Query No. 12

Subject:        Accounting treatment of various kind of budgetary support received from the Government and various                        types of expenditure incurred by the company.1

A.      Facts of the Case

1.      A company is incorporated under the provisions of the Companies Act, 1956. The authorised share capital of the company is Rs. 12,000.00 crores. The subscribed and paid up capital is Rs. 7095.00 crores as at 31-03-2014. The entire share capital is presently held by the Government of Karnataka (96.94%) and Karnataka State Financial Corporation, a Government of Karnataka undertaking (3.06%).

2.      The main objectives of the company is executing the Upper Krishna Multipurpose and other irrigation projects as per the directions of the Government of Karnataka (also referred hereinafter as ‘the State Government') including rehabilitation and resettlement of the project affected people. The company was formed in the year 1994 and commenced its business with effect from 14.11.1995. The assets of the then ongoing Upper Krishna Irrigation Project which was being implemented by the Water Resources Department of the Government of Karnataka along with selected liabilities were transferred to the company on 14.11.1995. Further works are carried out by the company. The company was preparing ‘Expenditure Pending Capitalisation Account' upto financial year 2006-07. On substantial completion of the project, the company started preparing profit and loss account from the year 2007-08. The expenditure incurred on the completed project components have been capitalised in the books of account of the company.

3.      The company does not have sufficient operational income from its core assets to meet the project expenditure. The project cost has therefore been partially funded by budgetary support from the Government of Karnataka and partially by borrowed funds, i.e., funds raised through bonds and term loans from banks and financial institutions. The Government of Karnataka also funds the repayment of principal and payment of interest on the borrowed funds. The querist has separately clarified that the Government of Karnataka was releasing funds required for the purpose of implementation of the irrigation projects through the budget allocation to the company as advance against equity till the company was preparing ‘Expenditure during Construction period (pending Capitalisation) Account' upto the year 2006-07, for which equity shares were allotted to the Government. Further, the Government of Karnataka started releasing budget allocation in the form of grant when the company started preparing profit and loss account from the year 2007-08 after substantial completion of the project. Thus, the Government of Karnataka is the major shareholder of the company. The Government of Karnataka also guarantees the borrowings of the company for project finance and since the company does not have sufficient income streams of its own to service the principal and interest of the borrowings, it provides funds for repayment of the principal and interest on the borrowing. According to the querist, as far as funds released by the Government for the purpose of repayment of borrowings, the Government as the owner of the company replaces the borrowing with the owners' funds.

4.      The company has also created some non-core assets like roads, culverts, bridges and filling of minor irrigation tanks etc., as per directions of the Government. The capital expenditure grants released by the Government are also allocated to these works as per the approved programme of works. Expenditure incurred on such assets are shown in the books as ‘Assets held for transfer to Government' under ‘Tangible Assets'.

5.     The querist has stated that the company prepares tentative project-wise budget requirement and submits the same to the Government for providing budget allocation each year. (One such request for the year 2012-13 has been provided by the querist for the perusal of the Committee.) As per the querist, the project is to be reckoned as an asset. The budget allocation is intimated by the Government to the Company. (One such intimation for the year 2012-13 has been provided by the querist for the perusal of the Committee.) The querist separately clarified that the Government, considering the request for the project-wise requirement of funds of the company, makes budget allocation (lumpsum) and intimates the same to the company. At the time of preparing and approving the annual programme of works, i.e., programme of capital expenditure, the company allots specific funds to each component of a project. The company is of the opinion that the requirement of paragraph 14 of Accounting Standard (AS) 12, 'Accounting for Government Grants' is fulfilled. The company requests the Government for release of funds based in the budget allocation and the Government releases the same in the form of grant. Even though the term 'budgetary support' has been used in this query, the funds received from the Government are in the nature if grants only, except in case of funds released by the Government for repayment of principal of the term loans from banks and funds raised by the company. (Emphasis supplied by the quriest.)

6.      The querist has further stated that based on the budget communication to the company, the company prepares the programme of works detailing the funds required for each capital works (indirect expenditure on projects), establishment expenditure, Bagalkot Town Development Authority (BTDA) (an autonomous body created by the Government for rehabilitating the people of Bagalkot town which is partially submerged in the backwaters of Almattu Dam constructed by the company), creation of Field Irrigation Canal (FIC), Command Area Development Authority (CADA) (a Government Department created by the Government of Karnataka for carrying out the command area development works, funded by the company), rehabilitation and resettlement (R&R) works of rural population affected by the project and debt servicing, i.e. (i) for payment of interest on borrowings and (ii) payment of principal amount. The annual programme of works based on the budget provision communicated by the Government is approved by the board of the company and the company takes up the works and effects payment for the items in the annual programme of works approved by the board. However, specific grants are allocated by the Government for Special Component Plan (SCP) and Tribal Sub Plan (TSP) works, maintenance expenditure for assets, principal repayment and interest payment.

