Query No. 5

Subject:           Accounting treatment of borrowing costs, administrative and other general overhead expenses incurred during the period when the construction work of the project is interrupted.[1]

A.        Facts of the Case

1.         A public sector company (hereinafter referred to as the ‘company’) registered under the Companies Act, 1956 is engaged in construction and operation of hydro electric power projects. The company is in a regulated regime and tariff for the power supplied from power stations of the company is fixed by the Central Electricity Regulatory Commission (CERC).

2.         Hydro electric projects (hereinafter referred to as the ‘projects’) by nature are not only capital intensive but also take considerable time for completion. The projects are mostly set up in far flung areas away from even smaller towns. The process of construction of projects may be divided into three stages namely pre-construction, construction and testing & commissioning. Pre-construction activities include survey and investigation, preparation of detailed project report (DPR), obtaining numerous approvals from various authorities, etc. Although all stages are important for the smooth completion of the projects, construction stage is very critical. Construction phase of the projects encompass numerous activities which must be properly aligned with each other so that project is completed in a timely manner. However, often, construction activities are interrupted by various stakeholders for a number of reasons. Local people who have not witnessed construction of projects of large magnitude and who are expected to be affected by construction of the project continuously raise issues of all sorts before every platform they find. All such activities are considered normal in the hydro power sector (emphasis supplied by the querist). As a result, the setting up of project may take 5 to 20 years depending upon various factors, viz., geographical, geological, status of infrastructure, etc.

3.         During the construction of one of such projects, the local people raised the issues related to safety and downstream impact of the proposed dam. The activists ramped up their agitation and stopped the supplies to the project by blocking national highway and other access roads to the project resulting in interruption of construction works of the major packages on 16.12.2011. The major works are under temporary delay since then and needful to resolve the issues are being vigorously acted upon both administratively as well as technically. The company had been in constant touch with the Central Government and State Government (SG) for immediate resumption of the construction activities of the project. Matter was actively pursued with the State Government and various pressure groups to sort out the issues and to eliminate fear psychosis from the people living downstream to the dam.

4.         Status of works in respect of major packages:

• Civil Works: Dam Concreting: 43% completed. Power House Concreting: 41% completed. Head Race Tunnel Heading, Benching & Overt Lining: 99%, 60% and 45% completed, respectively. Surge Tunnel Heading Excavation: 88% completed.
• Hydro-Mechanical (HM) Works: Erection of Diversion Tunnel Gates: 23% completed. Erection of Intake-5: 2% completed. Erection of Intake-7 and 8: 20% completed each. Pressure Shaft Steel Liner: 13% completed.
• E&M Works: Unit-1: Turbine Stay Ring and Spiral Case erection completed. Unit-2: Turbine Stay Ring and Spiral Case erection completed. Unit-3: Earth- mat is to be laid. Unit-4 to 8: No work.

5.         Keeping in mind the concerns of the people living downstream of the project and at the instance of the State Government, the company had constituted an Expert Group (EG) in May 2008 to evaluate the downstream impacts of the project. 

(i) The recommendations of EG were discussed in State Assembly. The EG report was also discussed by the Expert Appraisal Committee of the Ministry of Environment and Forests (MoEF) in the presence of representative from EG and the company.

(ii) As  desired by the State Government, the company constituted a Joint Steering Committee (JSC) in April 2011 to examine part II (downstream impact) of EG report and identify feasible remedial measures to take care of possible downstream impacts, flood, erosion etc. and report on their physical / financial aspects.

(iii) The State Government constituted a Group of Ministers (GoM) to appropriately advise the Government on the issues of hydro power projects in totality with an inter-disciplinary approach. Recommendations of the GoM have been accepted by the State Government.

(iv) Further, at the instance of Prime Minister’s Office (PMO), the Planning Commission constituted a Technical Experts Committee (TEC) to review the status of the Project and to recommend / report on how the company could move forward. The TEC has submitted its report.

(v) Pursuant to recommendations of TEC, Dam Design Review Panel (DDRP) under the chairmanship of Chairman, Central Water Commission (CWC) was constituted by the Ministry of Power (MOP), wherein all the aspects including foundation competency, earthquake parameters, energy dissipation arrangement (EDA) were deliberated upon. DDRP has submitted its report which has been accepted by the Government of India.

