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A. Facts of the Case
1. A public sector company registered under the Companies Act, 1956 is engaged in construction and operation of hydro-electric power projects. The components of a hydro-electric project, such as, power house, dam, tunnel, and colony are generally spread over a large area. For construction and operation of a hydro-electric project, good network of roads and bridges is a pre-requisite so as to facilitate the movement of men and machinery. Network of roads and bridges so created by the company is not only used for movement of men and machinery related to the project but is also used by the general local public residing in the vicinity of project area.
2. The land on which such roads/bridges are created are generally of the following three types:
(i) Freehold land;
(ii) Other Government land on which company has a right to use through lease agreement or other similar arrangement; and
(iii) Other land which is neither owned by the company nor the company has a right to use.
3. The querist has stated that roads/bridges created on land referred to in paragraph 2 (i) & (ii) above are treated as normal assets of the company following the provisions of the Accounting Standards and are depreciated as per depreciation policy of the company. So far as accounting for assets created on other land, which is neither owned by the company nor the company has a right to use, is concerned, the following accounting policies are being followed consistently:
“Policy No. 2.2:- Fixed assets created on land not belonging to the corporation are included under fixed assets.
Policy No. 2.3:- Capital expenditure on assets where neither the land nor the asset is owned by the company is reflected as a distinct item in capital work-in-progress till the period of completion and thereafter in the fixed assets.
Policy No. 5.8:- Capital expenditure referred to in Policy 2.3 is amortised over a period of 5 years from the year in which the first unit of project concerned comes into commercial operation and thereafter from the year in which the relevant asset becomes available for use.”
4. According to the querist, the above accounting policy is based on an earlier opinion of the Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (refer Query No. 1.3 of Volume XII of the Compendium of Opinions). Relevant paragraphs of the said opinion have been reproduced by the querist as below:
“(a) Fixed assets which, though having been built on land not belonging to the company, but are owned by the company, should form part of the relevant head of fixed assets belonging to the company and treated accordingly.
(b) Regarding fixed assets created on land not belonging to the company, which are also not owned by the company, the Committee reiterates its previous opinion (as referred to above), i.e., the expenditure incurred on the construction of such assets should be classified as ‘Capital Expenditure’ in the balance sheet indicating appropriately, the nature of the expenditure including the fact that the assets are not owned by the company. Also, after the commencement of commercial operations, the same should be written off to the profit and loss account over the approximate period of its utility or over a relatively brief period not exceeding five years, whichever is less. Thus, the expenditure may be written off in the year of commencement of commercial production if its utility does not last beyond that year, as indicated by the querist in para 4(b) of the query.”
(Emphasis supplied by the querist.)
5. The querist has stated that in one of the projects under construction, bridges/culverts etc. have been constructed over the land diverted to the company by forest department (falling under paragraph 2 (ii) above, as right to use the forest land is transferred to the company). Expenditure incurred for construction of these bridges/culverts etc. has been capitalised as distinct item of fixed asset under the head ‘Roads & Bridges’. Depreciation is being charged on such bridges from the date bridges are available for use. Expenditure is also incurred by the company for maintenance of these bridges.
6. During the audit of accounts for the financial year 2009-10, Office of the Comptroller and Auditor General (C&AG) of India has given an observation that expenditure incurred on construction of roads/bridges should have been treated as ‘Capital Expenditure on assets on land not owned by Company’, since such roads & bridges are constructed on land not belonging to the company and expenditure so incurred by the company is in the nature of common public facilities on which company does not have exclusive ownership. Accordingly, the auditor is of the view that such expenditure should be accounted for as per accounting policy No.2.3 and 5.8 of the company. The observation of the Office of the C&AG of India is reproduced below:
“Fixed Assets include Rs.____ lacs (inclusive of Bailey Bridge over______Nallah located on the road from_____ to _____ and Rs.____ lacs on two double lane permanent bridges over ______ Nallah and ____ Nallah) on Roads & Bridges constructed on the land not belonging to the Company.
