Expert Advisory Committee
ICAI-Expert Advisory Committee
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Query No. 3

Subject:

Provision for repair work-in-progress.1

A. Facts of the Case

1. A public sector undertaking under the Ministry of Shipping, Road Transport and Highways, was incorporated on 29th March, 1976 under the Companies Act, 1956. The main objective of the company is to provide integrated dredging services to all major and minor ports, Indian Navy, fishing harbors and other maritime organisations.

2. The dredging activities are carried out by ocean going dredgers, self-propelled or dumb dredgers. As compared to any other ocean going vessel, the dredger has got a much greater amount of machinery installed. The trailer dredgers have almost twice the amount of machinery fitted as compared to ocean going ships of the same size. Most of the time, the dredgers operate in various types of soils and sandy waters which affects the outer surface of hull plates as well as the internal plates of the hopper, which in turn, results in wear and tear of hull and other soil touching parts/equipments. These dredgers would normally be working 24 hours a day continuously for a period of about 3 weeks when the machinery will be stopped for undertaking preventive maintenance. Such continuous usage of the machinery in the shallow and sandy waters of the port causes heavy wear and tear necessitating periodic repairs in a drydock and also the consumption of spares and stores.

3. Keeping the above facts in view, the company undertakes major dry dock repairs of its dredgers on a requirement basis and to meet conditions imposed by classification society and periodical survey requirements. Every effort is made to dry dock the dredgers to keep them in a good condition to undertake the project works. The expenditure towards dry dock repairs of dredgers is expensed in the year of incurrence.

4. The company, being a listed company, has to publish its quarterly unaudited results and get the same reviewed by the company’s auditors as per clause 41 of the Listing Agreement with Stock Exchanges.

5. The method being followed by the company for interim reporting in respect of expenditure on dry dock repairs (usually on each occasion repair cost ranges between Rs. 7 to 8 crore per dredger) is as follows:

●The actual dry dock repair expenditure in respect of dredgers dry docked and the repairs fully completed during the period (up to the end of the relevant quarter) is expensed in full in the particular quarter.

 

●If  the repairs of a dredger spill over to the next quarter or beyond, the expenditure is accounted for on the basis of the percentage of work done as certified by the Technical Department of the company.



6. During the Limited Review, statutory auditors of the company expressed their view that if the dry dock repair of a particular dredger spills over to more than a quarter/ year, then the full expenditure is to be considered in the quarter/ year in which the dry dock repairs are fully completed.

7. According to the querist, there is also a different view that if the dry dock repair expenditure spills over to more than a quarter/ year, then the full expenditure is to be considered in the quarter/ year in which the dry dock repair actually commenced.

B. Query

8. The querist has sought the opinion of the Expert Advisory Committee on the following issues in respect of dry dock repair expenditure spilling over to the next quarter/year to meet the requirement of interim reporting as also at the end of the year, i.e., 31st March:

        (i) Whether dry dock repair expenditure should be provided based on the percentage of work completed as per the certifications of the Technical Department of the company applied on the estimated dry dock repair cost (as the actual cost will be known only after completion of repair and scrutiny of the repair bill).

        (ii) Whether full dry dock repair expenditure should be provided in the quarter/year in which the dry dock is fully completed, i.e., after knowing the actual liability towards dry dock repair expenditure.

        (iii) Whether full dry dock expenditure should be provided in the quarter/year in which the dry dock repair commenced based on the estimated dry dockrepair cost.

        (iv) Whether any other alternative method should be followed to provide expenditure in line with the accepted standard practices.

C. Points considered by the Committee

9. The Committee notes that the basic issue raised by the querist relates to recognition and measurement of dry dock repair expenditure to be accounted for interim reporting as also to be accounted for at the end of the year in case the repair expenditure spills over to next quarter/year. 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.

10. The Committee notes sub-section (3) section 209 of the Companies Act, 1956, which is reproduced below:

        “(3) For the purposes of sub-sections (1) and (2), proper books of account shall not be deemed to be kept with respect to the matters specified therein, –

        (a) …

        (b) if such books are not kept on accrual basis and according to the double entry system of accounting.”

11. The Committee further notes that ‘accrual’ is one of the fundamental accounting assumptions underlying the preparation and presentation of financial statements as per Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’. The term ‘accrual’ has been defined in the Standard as below:

        “Revenues and costs are accrued, that is, recognised as they are earned or incurred (and not as money is received or paid) and recorded in the financial statements of the periods to which they relate. (The considerations affecting the process of matching costs with revenues under the accrual assumption are not dealt with in this Standard).”

12. The Committee also notes paragraph 1.09 of the ‘Guidance Note on Terms Used in Financial Statements’, issued by the Institute of Chartered Accountants of India, which is reproduced below:

        “ 1.09 Accrued Liability

        A developing but not yet enforceable claim by another person which accumulates with the passage of time or the receipt of service or otherwise. It may arise from the purchase of services (including the use of money) which at the date of accounting have been only partly performed, and are not yet billable.”