(vi) During last more than one year, at no point of time it was felt that the interrupted works will not resume within reasonable period of time. Preparedness of the major works contractors was ensured and care of works was undertaken throughout the period since 16.12.2011 for resumption of the works at the earliest. Continuous efforts were undertaken by the company for resumption of the works of major packages of the project and breakthrough is now expected shortly as most of the concerns of the people have been addressed through the country’s reputed institutions and appropriate authorities. During the period of interruption, technical & administrative works and numerous activities related to ancillary works, infrastructure works, work related to corporate social responsibilities and running & maintenance works at the project were continued.

 

6.         During the audit of accounts of the project, the office of the Comptroller & Auditor General of India (C&AG) raised an observation on the capitalisation of the borrowing cost incurred during the period of interruption. The said observation was dropped by the C&AG on the basis of reply of the management that substantial technical and administrative works were continued to be carried on during the period of interruption. However, the joint statutory auditors of the company proposed to qualify their audit report for the financial year 2012-13 with the following qualification:

“Capital work-in-progress carried in the balance sheet amounting to Rs. 19,709.04 crore. Management has included borrowing cost of Rs. 386.88 crore and administrative & other cost of Rs. 139.69 crore incurred on the … Project, wherein active development of project is interrupted. Accounting Standards require these expenditure incurred during interruption period be charged to the statement of profit and loss. This constitutes departure from the Accounting Standards referred to in sub-section (3C) of section 211 of the Companies Act, 1956.
Accordingly, ‘Finance Cost’ would have increased by Rs. 386.88 crore and ‘Generation, Administration and Other Expenses’ would have increased by Rs. 139.69 crore and ‘Net Profit before Tax’, ‘Capital work-in-progress’ would have reduced by Rs. 526.57 crore and Shareholders’ Fund (net of taxes) would have reduced by Rs. 421.22 crore.”(Emphasis supplied by the querist.)

7.         The company did not agree with the qualification of the auditors due to following reasons:

(i) Auditors have placed reliance on paragraph 17 of Accounting Standard (AS) 16, ‘Borrowing Costs’ alone and have completely ignored paragraph 18 of AS 16, by virtue of which capitalisation of borrowing costs is permitted during the period when substantial technical and administrative work is being carried out.  Paragraph 17 and 18 of AS 16 are reproduced below:

 

“17. Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted.

18. Borrowing costs may be incurred during an extended period in which the activities necessary to prepare an asset for its intended use or sale are interrupted. Such costs are costs of holding partially completed assets and do not qualify for capitalisation. However, capitalisation of borrowing costs is not normally suspended during a period when substantial technical and administrative work is being carried out. Capitalisation of borrowing costs is also not suspended when a temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale. For example, capitalisation continues during the extended period needed for inventories to mature or the extended period during which high water levels delay construction of a bridge, if such high water levels are common during the construction period in the geographic region involved.” (Emphasis supplied by the querist.)

 

(ii) Hydro-electric projects are very much susceptible to time and cost overrun on account of various reasons, like natural calamities, geological surprises as well as law and order situation in the concerned area. Interruption of work in hydro projects due to such type of problems is common, which matches with example of high water levels in case of construction of bridge as given in example in paragraph 18 of AS 16.  Hence, borrowing cost and other general overheads during interruption of work due to these problems are allowed as per paragraph 18 of AS 16. (Emphasis supplied by the querist.)

(iii) Technical and administrative works were continued to be carried out at the project even during the period of interruption (Refer Appendix-A).

(iv) Tariff fixation for power generating companies is based on completion cost of the project duly approved by appropriate authority i.e., Press Information Bureau (PIB)/Cabinet Committee on Economic Affairs (CCEA), which takes into account the expenditure incurred as per audited balance sheet of the company for verifying the expenditure. As such, the said qualification will result into reduction of capital cost of the project and in turn, future earning capacity of the company, as the same will not be considered by CERC.

(v) The process of tariff fixation involves inviting comments from beneficiaries and once the expenditure is not allowed to be capitalised, the same may not be accepted by the beneficiaries at a later stage.

(vi) Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’ does not prohibit capitalisation of administrative and general overhead expenditure during the period of interruption.

(vii) Period of interruption is not substantial considering the overall construction period of a hydro-project of such magnitude.

(viii) The following disclosure has been given by the company in the notes to the accounts:

             “Construction activities at site of … Project have been interrupted w.e.f. 16.12.2011 due to protest of anti-dam activists, however substantial technical and administrative work is continuing. As such administration and other general overheads including borrowing cost directly attributable to Project has continued to be capitalised. The construction activities at site are expected to be resumed shortly since the matter is being pursued at the level of the Government of India.”

(ix) The company is a listed entity having domestic as well as foreign stake holders. Such qualification by auditors will have adverse impact on its corporate image. Further, Securities and Exchange Board of India (SEBI) may also take adverse view due to the said qualification of the auditors.

