Query No. 25
Subject: Treatment of capital expenditure on assets not owned by the company.1 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 (gross) of the company in the financial year 2010-11 was about Rs. 47,100 crore. It has a direct employment of about 1, 10, 000 people.
3. A steel plant (hereinafter referred to as ‘SP’) of the company is increasing production capacity to 7 million tonnes from the existing production of 4.8 million tonnes. Iron ore deposits of existing mines of SP are depleting. To sustain the existing production and requirement of iron ore for increased capacity, SP is developing a mining project for mining of iron ore in a certain state. This project would involve setting up of crushing plant, screening plant, beneficiation plant, heavy earth moving equipments and cranes etc. at the mining area. For setting up various mills at the mining area and their operation, electricity is required. For taking electricity connection, the matter was taken up with the concerned State Electricity Authority. The authority intimated that the nearest sub-station from where the power can be supplied is 51 km away from the mining area. The electricity connection can be provided only if the cost of transmission lines of 51 km is borne by the company.
4. For this purpose, the company has entered into a Memorandum of Understanding with the concerned State Power Transmission Company Limited (hereinafter referred to as ‘SPTCL’) for construction of the 132 KV Discrete and Continuous Dynamical Systems (DCDS) electricity power supply line. The total time period for implementation of project will be 36 months from the date of deposit of project cost, to be deposited in one installment. As on date, the company/SP has deposited an amount of Rs. 51.34 crore on 26th March, 2011, and is reflected as a ‘Deposit with Electricity Board’ under the head `Loans & Advances’ in the books of the company/SP. The ownership of the 132 KV DCDS power supply line will remain with the SPTCL.
5. Though, at present, the electricity power supply line is being laid down by SPTCL for use by the company for its mining area, the SPTCL may use the facility in future for the benefit of others. Further, if the work of laying down the electricity power supply line is not completed by SPTCL at all or partially completed or abandoned in between, then the full amount or partial amount, as the case may be, would be refundable to the company/SP.
6. The querist has stated that in the past, the company/SP had been following the accounting practice, as given below, in respect of such payments:
7. The querist has further stated that the Expert Advisory Committee of the Institute of Chartered Accountants of India has opined (as published in Journal of the Institute for the month of January 2011) that capital expenditure on items, like electricity transmission lines, railway siding, roads, culverts, etc., the ownership of which is not with the company, should be charged off to revenue in the accounting period of incurrence of such expenditure. Moreover, any amount shown under capital work-in-progress (CWIP), which was created in the previous years, being an error, should be rectified and disclosed as a ‘prior period item’. Based on the above opinion, the statutory auditors of the company are of the opinion that amount paid by the company/SP to SPTCL should be charged to revenue whenever payment is released to SPTCL.
8.The company’s management is of the opinion that the purpose of payments made by the company to SPTCL is to obtain electricity power connection for setting up and running of various machines at the mining area, the same should be capitalised as cost of the machines due to the fact that the expenditure is directly attributable to bringing the machines to their working condition for their intended use in the mining area. The accounting treatment is based on the following paragraphs of Accounting Standard (AS) 10 ‘Accounting for Fixed Assets’, notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as the ‘Rules’):
Further, based on the principle of matching of revenue with costs, such payments should be charged to revenue only once the construction of electricity transmission line is complete and machines start production of ore B. Query9. The opinion of the Expert Advisory Committee of the Institute is sought on the following matters:
C. Points considered by the Committee10. The Committee notes that the basic issue raised in the query relates to accounting treatment of amounts paid for construction of electricity power supply/transmission lines by SPTCL. 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 the expenditure incurred on expansion/increase in the capacity of the steel plant of the company, relation of payments in respect of transmission lines with increase in the production capacity of Steel Plant, etc. The Committee notes from paragraph 3 of the Facts of the Case that the company is increasing production capacity from existing 4.8 million tones to 7 million tones. However, it is not clear that how the existing production capacity is being increased without any improvement/addition to the Steel Plant, merely by increasing supply of raw material, viz., iron ore. The Committee further notes from the Facts of the Case that the SPTCL may use the facility (for which the construction cost is being paid by the company) in future for the benefit of others also. In the absence of any information to the contrary, the Committee presumes that the expenditure on such assets is neither adjustable against any payment to be made by the company towards future use of such assets nor provides any privilege/priority in terms of power supply.
