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A. Facts of the Case
1. A company was incorporated in the year 2003. Its registered
office is located in Tamil Nadu (TN). It has its project office and is
constructing its first power project within the State. As on date, the company has no other branch/ unit and is a single project company. Further projects will be taken-up after another 2-3 years only.
Construction activity will go on till the financial year 2010-11, when
the commissioning activity will start. The commissioning activity/
stabilisation may take 6-8 months’ time and, hence, commercial
operations are likely to start in the financial year 2011-12 only.
Accordingly, as on date, there is no other operation and
maintenance (O&M)/ revenue activity. The company, however,
earns certain interest on bank deposits from time to time.
2. According to the querist, for such a long duration project, at
times, there is a need to adopt more than one option/approach for
a particular construction activity. Ultimately, it will be any one of
those options which will finally be adopted and the rest may have
to be abandoned in between due to circumstances, on which,
some costs might have been incurred or the company may have
to pay foreclosure costs.
3. The company has recruited certain manpower, traditionally
called as O&M manpower. During construction phase, some of
them have been sent on training for O&M. The O&M training is a
long term activity and goes on for about a year. Even thereafter,
they will be placed on ‘on the job activities’ in some operating unit
or on some simulator. There being no watertight segregation, a
few of the O&M appointees may be involved in the construction
activities going on at present. The O&M staff needs to be qualified
and licensed before commissioning activities are undertaken. It is
then only that the regulators will give permission for commissioning
activities to start. At that time, they all will be placed on activities
related to commissioning and, thereafter, for O&M in due course.
Without trained, qualified and licensed man power in place by the
time of commissioning (which is routinely called/ known as O&M
man power), commissioning is just not possible as regulatory
clearances will not be forthcoming.
4. For such a long duration project, the company feels that it
needs to have a conducive atmosphere within and around the
project, because any disruption due to unrest from within or in the
surroundings can cause delay in completion of the project, thereby
causing more completion/ capital costs on the project. Removal of local fears and winning over confidence and support of locals are,
therefore, prerequisites for timely completion of the project. With
this objective and due approvals, the company plans to spend
about Rs. 25 lakh every year for ‘Neighborhood Development’.
This is used for construction of small infrastructure items in nearby
villages, helping them for their education and health related
activities. From the company’s view point, though the project is at
the construction stage and has no revenue generating activities,
this type of expenditure is unavoidable and has a long term
advantage for the company.
5. Cost of the project in hand is about Rs. 3,500 crore. Whereas
outlay during the financial year 2007-08 was Rs. 390 crore, the
amount involved in the three points given in paragraph 6 below
was Rs. 50.24 lakh, Rs. 36.79 lakh and Rs. 12.46 lakh, respectively.
(So, according to the querist, materiality, perhaps, may not be
there.)
6. The querist has stated that the auditor has raised a point as
below:
“…Statement of Expenditure during construction, pending
allocation…includes Rs. 99.49 lakh in respect of the following
items which are not represented by an asset in physical form :
Rs. in Lakh
(i) Amount paid towards compensation for
foreclosure of work
order of shifting an
equipment, using ‘strand jack system’. 50.24
(ii) Amount incurred on construction of community hall, compound
wall of a school
36.79
(iii) Stipend paid to trainees. 12.46
Total 99.49
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As the expenditure cannot be allocated to any asset, it should
have been treated as ‘Miscellaneous Expenditure’, to be written
off as ‘deferred revenue expenditure’ as and when the project is put into commercial operations and not as ‘Expenditure
during construction , pending allocation’.
Thus miscellaneous expenditure is understated with
overstatement of ‘Expenditure during construction, pending
allocation’ by Rs. 99.49 lakh.”
7. The company’s view for each of the item is as given below:
8. According to the querist, the company took into consideration
the following:
(i) Nature of its present activities – as stated in paragraphs
1 to 5 above.
(ii) Guidance Note issued by the Institute of Chartered
Accountants of India on Treatment of Expenditure during
Construction Period, which also suggests that sometimes
circumstances force a project to incur a capital
expenditure which is not represented by any specific or any tangible asset and that in such cases, the
expenditure so incurred would have to be treated in the
books of account as capital expenditure and not as
revenue expenditure.