7.     The Government, after considering the funding requirement for the year under various heads, also indicates the extent of funds, the company has to mobilise for the project expenditure from market borrowings. Depending on the market conditions, the company issues bonds in the nature of debentures on private placement basis or through availing term loans from the banks. These borrowings are secured by the assets of the company. These are long term funds repayable in 7 to 10 years and are backed by the Karnataka Government guarantee for payment of interest and principal during the life of these debts. As per the terms of sanction/ issue of these loans and bonds, the Government releases specific separate grants for making interest payment and separately for meeting liability for repayment of principal amounts. The querist has also separately clarified that funds are raised through term loans from banks and bonds to augment the grants released by the Government to meet the project expenses. The borrowings are not project specific and are generally to be used for all the projects being implemented by the company. The term loans are generally for tenure of 7 years with a moratorium of three to four years and are being repaid in four/three annual installments. The interest on the term loan is serviced each month. The bonds are for a period of 10 years with an option to exit at the end of 7 years. The interest on the bonds is serviced on yearly basis. The utilisation of the funds borrowed cannot be related to a particular work and the funds are released to project offices for making payments out of pooled funds, i.e., grants received from the Government, borrowed funds and internal accruals.

Scheme of budgetary support received from the Government in the nature of grants.

8.      The company prepares each year tentative budget requirement and submits the same to the Government for providing budget allocation. The budget allocation is intimated by the Government to the company. The budget heads under which the Government communicates the grant of funds to the company are as follows:

9.      The querist has separately clarified that the Government releases grants to the company under the following heads:

(i) Specific Grants

The above are the specific grants released by the Government to the company and are to be used only for meeting expenditure of the specific works /projects.

(ii) Other Grants

(a) Capital Grant

This is not a specific grant and these grants released by the Government to the company are utilised for capital expenditure on the project and project revenue expenditure. Besides, a part of this grant is also used for revenue expenditure like salary and employee payment and other administrative expenditure.

Grant for capital expenses/Capital Grant

10.     This is a grant released by the Government mainly for meeting capital expenditure of ongoing projects and fresh projects proposed to be taken up by the company and to meet incidental expenditure. The extent of grant is determined by the Government keeping in view the projects to be/being executed by the company, and the inter se allocation of the funds to the individual project/work is made by the board of the company. However, the Government does not specify the specific asset/assets/project on which such grants are to be used. The grants received from the Government are utilised for expenditure as per approved programme of work. The capital expenditure on the project is also met from borrowed funds as well as other income like interest on short term investment of temporary surplus funds etc.

11.     Grants received from the Government and spent on the capital assets, capital work in progress, assets held for transfer to the Government are allocated for these items of works. The allocated grants are accounted as under:

a. Government grants apportioned to capital works comprising of dams, canal systems, lift irrigation schemes, etc., are reduced from the value of the assets created and depreciation is provided on the net asset value.

 

b. Government grants apportioned to Capital Work in Progress are disclosed as Deferred Government Grants under the head "Other Long Term Liabilities". When once the asset is capitalised, the item will be taken to the asset head and the grants relating to this asset is treated as stated at item (a) above.

 

c. Government grants relating to assets held for transfer to government are reduced from the value of the assets created and held for transfer.

12.     The accounting policy adopted by the company with regard to ‘Government Grants’ as related to capital and revenue expenses is reproduced below:

"9.    Significant Accounting policy - Government Grants:

 

9.2    The Grants received from the Government are apportioned for Capital works, Assets held for transfer to Government,          and revenue expenditure based on expenditure incurred towards approved component of works and other payments. ”

 

9.3    Grants apportioned as enumerated at (a) above towards capital expenditure are reduced from the value of fixed assets          at the time of capitalization.

 

9.4    Grants apportioned as stated above, towards Capital work in progress is treated as "Deferred Government Grants"           and shown under "Other Long term Liabilities".

 

9.5    Grants apportioned towards revenue expenditure are treated as income.

 

9.7    Grants apportioned towards assets held for transfer are reduced from the value of the Assets held for transfer.

 

9.8    The funds released to BTDA, R&R and CADA are netted off against the grants allocated for the said purpose."

AIBP Grants

13.      In order to speedily complete the ongoing irrigation projects approved by the Ministry of Water Resources, Government of India and having investment clearance by the Planning Commission, Government of India, the Government is releasing central assistance in the form of grants being a portion of the capital expenditure on these specified works to the State Government. The State Government in turn releases the same to the company along with the State share as per the terms and conditions of release. A copy of the guidelines of the release by the Central Government has been provided by the querist for the perusal of the Committee. The querist has also stated that since the grants under AIBP are insufficient to complete these works, releases by the State Government under the head capital grant at sl. no. 8(3) as well as borrowed funds will also be utilised for capital expenditure of these works. The extent of release of funds under the head AIBP will be a specific grant for AIBP work. Since the expenditure is met from multiple sources, the releases from the Government under AIBP is also treated as capital grant, and treated accordingly in the books. They are treated in the accounts at par with grants for capital expenditure. (Refer to the accounting policy No.9.2 enumerated above.)