11. The Committee notes that paragraphs 49(a) 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:
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 expenditure on construction of electricity transmission lines. 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 would be considered to result into a tangible asset, i.e., electricity transmission lines, 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 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 ownership of electricity transmission lines shall remain with the SPTCL. The company has neither any say on the distribution of power supply to others nor it has any privilege/priority in terms of power supply. Moreover, SPTCL may use the facility (transmission lines) in future for the benefit of others also. Thus, none of the factors mentioned in paragraph 12 above indicating control of the company on electricity transmission lines is evident. Thus, electricity transmission line is not the resource controlled by the company and therefore, the amount paid by the company on construction of electricity transmission lines cannot be capitalised as a separate tangible asset.
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:
From the above, the Committee is of the view that the amounts paid for the construction of electricity transmission lines not owned by the company does not meet the definitions of the terms ‘asset’ and ‘intangible asset’ as, even though the economic benefits are expected to flow to the enterprise from such facilities, the company does not have control over such facilities. Accordingly, such payments towards construction of transmission lines cannot also be capitalised as a separate intangible asset.
15. The Committee has also examined whether the said payments can be considered as a component of cost of various fixed assets involved in the mining project or mining project itself. In this context, the Committee notes paragraphs 9.1 and 9.2 of AS 10 notified under the ‘Rules’, as reproduced in paragraph 8 above. The Committee is of the view that the basic principle to be applied while capitalising an item of cost to the cost of a fixed asset/project 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 generally those directly related 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. As regards the contention of the management that since the purpose of payments made by the company to SPTCL is to obtain electricity power connection for setting up and bringing various machines viz. crushing plant, screening plant, beneficiation plant etc., at the mining area, to their working condition for their intended use, the same should be capitalised as the cost of machines as it is directly attributable cost, the Committee is of the view that it is only the cost of electricity consumed in the setting up/construction of machines in the mining area/ mining project that can be considered as directly attributable cost to the machines/project rather than the cost of setting up the electricity transmission lines. Moreover, as the electricity transmission lines would not only be used for setting up of machines but also in their operation, therefore, the payments made for construction of such facility cannot be said to be directly attributable to construction activity in general. It is the power consumed in setting up of the machines/project which would be directly attributable cost of setting up machines/projects that can be capitalised.
16.The Committee further notes that paragraph 56 of AS 26, notified under the ‘Rules’ provides as below:
From the above, the Committee is of the view that the expenditure incurred on construction of electricity transmission lines should be expensed and charged to the statement of profit and loss of the period in which these are incurred.
17. With regard to the second issue relating to timing of recognition of expense in relation to payment towards transmission lines, the Committee notes from paragraph 5 above that if the work of laying down the transmission line is not completed by SPTCL at all or partially completed or abandoned in between, then the full amount or partial amount, as the case may be, would be refundable to the company/Steel Plant. From this, the Committee notes that the amount refundable to the company would be to the extent of the work not completed. In other words, to the extent of work completed, the amount deposited will not be refundable. The Committee is of the view that although in case of non-performance the amount is refundable, but at the time when payments are made by the company for transmission lines, these are towards unperformed services (construction of transmission lines), which are yet to be received from the other entity (SPTCL in the extant case). Moreover, the Committee notes from the Facts of the Case that the basic purpose of making such payments to SPTCL is to receive the power. Accordingly, the Committee is of the view that since the performance of the services is yet to be completed, considering the accrual concept of accounting, the expense would be incurred by the company only on performance of the services. In the extant case, such services would be performed with the progress of construction activity of transmission lines, viz., proportionate completion method and not when payment is made. Accordingly, as and when such payments are made to SPTCL, same should be recognised as ‘Advance to SPTCL’ and expensed with the progress of construction activity.
D. Opinion
18. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9 above:
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