged in any Operation & Maintenance Work of the project. All its expenses are therefore charged to IEDC. Even after 24.08.2005, the work of land acquisition, etc., continued which is a direct capital expenditure. This practice is continuing since last two years as per Accounting Policy no. 17 which is as follows:

“Payments made provisionally towards compensation and other expenses relatable to land, which is going to be submerged, are treated as Rehabilitation & Resettlement Expenses to be capitalised as Dam Cost.”

In view of the above, expenses pertaining to R&R activities have been correctly booked to IEDC and capitalised accordingly.”

10. The querist has stated that the reply of the company was further elaborated upon in the supplementary reply to the C&AG comments as follows:

“The office of R&R Division, Khandwa is engaged in balance R&R activities including land acquisition and payment of compensation to oustees falling between EL 255 M to EL 261 M or Maximum Water Level (MWL). This particular elevation is essential for the filling of reservoir to its maximum capacity for its maximum economic use. It is again for the information of audit that although the project has started commercial generation since 25.08.2005, but its complete commercial benefit as projected in the detailed project report will only be possible once the balance R&R works are completed. We have not yet fully spent the projected capital expenditure. Payment of compensation and incidental expenses are met out of the projected capital expenditure and charging of same to O&M expenses will be beyond the norms of Central Electricity Regulatory Commission (CERC).”

11. According to the querist, the following are the supporting facts for the reply:

 (a) The land acquisition and R&R work of a few villages, which come under submergence of back waters of ISP dam at Full Reservoir Level (FRL) to Maximum Water Level (MWL) are still in progress and shifting of PAFs is also in progress.

 (b) Apart from this, 8 villages have been totally surrounded by the back waters of ISP dam at FRL to MWL and have become islands. Land acquisition, R&R work and shifting of PAFs are still in progress.

(c) In view of the above, the Hon’ble High Court, Jabalpur has permitted the company to raise the water level of ISP upto EL 255 M only against the FRL of EL 262.13 M. The rated capacity of 1,000 MW was achieved on 24.08.2005 at the water level of EL 255 M and not at EL 262.13 M.

(d) The work of dam will be completed only after the completion of all land acquisition, R&R work, shifting of all PAFs and getting the permission of the Hon’ble High Court to raise the water level up to EL 262.13 M, i.e. FRL. The work of the project can only be considered to be completed when the dam along with all R&R activities is complete and is filled up to MWL of EL 262.13 M. Until then, the expenditure incurred on project related activities, including establishment expenditure will be included in IEDC and capitalised subsequently. Further, the full benefits of the project, as envisaged in the approved detailed project report and referred to in the company’s reply to C&AG’s comments, can only be exploited after the filling of reservoir up to the MWL of EL 262.13 M.

(e) As per the CERC guidelines no. 34.4 for tariff fixation, capital expenditure incurred after the completion of the project is also to be considered for the fixation of tariff. The generating company can file two revised tariff petitions, apart from the original tariff petition, within a tariff period, i.e., five years of the completion of the project, to include the capital expenditure incurred after the commissioning of the project in the total project cost and consider the same towards tariff fixation of the project.

(f) Accordingly, the company is of the view that the treatment of the expenditure of Rs. 6.43 crore incurred on R&R works from 24.08.2005 to 31.03.2006 as IEDC and capitalisation of the same is correct and as per the provisions of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, the company’s accounting policy and CERC guidelines.

B. Query

12. In view of the facts of the case, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) Whether the treatment given to R&R expenditure for the period from 24.08.2005 to 31.03.2006 is correct and as per the relevant Accounting Standards and practices.

(ii) If not, the corrective steps to be taken.

C. Points considered by the Committee

13. The Committee notes from a comprehensive reading of paragraphs 4 and 8 that the query relates to the issue of appropriateness of capitalisation of establishment expenses of Rehabilitation and Resettlement (‘R&R’) office incurred from 24.08.2005 till the end of the accounting year though, in paragraph 12, the querist has raised the issue with respect to R&R expenditure in general. Therefore, the Committee has not touched upon any other issue that may be contained in the Facts of the Case, such as the asset to which the R&R expenditure is to be capitalised with in case capitalisation criteria are met, treatment of R&R expenditure from the date of commissioning to the date of achieving 100 per cent rated capacity, etc.

14. The Committee further notes that the querist has mentioned two dates as the date of reaching 100 percent rated capacity, viz., 24.08.2005 and 25.08.2005. Also, at one place it is mentioned that Full Reservoir Level and Maximum Water Level are one and the same while at another place, they are stated to be different. However, such matters do not affect the accounting treatment for the issue involved.

15. The Committee notes that the last unit (i.e., 8th unit) of the mother project (ISP) was commissioned on 30.03.2005 itself while the rated capacity of 1,000 MW was achieved on 24.08.2005 (25.08.2005). There is huge unspent amount on account of balance civil, electrical and finishing works of dam and power house, pending claims of various contractors and remaining R&R works as well as the balance expenditure on compensatory afforestation and catchment area treatment. Further, the rated capacity is reached against the water level of EL 255 M and not at the maximum level, i.e., EL 262.13 M.