As per Accounting Policy No. 2.3 and 5.8, capital expenditure on assets where neither the land nor the asset is owned by the company is reflected as distinct item in Capital work-in-progress till the period of completion and thereafter in the fixed asset and amortised over a period of 5 years from the year in which the first unit of Project concerned comes into commercial operation.
The above expenditure incurred for the purpose of project are in the nature of common public facilities on which the company does not have exclusive ownership and as such the same should have been shown under “Capital Expenditure” in the Balance Sheet instead of Fixed Assets resulting in over-statement of Gross Block, Net Block and Accumulated Depreciation by Rs._____ lacs, Rs.___ lacs and Rs.___ lacs with corresponding under-statement of Capital Expenditure by Rs.____ lacs.”
7. The management of the company contended that the land, on which these roads/bridges are constructed, belongs to company by virtue of ‘right to use’. Therefore, assets created thereon shall be the assets of the company and mere use of these assets by public also does not change the nature of these assets. The contention of the management, however, did not find merit with the auditor on the ground that the roads/bridges under question are being used by common public also and as such, these should have been accounted for as per accounting policy no. 2.3 and 5.8 of the company. The management gave assurance to the auditor that the issue shall be referred to the Expert Advisory Committee. The excerpt of final assurance letter of management reads as under:
“-----------------Land in these cases was either diverted by Forest Department or handed over by the ________ Board (from whom the said Project was taken over) to the company. Since the land belongs to company / company has the right to use this land, the asset created on these pieces of land are being treated as assets of the company and use by public also of these assets does not change the nature of assets. These assets are also being maintained by company. As agreed during today’s discussions, we shall however be referring this issue to the Expert Advisory Committee of the Institute of Chartered Accountants of India and shall take further necessary action accordingly.”
8. The issue was dropped on the aforesaid assurance of the management.
B. Query
9. Keeping in view the above, the querist has sought the opinion of EAC on the following issues:
(a) Whether the accounting treatment followed by the company and referred to in paragraphs 2 and 5 above is correct in terms of Indian Generally Accepted Accounting Principles (GAAPs).
(b) If not, what should have been the accounting treatment for such assets.
(c) Whether mere use of the assets, created on land referred to in paragraph 2 (i) and (ii) above, also by public changes the nature of assets.
C. Points considered by the Committee
10. The Committee notes from the Facts of the Case that the basic issue raised in the query relates to accounting for expenditure incurred on construction of roads, bridges, etc. which are created by the company on two types of lands, viz., (i) freehold land owned by the company and (ii) land which is not owned by the company but the company has a right to use it. The Committee has, therefore, considered only this issue and has not touched upon any other issue that may arise from the Facts of the Case, such as, amortisation, if any, to be provided on roads, bridges, etc. At the outset, the Committee also wishes to point out that the opinion expressed by the Committee, hereinafter, is in respect of accounting for the expenditure incurred on above-mentioned assets and not in respect of freehold land or right to use of land which would be recognised separately in the books of the company.
11. The Committee notes that paragraphs 49 and 88 of the ‘Framework for the Preparation and Presentation of Financial Statements’, issued by the Institute of Chartered Accountants of India, give respectively, the following definition of and recognition criteria for, an asset:
“An asset is a resource controlled by the enterprise as a result of past events from which future economic benefits are expected to flow to the enterprise.”
“88. An asset is recognised in the balance sheet when it is probable that the future economic benefits associated with it will flow to the enterprise and the asset has a cost or value that can be measured reliably.”
From the above, the Committee notes that an expenditure incurred by an enterprise can be recognised as an asset only if it is a ‘resource controlled by the enterprise’. Thus, it is the control over the asset that is important for recognising an asset rather than ownership as being argued in the Facts of the Case. Therefore, the issue raised by the querist requires examination from the point of view of the type of the resource that the company controls, if any, as a result of expenditure on the said assets/facilities (roads, bridges, etc.). For this purpose, the Committee has examined whether the expenditure results into recognition of a tangible asset or an intangible asset.
