A. Facts of the Case
1. A public sector undertaking (hereinafter referred to as ‘the company’) is a leading steel-making company in India having five integrated steel plants and three special steel plants located at different places in India. A subsidiary company of the company produces ferro-alloys. The company produces both basic and special steels for domestic construction, engineering, power, railway, automotive and defence industries as well as for sale in export markets. The turnover of the company in the financial year 2008-09 was Rs. 48,681 crore. It has a direct employment of about 1,10,000 people.
2 The company also owns iron ore mines, flux mines and coal mines located in various states. The company is one of the largest producers of iron ore. The company is in the process of developing new iron ore and coking coal mines. The company has a competitive edge in terms of captive availability of iron ore, limestone, and dolomite, which are essential inputs for iron and steel making.
3. The company, jointly with National Mineral Development Corporation (NMDC) Limited, has entered into an agreement with the Ministry of Railways for the construction of Broad Gauge (BG) rail link in two phases. The phase-1 is for 95 km and phase-2 is for 140 km at an approximate cost of Rs. 968 crore to provide sustained iron ore supply to a steel plant (hereinafter referred to as ‘SP’) of the company. The total time period of construction will be 5 years for the phase-1. The commencement of the work on the phase-2 will be taken up simultaneously along with the phase-1.
4. The company will bear the actual cost of construction of the new BG line for the phase-1 (95 km.) estimated at Rs. 702.93 crore at June 2008 price level and any escalation during the construction period of 5 years. For the portion of the railway line section in the phase-2 (140 km), the company and NMDC will provide a proportionate assistance of Rs. 141.30 crore and Rs. 70.70 crore (2004-05 price level) respectively and any escalation therein. Out of the total estimated construction cost of Rs. 844.23 crore of both phases of laying of railway line, till date, the company/SP has made payments towards phase-1, of Rs. 123 crore in cash and Rs. 9.49 crore in kind, i.e., steel produced by the SP/the company. There is no progress of job in phase-2 and the agency for job in phase-2 is yet to be finalised. Accordingly, as per the querist, the company does not have revised estimates for phase-2 at 2008-09 price level. The querist has also stated that for phase-1, the estimate was of Rs. 304.30 crore (at 2004-05 price level), which was preliminary without observed data base and also did not include Interest During Construction (IDC). The updated estimate of Rs.702.93 crore (at 2008-09 level) was based on ground topographic data and on realistic basis. It also includes Rs. 71.15 crore towards IDC. The increase in estimates is towards both change in scope of work (Rs. 138.92 crore) as well as price escalation (Rs. 188.56 crore). The querist has also mentioned that the revised estimate in phase-1 was furnished by a third party, M/s. ABC Ltd. The State Government will provide concessions by making available, Government land free of cost, for construction of the said railway line and other benefits. The ownership of the railway line will remain with the Railways.
5. The querist has stated that the Railways will pay at the end of every year to the company, cash at the rate of 7% per annum for 37 years on total contribution towards redemption of the company’s contribution, commencing from the 1st year after commissioning of the phase-I of the project, provided that the company ensures a minimum of 4 million tonnes of iron ore traffic per year from the 1st year and 9 million tonnes from the 3rd year of operation onwards for the phase-2 as per their commitment. Reconciliation of compliance of minimum traffic guaranteed by the company shall be done at the end of every 4 years over the period of 37 years and the 37th year on cumulative basis. In case, any shortfall is observed during such reconciliation, further payment shall be made only after the shortfall, if any, in the minimum traffic guaranteed for the period reconciliation is made good.
6. Ministry of Railways will pay at the end of every year, cash at the rate of 7% per annum for 37 years on total investment by NMDC commencing from the 1st year after commissioning of phase-2 of the project. Railways will provide priority to traffic transportation requirements of the company and NMDC on this route for 37 years.
7. The querist has further stated that there is no uncertainty with regard to minimum traffic movement of 9 million tonnes annually, as the iron ore requirements of the company/SP will be sourced mainly through this rail route only.
8. According to the querist, against the payment of Rs. 844.23 crore, the company would recover Rs. 2,186.55 crore over a period of 37 years. As on 31st March, 2011, cost incurred on the project amounting to Rs. 123 crore is shown as ‘Deposit with Railways’ under the head ‘Loans & Advances’.
B. Query
9. The opinion of the Expert Advisory Committee (EAC) is being sought by the querist on the following matters:
(i) Whether the payments of Rs. 844.23 crore by the company to Railways should be disclosed as ‘Advance Recoverable’ under Current Assets. Whether the amount received from Railways every year should be bifurcated into principal and interest by applying the effective rate of interest. The Deposit Advance amount should be reduced by the principal recovery amount and interest amount will be disclosed as income.
or
(ii) Whether the payments to Railways should be charged to revenue as per the opinion given by the EAC, published in January 2011 issue of the Institute’s Journal, ‘The Chartered Accountant’, for assets constructed on land not owned by the company and either the amount recoverable from railways should be treated as ‘Advance Recoverable’, to be adjusted over 37 years against recoveries thereof from Railways after bifurcation between principal recoveries and interest income or the amount recoverable at the rate of 7% p.a. should be disclosed as income of the year every year.
or
(iii) Whether the payments to Railways should be capitalised under the head ‘Railway Lines’ to be depreciated over its normal life and the amount recoverable after reducing the amount paid to Railways should be classified as advance recoverable, to be adjusted over 37 years against recoveries thereof from Railways after bifurcation between principal recoveries and interest income.
