Query No. 11
A. Facts of the Case
1. A company (hereinafter referred to as ‘the company’ or ‘the corporation’) was incorporated in the year 1976 as a wholly owned Government of India enterprise under the administrative control of the Ministry of Power (MoP) to plan, promote, investigate, survey, design, construct, generate, operate and maintain hydro and thermal power stations and to explore and utilise the power potential of North East in particular. The company is presently running three hydro projects and two thermal projects in North Eastern States and catering to the demand of North Eastern States. The company’s shares are not listed with any stock exchange but bonds are listed in the BSE. The authorised and paid up share capital of the company as on 31.03.2014 are Rs. 5000 crore and Rs. 3385.09 crore, respectively. The turnover of the company for the year ending 31/03/2014 is Rs. 1279.75 crore.
2. The Government of Arunachal Pradesh (GoAP) (hereinafter also referred to as the ‘State Government’) has earmarked certain projects for allocation to private developers, central sector developers, state sector developers for the development of hydro power projects in the State, which will generate economic activity in the State leading to its growth and will also serve as engine to achieve the objective of promoting all round development in the State and the country. The Government of Arunachal Pradesh had permitted the company for carrying out survey and investigations for preparation of the project feasibility report (PFR) of Siang Upper Hydro Electric Project (HEP) in February 2009.
3. The Hon’ble Cabinet, at its meetings on 3rd February, 2013 and 4th April, 2013 has approved the allotment of power project ‘Siang Upper Stage II (3750 MW)’ (hereinafter referred to as the ‘project’) to the company on joint venture (JV) with the Government of Arunachal Pradesh. The project (3750 MW) being established on Siang river in the Upper Siang District of Arunachal Pradesh with FRL at EL 340 M & TWL at EL 235 M including complete hydroelectric power generating facility covers all components such as, dam, intake works, water conductor system, power station generating units, project roads, bridges, offices, residential facilities, store, guest houses, security office and other connected facilities including the interconnection facilities.
4. As per clause 2.1 of the Memorandum of Agreement (MoA) between the Government of Arunachal Pradesh and the company, the Government of Arunachal Pradesh granted permission to the company to undertake preliminary investigation for preparation of the pre-feasibility report, detailed investigation for the preparation of the pre-feasibility report, detailed investigation for DPR preparation, financing and subsequent development, commissioning, implementation, operation and maintenance of the project. The project shall be implemented by the company on BOOT (Build, Own, Operate & Transfer) basis for a lease period of 40 years from the commercial operation date (COD). It will be reverted back to the State Govt. on expiry of above lease period, free of cost, in good working condition. However, the company being central public sector undertaking (CPSU), the lease period can be extended beyond 40 years period by the State Govt. on mutual agreement. The entire cost of investigation, DPR preparation, project implementation and subsequent operation and maintenance of the project will be borne by the company.
5. For the aforesaid project, the company was to deposit non-refundable upfront premium including processing fee of Rs. 225.00 crore (Rupees two hundred twenty five crore) only @ 6.00 lakh (Rupees six lakh) per MW of the proposed installed capacity with the State Government. The company has now deposited a sum of Rs. 50.00 crore (Rupees fifty crore) towards non-refundable upfront premium. The company has booked the said expenditure as survey and investigation expenses in capital work in progress (CWIP).
6. The querist has separately clarified that as per clause 2.22 of MoA, the corporation shall be permitted to create a Special Purpose Vehicle (SPV), as defined under the MoA, for implementation of this project as joint venture between the GoAP or any of its entity/agency (fully owned by GoAP) with 26% equity share (to be allocated to the State Government by the joint venture company) and balance by the corporation and another entity, N Ltd., holding equity shares by them. As such, the corporation or the SPV as per clause 2.22 will be responsible for survey & investigation, implementation and subsequent operation & maintenance of the project. Further, as per clause 14.1 of the MoA, the corporation is responsible for payment of non refundable upfront premium and processing fees. However, the Ministry of Power, Government of India at its meeting dated 06.06.2014 decided that a JV company shall be formed between N Ltd. and the corporation for the project (3750MW). Accordingly, a Tripartite Agreement between the JV partners and Govt. of Arunachal Pradesh shall be signed for the project in supersession of the MoA already signed between GoAP and the company in respect of Siang Upper Stage-II HEP (3750MW). Therefore, formation of JV between the company and N Ltd. and finalization of tripartite MoA between the company, N Ltd. and the GoAP are in process. The tripartite agreement is yet to be executed between the partners, wherein the above aspects of sharing the upfront non-refundable premium in the proportionate equity ratio shall be taken care of. Further, the querist has stated that the company is the parent corporation for performing the obligations and duties under the MoA till the formation of JV/SPV and accordingly, after the formation of JV/ SPV, all the activities of the project under the MoA including construction/ development, commissioning, implementation, operation and maintenance shall be undertaken by the JV/SPV.