(iii) Accounting Standard (AS) 26, ‘Intangible Assets’, issued
by the Institute of Chartered Accountants of India which,
as per the querist, requires that deferred revenue
expenditure incurred on or after 1st April, 2003, should
be written off as current year expenses only.
9. As per the querist, keeping in view the points mentioned in
paragraph 8 above, it was viewed by his professional colleagues
that the three types of expenses (stated and detailed in paragraph
7 above) should be treated as ‘expenditure during construction’
and not as deferred revenue expenditure to be written off as and
when the project is put into commercial operations. The company
has accordingly treated the three types of expenses in its annual
financial statements.
B. Query
10. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(i) Whether the expenses stated and detailed in paragraph
7 above can be treated as ‘miscellaneous expenditure’,
to be written off as ‘deferred revenue expenditure’ as
and when the project is put into commercial operations.
(ii) Whether it is correct/ fair to treat these expenses as
‘expenditure during construction, pending allocation’.
(iii) Whether there is any other treatment and if so, it may
be elaborated.
C. Points considered by the Committee
11. The Committee notes that the basic issue raised by the querist
relates to the accounting treatment of the specific three types of
expenses incurred during the construction period. Therefore, the
Committee has examined only this issue and has not considered
any other issue that may be contained in the Facts of the Case.
12. At the outset, the Committee wishes to point out that
recommendations of a Guidance Note would be applicable only to
the extent that they are not contrary to an Accounting Standard.
Hence, the recommendations of the ‘Guidance Note on Treatment
of Expenditure during Construction Period’ 2 may be considered,
only if they are not contrary to an Accounting Standard. In particular,
the Committee notes that for the accounting year under
consideration viz. 2007-08, Accounting Standard (AS) 26, ‘Intangible
Assets’, notified by the Central Government under the Companies
(Accounting Standards) Rules, 2006 (the ‘Rules’) is applicable.
Further, the Committee notes that a project may consist of several
fixed tangible and intangible assets. The Committee is of the view
that if an expenditure is eligible for capitalisation based on the
applicable Accounting Standard, such as, Accounting Standard
(AS) 10, ‘Accounting for Fixed Assets’, 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 cost of that asset.
(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 can be established
technologically.
(iii) If the expenditure is related to, or benefits, more than
one asset under construction, it should be booked to
‘expenditure during construction’ and capitalised as part
of cost of the relevant assets appropriately at the time
of completing the exercise of capitalisation.
Further, the Committee is of the view that if an expenditure is not
eligible for capitalisation, it should be expensed, unless another Accounting Standard requires or permits a different treatment.
Amount paid towards compensation for foreclosure of work order
of shifting an equipment, using ‘strand jack system’
13. The Committee notes from the Facts of the Case that strand
jack system was initially contemplated to save erection time in the
absence of cranes. At the same time, since it requires regulatory
approval, option for crane hiring/purchase was also pursued in
parallel. Since the regulatory approval was taking time, it was
decided to go for heavy duty crawler crane, leaving the option of
strand jack system midway. In this connection, the Committee
notes the following paragraphs from AS 10 notified under the
‘Rules’:
“9.1 The cost of an item of fixed asset comprises ...any directly
attributable cost of bringing the asset to its working condition
for its intended use…
9.2 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.
9.3 The expenditure incurred on start-up and commissioning
of the project, including the expenditure incurred on test runs
and experimental production, is usually capitalised as an
indirect element of the construction cost…”
“10.1 In arriving at the gross book value of self-constructed
fixed assets, the same principles apply as those described in
paragraphs 9.1 to 9.53. Included in the gross book value are
costs of construction that relate directly to the specific asset
and costs that are attributable to the construction activity in
general and can be allocated to the specific asset. Any internal
profits are eliminated in arriving at such costs.”
“20. The cost of a fixed asset should comprise its
purchase price and any attributable cost of bringing the
asset to its working condition for its intended use.
21. The cost of a self-constructed fixed asset should
comprise those costs that relate directly to the specific
asset and those that are attributable to the construction
activity in general and can be allocated to the specific
asset.”
