Query No. 26
Subject: Treatment of capital expenditure on assets not owned by the company.1 A. Facts of the Case
1. A public sector company (hereinafter referred to as ‘the company’) has an integrated steel plant engaged in the manufacture of iron and steel products, with an installed capacity of 3.0 Metric Tonne (MT) of liquid steel per annum. The company is executing an expansion project to double its capacities.
2. While setting up new facilities as a part of ongoing expansion project to double the existing capacities, the company has to incur expenditure on the construction/development of certain assets, like electricity transmission lines, railway siding, roads, culverts, bridges, etc., in order to facilitate construction of the project and subsequently to facilitate its operations. The ownership of such assets (hereinafter referred to as ‘enabling assets’) as well as the land on which these assets are situated does not vest with the company.
3.The querist has stated that the Expert Advisory Committee (EAC) of the Institute of Chartered Accountants of India (ICAI), in its recent opinion on the subject, ‘Treatment of capital expenditure on assets not owned by the company’ which was published in January 2011 issue of the Institute’s Journal, ‘The Chartered Accountant’, has opined in paragraph 19 that expenditure incurred on ‘enabling assets’ not owned by the company should be charged off to revenue in the accounting period of ‘incurrence’ of such expenditure (emphasis supplied by the querist). The Committee expressed its view considering paragraph 56 of Accounting Standard (AS) 26 ‘Intangible Assets’, which states, inter alia that, “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. ...”
4.The querist has further stated that as a part of implementation of the expansion project, to meet the enhanced power import requirement for additional production envisaged at 6.3 MT of liquid steel with an outlay of 12,500 crore approximately, the company has proposed to extend the power supply for Contracted Maximum Demand (CMD) of 400 MVA at 220 KV level including existing load.
5. The scope of work includes upgrading Kalapaka VSS 220 KV DC line with twin moose conductor, erection of 220 KV DC line, erection of 315 MVA power transformer, bay extensions (GV & LV) and laying of 220 KV cable.
6. STRANSCO, a state owned company, being the Electrical Licensing Authority, has given two options for execution of the above job. First option is that the company is permitted to take up the work on turnkey basis subject to certain terms and conditions and on completion in full shape, the works executed will be taken over by STRANSCO; alternatively, STRANSCO will take up the work under ‘Deposit Contribution Scheme’ for an amount of Rs. 86.61 crore.
7.Considering the merits in each case, the company requested STRANSCO to take up the works on Deposit Contribution Works basis with a condition that STRANSCO to accept the claim for reimbursement / refund of differential expenditure between the actual and estimate to the company as the case may be on completion of the project.
8.Under this scheme, the company is expected to pay the estimated costs, in advance, for the above scope of work in four phases, failing which the work shall not be taken up. Where any applicant withdraws his requisition before taking up the job the amount will be refunded by STRANSCO with nominal deductions towards administration charges. However, the works taken up shall be the property of STRANSCO which shall maintain it at its own cost and STRANSCO shall also have the right to use the service line for supply of energy to others as well. Accordingly, the expenditure incurred is towards creating an ‘enabling asset’ and is to be charged off to revenue in the accounting period of incurrence of such expenditure in view of the recent opinion of EAC of ICAI referred in paragraph 3 above (emphasis supplied by the querist).
9.The company is, however, of the view that ‘enabling assets’ are required not for their own individual purposes but for the purpose of bringing the envisaged expansion unit to its working condition. The company has control over the envisaged expansion units as the company has the power to obtain future economic benefits that are expected to be derived from these expansion units and can also restrict the access of others to these units. The ‘enabling assets’ do not serve as a single independent asset but form part of whole expansion unit over which the company is having control. Moreover, had the project for the expansion not been undertaken, the ‘enabling assets’ themselves would not have been required as they do not serve any purpose independently. The expenditure on the ‘enabling assets’ is required as a part of the cost of envisaged expansion units and hence, should be treated as a part of total project cost instead of identifying as a single independent asset.