Grant for CADA

14.     Certain assets like roads, bridges, culverts, tank filling works are created within the overall command area of the irrigation projects. Such assets will be ultimately transferred to Government departments like PWD, RDPR, Minor Irrigation Department etc. Such assets are held temporarily by the company and hence, they are separately disclosed as assets held for transfer to Government. For treatment of grants, refer to Significant Accounting Policy No. 9.7 enumerated above. The querist has separately clarified that command area is the area which can be irrigated from an irrigation project/ scheme and is fit for cultivation. The activities involves construction of field canals for carrying water from canal outlet up to the farms and field, intermediate and link drains. These activities are carried out by Command Area Development Authority (CADA), a Government Authority.

15.     The querist has stated that the irrigation systems created by the company consist of dams, barrages, lift irrigation schemes, tanks, canal systems etc. The canal system up to the laterals are created on the lands acquired for that purpose and the expenditure incurred for the same is capitalised in the books of the company once the schemes are substantially completed. However, the field irrigation canals created from the company's funds in the farmers agricultural field do not belong to the company. As such, the company has not capitalised the expenditure incurred for Field Irrigation Canals (FICs). Pending formalisation of a suitable accounting policy, the company has been reflecting the same under advance to Government / Government agencies (Refer toNote no. 2.11 - Long term Loan and Advances). In this regard, the querist has also clarified that the irrigation projects contain several components. The components are - a dam, a canal system including distributory canals, and canal system upto the outlet point (just prior to the farmer draws water in his field irrigation canal). It is the responsibility of Command Area Development Authority (CADA) to create the field canals on the lands of the farmers. The field irrigation canals are created for carrying water from canal outlet upto the farms and field, intermediate and link drains. Ultimately, without the field irrigation canal, water cannot be put to use by the farmer.

16.     The objective of creating field irrigation canals is to bridge the gap between the irrigation potential created at the outlet and that utilised through micro level infrastructure development and efficient farm water management practices for optimising agricultural productivity and production and improving socio-economic condition of farmers. The project is fully complete if water is used by farmers through the irrigation facilities created. Thus, FICs created by CADAs from funds provided by the company is critical to the irrigation project. However, since the underlying land for creating the FICs is not acquired by the company, the amounts spent on the fields of the farmers for creation of FICs are treated as advance to CADA under ‘Advance to Government /Government Agencies’. This could be capitalised by allocating the expenditure for FICs to the capitalised cost of the canal systems. In this regard, the querist has also clarified that there is no specific grant received from the Government by the company for CADA, BTDA and R&R works. But grants indicated by the Government under capital head are allocated specifically to CADA, BTDA and R&R works by the company. The general capital grant funds and borrowed funds, if any, are spent on CADA, BTDA and R&R works.

Grants for Interest Payment

17.      The querist has stated that the company does not have sufficient operational income to meet the liability of payment of interest on the borrowed funds. As such, such obligations are met out of the government grants specifically released for payment of interest (a copy of the Government order releasing interest has been furnished by the querist for the perusal of the Committee). The same is disclosed in the books as follows

“Government grants received from Government towards meeting interest liability is treated as income” since it is a specific grant and interest payment is disclosed as expenses under Finance Cost. Since the interest expenditure is met out of specific grant given by Government for this purpose, the interest cost, though, considered under the finance cost, is not allocated as incidental expenditure as the full liability is met out of the Government grant released for this specific purpose under the Govt budget head 2701-80-190-0-01-240.

SCP and TSP grants:

18.      Special Component Plan (SCP) and Tribal Sub-Plan (TSP) were initiated by the Government as strategies to cater exclusively to scheduled castes (SC) and scheduled tribes (ST) respectively. Such plans are meant to ensure benefits to these special groups by guaranteeing flow of funds from the Government. The Government makes/releases specific funds for such expenditure. The details and nature of works taken up under Special Component Plan (SCP) and Tribal Sub Plan (TSP) are given below:

(a) Providing irrigation facilities by providing bore wells with electrification, ponds, check dams, drinking water facility etc.

(b) Construction of SC/ST community centres, SC, ST colony street lights, toilets etc.

(c) Construction of roads and drains in the SC/ST colonies.