Audit queries
7. An amount of Rs. 50 crore had been paid as upfront fee (non- refundable) to the Govt. of Arunachal Pradesh in May 2013 for securing the right for construction and operation of Siang Upper Stage-II Hydro Electric Project (3750 MW) in Arunachal Pradesh. However, the project is yet to be approved by the Govt. of India. The company has booked the expenditure as survey and investigation (S&I) expenses in capital work in progress (CWIP). Such expenditure does not relate to acquisition/ construction of an asset and is in the nature of cost of prospecting activities. Accordingly, this should be charged off as revenue expenditure as and when incurred. Noncompliance of this has resulted in overstatement of CWIP by Rs. 50 crore with corresponding overstatement of profit.
Reply of the management
8. The company has paid Rs. 50.00 (fifty) crore being part of the non-refundable upfront fees to the Govt. of Arunachal Pradesh (GoAP) in May 2013 for securing the right for construction and operation of Siang Upper Stage - II Hydro Electric Project (3750 MW) in Arunachal Pradesh. The upfront fees was paid by the company as per the Memorandum of Agreement (MoA) signed. The MoA was prepared in line with the conditions mentioned in clause 9.13 of the Hydro Policy 2008; Arunachal Pradesh. As per the said Hydro Policy, the interested power producers have to pay non-refundable upfront fees to the GoAP before taking up the construction activity.
9. The management of the company is of the view that this expenditure can be capitalised in view of paragraph 9.2 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets2, notified under the Companies (Accounting Standards) Rules, 2006, which inter alia, states that such expenses, which are specifically attributable to construction of a project or to the acquisition of fixed asset or bringing it to its working condition, may be included as part of the cost of the project. This is also in accordance with the approved accounting policy No. 2(b1) of the company. The company is of the view that the basic principle to be applied while capitalising an item of cost to the cost of fixed asset(s)/project under construction/expansion is that it should be directly attributable to the construction of the project/fixed asset(s) for bringing it to its working condition for its intended use. The costs that are directly attributable to the construction/acquisition of fixed asset(s)/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(s) could not have taken place and the project/asset(s) could not be brought to its working condition.
10. The company notes that the accounting principles for determination of the cost of a self-constructed fixed assets have been laid down in paragraph 10.1 of AS 10, which provides as follows:
The company further notes paragraphs 9.1 and 9.2 of the notified AS 10 as reproduced below:
From a combined reading of the above paragraphs of AS 10, the company is of the view that the basic principle to be applied while capitalising an item of cost to fixed asset(s)/project under construction is that it should be directly attributable to the construction of the project /fixed asset(s) for bringing it to its working condition for its intended use. The company further notes the lines mentioned in paragraph 9.1 of AS 10 which states that the cost of an item of fixed asset comprises its purchase price, including import duties and other non-refundable taxes and levies. (Emphasis supplied by the querist.)
11. In this connection, the querist has referred to the word ‘levies' as mentioned in the above paragraph. The connotation of the word levies, as per dictionary, is “impose or collect compulsory /statutory payment etc.”. The right to start the project activity including S & I works will be enjoyed by the power producer in Arunachal Pradesh only when the company makes such non-refundable upfront fees to the GoAP. Such collection of non-refundable fees by the State Government is as per Hydro Policy of Arunachal Pradesh which has been approved by the Legislative Assembly of the State. (Emphasis supplied by the querist.)
