Item (A)	Rs. 17.68 crore incurred and booked as expenditure. The remaining portion of expenditure will be booked according to the accounting policy of the company, as and when the land is acquired.
Item (B) (C)& (D)	Rs. 4.89 crore has been incurred and accounted for, and accounting for further expenditure shall be made as and when the company’s obligation (contractual/legal) shall arise.

The querist has also clarified that while no specific agreement was entered into with village panchayats, an amount of Rs. 1250 lakh would be spent on the infrastructure works of various villages/ panchayats on the basis of the plan approved and sent by different panchayats. This is included in the amount of Rs. 2,353 lakh for item (D) above.

6. The Government auditors, during the review of accounts of the company, had commented that ‘Capital Work in Progress (CWIP) – Incidental Expenditure During Construction’ and ‘Current Liabilities & Provisions’ were understated due to short provision of Rs 30.90 crore due to non-providing of balance amount of Rs. 30.90 crore being the difference between the rehabilitation and resettlement cost approved by the Board (Rs. 53.47 crore) and the expenditure accounted for up to 31.03.2007 amounting to Rs. 22.57 crore (Rs. 17.68 crore and Rs. 4.89 crore) in the books.

7. The company, in its reply to the auditors, had stated that the rehabilitation and resettlement cost approved by the Board was an estimated cost for the entire duration of the project which may change ((+)/(-)) depending on the actual requirement. The expenditure incurred upto 31.03.2007 had already been accounted for. Further expenditure can be booked only after goods/services have been received by the company or the company, by virtue of contractual/legal obligation, is required to incur the expenditure and not merely based upon approved plans. The work of the project has just begun and no such event has occurred at the date of balance sheet which has resulted in company’s obligation for rehabilitation and resettlement beyond what has been accounted for and no provision is required to be made for balance expenditure which is yet to be incurred. It was agreed with the auditors to refer the matter to the Expert Advisory Committee of the Institute of Chartered Accountants of India for opinion.

8. The querist has quoted the following paragraph of Accounting Standard (AS) 29, ‘Provisions, Contingent Liabilities and Contingent Assets’:

       “14. A provision should be recognised when:

         (a) an enterprise has a present obligation as a result of a past event;

        (b) it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and

         (c) a reliable estimate can be made of the amount of the obligation.

         If these conditions are not met, no provision should be recognised.”

The querist has also referred to paragraph 17 of AS 29, which, inter alia, states that no provision is recognised for costs that need to be incurred to operate in the future and that the only liabilities recognised in an enterprise’s balance sheet are those that exist at the balance sheet date. The querist has also referred to paragraph 18 of AS 29 which, inter alia, prescribes that it is only those obligations arising from past events existing independently of an enterprise’s future actions (i.e., the future conduct of its business) that are recognised as provisions. Some examples are also given in Appendix C to AS 29 which illustrate the circumstances in which provisions are required to be made. As per the querist, these examples do not specifically cover the case of the company.

9. According to the querist, since no event has occurred which may result in a present obligation, no provision was required to be made at the balance sheet date (31.03.2007).

B. Query

10. In view of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

      (i) Whether the company is required to make a provision for the balance of planned rehabilitation and resettlement cost as explained above for which no contractual obligation has arisen on the balance sheet date.

      (ii) If the answer to the above is in the affirmative,

          (a) whether the amount should be booked through ‘Incidental Expenditure During Construction (IEDC)’ or directly to capital work-in-progress.

          (b) whether it also requires a change in the accounting policy mentioned in paragraph 4(a) above.

C. Points considered by the Committee

11. The Committee notes that the basic issue raised by the querist relates to the need for provision towards balance of planned rehabilitation and resettlement cost. Therefore, the Committee has examined only this issue and has not examined any other issue that may be contained in the Facts of the Case, such as, correctness of accounting policy of the company as reproduced by the querist in paragraph 4(a) above in general, or appropriateness of capitalisation of various expenses, e.g., those related to afforestation, as part of cost of land, etc. The Committee has also not examined the accounting policy of the company as reproduced in paragraph 4(b) above, as that issue has not been raised by the querist.

12. The Committee notes, from the copy of Resettlement and Rehabilitation Scheme (R & R Scheme) for the project affected families of ‘Y’ Hydro Electric Project furnished by the querist, that the same has been made by the State Government and the company pursuant to Rule 8-A of the HP Nautor Land Rules, 1968. Hence, in the view of the Committee, the obligations created under the scheme are legal in nature.

13. The Committee notes paragraph 14 of AS 29 quoted by the querist in paragraph 8 above and the following paragraphs from AS 29:

      “10.1 A provision is a liability which can be measured only by using a substantial degree of estimation.

       10.2 A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.

       10.3 An obligating event is an event that creates an obligation that results in an enterprise having no realistic alternative to settling that obligation.”

      “10.6 Present obligation - an obligation is a present obligation if, based on the evidence available, its existence at the balance sheet date is considered probable, i.e., more likely than not.”

       “11. An obligation is a duty or responsibility to act or perform in a certain way. Obligations may be legally enforceable as a consequence of a binding contract or statutory requirement. Obligations also arise from normal business practice, custom and a desire to maintain good business relations or act in an equitable manner.”

        “16. A past event that leads to a present obligation is called an obligating event. For an event to be an obligating event, it is necessary that the enterprise has no realistic alternative to settling the obligation created by the event.

          17. Financial statements deal with the financial position of an enterprise at the end of its reporting period and not its possible position in the future. Therefore, no provision is recognised for costs that need to be incurred to operate in the future. The only liabilities recognised in an enterprise’s balance sheet are those that exist at the balance sheet date.