(x) There is going to be huge consequential impact on the financial health of the company due to such narrow interpretation of Accounting Standards.

(xi) The company is in a regulated regime and is governed by Electricity Act, 2003. All expenditure incurred by the company for construction of project is allowed by CERC for fixation of tariff and as such, the provisions of Accounting Standards should be construed accordingly.

8.         Auditors however persisted with their qualification and included the proposed qualification in their final report. After issuance of the audit report by auditors, the office of Principal Director of Commercial Audit, MAB-III, New Delhi issued nil comments on the accounts for the company of the financial year 2012-13. Principal Director, MAB-III, New Delhi has also advised the company to refer the matter to the Expert Advisory Committee of the Institute of Chartered Accountants of India for its opinion in the matter of qualification in the audit report of auditors.

B. Query      

  
9.         In view of the above, opinion of the Expert Advisory Committee is sought by the querist on the following issues:

(i) Whether the capitalisation of borrowing cost during the period when construction work of the project is interrupted, as above, is in line with provisions contained in paragraph 18 of AS 16 on ‘Borrowing Costs’, considering the technical and administrative works being carried on at the project as mentioned in Appendix A.

(ii) Whether capitalisation of directly attributable administrative and other general overhead expenses during the period of interruption is in line with provisions contained in AS 10.

C. Points considered by the Committee

10.       The Committee notes that the basic issues raised in the query relate to whether capitalisation of borrowing cost as well as administrative and other general overhead expenses (which as per the querist, are directly attributable to project), incurred during the period when construction work of the project is interrupted   is in line with the principles of AS 16 and AS 10, respectively. The Committee wishes to point out that henceforth ‘the period when the construction work of the project is interrupted’ has been referred to as ‘interruption period’. The Committee has, therefore, considered only aforesaid issues and has not examined any other issue that may arise from the Facts of the Case, such as, commencement of capitalisation of borrowing costs, accounting treatment of expenditures during interruption period other than  administrative and other general overhead expenses (which as per the querist, are directly attributable to project), etc.

11.       With regard to capitalisation of borrowing cost during the period of interruption, the Committee notes the following paragraphs from Accounting Standard (AS) 16, ‘Borrowing Costs’, notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as the ‘Rules’):

“16.     The activities necessary to prepare the asset for its intended use or sale encompass more than the physical construction of the asset. They include technical and administrative work prior to the commencement of physical construction, such as the activities associated with obtaining permits prior to the commencement of the physical construction. However, such activities exclude the holding of an asset when no production or development that changes the asset’s condition is taking place. For example, borrowing costs incurred while land is under development are capitalised during the period in which activities related to the development are being undertaken. However, borrowing costs incurred while land acquired for building purposes is held without any associated development activity do not qualify for capitalisation.


17. Capitalisation of borrowing costs should be suspended during extended periods in which active development is interrupted.

18. Borrowing costs may be incurred during an extended period in which the activities necessary to prepare an asset for its intended use or sale are interrupted. Such costs are costs of holding partially completed assets and do not qualify for capitalisation. However, capitalisation of borrowing costs is not normally suspended during a period when substantial technical and administrative work is being carried out. Capitalisation of borrowing costs is also not suspended when a temporary delay is a necessary part of the process of getting an asset ready for its intended use or sale. For example, capitalisation continues during the extended period needed for inventories to mature or the extended period during which high water levels delay construction of a bridge, if such high water levels are common during the construction period in the geographic region involved.”

From the above, the Committee notes that borrowing costs which are incurred during an extended period in which the activities necessary to prepare an asset for its intended use or sale are interrupted do not qualify for capitalisation. The Committee also notes that ‘interrupted period’ refers to a period when no active development that changes the asset’s condition is taking place. The Committee further notes that capitalisation of borrowing costs is not normally suspended in case of  ‘temporary delay’ which is a necessary part of the process of getting an asset ready for its intended use or sale or when substantial technical and administrative work is being carried out. 