C. Points considered by the Committee
10. The Committee notes that the basic issues raised in the query relate to accounting treatment of payments/contribution made and materials supplied for construction of assets not owned by the company and its subsequent recovery (along with interest) at a fixed rate after commissioning of the relevant phase of the Project. The Committee has, therefore, considered only these issues and has not examined any other issue that may arise from the Facts of the Case, such as, accounting for interest paid by the company during construction, accounting treatment under the situation when the company fails to make good the shortfall in minimum traffic guarantee of iron ore, correctness in calculation of total recovery amount from the Railways and appropriateness of using the term ‘Deposit with Railways’ for the payment made by the company, etc. At the outset, the Committee wishes to point out that while making estimate of the total expenditure required for construction of the Project, the estimates for Phase-1 have been determined at the 2008-09 price level, whereas for Phase–2, the estimates have been determined at the 2004-05 price level; however, the Committee is of the view that this does not affect the opinion of the Committee expressed hereinafter. The Committee, while expressing its opinion, has also presumed that there is no uncertainty with regard to the guaranteed minimum traffic movement of 4 million tonnes / 9 million tonnes of iron ore annually as per the terms agreed with the Government. The Committee also notes that the amount of Rs. 844.23 crore at certain places in the Facts of the Case has been stated as estimates and at other places, it has been stated as payments. The Committee wishes to point out that the opinion expressed hereinafter is only in respect of the actual payment/contribution made to the Railways as that is the issue raised by the querist.
11. The Committee notes from the Facts of the Case that the contribution is being made by the company to the Railways in cash as well as in kind, viz., supply of materials (steels). With regard to recognition of contribution made by the company in cash/kind, 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’. 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 contribution towards the construction of the BG rail link. For this purpose, the Committee has examined whether such contribution results into recognition of a tangible asset, an intangible asset or an advance to be reimbursed in future.
12. The Committee is of the view that the above-mentioned contribution would be considered to result into a tangible asset, i.e., BG rail link, only when, the company is able to control 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, employ it to produce goods or services, charge a price for others to use it, use it to settle liabilities, hold it, or distribute it to owners. Further, the Committee is of the view that an indicator of control of an item of (tangible) fixed asset would be that the company is ordinarily responsible for the repairs, maintenance, upgradation and replacement of that item. In other words, the company should have the ability to decide how the fixed asset is operated and maintained and when it is replaced. Since no such indicators exist in the extant case, the Committee is of the view that the company, although utilising the rail link for its business, does not possess any control over the ‘BG rail link’, and accordingly, such contribution cannot be recognised as a tangible asset in the books of the company.
13. The Committee now examines whether the payment results into an intangible asset for the company. In this regard, the Committee notes the definition of the term, ‘intangible asset’ as provided by paragraph 6.1 and paragraphs 11 and 13 of Accounting Standard (AS) 26, ‘Intangible Assets’, notified under the Companies (Accounting Standards) Rules, 2006, which provide as follows:
“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.”
“11. The definition of an intangible asset requires that an intangible asset be identifiable. To be identifiable, it is necessary that the intangible asset is clearly distinguished from goodwill. Goodwill arising on an amalgamation in the nature of purchase represents a payment made by the acquirer in anticipation of future economic benefits. The future economic benefits may result from synergy between the identifiable assets acquired or from assets which, individually, do not qualify for recognition in the financial statements but for which the acquirer is prepared to make a payment in the amalgamation.”
“13. Separability is not a necessary condition for identifiability since an enterprise may be able to identify an asset in some other way. For example, if an intangible asset is acquired with a group of assets, the transaction may involve the transfer of legal rights that enable an enterprise to identify the intangible asset. Similarly, if an internal project aims to create legal rights for the enterprise, the nature of these rights may assist the enterprise in identifying an underlying internally generated intangible asset. Also, even if an asset generates future economic benefits only in combination with other assets, the asset is identifiable if the enterprise can identify the future economic benefits that will flow from the asset.”
From the above, the Committee notes that ‘identifiability’ is a necessary condition for recognition of an intangible asset. The Committee notes from the Facts of the Case that although the company may acquire a right of priority in terms of traffic transportation on the BG rail link, from the above-mentioned contribution; yet, from the Facts of the Case and circumstances, it appears that the primary objective of the transaction is to develop infrastructure for transportation of the material, rather than to obtain a right of priority to transport the material. In the view of the Committee, therefore, such right does not appear to satisfy the test of identifiability. Accordingly, it cannot be recognised as an intangible asset in the books of the company.