Such expenditure is incurred on creation of these facilities for the SC/ST beneficiaries and such facilities are transferred to the beneficiaries once the assets are completed. These expenditure will not create any asset to the company and hence not treated as capital expenditure. The querist has also stated that it is mandatory for the State Government for spending 17.15% of the budget allocation towards Special Component Plan and 6.95% towards Tribal Sub Plan. When budgetary allocation is made to the company, the Government indicates specific amount to be spent by the company to benefit the specific beneficiary groups. Since the company is receiving budget allocation from the Government towards capital expenditure, it is mandatory for the company to also take up the SCP and TSP works, even though such works are not incidental or a part of the capital projects of the company. Since these assets are handed over to the beneficiary groups after the expenditure is incurred these assets cannot be capitalised in the books of the company and hence these expenditure are treated as expenditure in the profit and loss statement under ‘SCP/TSP works'. (Refer Note No. 2.22 - Other Expenses, in 2012-13 Annual Report.) The specific grant received is also taken to the profit and loss statement as income under Government Grants for SCP/TSP works. (Refer item (b) ix in Note No. 2.19.) Any unspent amount of the grant at the end of the financial year is reflected under deferred government grant under ‘Other Current Liabilities' and utilised during the next financial year.

Rehabilitation and resettlement

19.      Rehabilitation and resettlement of the project affected people involves shifting of the affected people and resettling them in rehabilitation centers after providing basic infrastructure facilities in the rehabilitation centers (RCs). Part of a township called Bagalkot Town also got submerged in the back waters of Almatti Dam constructed by the company. While the rehabilitation of affected rural population is carried out by the Revenue Department of Government of Karnataka headed by the Commissioner, Rehabilitation, the resettlement of the population affected at the Bagalkot Town is carried out by the Bagalkot Town Development Authority (BTDA) created under the provisions of a special Legislation of the Karnataka Government called the ‘Bagalkot Town Development Act, 1993'. The Act provides for establishment of separate authority to plan, develop and manage the resettlement and rehabilitation of the project displaced families of the submerged Bagalkot Town by creating a new township by providing necessary infrastructure like roads, water supply, underground drainage, electrification and public buildings etc. The funding of the entire R&R activity both under the BTDA and the rural R&R is made by the company. As such, the expenditures incurred are part of and incidental to the overall project cost. However, the assets created will not be assets of the company as the infrastructure created will have to be transferred to the Bagalkot Town Development Authority (BTDA) in respect of Bagalkot Town and to the Zilla Panchayats in respect of rural rehabilitation and resettlement, as the case may be.

20.      Grants received from the Government, allocated and spent on rehabilitation and resettlement (R & R), Bagalkot Town Development Authority (BTDA) together with funds released from the borrowed funds are accounted as advance to BTDA and advance to Rehabilitation and Resettlement Authority. The apportioned capital grants are reduced from the advance to these entities, and the net amount is shown as advance to BTDA, Advance to R&R etc. These accounts will be squared off when the assets are transferred to the various departments as enumerated above.

Land Acquisition

21.      The land required for the submergence under the dams, land required for creation of canal systems, lift irrigation schemes, land required for creating township, rehabilitation centers, staff colonies, roads and quaries for exploiting project construction materials is acquired by the Commissioner, Land Acquisition from the funds provided by the company from the capital grants and borrowed funds. The land acquired from the funds provided by the company are treated as assets under ‘Land and submergence' in the books of the company. Initially, funds are released to the LAQ and RR authority and accounted as advance to the Government/Government Departments pending furnishing of the full details of land acquired, rehabilitation expenditure incurred by the concerned authority. The Grant apportioned to this account will be reduced from the land value at the time of capitalisation.

The querist has also provided the details of various expenditure incurred as follows:

Expenditure on Roads: The expenditure on roads are incurred from the common capital grants released by the Government. Since some of the roads though, come under the project area they are held as assets held for transfer to the Government.

 

Quarries: For construction activity, the company’s contractor need to use construction material like sand, soil, metal (stones) etc. The land in which the sand, soil and metal (stone) quarries are situated is acquired by the company for taking out these materials for use in the Project construction work. The land acquired is capitalised in the books of the company as ‘Land’ and reflected in the ‘tangible assets’ Note.

In this regard, the querist has also clarified that the land acquired by the company for project implementation is owned by the company. The company has control over the land being the owner. The ownership of land in favour of the company is established through mutation entries in favour of the company in the revenue records of the Government of Karnataka.

22.      The statutory auditors of the company have expressed reservation over the accounting treatment of grant received in their audit report on the financial statements for the year ended 31.3.2013. Refer paragraph 1(c) of Basis for Qualified Opinion annexed as Annexure A to the audit report. The auditors have also qualified the method of accounting expenditure on rehabilitation and resettlement, BTDA and CADA (See paragraph 1(d) of Annexure A in the company’s 19th Annual Report.) The copy of the statutory auditors observation on the accounting of Government Grants has been provided by the querist for the perusal of the Committee.

B.       Query

23.      On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i)      Accounting treatment of budgetary support received from the Government for meeting capital and revenue expenses.

 

(ii)      Accounting treatment of budgetary support received from the Government relating to assets held for transfer to Government/ Government agencies.