16. In the context of the comments of the C&AG contained in paragraph 8 above, the Committee notes the following portions of the Guidance Note on Treatment of Expenditure during Construction Period, issued by the Institute of Chartered Accountants of India:

  “…from the moment the plant is completed and commissioned and is ready for commercial production, all expenditures of revenue nature must be charged to the profit and loss account.” [Paragraph 12.3]

 “The term “commercial production” refers to production in commercially feasible quantities and in a commercially practicable manner.” [Paragraph 12.2]

 From the above, the Committee is of the view that it is the commissioning date that signifies readiness for commercial production and not the date of achieving 100 per cent rated capacity so far as power plant units are concerned. Accordingly, in respect of commissioned units, revenue expenditure related to post- commissioning period should be charged to profit and loss account.

17. With respect to capitalisation of expenses, the Committee notes the following paragraphs from Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’:

  “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 for 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.”

“9.3 Administration and other general overhead expenses are usually excluded from the cost of fixed assets because they do not relate to a specific fixed asset. However, in some circumstances, such expenses as are specifically attributable to construction of a project or to the acquisition of a fixed asset or bringing it to its working condition, may be included as part of the cost of the construction project or as a part of the cost of the fixed asset.”

18. The Committee also notes that paragraph 23 of AS 10 states as below:

“23. Subsequent expenditures related to an item of fixed asset should be added to its book value only if they increase the future benefits from the existing asset beyond its previously assessed standard of performance.”

The Committee is of the view that the ‘subsequent expenditure’ mentioned above can be capitalised, only if:

(a) it is a directly attributable cost;

(b) it is probable that the expenditure will increase the future benefits from the relevant asset beyond the previously assessed standard of performance; and

(c) such expenditure can be measured reliably.

The expression ‘subsequent expenditure’ indicates that expenditure incurred after the initial recognition of a fixed asset or completion of a project is also eligible for capitalisation, subject to meeting the aforesaid three conditions.

19. The Committee is of the view that for determining whether the subsequent expenditure is a ‘directly attributable cost’, factors, such as, whether the concerned expenditure directly benefits or is related to the relevant asset may be considered. In establishing whether the expenditure directly benefits or is related to an asset, a nexus between the expenditure and the benefit/relationship with the asset can be established technologically.

20. The Committee notes that R&R expenditure, including the establishment expenditure, is incurred as a direct consequence of the project. The R&R office is doing only the work of land acquisition and related activities and is not engaged in any operation and maintenance work. Though the R&R office expenditure is administrative in nature, it is specifically attributable to the project and not general in nature. Thus, it is a directly attributable cost.

21. The querist has not stated what incremental benefits will flow from raising the existing water level to the maximum level. However, the querist has indicated in paragraphs 10 and 11(d) above that it is probable that future benefits from the relevant asset will increase beyond the previously assessed standard of performance. Thus, it seems that the R&R expenditure is continued with a view to exploiting the commercial benefits of the project fully by raising the water level from the existing level of EL 255 M to the maximum level of EL 262.13 M, after obtaining the Court’s approval. Though the dam has already been raised to the maximum height of 262.13 M, to raise the water level to this height, Court’s permission is necessary. It seems that for getting the Court’s permission, R&R work must be complete, for which the R&R office is to be maintained.

22. The Committee notes that R&R office is exclusively devoted to R&R activities only. Hence, the expenditure incurred by the R&R office can be reliably measured.

23. In view of the above, all the three conditions mentioned in paragraph 18 above appear to be satisfied. Though the capacity of the dam is not going to be increased further, the standard of performance so far assessed in terms of benefits is related to existing level of water only. Since it is probable that the raising of existing water level to the maximum level will increase the future benefits and the expenditure thereon can be measured reliably, continued incurrence of the R&R expenditure, including R&R office expenditure, which is a directly attributable cost in the case of the querist, is eligible for capitalisation as part of cost of the relevant asset.

24. The Committee is of the view that even if the continued incurrence of R&R expenditure is to be capitalised on the considerations mentioned in paragraph 23 read with paragraph 18 above, incidental expenditure, such as, establishment expenses of R&R office should not be capitalised if no activity is in progress or the delay in the progress of R&R activities is avoidable. In this connection, the Committee notes the following paragraphs from Accounting Standard (AS) 16, ‘Borrowing Costs’:

 

“17. Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted.

 

18. Borrowing costs may be incurred during an extended period in which the activities necessary to prepare an asset for its intended use or sale are interrupted. Such costs are costs of holding partially completed assets and do not qualify for capitalisation. However, capitalisation of borrowing costs is not normally suspended during a period when substantial technical and administrative work is being carried out. Capitalisation of borrowing costs is also not suspended when a temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale. For example, capitalisation continues during the extended period needed for inventories to mature or the extended period during which high water levels delay construction of a bridge, if such high water levels are common during the construction period in the geographic region involved.”

 

The Committee is of the view that the above principle can be applied to other expenditure also.

D. Opinion

25. On the basis of the above, the Committee is of the following opinion on the issues raised by the querist in paragraph 12 above:

(i) The treatment of R&R expenditure, so far as it relates to establishment expenses of R&R office for the period from 24.08.2005 to 31.03.2006, is correct, provided R&R activities are in progress during this period and delay, if any, is unavoidable.

(ii) In view of (i) above, this question does not arise. However, in case R&R activities are not in progress or the delay in R&R activities is avoidable, capitalisation of establishment expenditure of R&R office is an error, the correction of which should be accounted for as a prior period item in accordance with Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’.

¹Opinion finalised by the Committee on 17.1.2007