1.5       Query

Whether materials produced by a company and used in an expansion project

should be capitalised at the manufacturing cost or at selling price.

A public limited company manufacturing rolled steel has recently expanded to produce concast steel. More than 500 tons of rolled steel had been consumed in the expansion project. During the relevant period the cost of manufacturing rolled steel was more than its selling price. The querists have sought the opinion of the Expert Advisory Committee whether the cost of manufacture of rolled steel or its selling price should be considered for computing the project cost.

Opinion                                         February 18, 1983

 1.The Committee notes that para 16.2 of the Institute’s Study on Expenditure During Construction Period suggests that “the following guidelines may be regarded as the basis for determining the correct accounting treatment in the case of a project which carries out a programme of capital expansion concurrently with normal production: -

 “(a) All direct capital expenditure must be capitalised in the normal way.”

 2. The normal way of capitalising a direct capital expenditure is on cost basis. Para 15 of IAS-16 on Accounting for Property Plant and Equipment clearly states: “Included in the gross carrying amount 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.” However, according to para 16 of IAS-16 “Cost inefficiencies in the production of self-constructed assets, whether due to temporarily idle capacity, industrial disputes or other causes, are normally not considered to be suitable for capitalisation. It is usually appropriate to have regard to a comparison with the cost of equivalent purchased assets or, if an enterprise makes similar assets for sale in the normal course of business, the cost of producing the assets for sale”.

 3. On the basis of the above, the Committee is of the opinion that since the company is manufacturing rolling steel for sale in the normal course of business, the cost of producing the same should be considered for computing the project cost. However, the cost of production of rolling steel should be calculated on the basis of normal capacity utilisation of plant so that the cost inefficiencies are not capitalised.

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