14. The Committee is of the view that compensation for foreclosure
of the option of strand jack system is an expenditure incurred in
stopping a particular course of action and is not directly attributable
to bringing an asset (or the relevant assets) to its (their) working
condition. On the basis of the principles of AS 10 quoted in
paragraph 13 above in conjunction with the principles mentioned
in paragraph 12 above, the Committee is of the view that such
compensation is not eligible for capitalisation and the same should
be expensed, since, a different accounting treatment is not required
or permitted in any other Accounting Standard.
Amount incurred on construction of community hall, compound
wall of a school
15. As regards the expenditure incurred on construction of
community hall and compound wall to school, though the said
expenditure might have avoided possible delay in construction/
completion of the project and possible cost overrun as stated by
the company in paragraph 7 above, the said expenditure was not
incurred for the purpose of construction of any asset(s) and/or for
bringing the asset to its working condition for its intended use. The
Committee notes that the main purpose of the expenditure is
removal of local fears and winning over confidence and support of
locals. As stated by the querist in paragraph 4 above, this has
long term advantage for the company. The Committee is of the
view that this is akin to expenditure incurred on internally generated
goodwill. Relevant paragraphs of AS 26 are reproduced below:
“35. Internally generated goodwill should not be
recognised as an asset.
36. In some cases, expenditure is incurred to generate future
economic benefits, but it does not result in the creation of an
intangible asset that meets the recognition criteria in this
Standard. Such expenditure is often described as contributing
to internally generated goodwill. Internally generated goodwill
is not recognised as an asset because it is not an identifiable
resource controlled by the enterprise that can be measured
reliably at cost.”
“55. Expenditure on an intangible item should be
recognised as an expense when it is incurred unless:
(a) it forms part of the cost of an intangible asset
that meets the recognition criteria…; or
...”
16. From the above, the Committee is of the view that expenditure
incurred on construction of community hall and compound wall to
school should be expensed, since a different accounting treatment
is not required or permitted in any other Accounting Standard for
such expenditure.
Payment of stipend to trainees
17. As regards the stipend to trainees (O & M staff), the Committee
notes from the Facts of the Case that a few of them may be
involved in the construction activities going on at present. The
Committee is of the view that to the extent the trainees are involved
in construction activities, the stipend should form part of capital
work in progress, if those activities are identifiable with a specific
fixed asset, or ‘expenditure during construction, pending allocation’
if those activities are identifiable with more than one fixed asset,
as the case may be. To the extent the trainees are not involved in
construction during the period, the project is under construction,
the stipend should be expensed, since, a different accounting
treatment is not required or permitted in any other Accounting
Standard for that expenditure. In particular, the Committee notes
the following portion of paragraph 56 of AS 26 (read in conjunction
with paragraph 55 of AS 26 quoted in paragraph 15 above).
“56. …Examples of other expenditure that is recognised as
an expense when it is incurred include:
(a) …
(b) expenditure on training activities;
(c) …
(d) …”
The Committee is of the view that the above paragraph 56 of AS
26 is applicable for all types of training and not restricted to general
training of sales or other auxiliary/administrative staff. Though
training may be necessary to get authorisation to commission the
plant and to enable the plant to start commissioning operations,
the training expenditure is not incurred for construction of any
asset(s) and/or bringing the asset to its working condition for its
intended use.
D. Opinion
18. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 10 above:
(i) The expenses stated and detailed in paragraph 7 above
cannot be treated as ‘miscellaneous expenditure’, to be
written off as ‘deferred revenue expenditure’ as and
when the project is put into commercial operations.
(ii) It is not correct/fair to treat these expenses as
‘expenditure during construction, pending allocation’,
except for stipend paid to trainees involved in
construction activities when those activities are
identifiable with more than one fixed asset.
(iii) Compensation for foreclosure of work order for strand
jack system, expenditure incurred on construction of
community hall, etc. and stipend paid to trainees not
involved in construction activities should be expensed.
Stipend to trainees involved in construction activities
should form part of capital work in progress, if those activities are identifiable with a specific fixed asset, or
‘expenditure during construction period, pending
allocation’ if those activities are identifiable with more
than one fixed asset.
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