12.   In the extant case, the Committee notes from the Facts of the Case that construction activities of the project are interrupted as the local people alongwith the activists have raised issues relating to their safety and downstream impact of the proposed dam. Their agitation leading to stoppage of the supplies to the project resulted into interruption of construction works. The company is making continuous efforts for resumption of the works of major packages of the project by actively pursuing with the State Government and various pressure groups, viz., TEC, Group of Ministers, Joint Steering Committee (JSC) to sort out the issues. The Committee notes that the querist has argued that the company has undertaken certain technical and administrative works which are listed in Annexure A and as per AS 16, borrowing cost incurred during the period when substantial technical and administrative work is being carried out should be considered for its capitalisation. The Committee also notes Annexure A provided by the querist containing details of the technical and administrative works being carried out by the company and is of the view that most of these works do not apparently lead to the development/construction of the project rather are aimed at taking remedial measures so  that matter may be resolved. Such remedial measures includes undertaking geological studies, dam studies, landslide and earthquake studies, hydraulic model studies, works related to CSR and SD, etc. and preparing report thereon for various Government Departments and Ministries, viz., report to planning commission, report of JSC, DDRP report to MoP, etc. for obtaining necessary approvals for resumption of the interrupted work. In other words, the technical and administrative works which are being carried out cannot be considered to be leading to active development of the project, rather these are the activities necessary for resumption of construction work of the project. Further, agitation of local people and interruption of work in the extant case cannot be considered as a temporary delay which is a necessary part of the process for getting the project ready for its intended use. In fact, borrowing costs incurred during such period are costs incurred for holding partially completed assets rather than cost of undertaking activities for developing the project. Hence, capitalisation of borrowing costs incurred during such period should be suspended.

13.       As regards capitalisation of administrative and other general overhead expenses during the period of interruption, 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 ‘Rules’, 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 9.5. 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 AS 10, notified under the ‘Rules’, 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:
          …”

“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.  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 Committee also notes that as no specific accounting treatment for the expenses incurred during the interruption period of project has been prescribed, the same principle of capitalisation as prescribed under AS 10 will be applicable.  The Committee notes that in the extant case, the querist has argued that the administration and overhead expenses incurred are directly attributable to the project. However, the Committee is of the view that only if the expenses, so incurred, add to the value or utility of the already constructed project or is leading to development/construction of the project then only to that extent these costs can be considered to be directly attributable to the project and can be capitalised with the cost of the concerned fixed asset(s)/ project(s). However, the administrative and overhead expenses incurred to resolve the issue like undertaking technical and administrative activities at the instance of various groups involved in resolving the issues, etc., do not add value to already existing project in progress. In fact, these remedial measures are being undertaken to resume the construction rather than developing the project. Hence, such expenses do not qualify for capitalisation.

14.       As far as the impact of accounting treatment of the borrowing costs and other expenditure incurred by the company during interruption of the project, on tariff as per the tariff regulations is concerned, the Committee is of the view that the accounting treatment of an expenditure is to be determined on the basis of the nature of the expenditure as per the generally accepted accounting principles. It is on this basis that the treatment to be accorded by the company in the present case has been arrived at in the above paragraphs. Whether or not this expenditure should be made a part of fixed charges for tariff fixation as per the tariff regulations is a matter to be considered by the relevant authority/company.

D. Opinion

15.       On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 9 above:

(i)         No, the capitalisation of borrowing cost during the period of interruption, is not in line with provisions contained in paragraph 18 of AS 16, considering the technical and administrative works being carried on at the project as mentioned in Appendix A, as discussed in paragraph 12 above.
(ii)        The capitalisation of administrative and other general overhead expenses during the period of interruption would be correct provided such expenses facilitate the development/construction of the project, rather than facilitating resumption of the construction, as discussed in paragraph 13 above.

Annexure -A

The major technical and administrative works undertaken during the financial year 2012-13 are detailed below:-

A: Technical works

(i) During the year, the Engineering and Environment Group at Corporate Office and   officers of the Project were associated for the discussions and deliberations with the Technical Expert Committee (TEC) constituted by the Planning Commission, Government of India.   The TEC submitted its report by the end of July 2012 to Planning Commission, Government of India.

(ii) During the year, the Engineering & Environment Group at Corporate Office and   officers of the Project, officers were associated with the Joint Steering Committee (JSC) for discussions and deliberations to find out the applicability of suggested measures by the Expert Group.  The JSC was constituted by the company in consultation with Ministry of Power (MoP), Government of India and State Government. The JSC submitted its report in August 2012.

(iii) As per TEC recommendation, the Dam Design Review Panel (DDRP) has been constituted by the Ministry of Power, Government Of India under the chairmanship of Chairman CWC and other experts from Central Electricity Authority (CEA), Central Water Commission) CWC, Geological Survey of India (GSI), IIT Roorkee, CWPRS and the company to review some design features of Project. The sub-committee of DDRP has visited site on 7/8-03-2013 and members of DDRP visited Project site on 5-5-2013. DDRP has submitted its report to MoP, Government of India by the end of May 2013 which stands accepted by the Govt. of India.