          18. It is only those obligations arising from past events existing independently of an enterprise’s future actions (i.e. the future conduct of its business) that are recognised as provisions. Examples of such obligations are penalties or cleanup costs for unlawful environmental damage, both of which would lead to an outflow of resources embodying economic benefits in settlement regardless of the future actions of the enterprise. Similarly, an enterprise recognises a provision for the decommissioning costs of an oil installation to the extent that the enterprise is obliged to rectify damage already caused. In contrast, because of commercial pressures or legal requirements, an enterprise may intend or need to carry out expenditure to operate in a particular way in the future (for example, by fitting smoke filters in a certain type of factory). Because the enterprise can avoid the future expenditure by its future actions, for example by changing its method of operation, it has no present obligation for that future expenditure and no provision is recognised.

         19. An obligation always involves another party to whom the obligation is owed. It is not necessary, however, to know the identity of the party to whom the obligation is owed – indeed the obligation may be to the public at large.”

14. From the above, the Committee is of the view that a provision cannot be recognised simply because there is an approved cost or there is a legal or contractual obligation. A provision should be made only if it fits within the parameters discussed in paragraph 13 above, apart from meeting the recognition criteria prescribed in paragraph 14 of AS 29, reproduced by the querist in paragraph 8 above. In particular, provision should not be recognised before the obligating event arises under the provisions of law or the terms of contract.

15. As stated by the querist in paragraph 5 above, the approved cost for rehabilitation and resettlement consists of cost of land, resettlement cost, rehabilitation cost and cost of area development/ community development. The Committee notes that the financial plan furnished by the querist contains detailed list of various expenses. As examples, likely obligating events for some items are given below:

       (i) So far as cost of land is concerned, the Committee is of the view that acquisition of land is the obligating event. Hence, if the land owner is yet to fulfill his obligation of transferring the property in the land to the company, the company has no present obligation to pay compensation to the land owner. The Committee is, therefore, of the view that until land is acquired, no provision should be created in respect of the cost of land.

      (ii) A published environmental policy of the company by itself, does not create a legal or contractual obligation. From the Facts of the Case and copies of documents furnished by the querist, it is not clear as to whether there is any legal or contractual obligation for afforestation, compensatory afforestation, soil conservation and reforestation towards forest land. In case there is any legal or contractual obligation for compensatory afforestation, felling of existing trees or even acquisition of land could be the obligating event depending on the provisions of law or the terms of the contract.

      (iii) Acquisition of land is the obligating event triggering the provision for resettlement grant payable to the concerned project affected family.

The Committee is of the view that the obligating events for other items should similarly be identified before recognising any provision.

16. On the basis of the above, the Committee is of the view that provision should be made as soon as the obligating event arises provided it also meets the other recognition criteria stated in paragraph 14 of AS 29. The amount of the provision would depend on the extent of the obligation arising from the obligating event rather than being made for the entire difference between the approved cost and actual expenditure incurred. The approved cost could be used as the basis for estimating the extent of the obligation arising from the obligating event, i.e., the amount for which the provision is to be recognised. As regards the company’s approach, it is not clear as to whether the underlying obligating events were identified and the recognition criteria were met in respect of provisions recognised based on contractual/legal obligations and whether all the provisions to be recognised on that basis have been recognised for amounts as discussed above.

17. As regards capitalisation of the relevant items, the Committee is of the view that it is to be decided based on the applicable Accounting Standards, such as, Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’. Thus, simply because an expenditure is incurred during construction, it does not necessarily mean that the said expenditure is eligible for capitalisation. If an expenditure is not eligible for capitalisation, it should be expensed, unless another accounting standard requires or permits a different treatment.

18. A project may consist of several fixed and intangible assets. The Committee is of the view that if an expenditure is eligible for capitalisation, it should be accorded the following treatment:

       (i) If the expenditure results in the acquisition of an asset, it should be directly capitalised as part of the cost of that asset. For example, cost of land should be directly capitalised as ‘Land’. Similarly, resettlement grant payable to the project affected families should be capitalised as part of cost of land, since the land cannot be acquired without incurring that expenditure.

      (ii) If the expenditure is directly related to, or benefits, a particular asset under construction, it should be booked to ‘Capital Work in Progress’ and identified with the relevant asset under construction. 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 should be established technologically. For example, compensation for damage to private property due to blasting during construction should be booked to ‘Capital Work in Progress’, if the blasting is done for the purpose of construction of a particular asset.

     (iii) If the expenditure is related to, or benefits, more than one asset under construction, it should be booked to ‘Incidental Expenditure During Construction’ and capitalised as part of the cost of the relevant assets appropriately at the time of completing the exercise of capitalisation. For example, compensation for damage to private property due to blasting during construction should be booked to ‘Incidental Expenditure During Construction’, if the blasting is done for the purpose of construction of more than one asset.

Thus, capitalisation of the relevant expenditure should be done on the basis of the principles stated above when the expenditure is incurred/provision is made in accordance with paragraph 16 above.

19. As regards the company’s accounting policy mentioned by the querist in paragraph 4(a) above, the Committee is of the view that subject to the considerations stated in paragraph 11 above, the said policy of the company may require a change on the basis of considerations discussed in paragraphs 17 and 18 above. Further, while applying the accounting policy, the provision should be recognised immediately when and to the extent the obligating event takes place, and when the other recognition criteria for provision are met.

D. Opinion

20. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 10 above:

      (i) The company is not required to make a provision for the balance of planned rehabilitation and resettlement cost until in respect of the individual items of expenses, the obligating event arises and the recognition criteria are met.

      (ii) (a) For treatment of expenditure, see paragraphs 17 and 18 above.

           (b) As regards need for change in the company’s accounting policy mentioned in paragraph 4(a) above, see paragraph 19 above.