12. Further, the management of the company 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 (ICAI) give the following definition towards recognition criteria for an asset:
On the basis of the above, the management is of the view that the expenditure incurred by the company is to be recognised as an asset since the enterprise enjoys the rights to start the project activity and will have a capacity to control the benefits and the enterprise can also restrict the access of others to the benefits arising from it. The management further opines that the probable future economic benefits will flow to the company from the asset(s) created. Thus, the non-refundable upfront fee paid by the company is to be recognised as asset and cannot be treated as cost of prospecting activity.
13. The querist has further stated that in case the above expenditure is charged off to revenue consequent to the observation given by the Comptroller and Auditor General (C&AG), this expenditure will neither be serviced as part of project cost (fixed charges) nor it will be allowed as a part of operation and maintenance (O&M) charges as provided by the CERC in the tariff regulations. Accordingly, charging off the expenditure will not be in line with the true spirit of the Hydro Policy 2008 of GoAP nor it will satisfy the basic intention of the tariff regulations notified by the CERC, which is based on cost plus return basis. The charging off such expenditure to the profit and loss account shall also not be in accordance with the provisions of AS 10. From the above, the company is of the view that the non-refundable upfront fees paid to GoAP as per MoA as well as Hydro Policy 2008, is to be recognised as an asset.
14. The querist has also separately clarified that in principle, it is agreed by the Govt. of Arunachal Pradesh and MoP, Govt. of India to allot the above projects to JV company as above. Hence, there is no uncertainty involved as far as final allotment of the project is concerned. However, after submission of DPR of the project and till obtaining of all the clearances from the authorities, such as, techno-economic clearance (TEC), environment & forest etc. as required by Central Govt./State Govt., there will be some element of uncertainty involved sofaras capacity and implementation of the project is concerned.
B. Query
15. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
C. Points considered by the Committee
16. The Committee notes that the basic issues raised in the query pertain to accounting treatment of deposit of non-refundable upfront premium including processing fee (also referred to as ‘premium’) paid for the project in the financial statements of the company. The Committee has, therefore, examined only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, accounting for lease of land, propriety of using the nomenclature of survey and investigation (S&I) expenses for booking the expenditure on non-refundable upfront premium, accounting treatment of the said premium for the purpose of joint venture accounting, etc. Further, the opinion expressed, hereinafter is purely from accounting perspective and not from the perspective of legal interpretation of MoA or the Hydro Policy, 2008 or the tariff regulation of CERC, etc. At the outset, the Committee presumes from the Facts of the Case that non- refundable upfront premium including processing fee is a composite amount that is payable to the State Government as per the terms of the MoA rather than of the nature of expenses, such as, legal or documentation preparation expenses incurred by the company in the process of obtaining the right to commence the project. Further, the Committee also presumes that the company in the extant case is not acting as an agent on behalf of the J.V or S.P.V. company which is in the process of formation.
17. The Committee notes that the accounting for non-refundable upfront premium including processing fee would depend upon the nature of expenditure. Therefore, for examining the nature of the expenditure, the Committee notes the following paragraphs of Memorandum of Agreement (MoA) between the Government of Arunachal Pradesh (the State Govt.) and the company for execution of Siang Upper Stage-II hydro electric project (HEP) (3750 MW) on Siang River in Arunachal Pradesh and Arunachal Pradesh State Hydro power Policy, 2008:
Memorandum of Agreement (MoA)
Arunachal Pradesh State Hydro Power Policy, 2008
(Emphasis supplied by the Committee)
From the above, the Committee notes that the MoA in the extant case provides the permission to the corporation to undertake preliminary investigation for preparation of the pre-feasibility report, detailed investigation for the preparation of the pre-feasibility report, detailed investigation for DPR preparation, financing and subsequent development, commissioning, implementation, operation and maintenance of the project. The Committee further notes that as a part of the MoA, apart from various payments/ obligations, such as, lease payments for acquisition of site, afforestation charges, rehabilitation and resettlement, etc., the company has to deposit the prescribed non-refundable upfront premium including processing fee for a specified project capacity (MW) and the failure in payment of such a premium would result in the cancellation of the agreement. Accordingly, the Committee is of the view that payment of the premium is a pre-condition to commence the project activity and is also an integral part of the overall arrangement (MoA), as the company will not be allowed to proceed further without such payment and the State Government reserves the right to terminate the agreement.
