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A. Facts of the Case
1. A company is a public sector undertaking engaged in refining of crude oil. The company had initially set up a crude oil refinery of 3 million metric tonnes per annum (MMTPA), called Phase 1, at a capital cost of Rs 2,600 crore. This was commissioned in March 1996. Thereafter, the company had set up an additional refinery of 6 MMTPA as Phase 2 project in the same complex with a capital outlay of Rs 3,700 crore. This was commissioned in April 2001. Both the refineries were set up with capital items – both indigenously procured as well as imported components. The import of capital goods is governed under the Customs Act, 1962 and attracts customs duty at the applicable rates.
2. As per the querist, Customs Notification No. 11/97 dated 1st March, 1997 (as amended) allowed import of goods for setting up of new refinery or for substantial expansion at nil rate (zero duty) with Countervailing Duty (CVD) of 10%. At the same time, customs tariff rate (project duty) for import of capital goods for projects was 20% with CVD of 13%. During the period of the project imports, the duty structure was varying from period to period. During Phase 2 construction, the company paid customs duty at the rate of 0% and CVD of 10%. The entire amount of customs and other applicable duties was debited to ‘Assistant Commissioner (AC) Customs Account’ as advance pending capitalisation by crediting bank account.
3. The querist has informed that the customs authorities initially admitted the Bills of Entry (BEs) filed as per Notification No. 11/97. However, authorities later disputed the filing of BEs and claimed that the company was not eligible for concessional customs duty under the said notification. Therefore, the company was asked to pay the duties as per the project rate of customs duty applicable for project import of capital goods. To avoid delay in project execution, the company started indicating this duty structure in the BEs and made payment as demanded by authorities under protest. These amounts were also debited to ‘AC Customs Account’ as advance pending capitalisation.
4. Aggrieved by the actions of the Customs authorities, the company filed a writ petition in the High Court of Karnataka. The High Court of Karnataka passed an interim order pending final decision by the Customs authorities, directing the company to deposit 50% of the duty applicable as per project rate as deposit and balance 50% by way of bank guarantee and reverted the case to appeal authorities of Customs. As per the directives of the High Court’s interim order, the company deposited 50% of the applicable customs duty computed at project rate and applicable CVD after taking into account the amounts already paid, and recorded the same in the books of account by crediting bank account and debiting ‘AC Customs Account’ as advance pending capitalisation.
5. In February 2001, the Phase 2 refinery was capitalised. Pending final order of the Customs, Excise & Service Tax Appellate Tribunal (CESTAT), the company completed the capitalisation based on ‘best estimate’ with the available information. The accounting treatment followed for customs and other duties is as enumerated below:
(a) The amount outstanding to the debit of AC Customs Account was transferred to Capital Work-in-Progress (CWIP) Account.
(b) Based on the BEs filed with the Customs authorities and the amount of CVD indicated in the BEs at 13%, 100% of the amount of CVD was transferred to MODVAT/CENVAT Credit Receivable Account by crediting CWIP. This was done considering the fact that MODVAT/CENVAT credit needs to be claimed within the stipulated time period and delay in the claim, pending decision, would have resulted in total loss of MODVAT/CENVAT credit claims, if claim for benefit of Notification No. 11/97 was not to be allowed.
(c) From the CWIP Account, the additional duty paid (i.e., the difference between the 50% of the project duty paid and the applicable duty as per the Notification No. 11/97) was transferred to the ‘Receivable from Customs Account’ by crediting the CWIP Account and debiting the ‘Receivable from Customs Account’.
6. During the year 2005-06, the company received the decision from CESTAT, which upheld the appeal of the company and held that the company was eligible to import under Notification No. 11/97 as ‘setting up of new refinery’. As a result of this decision, authorities completed the assessment of BEs considering the applicable duties under Notification No. 11/97. As the company had earlier claimed and accounted for MODVAT/CENVAT credit as per project rate of duty, the department assessed the BEs and allowed the refund claims assessing higher CVD than applicable CVD which was lower and adjusted the refund amount accordingly. The querist has stated that the accounting for MODVAT/CENVAT credit receivable at higher rate based on the project rate of duty than the actual amount of MODVAT/CENVAT credit eligible at 10% resulted in lower capitalisation to the extent of Rs. 9.46 crore.
7. The querist has also stated that some of the customs duty payments which were transferred to CWIP Account as per paragraph 5(a) above, were not transferred to the ‘Receivable from Customs Account’ and accordingly, the actual deposit amount determined as refundable on final assessments was higher as compared to the balance in the ‘Receivable from Customs Account’. Since the balance in CWIP Account after transferring to the ‘Receivable from Customs Account’ and ‘MODVAT/CENVAT Credit Receivable Account’, was capitalised, this resulted in a higher transfer to the ‘Asset Account’. Accordingly, this has resulted in higher capitalisation by Rs. 4.78 crore.
8. In the year 2006-07, on receipt of final assessment orders from the Customs authorities, the company passed the following rectification entries:
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On account of higher MODVAT/CENVAT credit claimed by the company amounting to Rs. 9.46 crore: Since this had resulted in lower capitalisation, ‘Asset Account’ was debited and the ‘Receivable from Customs Account’ was credited.
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On final assessment, the deposit amount payable to the company by the Customs department was higher by Rs. 4.78 crore as compared to the balance available in the books of account: Since this resulted in higher capitalisation, ‘Receivable from Customs Account’ was debited by crediting ‘Asset Account’.
The net impact on fixed asset due to these rectification entries passed in the year 2006-07 was Rs. 4.68 crore.