13. From the above, the Committee is of the view that in respect of dry dock repairs which are in progress on the balance sheet date, the company has an accrued liability. There is a present obligation but only in respect of the extent of work done as at the balance sheet date. This will result in a payment in future (after adjustments such as advance payment, if any). The amount of such an obligation should be recognised in the financial statements, if a reliable estimate of the same can be made. The amount recognised should be the best estimate of the expenditure required to settle the accrued liability at the balance sheet.

14. The Committee notes the following paragraphs from Accounting Standard (AS) 25, ‘Interim Financial Reporting’:

        “2. A statute governing an enterprise or a regulator may require an enterprise to prepare and present certain information at an interim date which may be different in form and/or content as required by this Standard. In such a case, the recognition and measurement principles as laid down in this Standard are applied in respect of such information, unless otherwise specified in the statute or by the regulator.”

        “27. An enterprise should apply the same accounting policies in its interim financial statements as are applied in its annual financial statements, except for accounting policy changes made after the date of the most recent annual financial statements that are to be reflected in the next annual financial statements. However, the frequency of an enterprise’s reporting (annual, half-yearly, or quarterly) should not affect the measurement of its annual results. To achieve that objective, measurements for interim reporting purposes should be made on a year-todate basis.

        28. Requiring that an enterprise apply the same accounting policies in its interim financial statements as in its annual financial statements may seem to suggest that interim period measurements are made as if each interim period stands alone as an independent reporting period. However, by providing that the frequency of an enterprise’s reporting should not affect the measurement of its annual results, paragraph 27 acknowledges that an interim period is a part of a financial year. Year-to-date measurements may involve changes in estimates of amounts reported in prior interim periods of the current financial year. But the principles for recognising assets, liabilities, income, and expenses for interim periods are the same as in annual financial statements.”

        “32. Income is recognised in the statement of profit and loss when an increase in future economic benefits related to an increase in an asset or a decrease of a liability has arisen that can be measured reliably. Expenses are recognised in the statement of profit and loss when a decrease in future economic benefits related to a decrease in an asset or an increase of a liability has arisen that can be measured reliably. The recognition of items in the balance sheet which do not meet the definition of assets or liabilities is not allowed.”

       “38. Costs that are incurred unevenly during an enterprise’s financial year should be anticipated or deferred for interim reporting purposes if, and only if, it is also appropriate to anticipate or defer that type of cost at the end of the financial year.”

15. The Committee notes that at present, the Listing Agreement with Stock Exchanges as per clause 41 specifically requires the quarterly and year to date results to be prepared in accordance with the recognition and measurement principles laid down in AS 25.

16. From the above, the Committee notes that the principles for recognition and measurement of the dry dock repair expenditure which is in progress at the balance sheet date as stated in paragraph 13 above are equally applicable to such expenditure for the purposes of interim reporting under clause 41 of the Listing Agreement with Stock Exchanges. Accordingly, the Committee is of the view that dry dock repair expenditure should be recognised by the company in a particular interim period (quarter in the case of the company) only to the extent of work done during that period, provided a reliable estimate can be made. The reliable estimate depends on particular circumstances. There can be a variety of methods for assessing the work completed, such as, a survey of work performed, completion of a physical proportion of the work performed, etc. The method which reliably measures the work performed should be used. Apart from an appropriate measurement of work, cost estimation should also be reliable. Only if the certificate of the Technical Department of the company meets these parameters resulting in a reliable estimate, it can be the basis for recognition of the expenditure, otherwise an appropriate method of estimation is to be devised, which may include an estimation given by the party performing the repair work and a survey by an outside agency. The amount recognised should be the best estimate of the expenditure required to settle the accrued liability at the interim reporting date. Further, the Committee is of the view that dry dock repair expenditure incurred in the current interim period spilling over to the next period cannot be deferred to future for interim reporting purposes. Similarly, dry dock repair expenditure that continues to be incurred in future cannot be estimated and accounted for in the period of commencement of the repair work. Recognition of dry dock repair expenditure to the extent of work done in a particular interim period ensures that measurement for interim reporting purposes is made on an year-to-date basis. This principle is equally applicable for annual reporting also.

D. Opinion

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

        (i) Dry dock repair expenditure should be recognised to the extent of work done during a period provided a reliable estimate can be made. This principle is applicable both for annual reporting as well as for interim reporting under clause 41 of the Listing Agreement with Stock Exchanges. The reliable estimate depends on particular circumstances. The certificate of the Technical Department of the company or any other appropriate method of estimation is acceptable, only if it is a reliable estimate as explained in paragraph 16 above. The amount recognised should be the best estimate of the expenditure required to settle the accrued liability at the reporting date.

       (ii) Providing for full dry dock expenditure in the quarter/ year in which the dry dock repair is fully completed, i.e., after knowing the actual liability towards dry dock repair expenditure, is not correct.

       (iii) Providing for full dry dock expenditure in the quarter/ year in which the dry dock repair commenced based on the estimated dry dock repair cost is not correct.

      (iv) Other than (i) above, there is no other alternative method so far as timing and quantum of the expenditure to be recognised in a period is concerned. As regards the method of estimation of work performed and cost, as stated in paragraph 16 above, it depends on the particular circumstances.

 

1Opinion finalised by the Committee on 17.3.2008