12. The Committee is of the view that the above-mentioned expenditure can be considered to result into a tangible asset, only when, the company has a ‘control’ over such asset(s). The Committee is of the view that an entity that controls an asset can generally deal with that asset as it pleases. For example, the entity having control of an asset can exchange it for other assets, charge a price from others to use it, use it to settle liabilities, or distribute it to owners. Further, the Committee is of the view that an indicator of control of an item of fixed asset would be that the entity can restrict the access of others to the benefits derived from that asset. This view is also supported by the principles enunciated in paragraph 14 of Accounting Standard (AS) 26, ‘Intangible Assets’, as reproduced in paragraph 14 below.
13. The Committee notes from the Facts of the Case that the facility of roads, bridges, etc. is being used by the general public. However, it is not clear from the Facts of the Case that whether the company has a right to restrict their use by the general public. Also, it is not clear whether the other above-mentioned factors indicating control of the company on these assets exist.
14. The Committee now examines whether the above-said expenditure results into an intangible asset for the company. In this context, the Committee notes the following paragraphs from AS 26:
“An intangible asset is an identifiable non-monetary asset, without physical substance, held for use in the production or supply of goods or services, for rental to others, or for administrative purposes.
An asset is a resource:
(a) controlled by an enterprise as a result of past events; and
(b) from which future economic benefits are expected to flow to the enterprise.”
“14. An enterprise controls an asset if the enterprise has the power to obtain the future economic benefits flowing from the underlying resource and also can restrict the access of others to those benefits. …”
From the above, the Committee is of the view that the expenditure incurred by the company on these assets would meet the definitions of the terms ‘asset’ and ‘intangible asset’ only when these assets are controlled by the company. Accordingly, the expenditure incurred by the company on these assets can be recognised as an asset only when the company has a ‘control’ over these assets keeping in view the various factors as mentioned in the above paragraphs. The Committee is further of the view that in the absence of such ‘control’, the expenditure incurred on the said assets should be expensed and charged to the profit and loss account of the period in which these are incurred, even though the economic benefits are expected to flow to the enterprise from such facilities. In this regard, the Committee notes paragraph 56 of AS 26 which provides as follows:
“56. In some cases, expenditure is incurred to provide future economic benefits to an enterprise, but no intangible asset or other asset is acquired or created that can be recognised. In these cases, the expenditure is recognised as an expense when it is incurred. …”
15. The Committee may also state that the treatment given in the earlier opinion of the Committee (Query No. 1.3 of Volume XII of the Compendium of Opinions), as referred by the querist was based on the provisions of the Guidance Note on Treatment of Expenditure during Construction Period, which has been withdrawn by the Council of the Institute of Chartered Accountants of India vide its decision taken at its 280th meeting held on August 7-9, 2008. Further, the recommendations contained in the Guidance Note in respect of this type of expenditure were superseded from the date AS 26 became applicable to the company, which required expensing of such expenditures where no asset is created as discussed above. Therefore, if, after AS 26 became applicable to the company, the expenditure incurred on these assets where no ‘control’ exists, was not expensed by the company as per the requirements of AS 26, as discussed above, the same is an error committed in the prior years which should be rectified in the financial statements and disclosed as a ‘prior period item’ of the period in which such rectification is carried out in accordance with the requirements of Accounting Standard (AS) 5, ‘Net Profit or Loss for the Period, Prior Period Items and Changes in Accounting Policies’.
D. Opinion
16. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9 above:
(a) The accounting treatment followed by the company of recognising the expenditure incurred on roads, bridges, etc. which are created on freehold land/land on which the company has a right to use as fixed asset/‘capital expenditure on assets on land not owned by the company’ would be correct only when the company has a ‘control’ over these resources as discussed in paragraphs 12, 13 and 14 above.
(b) The accounting treatment of the expenditure incurred on these assets not owned by the company would depend upon whether these assets are controlled by the company. Refer to paragraphs 12, 13, 14 and 15 above.
(c) Mere use of the assets by public, created on the land in question does not change the nature of the assets, the basic idea is to consider control as discussed in paragraphs 13 and 14 above.
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