 

(iii)     Accounting treatment of budgetary support received from the Government for meeting expenses on accelerated irrigation benefit programme.

 

(iv)     Accounting treatment of budgetary support received from the Government for servicing interest on long term loans such as bonds and term loans.

 

(v)      Accounting treatment of budgetary support received from the Government for meeting expenses of Special Component Plan (SCP) and Tribal Sub Plan (TSP).

 

(vi)     Treatment of expenses incurred on rehabilitation and resettlement (R&R) activity due to relocation of Bagalkot Town through Bagalkot Town Development Authority (BTDA), and rural R&R where the assets created will not be the assets of the company.

 

(vii)     Treatment of expenses incurred on land acquisition for submergence under the dams, creation of canal systems, lift irrigation schemes, creating township, rehabilitation centres, staff colonies, roads and quaries for exploiting project construction material etc., out of the funds provided by the company.

 

(viii)     Accounting treatment of creation of field irrigation canals in the farmers' fields by the Command area Development Authority (CADA) from the funds provided by the company which do not belong to the company.

 

(ix)      Accounting treatment of Government grants received and spent on R&R, BTDA and CADA.

 

(x)       Treatment of interest payment on long term loans/bonds etc.,  in respect of capital projects/capital expenses   incurred.

C.      Points considered by the Committee

24.      The Committee, while expressing its opinion, has considered only the issues raised in paragraph 23 above and has not examined any other issue that may arise from the Facts of the Case, such as, propriety of preparation of ‘Expenditure pending capitalisation Account’ upto 2006-07 and not the profit and loss account, accounting for expenditure incurred on AIBP, SCP, TSP, accounting for interest on short term investment of temporary surplus funds, etc.

25.      With respect to nature of budgetary support received by the company, the Committee notes the definition of ‘Government grants’ from Accounting Standard (AS) 12, ‘Accounting for Government Grants’, which provides as follows:

“3.2 Government grants are assistance by government in cash or kind to an enterprise for past or future compliance with certain conditions. They exclude those forms of government assistance which cannot reasonably have a value placed upon them and transactions with government which cannot be distinguished from the normal trading transactions of the enterprise.”

From the above, the Committee notes that in the extant case, the budgetary support provided by the Government is assistance by the Government for meeting various kind of expenditures by the company. In this context, the Committee also notes that the querist has stated in the Facts of the Case that the company requests the Government for release of funds based on the budget allocation and the Government releases the same in the form of grant. Further, even though the term ‘budgetary support’ has been used in this query, the funds received from the Government are in the nature of grants only. Accordingly, relying on the above contentions of the querist and from the Facts of the Case, the Committee is of the view that the budgetary support provided by the Government is of the nature of government grant. Therefore, the principles of AS 12 can be applied in the extant case.

26.      The Committee further notes that the budgetary support received from the Government can be broadly classified into the following categories:

I.    Budgetary support received specifically for acquisition of a specific asset which are controlled by the company.

 

II.  Budgetary support received for assets that are not controlled by the company, for example, the assets that are ultimately transferred to the Government/Government Departments.

 

III.  Budgetary support for meeting specific revenue expenditure of the company.

 

IV.  Budgetary support to support the activities of the company in general.

27.      With regard to budgetary support received from the Government for specific asset, i.e., where the specific asset has been identified (either by the Government while providing the support or by the company while submitting the budget requirement to the Government), the issue to be examined is whether the company has the ability to exercise any ‘control' on the asset created out of the expenditure incurred. In this context, the Committee notes the definition of ‘asset' and paragraph 14 of Accounting Standard (AS) 26, ‘Intangible Assets' notified under the Companies (Accounting Standards) Rules, 2006 (hereinafter referred to as the ‘Rules') as follows:

"6.1 An asset is a resource:

(a) controlled by an enterprise as a result of past events; and

(b) from which future economic benefits are expected to flow to the enterprise."

"14. An enterprise controls an asset if the enterprise has the power to obtain the future economic benefits flowing from the underlying resource and also can restrict the access of others to those benefits. The capacity of an enterprise to control the future economic benefits from an intangible asset would normally stem from legal rights that are enforceable in a court of law. In the absence of legal rights, it is more difficult to demonstrate control. However, legal enforceability of a right is not a necessary condition for control since an enterprise may be able to control the future economic benefits in some other way.”

From the above, the Committee notes that asset is a resource controlled by the enterprise and an enterprise controls an asset if the enterprise has the power to obtain the future economic benefits flowing from the underlying resource and also can restrict the access of others to those benefits. Accordingly, the Committee is of the view that it is only where the asset is controlled by the company in the manner envisaged by paragraph 14 of AS 26, the company should recognise asset in its financial statements in respect of the expenditure incurred. Further, with regard to budgetary support received from the Government for the assets that will be controlled by the company, the Committee is of the view that in case such support is provided for the purchase, construction or acquisition of a specific asset, it should be recognized as ‘grant related to specific asset' in accordance with paragraphs 8.1 to 8.4 of AS 12, notified under the Rules, 2006, reproduced below:

"8.1 Grants related to specific fixed assets are government grants whose primary condition is that an enterprise qualifying for them should purchase, construct or otherwise acquire such assets. Other conditions may also be attached restricting the type or location of the assets or the periods during which they are to be acquired or held.

