Query No. 3

Subject:

Treatment of subsequent expenditure on fixed asset as deferred

revenue expenditure – whether appropriate.¹

A. Facts of the Case

1. A company was incorporated in the year 1976 as a wholly owned Government of India enterprise under the administrative control of the Ministry of Power to plan, promote, investigate, survey, design, construct, generate, operate and maintain hydro and thermal power stations and to explore and utilise the power potential of North East in particular. The company is presently running three hydro projects and two thermal projects in north-eastern States and is catering to the demand of north-eastern States only. The company’s shares are not listed with any stock exchange. The authorised and paid up share capital of the company as on 31.03.2008 are Rs. 3500 crore and Rs. 3178.93 crore, respectively. The turnover of the company for the year ending 31.03.2008 is Rs. 860.31 crore.

2. The querist has referred to the notes to accounts of the company for the year 1987-88 which is reproduced below:

    “A mishap occurred in Umrong Tunnel during filling in September, 1986 followed by submerging of generating units of Kopili Power Station due to the unprecedented flood in the river in October, 1986. The total cost of rectification and remedial works, restoration of generating Unit of Kopili Power House, Power house protection works and strengthening of portion of both Umrong and Khandong Tunnel due to leakage in tunnel after completion was estimated at Rs. 21.1 crore. This estimate has been cleared by Central Electricity Authority (CEA), but approval of Government of India is awaited. As per general practice, the Umrong Tunnel was not insured during construction and commissioning stage. The claim has however been made for damage to the power house equipments which were under insurance coverage. A sum of Rs. 20.00 lakh received from the insurance company towards this claim as an on-account payment pending completion of final assessment towards the cost of repairs/replacements of the power house equipment has been credited to the plant and machinery under installation under capital work-in-progress. The final position of claim will be known on final assessment of cost of repairs/replacements of the power house equipments.

    The expenditure on remedial and strengthening of Khandong system which was under operation is being treated as deferred revenue expenditure to be written off in five accounting years including the accounting year in which the power house has been recommissioned.”

B. Query

3. The querist has sought the opinion of the Expert Advisory Committee as to whether the treatment of expenditure incurred on remedial and strengthening measures of units which were under operation as deferred revenue expenditure to be written off in 5 accounting years, is in compliance with the existing Accounting Standards and generally accepted accounting principles. If not, the querist has sought advice with respect to the modification required.

C. Points considered by the Committee

4. The Committee notes from the Facts of the Case that rectification and remedial works were performed on certain units which were under construction and at commissioning stage and also on units which were under operation. The Committee further notes that the querist has raised the query only with respect to the expenditure incurred on units which were under operation and, therefore, the Committee restricts its opinion to this issue only. The Committee has not examined any other issue(s) that may be contained in the Facts of the Case.

5. The Committee is of the view that since the units were already under operation when the mishap occurred, any rectification and remedial work performed on the same would constitute subsequent expenditure related to the fixed asset. In this respect, the Committee notes the following paragraphs of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’:

    “12.1 Frequently, it is difficult to determine whether subsequent expenditure related to fixed asset represents improvements that ought to be added to the gross book value or repairs that ought to be charged to the profit and loss statement. Only expenditure that increases the future benefits from the existing asset beyond its previously assessed standard of performance is included in the gross book value, e.g., an increase in capacity.

     12.2 The cost of an addition or extension to an existing asset which is of a capital nature and which becomes an integral part of the existing asset is usually added to its gross book value. Any addition or extension, which has a separate identity and is capable of being used after the existing asset is disposed of, is accounted for separately.”

     “23. Subsequent expenditures related to an item of fixed asset should be added to its book value only if they increase the future benefits from the existing asset beyond its previously assessed standard of performance.”

6. The Committee is of the view that expenditure on fixed assets subsequent to their installation may be categorised into (i) repairs, and (ii) improvements or betterments. Repairs, in the Committee’s view, implies the restoration of a capital asset to its full productive capacity after damage, accident, or prolonged use, without increase in the previously estimated useful life or capacity. Expenditure on repairs, including replacement cost necessary to maintain the previously assessed standard of performance, is expensed in the same period. On the other hand, in the view of the Committee, expenditures on improvements or betterments are expenditures that add new fixed asset unit, or that have the effect of improving the previously assessed standard of performance, e.g., an extension in the asset’s useful life, an increase in its capacity, or a substantial improvement in the quality of output or a reduction in previously assessed operating costs. Such expenditures are capitalised. The Committee is of the view that ‘previously assessed standard of performance’ is not the actual performance of the asset at the time of repair, improvement, etc., but the standard performance of the same asset expected at this stage of life, as assessed when the asset was installed.

7. From the above and in the absence of any information to the contrary, the Committee is of the view that subsequent expenditure incurred by the company on the units under operation is of the nature of repairs and, accordingly, the same should be expensed when incurred.

D. Opinion

8. On the basis of the above, the Committee is of the opinion that treatment of expenditure on remedial and strengthening measures of units which were under operation as deferred revenue expenditure to be written off in 5 accounting years is not in compliance with the existing Accounting Standards and generally accepted accounting principles. Such expenditure, in the case of the company, should be expensed when incurred. The accounting policy should be modified accordingly.

¹Opinion finalised by the Committee on 5.3.2009