(iv) At the instance of (TEC), landslide studies of the area where River got blocked during 1950 earthquake have been carried out by M/s ABC, New Delhi. Report submitted in May-2012.

(v) Assessment of engineering properties of rock mass was carried out by  an expert in Rock Mechanics at the instance of TEC. Report on Foundation of Dam was submitted in May-2012.

(vi) Additional hydraulic model studies in Stilling Basin was carried out by CWPRS, Pune at the instance of TEC. CWPRS submitted the report during June’12.

(vii) During the year, around 1660 MT of total consignments of steel plates and steel gates have been received at site for HM works of the Project under LOT SSL-3.

(viii) The shifting of 2 no’s of turbine runners, 1 set of MIV and 1 no. of annul ring has been completed from Kolkata to Jogigopa in Assam in Dec. 2012.

(ix) Total 120 consignments comprising of turbine and generator spares and other BOP items of E&M components under LOT SSL-4 contract has been received at site during the financial year 2012-13. 

(x) The water pressure testing of Unit-1 spiral casing along with other ancillary works has been completed during Nov. 2012.

(xi) The erection of spiral casing along with associated works of Unit-2 has been completed upto Dec. 2012.  Further, the erection of rail line at Transformer Floor in Unit-1 & 2 areas has been completed by Nov. 2012.

(xii) During the year, preservation works for the E&M equipments/components have been undertaken by the contractor for E&M works.

(xiii) As per recommendation of TEC, 24th meeting of National Committee on Seismic Design Parameter (NCSDP) was held on 15-03-2013 at New Delhi to review the Seismicity aspects, for the Project. The Committee decided that further revisions in the approved seismic design parameters of Project (as approved by NCSDP in its 14th meeting held on 29-04-2004) may not be required. (Emphasis supplied by the querist.)

(xiv) Apart from above, various infrastructure works and CSR-SD have been undertaken by the Project during the financial year 2012-13.

(xv) During the year 2012-13, various design and re-engineering works as per the requirements/suggestions of TEC, JSC, NCSDP and DDRP have been undertaken by the Design & Engineering Group at Corporate Office.

(xvi) Project has awarded the supply of 36500MT OPC/PPC cement on 22nd March 13 for meeting the day to day requirements for infrastructural and CSR works and the future requirement of the project in case the project starts and gains momentum.

(xvii) Dewatering was continued throughout the year 2012-13 at all the required sites of underground and surface works as per the requirement for safety of structures by the major civil contractors of the Project. The quantity has been measured, recorded and paid to the contractors from time to time as per the contract.

(xviii) The instrumentation readings of all the instruments installed in underground structures and at surface works as per the construction drawings have been recorded regularly throughout the year 2012-13 by the major civil contractors of the Project and submitted to the company from time to time for interpretation of the data and continuous monitoring of the behavior of underground and surface structures. This is required for continuous monitoring of the safety and stability of the major components of the Project.

B: Administrative works

(i) The company Management held meeting on 27-08-2012 with agitating groups to resolve the issues for re-start of project work.

(ii) The company Management held meeting on 20-09-12 with 25 ethnic groups of the State to resolve the issues for re-start of project work.

(iii) Meeting of officials of Government of India, State Government and the company was held on 26-11-2012 at Delhi to negotiate the issues raised by protestors.

(iv) Further, the meeting on 14-12-2012 was held with State Government for resolving the issues raised by the activists.

(v) 1st meeting of DDRP has been held on 06-02-13 in CWC office, New Delhi.

(vi) A Committee of Group of Ministers(GoM) constituted by the Government of Assam vide notification dated 17-12-2011 to appropriately advise the Government on the issues of hydropower project in totality with an interdisciplinary approach, submitted its report to state cabinet and the report was accepted on 20-02-2013.

(vii) A presentation on status of works vis-a-vis issues of this project in view of the ongoing protest and view of the company on the entire issues was made to the Advisor to the Prime Minister, Dy. Secretary, Planning Commission and Chief Secretary, adjoining State Govt. on 01-03-2013.

(viii) Based on recommendations of TEC and the GoM of State Government, a meeting was held on 04-03-2013 with the State Government which was attended by the CMD, Director (Tech), Director (projects), Executive Director of the Project and other officials from Company.

(ix) During the year 2012-13, Project is has made continuous efforts to make people aware of the benefits of the Project by intensive public meetings, media campaign, meeting with state officials and local ethnic groups. CSR activists as per policy are being carried out.

(x) During the year 2012-13, the running and maintenance and service contract works for the establishments and the project sites have been undertaken by the Project.

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[1]Opinion finalised by the Committee on 11.4.2014.