 

8.2 Two methods of presentation in financial statements of grants (or the appropriate portions of grants) related to specific fixed assets are regarded as acceptable alternatives.

 

 8.3 Under one method, the grant is shown as a deduction from the gross value of the asset concerned in arriving at its book value. The grant is thus recognised in the profit and loss statement over the useful life of a depreciable asset by way of a reduced depreciation charge. Where the grant equals the whole, or virtually the whole, of the cost of the asset, the asset is shown in the balance sheet at a nominal value.

 

8.4  Under the other method, grants related to depreciable assets are treated as deferred income which is recognised in the profit and loss statement on a systematic and rational basis over the useful life of the asset. Such allocation to income is usually made over the periods and in the proportions in which depreciation on related assets is charged. Grants related to non-depreciable assets are credited to capital reserve under this method, as there is usually no charge to income in respect of such assets. However, if a grant related to a non-depreciable asset requires the fulfillment of certain obligations, the grant is credited to income over the same period over which the cost of meeting such obligations is charged to income. The deferred income is suitably disclosed in the balance sheet pending its apportionment to profit and loss account. For example, in the case of a company, it is shown after ‘Reserves and Surplus' but before ‘Secured Loans' with a suitable description, e.g., ‘Deferred government grants'."

28.      With regard to the budgetary support received from the Government relating to assets that are not controlled by the company as envisaged by paragraph 14 of AS 26, as discussed in paragraph 27 above, for example, the assets that are ultimately to be transferred to the Government/Government agencies/departments, the company should not recognise such assets in its financial statements in respect of the expenditure incurred. Further, with regard to the budgetary support in respect of such assets which are not controlled by the company, the Committee notes that in these cases, the company is merely incurring expenditure out of the budgetary support received and is holding the assets on behalf of the Government/Government agencies/departments. Therefore, the funds received from the Government to the extent not utilised for creation of the assets or for execution of the project represents an obligation on the part of the company and should be disclosed on the ‘Liabilities’ side in the balance sheet under a separate head, say the ‘funds received for projects/assets being constructed/executed on behalf of the Government/Government departments’. Further, the details of total funds received from the Government on this account, the funds utilised and the assets/project completed until transferred and capital work in progress (CWIP) should be provided in the notes to accounts to clearly explain the transactions.

29.      With regard to the budgetary support received from the Government for meeting specific revenue expenditure of the company, the Committee notes the following requirements of AS 12:

"9.1 Grants related to revenue are sometimes presented as a credit in the profit and loss statement, either separately or under a general heading such as ‘Other Income’. Alternatively, they are deducted in reporting the related expense."

 

“15. Government grants related to revenue should be recognised on a systematic basis in the profit and loss statement over the periods necessary to match them with the related costs which they are intended to compensate. Such grants should either be shown separately under ‘other income’ or deducted in reporting the related expense.”

From the above, the Committee is of the view that the budgetary support received from the Government for meeting specific revenue expenditure of the company should be recognised on a systematic basis in the profit and loss statement over the periods necessary to match them with the related costs which they are intended to compensate.

30.      With regard to the budgetary support received to support the activities of the company in general and not with respect to any specific capital asset or revenue expenditure, the Committee is of the view that since these grants are not granted with reference to the total investment in an undertaking or by way of contribution towards its total capital outlay (as in case of grants of the nature of promoters' contribution) or with reference to acquisition of a specific asset, such grant should be recognised as grants related to revenue in accordance with the requirements of paragraphs 9.1 and 15 of AS 12 as reproduced in paragraph 29 above.

31.      In the background of the above discussion, the Committee is of the view that detailed information with regard to the type of budgetary support, whether it is for any specific project/asset and whether the expenditure results into creation of an asset controlled by the company, etc. is required to determine the accounting for any budgetary support. The Committee notes that such detailed information and facts pertaining to various budgetary supports received from the Government are not available in the extant case. For example, in case of budgetary support received for assets held for transfer to the Government /Government agencies, it is not clear whether these assets will be controlled by the company or not. Accordingly, the Committee is of the view that in respect of various budgetary supports received from the Government, viz., issues No. (i), (ii), (iii), (iv), (v) and (ix), as listed in paragraph 23 above, the company should determine as to whether these fall in category I, II, III or IV, viz., budgetary support received specifically for acquisition of specific assets which are controlled by the company, budgetary support received for assets that are not controlled by the company, budgetary support for meeting specific revenue expenditure of the company, or budgetary support to support the activities of the company in general, as discussed in paragraph 26 above and then accordingly, account for such budgetary support, as discussed in paragraphs 27 to 30 above.