10.The querist has reproduced paragraph 9.1 of Accounting Standard (AS) 10 ‘Accounting for Fixed Assets’, which, inter alia, states as below:
Further, paragraph 10.1 of AS 10 states, inter alia, as follows:
Since the expenditure is incurred by the company to meet the enhanced power import requirement for additional production envisaged at 6.3 MT of liquid steel, i.e., to bring expansion unit into operation, it can be said that the expenditure incurred by the company on ‘enabling assets’ is directly related to the expansion of production capacity and is solely for the purpose of bringing the expansion unit to its working condition for its intended use.
11. The company is, therefore, of the view that the entire project cost including those incurred on the ‘enabling assets’ shall be captured as cost of the expansion project instead of capitalising such ‘enabling assets’ as a separate asset. Further, the company has control over the future economic benefits from the expansion project of which ‘enabling assets’ are necessarily a part thereof. Thus, the expenditure incurred should be recognised as a part of project cost but not separately and should be allocated to individual expansion units, once they are put to use.
12. Further to the above, for giving the accounting treatment in line with the opinion of the Expert Advisory Committee (EAC) of the ICAI on the subject with regard to ‘incurrence of expenditure’, the following data is supplemented for the opinion of EAC.
13. The scope of the Deposit Contribution Work by STRANSCO involving supply of power by STRANSCO includes survey of transmission lines considering STRANSCO’s existing line routes, obtaining permissions/clearances for the right of way for the lines from various agencies, such as, PTCC, Railways and Forest Department, design of the lines as per STRANSCO’s standards, obtaining approval from STRANSCO/PGCL at various stages of design, tendering, vendor drawing approval, manufacturing and erection. The job also includes procurement of equipment and materials from STRANSCO/PGCL approved vendors, erection by STRANSCO/PGCL approved erection contractors, performance guarantee and supply of spares. Since this job involves execution of various stages as described above over a period of time, which may spread over more than one reporting period, the parties involved in the execution of jobs require certain amounts to be paid as advance to be adjusted against their future claims based on progress of work executed and accordingly, the expenditure is being incurred progressively over more than one accounting period.
14. Where the company chooses the alternative to take up the job by itself on turnkey basis, it will be carried out through a contractor or by a department of the company, in which case the payments to contractors or payments to acquire the resources to complete the work will be dealt with like any other revenue contract and the expenditure is to be recognised in the books of account based on the work completion method as certified by the engineer-in-charge for the bills raised as well as works completed but bills not raised. In case where the work is taken up by the department of the company, the resources utilised towards the works will be recognised as expenditure on accrual basis.
15. In the present case, for the works taken up by STRANSCO, on deposit contribution work basis, as explained in the paragraph 7 above, STRANSCO demanded the payments to be made in advance in a phased manner, accepting to the condition that STRANSCO to accept the claim for reimbursement/refund of differential expenditure between the actual and estimate to the company, as the case may be, on completion of the job.
16. Accordingly, as per the querist, the amounts paid in advance to STRANSCO are required to be booked as revenue advances and on progressive work completion / claims received, the advances are to be adjusted by accounting expenditure in the books of account, in the respective reporting periods, to give treatment of ‘charge off to revenue in the accounting period of incurrence of such expenditure’, in view of the Opinion of the EAC of the ICAI on the subject, referred at paragraph 3 above.
17. The company has paid in advance, the amounts in phases, against the scope of work, to STRANSCO, during the financial years 2008-09 and 2010-11 of` Rs. 14.78 crore and Rs. 32.16 crore respectively, totalling to Rs. 46.94 crore. Out of this amount, the company charged off Rs.14.78 crore to the profit and loss account, during the financial year 2010-11, based on work completion method, and the balance was disclosed under ‘revenue advance’ as the work against the advances given in the financial year 2010-11 is not yet started by STRANSCO on the reporting date of financial year 2010-11.