14. The Committee further notes from the Facts of the Case that while the company contributes towards construction of the BG rail link both in cash as well as in kind, viz., supply of materials (steels), the ownership of the BG rail link shall remain with the Railways. Further, such contribution will be reimbursed by the railways in cash at the rate of 7% of the contribution per annum for a period of 37 years, thus, repaying more than the contribution made by the company. As regards contribution made by the company in cash, the Committee is of the view that since the amount being recovered is more than the amount originally contributed by the company, such contribution, in substance, is an interest-bearing advance to the Railways from the company. It is irrelevant that the amount so advanced is being utilised by the Railways for construction of the BG rail link. Further, the Committee notes that as per Schedule VI2 (pre-revised) to the Companies Act, 1956, the sub-head, ‘Loans and Advances’ of the head ‘ Current Assets, loans and Advances’ to the ‘Assets’ side of the balance sheet include ‘Advances recoverable in cash or kind or for value to be received’. Hence, the Committee is of the view that the aforesaid amount should be disclosed as an ‘advance’. Under revised Schedule VI also, such advance is to be classified under the sub-head ‘Long-term loans and advances’ under the head ‘Non-current assets’ on the assets side of the balance sheet. As regards the contribution made by the company in kind, viz., through supply of materials, the Committee is of the view that the company is in a way selling its goods to the Railways, for which consideration will be received in future. Thus, it is sale of goods on deferred credit terms. In this regard, the Committee notes that paragraph 4.1 of Accounting Standard (AS) 9, notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as the ‘Rules’) defines the term ‘revenue’, which provides as follows:
“ 4.1 Revenue is the gross inflow of cash, receivables or other consideration arising in the course of the ordinary activities of an enterprise from the sale of goods, from the rendering of services, and from the use by others of enterprise resources yielding interest, royalties and dividends. Revenue is measured by the charges made to customers or clients for goods supplied and services rendered to them and by the charges and rewards arising from the use of resources by them. In an agency relationship, the revenue is the amount of commission and not the gross inflow of cash, receivables or other consideration.”
From the above, the Committee is of the view that the contribution by the company in kind should be recognised as ‘revenue’ at the time when the material is supplied to the Railways provided other conditions for recognition of such revenue as per the principles of AS 9 are satisfied. The revenue so recognised should be disclosed as ‘sundry debtors’ as per the pre-revised Schedule VI and as ‘trade receivables’ as per revised Schedule VI under the head ‘Current Assets’. The Committee also notes from the Facts of the Case that the amount contributed by the company is recoverable every year at the rate of 7% of the contribution over a period of 37 years, thus, the total contribution which includes the revenue earned by the company is being recovered in instalments. In this regard, the Committee notes paragraph A(8) of the ‘illustrations’ to AS 9, notified under the Rules, which provides as follows:
“8. Instalment sales
When the consideration is receivable in instalments, revenue attributable to the sales price exclusive of interest should be recognised at the date of sale. The interest element should be recognised as revenue, proportionately to the unpaid balance due to the seller.”
15. From the above, the Committee is of the view that as far as recovery against the contribution in kind is concerned, on receipt of each instalment, the company should recognise the interest element as ‘other income’ proportionately to the unpaid balance of debtors due to the company and balance will be treated as principal recovery amount. Accordingly, on such recovery, the debtors’ balance will be reduced by the principal recovery amount.
16. The Committee notes that out of the total amount being recovered, besides recovery against installment sales, the balance amount being recovered against ‘advances’ (as discussed in paragraph 14 above) also consists of two elements – the principal amount as well as the interest amount. So, while accounting for the same, it should be bifurcated into the ‘principal’ and the ‘interest’ elements by applying a rational method, for example, by adopting an appropriate effective rate of interest. Accordingly, on each recovery, the interest portion will be recognised as ‘other income’ in the books of account of the company and the principal portion will be treated as recovery of the ‘advances’ which will reduce the amount of ‘advances’.
D. Opinion
17. On the basis of the above, the Committee is of the opinion that the payments being made by the company to the Railways cannot be recognised either as a tangible or intangible asset. Based on the nature of contribution being made, viz., in cash or in kind, the contribution in kind should be recognised as ‘revenue’ from sale of goods and the contribution in cash should be recognised as an Advance under the head ‘Loans and Advances’. On recovery of the contribution in kind, the company should recognise the interest element as ‘other income’ proportionately to the unpaid balance of debtors due to the company and the balance should be treated as recovery of the principal amount. Accordingly, the debtors’ balance will be reduced by the recovery of the principal amount on each recovery. Further, recovery against the cash contribution, i.e., advances, should again be bifurcated into the ‘principal’ and the ‘interest’ elements as discussed in paragraph 16 above. The reasoning and methodology of the said treatment is given in paragraphs 11 to 16 above.
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