32.      With regard to the issue (vi) relating to accounting treatment of expenses incurred on rehabilitation and resettlement activity due to relocation of Bagalkottown through BTDA and rural R&R, where, as per the querist, the assets created will not be the assets of the company, the Committee notes that the querist has stated that the funding of the entire R&R activity is made by the company and that the expenditure incurred is part of and incidental to the overall project cost. With respect to capitalisation of expenses, the Committee notes the following paragraphs from Accounting Standard (AS) 10, ‘Accounting for Fixed Assets²:

"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:

(i) site preparation;

(ii) initial  delivery and handling costs;

(iii) installation cost, such as special foundations  for plant; and

(iv) professional fees, for example fees for  architects and engineers.

The cost of a fixed asset may undergo changes subsequent to its acquisition or construction on account of exchange fluctuations, price adjustments, changes in duties or similar factors."

From the above, the Committee is of the view that R&R expenditure is normally incurred as a direct consequence of the project and though the R&R activity does not result into creation of any asset controlled by the company, it is directly attributable to the project. Accordingly, the Committee is of the view that expenditure on R & R activity should be capitalised as a part of the relevant project/assets provided the related assets/project in respect of which the R&R expenditure is being incurred is ‘controlled' by the company and is accordingly, capitalised in the books of the company in accordance with the requirements of AS 10. However, in case the related asset/project is not ‘controlled' by the company, the Committee notes from paragraph 28 above that in such cases, no asset would be recognised in its financial statements. Accordingly, the Committee is of the view that even the R&R expenditure incurred for such assets/projects out of the funds provided by the Government should be considered to be incurred on behalf of the Government as an executing/implementing agency. Therefore, the same should not be recognised as an expense in the statement of profit and loss; rather the same should be adjusted against any budgetary support received for such R&R expenditure while disclosing the net amount as liability in the balance sheet, as discussed in paragraph 28 above. However, if any internal funds (for example, from internal accruals) are also utilised for such expenditure, the same should be recognised as an expense in the statement of profit and loss, since no asset ‘controlled’ by the company comes into existence.

33.      With regard to the issue (vii) relating to treatment of expenses incurred on land acquisition for submergence under the dams, creation of canal systems, lift irrigation schemes, creating township, rehabilitation centres, staff colonies, roads and quarries for exploiting project construction material etc., the Committee notes that land is being acquired out of the capital grants and borrowed funds for various kind of assets, some of which would be transferred to the Government department/agencies and some of which may be retained by the company. The Committee further notes that the querist has stated that the land acquired by the company for project implementation is owned by the company and the company has control over the land being the owner. In this regard, the Committee is of the view that the ‘control’ over land should be determined in the context of paragraph 14 of AS 26, as reproduced in paragraph 27 above. The Committee is of the view that in case of lands acquired for creation of the assets which would ultimately be transferred to the Government departments/agencies on completion of their construction, such as roads, townships, rehabilitation centres, etc., ordinarily, the company would not possess ‘control’ over such lands after transfer and as such, in these cases, land should not be recognised as an asset of the company. In such cases, the expenditure incurred on land acquisition shall be considered to be incurred on behalf of the Government. Therefore, the same should be deducted from any budgetary support received for such land acquisition while disclosing the net amount as liability in the balance sheet, as discussed in paragraph 28 above. In such cases, if the expenditure is being incurred out of the internal funds (for example, from internal accruals), the same should be recognised as an expense in the statement of profit and loss. However, in cases where the company possesses ‘control’ over such lands as discussed above, the same should be recognised as ‘asset’ of the company.

34.      With regard to the issue (viii) relating to accounting treatment of creation of field irrigation canals (FICs) in the farmers’ fields by the Command Area Development Authority (CADA) from the funds provided by the company which do not belong to the company, the Committee notes that the querist has stated that the field irrigation canals are created for carrying water from canal outlet upto the farms and fields and that without the field irrigation canal, water cannot be put to use by the farmer. Further, it has also been stated that the objective of creating field irrigation canals is to bridge the gap between the irrigation potential created at the outlet and that utilised and that the project is fully complete if water is used by farmers through the irrigation facilities created. Thus, FICs created out by CADA from funds provided by the company is critical to the irrigation project. In this regard, the Committee also notes that the FICs in the farmers' fields do not belong to the company. However, it is not clear whether these are ‘controlled' by the company in the manner envisaged in paragraph 14 of AS 26, as discussed in paragraph 27 above. The Committee is of the view that if these are ‘controlled' by the company and meet the definition of ‘asset', these can be recognised as separate assets in the books of account of the company. However, if FICs are not controlled by the company, the Committee further notes paragraph 9.1 of AS 10, as reproduced in paragraph 32 above and the following paragraphs of AS 10, notified under the Companies (Accounting Standards) Rules, 2006:

"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 9.4. 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.”