9. The querist has stated that as per paragraph 6 of Accounting Standard (AS) 6, ‘Depreciation Accounting’, the cost of fixed asset may undergo changes subsequent to its acquisition or construction on account of exchange fluctuations, price adjustments, changes in duties or similar other factors. The querist has also stated that paragraph 25 of AS 6 states, inter alia, that where the historical cost of the asset has undergone a change due to the circumstances specified in paragraph 6 of AS 6, depreciation on the revised unamortised depreciable amount is to be provided prospectively over the residual useful life of the asset. Accordingly, as per the querist, the rectification entries carried out by the company on the basis of the decision of CESTAT were considered as changes due to the circumstances specified in paragraph 6 of AS 6 and depreciation on the additional amount capitalised on account of the circumstances explained above, was provided prospectively over the residual useful life of the asset.
10. The government auditors from the C&AG’s office, while conducting the audit under section 619(4) of the Companies Act, 1956, observed that the above case did not fall under ‘changes in duties or similar factors’, as the change in historical cost occurred not due to an event which occurred during the relevant accounting year (2006-07) but due to the fact that the company had claimed higher MODVAT/CENVAT credit benefit, without corresponding amount being capitalised in the previous year. Moreover, this change in cost has not occurred due to change in duty structure, either by the statute or consequent to the Tribunal Order.
B. Query
11. In view of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether changes in the cost of fixed assets arising out of CESTAT order and subsequent assessment fall within the purview of paragraph 6 of AS 6 as changes subsequent to acquisition or construction on account of changes in duties or other similar factors.
(ii) Whether computation of depreciation on such changes prospectively over the residual useful life of the asset is in order.
(iii) Whether subsequent adjustment to capitalisation as indicated in paragraph 10 above can be treated as ‘change in cost’ due to reasons given in paragraph 6 of AS 6 and consequent benefit of paragraph 25 of AS 6 can be availed.
C. Points considered by the Committee
12. The Committee notes that the basic issues raised by the querist relate to nature of the adjustment to the cost of the relevant fixed assets due to order of the Tribunal and subsequent assessment of BEs, and the manner of giving consequent effect to depreciation. Therefore, the Committee has examined only these issues and has not touched upon any other issue that may arise from the Facts of the Case, such as, timing of recognition of MODVAT/CENVAT credit receivable in the books of account and the propriety of the amount claimed by the company in respect thereof, various accounting entries passed by the company, difference in the date of capitalisation and the date of commissioning of the project, etc. The Committee’s opinion contained herein is purely from an accounting point of view. The Committee has not examined the laws relating to excise/customs duty.
13. The Committee notes paragraphs 6 and 25 of AS 6 as reproduced below:
“6. … The historical cost of a depreciable asset may undergo subsequent changes arising as a result of increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors.”
“25. Where the historical cost of a depreciable asset has undergone a change due to increase or decrease in long term liability on account of exchange fluctuations, price adjustments, changes in duties or similar factors, the depreciation on the revised unamortised depreciable amount should be provided prospectively over the residual useful life of the asset.”
The Committee also notes paragraph 9.1 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’ as reproduced below:
“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:
…
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.”
14. The Committee notes that at the time of capitalisation in the year 2001, the company applied the concessional rates as per Notification No. 11/97 (paragraph 5 above). Thus, the fixed assets were capitalised taking into account the concessional duties which was also the final order of the CESTAT received later. Upon receipt of final assessment, the company, in the year 2006-07, made two adjustments to the cost of fixed assets, viz., setting right the under-capitalisation of Rs. 9.46 crore (paragraph 6 above) and setting right the over-capitalisation of Rs. 4.78 crore (paragraph 7 above). The discussion regarding the two adjustments is contained in paragraphs 15 and 16 below.
15. As regards the first adjustment of Rs. 9.46 crore, the Committee notes that the under-capitalisation arose due to transfer of full CVD to MODVAT/CENVAT Credit Receivable Account from the CWIP Account instead of the amount of CVD which had actually been paid and debited to CWIP Account. The Committee is of the view that this is not a case of change in the cost due to change in import duties or similar factors. It is a case of an error which should be rectified. Accordingly, paragraphs 6 and 25 of AS 6 are not relevant for determining the manner of giving effect to depreciation adjustment arising out of setting right the under-capitalisation of Rs. 9.46 crore.
16. As regards the second adjustment of Rs. 4.78 crore, the Committee notes that the over-capitalisation arose due to non-transfer of some duties from CWIP Account to Receivable from Customs Account. The querist has not furnished any reason for such non-transfer. The Committee presumes that this is a case of omission. Consequently, in the view of the Committee, the adjustment of Rs. 4.78 crore is also a case of error which should be rectified. Accordingly, paragraphs 6 and 25 of AS 6 are not relevant for determining the manner of giving effect to depreciation adjustment arising out of setting right the over-capitalisation of Rs. 4.78 crore.
17. The Committee notes the following paragraphs of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’:
“4.3 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.”
Since the adjustments of Rs. 9.46 crore and Rs. 4.78 crore, mentioned in paragraphs 15 and 16 above, respectively, are rectification of errors, the consequent adjustment to depreciation amount should be treated as prior period item. Accordingly, adjustment to depreciation should be calculated with retrospective effect (and not prospective effect) and disclosed in accordance with AS 5.
D. Opinion
18. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 11 above:
(i) Changes in the cost of fixed assets arising out of CESTAT order and subsequent assessment do not fall within the purview of paragraph 6 of AS 6 as changes subsequent to acquisition or construction on account of changes in duties or other similar factors, as explained in paragraphs 15 and 16 above.
(ii) Computation of depreciation on such changes prospectively over the residual useful life of the asset is not in order.
(iii) See (i) and (ii) above.
1 Opinion finalised by the Committee on 15.12.2009
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