Query No. 4

Subject:

Depreciation of Water Treatment Plant (WTP) and

Effluent Treatment Plant (ETP).¹

A. Facts of the Case

1. A public sector company with majority shareholding by a state government, manufactures paper for newsprint, printing and writing. The company has a water treatment plant and an effluent treatment plant.

Water Treatment Plant (WTP)

2. The company constructed a WTP in 1985 to treat raw water drawn from a river to carry out various production activities. The capacity of WTP was augmented in 1995. WTP consists of the following:

       (i)   Clarifiers

      (ii)   De-mineralisation plants (DM plants)

      (iii)  Neutralisation pit and drain

      (iv)  Pipelines

3. The querist has stated that the machineries installed in the WTP, including civil foundation works to install the machinery, were capitalised as ‘plant and machinery’. The other civil works were capitalised as ‘Factory Buildings’. The assets are still in use.

4. The querist has further stated that the company has constructed three water storage reservoirs during the years 2000, 2003 and 2005 to store water pumped from a river and use the same for the requirements of the factory. The life of these storage reservoirs is expected to be very long. These water storage reservoirs and connected pipelines have been capitalised as ‘Factory Buildings’ by considering the nature of works.

Effluent Treatment Plant (ETP)

5. The company constructed ETP to treat the effluent in 1985 and augmented the capacity in 1995. ETP consists of the following:

        (i) Effluent clarifiers (primary and secondary clarifiers)

        (ii) Effluent filter house and clarifiers

        (iii) Drains

        (iv) Effluent/anaerobic lagoon

6. According to the querist, the machineries installed in the effluent clarifiers, effluent filter house and clarifiers, and lagoon including civil foundation works to install the machineries were capitalised as ‘Plant and Machinery’. The other civil works were capitalised as ‘Factory Buildings’. These assets are still under use.

7. The querist has provided the following tables containing the processes/activities carried on by using various civil works involved in WTP and ETP, respectively, along with the remarks of the company:

CIVIL WORKS IN WATER TREATMENT PLANT (WTP)

CIVIL WORKS IN EFFLUENT TREATMENT PLANT (ETP)

B. Query

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

(i) Whether the capitalisation of civil works in Water Treatment Plant (WTP) and Effluent Treatment Plant (ETP) as ‘Factory Buildings’ is correct? If not, what should be the treatment for the above civil works?

(ii) Whether the capitalisation of raw water storage reservoir as ‘Factory Buildings’ is correct? If not, what should be the treatment?

(iii) If the above items are to be capitalised as ‘Plant and Machinery’, whether the revised depreciation rates are applicable prospectively or retrospectively.

(iv) If the revised depreciation rates are to be applied retrospectively, whether the depreciation pertaining to prior periods should be presented under ‘prior period items’.

C. Points considered by the Committee

9. The Committee is of the view that in the absence of the definitions of the terms ‘Factory Buildings’ and ‘Plant and Machinery’, under the Companies Act, 1956, a functional test has to be applied to determine whether a structure is ‘plant’ or not. The functional test requires to examine various aspects of the structure to determine whether it is an apparatus with which the activity or activities is/are carried on or it is a mere setting of or part of the premises in which the activity is/activities are carried on.

10. The Committee notes from the Facts of the Case that the civil works of WTP and ETP consisting of reservoirs, drains, lagoons, various clarifiers, neutralisation pit, aeration pond, and sludge thickener are directly involved in the process of treatment of water and effluent. On this basis, the Committee is of the view that the civil works involved in the Water Treatment Plant and Effluent Treatment Plant, excluding intake well sumps, de-mineralisation plant, softening plant and filter house building, are not merely the premises in which the work is carried on; these are rather the means with which and through which the activities of treatment of water and effluent are carried on. Hence, in the view of the Committee, the civil works directly involved in the treatment of water and effluent should be capitalised as ‘Plant and Machinery’ instead of ‘Factory Buildings’ and accordingly, depreciation as per the rates applicable to ‘Plant and Machinery’ should be provided on these items, taking into account the rates given in Schedule XIV to the Companies Act, 1956.

11. As far as depreciation on other civil works, i.e., which are not directly involved in the process of treatment of water and effluent, such as, intake well sumps, de-mineralisation plant, softening plant and filter house building is concerned, the Committee notes from the Facts of the Case that these civil works only act as the setting or structure containing various equipments and are not directly involved in the process of water treatment and effluent treatment. Hence, the Committee is of the view that these civil works should be classified as ‘Factory Buildings’ and accordingly, depreciation on these items should be provided as per the rates applicable to ‘Factory Buildings’ under Schedule XIV.

12. The Committee notes that the information provided by the querist in tables (paragraph 7 above), explaining the nature of civil works involved and the process activities carried on by them, does not specifically mention raw water storage reservoir. Hence, if the nature of the reservoir is such that it is not directly involved in the treatment of water and effluent, it should be treated as ‘Factory Building’.

13. Regarding the revision of the rates of depreciation to be applied on civil works directly involved in WTP and ETP, the Committee is of the view that the practice followed by the company of providing depreciation on these civil works, at the rates applicable to ‘Factory Buildings’, is an error as depreciation on these items should have been provided as per the rates applicable to ‘Plant and Machinery’, from the very beginning. In view of this, depreciation on the said items should now be provided with retrospective effect. The deficiency or surplus arising from retrospective recomputation of depreciation in accordance with the changed rates due to change in classification of assets should be adjusted in the accounts in the year in which change is given effect to as a prior period item as discussed in the following paragraphs.

14. The Committee notes the definition of the term ‘prior period items’ and paragraphs 15 and 19 of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’, issued by the Institute of Chartered Accountants of India, which state as follows:

   “Prior period items are income or expenses which arise in the current period as a result of errors or omissions in the preparation of the financial statements of one or more prior periods.”

   “15. The nature and amount of prior period items should be separately disclosed in the statement of profit and loss in a manner that their impact on the current profit or loss can be perceived.”

    “19. Prior period items are normally included in the determination of net profit or loss for the current period. An alternative approach is to show such items in the statement of profit and loss after determination of current net profit or loss. In either case, the objective is to indicate the effect of such items on the current profit or loss.”

15. From the above, the Committee is of the view that the change in the depreciation rates due to change in the classification of assets arising from an error, as discussed in paragraph 13 above, is a prior period item and, therefore, excess/short depreciation charge pertaining to prior periods should be disclosed separately in the current year’s profit and loss account in a manner that its impact on the current year’s profit or loss can be perceived.

D. Opinion

16. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 8 above:  

(i) No, capitalisation of civil works directly involved in water treatment and effluent treatment, as ‘Factory Buildings’ is not correct. These civil works should be treated as ‘Plant and Machinery’.

(ii) Capitalisation of raw water storage reservoir as ‘Factory Buildings’ would be correct only if it is not directly involved in the process of treatment of water and effluent as discussed in paragraph 12 above.

(iii) The revised depreciation rates are applicable retrospectively.

(iv) Depreciation pertaining to prior period due to retrospective application of depreciation rates is a prior period item, which should be separately disclosed. 

¹ Opinion finalised by the Committee on 27.3.2006