3. The statutory auditor of the company is of the view that as these expenses are not related to any specific fixed asset of the company, the same should be charged to the profit and loss account and should not be capitalised as pre-operative expenditure to the project cost as per paragraph 9.3 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India (ICAI) (Paragraph 9.2 of AS 10, notified under the Companies (Accounting Standards) Rules, 2006), which, inter alia, states that 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. The querist has stated that the management of the company is of the view that these expenditures can be capitalised in view of paragraph 9.3 of AS 10, issued by the ICAI, which, inter alia, states that 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. However, as per the querist, the statutory auditor does not agree with the same. (Emphasis supplied by the querist.)

B. Query

4. The querist has sought the opinion of the Expert Advisory Committee of the ICAI on the following issues in respect of the accounting treatment of the said administrative expenses/expenses which are not specifically related to any particular fixed asset, in view of AS 10 and other accounting standards, if applicable in this particular case:

    (i) Whether the expenses incurred during the construction of the project can be capitalised with the cost of fixed assets.

    (ii) Whether the expenses incurred during the construction of the project should be charged off to the profit and loss account. If yes, then whether the same should be charged every year, if the gestation period of the project is more than one year, though no commercial activity has been carried on by the company except that it was engaged in construction of the project only. (In this case, the profit and loss account will only show losses related to these expenditures.)

    (iii) If these expenses can not be capitalised, then whether the expenses incurred during construction of the project can be treated as pre-operative expenses and written off in installments or otherwise in future years, after start of commercial production instead of charging it to the profit and loss account in the same year in which the expenditure has been incurred.

C. Points considered by the Committee

5. The Committee notes that the basic issue raised in the query relates to the accounting treatment of administration expenses / indirect expenses not specifically related to any particular fixed asset, incurred during the construction of the project upto the date of commencement of commercial production. The Committee has, therefore, considered only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, accounting for preliminary expenses incurred during incorporation of the company, accounting for individual items of various expense heads as provided by the querist in paragraph 2 above, etc. The Committee presumes that the ‘financial expenses’ mentioned in paragraph 2 above, do not refer to ‘borrowing costs’ covered under Accounting Standard (AS) 16, ‘Borrowing Costs’, as the querist has referred to only AS 10 in the context of expenses mentioned in paragraph 2 above. The Committee’s opinion contained hereinafter is based on the general principles to be followed while accounting for such expenditure incurred during construction of the project. The exact expenditures that are to be capitalised/expensed will have to be determined on the basis of the said principles.

6. The Committee notes that the accounting principles for determination of the cost of a self-constructed fixed asset, have been laid down, inter alia, in paragraph 10.1 of AS 10, notified under the Companies (Accounting Standards) Rules, 2006, which provides as follows:

    “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 9.5² . 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.”

The Committee further notes paragraphs 9.1 and 9.2 of the notified AS 10 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:

        (i) site preparation;

        (ii) initial delivery and handling costs;

        (iii) installation cost, such as special foundations for plant; and

        (iv) professional fees, for example fees of architects and engineers.

…

    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.”

From a combined reading of the above paragraphs of AS 10, the Committee is of the view that the basic principle to be applied while capitalising an item of cost to a fixed asset/project under construction is that it should be directly attributable to the construction of the project/fixed asset for bringing it to its working condition for its intended use. The costs that are directly attributable to the construction/acquisition of a fixed asset/project for bringing it to its working condition are those costs that would have been avoided if the construction/acquisition had not been made. These are the expenditures without the incurrence of which, the construction of project/asset could not have taken place and the project/asset could not be brought to its working condition, such as, site preparation costs, installation costs, salaries of engineers engaged in construction activities, etc. The above-discussed principle of avoidance of costs as the basis of identifying directly attributable cost for the purpose of capitalisation is also supported by AS 16. In the extant case, the Committee is of the view that it should be seen that whether the expenses incurred are directly attributable to construction as discussed above. Accordingly, if the expenses incurred are directly attributable to construction, these can be capitalised with the cost of the concerned fixed asset(s)/ project. However, if these expenses cannot be said to be directly attributable to the construction of project/fixed asset(s), these should be expensed by way of a charge to the profit and loss account in the period in which these are incurred as no future economic benefit is expected from the same. The Committee is of the view that for this purpose, profit and loss account will have to be prepared by the company even before the commencement of commercial operations.

7. The Committee also wishes to point out that there may be an intervening period between the date the asset/project is ready for commercial production and the date when commercial production actually begins. The Committee is of the view that only those costs directly attributable to the construction incurred upto the stage of bringing the asset/project to its working condition for its intended use, i.e., for getting the asset/project ready for commercial production, can be capitalised with the cost of the asset/project. The costs incurred thereafter are to be expensed immediately.

D. Opinion

8. On the basis of the above, in respect of the administrative expenses/expenses which are not speficially related to any particular fixed asset, as given by the querist in paragraph 2 above, and subject to the considerations contained in paragraph 5 above, the Committee is of the following opinion on the issues raised in paragraph 4 above:

    (i) The expenses incurred during the construction of the project should be capitalised provided the expenses are considered to be directly attributable to the construction of the project/fixed asset(s) for bringing it(them) to its(their) working condition for its(their) intended use as discussed in paragraph 6 above.

    (ii) If the expenses incurred during the construction of the project cannot be said to be directly attributable to the construction of the project/fixed asset(s) for bringing it(them) to its(their) working condition for its(their) intended use and, therefore, not capitalised under (i) above, these should be expensed by way of charge to the profit and loss account in the period in which these are incurred. Refer paragraph 6 above.

    (iii) If the expenses incurred during the construction of the project cannot be said to be directly attributable to the construction of the project/fixed asset(s) for bringing it(them) to its(their) working condition for its(their) intended use and, therefore, not capitalised under (i) above, these cannot be written off in installments or otherwise in future years. Such expenses should be expensed in the period in which the same are incurred as per (ii) above.