18. The Committee further notes from the Facts of the Case that the Cabinet has approved the allotment of power project ‘Siang Upper Stage II (3750 MW)' to the company on joint venture with the Government of Arunachal Pradesh which includes creation of complete hydroelectric power generating facility covering all components such as, dam, intake works, water conductor system, power station generating units, project roads, bridges, etc. The project shall be implemented by the company on BOOT (Build, Own, Operate & Transfer) basis for a lease period of 40 years from the commercial operation date (COD) and it will be reverted back to the State Govt. on expiry of the above lease period, free of cost, in good working condition. The Committee further notes that as a part of allotment of this project, the company has to deposit a non-refundable upfront premium including processing fee, which as per the querist, shall provide to the company, the right for construction and operation of the Project. In this context, the Committee is of the view that to determine the accounting for non-refundable upfront premium including processing fee, it is important to understand the nature of the arrangement under which such deposit is being made and the asset, if any, that the company is acquiring out of such arrangement. In this context, on a perusal of the terms of the MoA between the Government of Arunachal Pradesh and the company for execution of the Project, the Committee is of the view that the company in the extant case has obtained from the Government, only a right to construct, implement and operate the project that will be transferred back to the Government and therefore, the company can recognise only an intangible asset for such a right following the provisions of Accounting Standard (AS) 26, ‘Intangible Assets'. In this regard, the Committee notes the definitions of the terms ‘intangible asset' and ‘asset' given in paragraph 6 of Accounting Standard (AS) 26, ‘Intangible Assets', and meaning of ‘control' dealt with in paragraph 14 thereof as reproduced below:
The Committee notes from the above that an item can be classified as an intangible asset only if it fulfils all the three conditions: (a) it is identifiable, (b) the enterprise has control over the resource, and (c) it is expected that future economic benefits will flow to the enterprise. The Committee notes that in the extant case, in lieu of the construction and development services related to the power project, the company has been granted an exclusive right to construct, implement and operate the project that shall provide economic benefits to the company from the sale of power generated out of such project on its commissioning. Thus, such an arrangement (MoA) gives rise to an intangible asset that should be recognised in the books of account of the company. The Committee is further of the view that out of the various conditions, activities and obligations to be complied with/undertaken under such an arrangement, one of the condition is to deposit the non-refundable upfront premium including processing fee depending upon the power capacity (MW) of the project. Accordingly, the Committee is of the view that such a deposit is a part of the intangible asset being recognised under the arrangement as afore-mentioned and, therefore, the deposit of premium should be recognised as ‘intangible asset under development' under the head ‘intangible assets' in the books of account of the company.
19. With regard to the auditor's argument that such expenditure does not relate to acquisition/ construction of an asset and is in the nature of cost of prospecting activities as the project is yet to be approved by the Government of India, the Committee notes from the Facts of the Case that the querist has stated that there is no uncertainty involved as far as final allotment of the project is concerned. However, after submission of DPR of the project and till obtaining of all the clearances from the authorities, there will be some element of uncertainty involved so far as capacity and implementation of the project is concerned. Considering this being the true position, the Committee is of the view that if there is no uncertainty regarding final allotment of the project and future economic benefits are expected to flow to the company, non-refundable upfront premium including processing fee should not be considered as the cost of prospecting activities; rather it should be treated as a part of an intangible asset, as discussed above.
D. Opinion
20. (i) and (ii) On the basis of the above, the Committee is of the opinion that the deposit of non-refundable upfront premium including processing fee should be recognised as an ‘intangible asset under development' under the head ‘intangible assets' in the books of account of the company, rather than as survey and investigation expenses under ‘capital work in progress' and, therefore, the accounting treatment adopted by the company is not in compliance with the existing accounting standards and as per standard accounting principles, as discussed in paragraph 18 above.
___________ 1 Opinion finalised by the Committee on 11.8.2015. 2 The opinion should be read in the context of Accounting Standard (AS)10, ‘Accounting for Fixed Assets', which has been revised as AS 10, ‘Property, Plant and Equipment' by the Companies (Accounting Standards) Amendment Rules, 2016 vide Ministry of Corporate Affairs (MCA) Notification No. G.S.R. 364(E) dated 30.3.2016. |