18. In view of the above nature of payments, the company is of the view that while determining the expenditure incurred on ‘enabling assets’, a distinction is required to be made between the amounts paid on account of advances as well as expenditure considering the following:
19. As per the querist, the expenditure incurred on setting up of ‘enabling assets’ has to be arrived at in line with other revenue contracts in which case the expenditure will be recognised on the basis of work completion as at the reporting date. In such cases, even though no payment is made as advance or otherwise, the expenditure has to be recognised on the basis of work completed as at the reporting date in line with accrual basis of accounting.
20. The statutory auditors are, however, of the view that payments made in advance against relevant envisaged works for creating the ‘enabling assets’ become irrecoverable, the moment the work is commenced and accordingly on commencement of the relevant work, the amounts paid in advance shall be treated as incurred irrespective of the status of the work after commencement. In other words, in view of the terms and conditions of agreement, the amounts paid in advance shall be treated as ‘incurred’, the moment the work is commenced as the amounts paid in advance become irrecoverable the moment the work is commenced. B.Query21. On the basis of the above, the querist seeks the opinion of the Expert Advisory Committee on the following issues:
C. Points considered by the Committee22. The Committee notes that the basic issue raised in the query relates to accounting treatment of amounts paid by the company to STRANSCO for augmenting power supply involving laying of electricity transmission lines, etc. (hereinafter referred to as ‘amounts paid for transmission lines’). The Committee wishes to mention that since the relevant details in respect of other enabling assets, such as, railway siding, roads, etc. have not been provided by the querist, the Committee, while opining, has not considered accounting in respect of the same. Further, the Committee 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 the Facts of the Case that the STRANSCO shall have the right to use the facility (for which the construction cost is being paid by the company) for supply of energy to 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. The Committee notes from the Facts of the Case that the querist has referred to the opinion published in the January, 2011 issue of the Institute’s Journal and has agreed with the view of the Committee in that opinion that the payments made to the STRANSCO does not give rise to any separate independent tangible/intangible asset. Accordingly, the Committee has only examined that whether such payment can be considered as a part of component of cost of any fixed asset/project, for the construction of which such facility will be utilised in the extant case in the following paragraphs.
23. In the context of whether the said payment for transmission lines can be considered as a component of cost of any fixed asset/project, for the construction of which such facility will be utilised, the Committee notes paragraphs 9.1 and 9.2 of AS 10 notified under the Companies (Accounting Standards) Rules, 2006 as reproduced below:
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 company that since the purpose of payments made by the company to STRANSCO is to meet the enhanced power import requirement for additional production of liquid steel, i.e., to bring expansion unit into operation, the expenditure incurred by the company on ‘enabling assets’ is directly related to the expansion of production capacity and is solely for the purpose of bringing the expansion units to its working condition for its intended use, the same should be capitalised as the cost of expansion project cost to be allocated over individual expansion units, the Committee is of the view that it is only the cost of electricity consumed for the expansion of the project that can be considered as directly attributable cost to the expansion units/project rather than the cost of setting up the electricity transmission lines. Moreover, as stated by the querist in paragraph 2 above, as the electricity transmission lines would not only be used to facilitate construction of the project but also subsequently to facilitate its 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 the construction for expansion project which would be directly attributable cost of the expansion project and therefore, can be capitalised with the individual expansion units.
24. The Committee further notes that paragraph 56 of AS 26 provides as below:
From the above, the Committee is of the view that the expenditure incurred on construction/laying of electricity transmission lines should be expensed and charged to the profit and loss account of the period in which these are incurred.
25. With regard to the second issue relating to timing of recognition of expense in relation to payment towards transmission lines, the Committee notes the contention of the statutory auditors that such payment becomes irrecoverable at the moment the work is commenced and therefore it should be expensed at the time of commencement of such construction. However, the Committee is of the view that the payments made by the company for transmission lines are towards unperformed services (construction of transmission lines), which are yet to be received from the other entity (STRANSCO in the extant case). Moreover, the Committee notes from the Facts of the Case that the basic purpose of making such payments to STRANSCO 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 basis 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 STRANSCO, same should be recognised as ‘Advance to STRANSCO’ and expensed with the progress of construction activity.
D. Opinion
26.On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 21 above:
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