 

“21. The cost of a self-constructed fixed asset should comprise those costs that relate directly to the specific asset and those that are attributable to the construction activity in general and can be allocated to the specific asset.”

From the 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. Accordingly, the Committee is of the view that in case, expenditure on FICs does not result into creation of a separate‘asset' for the company, such expenditure can still be capitalised with the cost of the related irrigation project being capitalized by the company provided such expenditure is directly attributable to the related irrigation project, as discussed above. In case such expenditure is not directly attributable to the irrigation project, the same should be charged to the statement of profit and loss to the extent such expenditure is being incurred out of the internal funds (for example, internal accruals). However, if the expenditure is being incurred out of the funds provided by the Government, the expenditure incurred to such an extent should be adjusted against the budgetary support received from the Government.

35.      With regard to the issue (x) relating to treatment of interest payment on long term loans/bonds etc. in respect of capital projects/capital expenses incurred, the Committee notes the following relevant accounting principles related to borrowing costs as provided under Accounting Standard (AS) 16, ‘Borrowing Costs', notified under the Rules, as follows:

“3.2 A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.”

 

“6. Borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as part of the cost of that asset. The amount of borrowing costs eligible for capitalisation should be determined in accordance with this Standard. Other borrowing costs should be recognised as an expense in the period in which they are incurred.”

 

"8. The borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset are those borrowing costs that would have been avoided if the expenditure on the qualifying asset had not been made. When an enterprise borrows funds specifically for the purpose of obtaining a particular qualifying asset, the borrowing costs that directly relate to that qualifying asset can be readily identified."

 

“12. To the extent that funds are borrowed generally and used for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation should be determined by applying a capitalisation rate to the expenditure on that asset. The capitalisation rate should be the weighted average of the borrowing costs applicable to the borrowings of the enterprise that are outstanding during the period, other than borrowings made specifically for the purpose of obtaining a qualifying asset. The amount of borrowing costs capitalised during a period should not exceed the amount of borrowing costs incurred during that period.”

 

“14. The capitalisation of borrowing costs as part of the cost of a qualifying asset should commence when all the following conditions are satisfied:

(a) expenditure for the acquisition, construction or production of a qualifying asset is being incurred;

(b) borrowing costs are being incurred; and

(c) activities that are necessary to prepare the asset for its intended use or sale are in progress.”

From the above, the Committee notes that the borrowing costs can be capitalised as a part of the cost of a qualifying asset only when expenditure for the acquisition, construction or production of qualifying asset is being incurred and other conditions of paragraph 14 of AS 16, as reproduced above are fulfilled. Further, only the borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset should be capitalised as a part of the cost of that asset. The Committee further notes from the Facts of the Case that the querist has stated that borrowings are not project specific and the borrowings are generally to be used for all the projects being implemented by the company. Further, it is also stated that the utilisation of the funds borrowed cannot be related to a particular work and the funds are released to project offices for making payments out of pooled funds i.e., grants received from the Government, borrowed funds and internal accruals. In this regard, the Committee notes from paragraph 12 of AS 16 that to the extent that funds are borrowed generally, (i.e., without specifying any particular project) and used for the purpose of obtaining a qualifying asset, the amount of borrowing costs eligible for capitalisation should be determined by applying a capitalisation rate to the expenditure on that asset. The Committee is of the view that in the extant case, since the company raised loans for various projects in general and the payment for the project is being made out of the pooled funds comprising of loans, internal accruals, etc. it may be difficult to identify exact amount of borrowing funds utilised for a particular project. However, determining to what extent general borrowings have been used for a specific project, is a question of fact and should be determined by exercising the best judgement considering various factors, for example, information related to cash inflows and outflows. Accordingly, the Committee is of the view that the company should determine the borrowing cost, if any, to be capitalised as a part of the project cost as discussed above. The balance interest cost, if any, should be charged to the statement of profit and loss. In this context, the Committee also wishes to point out that the borrowing costs to be capitalised with the project cost should be net of the related budgetary support, received, if any.

D.      Opinion

36.      On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 23 above:

(i), (ii), (iii), (iv), (v) and (ix) - The company should determine as to whether these fall in the category I, II, III or IV, as listed in paragraph 26 above, viz., budgetary support received specifically for acquisition of specific assets which are controlled by the company, budgetary support received for assets that are not controlled by the company, budgetary support for meeting specific revenue expenditure of the company, or budgetary support to support the activities of the company in general, as discussed in paragraph 26 above and then accordingly, account for such budgetary support, as discussed in paragraphs 27 to 30 above

 

(vi)   Refer paragraph 32 above.

(vii)  Refer paragraph 33 above.

(viii)  Refer paragraph 34 above.

(ix)   Refer paragraph 35 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 30.03.2016.