1.13     Query

Capitalisation of interest on borrowings made

for the purchase of fixed assets

1. A State Road Transport Corporation purchases its vehicle chasis (buses as well as trucks chasis) under I.D.B.I. rediscounting scheme. The interest charges, including discount, work out to 10.85%. The principle and the interest are repayable within a period of 60 months under increasing, decreasing or equalising method scheme. Under these three schemes there is slight variation in the interest payments. On receipt of chasis, the Corporation allots them to various body-builders for fabrication of bus/truck bodies. The period from acquisition of chasis to completion of bodies varies from 3 to 9 months depending upon the capacity of body-builders and availability of funds for releasing of completed vehicles from the concerned fabricators. Within a period of 15 days to one month after completion of bodies these vehicles become operational.

2.The querist has sought the opinion of the Expert Advisory Committee whether interest can be capitalised in respect of the period for which interest is charged by IDBI, in the above circumstances.

                                                        Opinion                                            May 15, 1986

1.The Committee notes that the Council of the Institute of Chartered Accountants of India has issued an announcement 1on “Auditor’s duty in circumstances in which interest payable on borrowing made for the purchase of fixed assets is capitalised for periods subsequent to the commercial production.” The said announcement is reproduced below:

              “It has been brought to the notice of the Council of the Institute of Chartered Accountants of India that certain companies have followed an accounting practice whereby interest payable on borrowings made for purchase of fixed assets or in respect of assets purchased on deferred payment basis has been capitalized for periods extending beyond the date of commencement of commercial production. The Council notes that this practice is not in accordance with the recommendations made in the “Guidance Note on Treatment of Interest on Deferred Payments” issued by the Research Committee of the Institute in 1979. In this regard the council wishes to bring to the notice of the members, paragraphs 11 and 22 of the aforesaid Guidance Note which read as under:

“11-In the light of the above discussion, the Research Committee would like to reiterate its view that interest payable for the period after commencement of production in respect of assets purchased on deferred credit basis should not be capitalized. If, however, any company decides to capitalize the total amount of interest which is likely to be payable over the period during which the deferred credit is allowed on the basis of the decisions of the Courts referred to in para 6 above, the fact that interest has been so capitalized and the amount of the interest capitalized should be indicated by way of a note in the Balance Sheet of the company in the year in which such capitalisation has been made and in each of the subsequent years as long as the asset continues to appear in the Balance Sheet. It will also be necessary for the auditor to make a reference to this note in his report to the members. In such a case, depreciation should be provided in the accounts on the total cost, including the interest so capitalized. Once, the total interest for the period during which the deferred credit is to run is treated by the company as part of the cost of the asset, the question of charging the interest payable as revenue expenditure against the income of year will not arise.”

“22- After careful consideration of all the aspects discussed above the Research Committee is of the view that there is no reason to deviate from its existing recommendation about accounting treatment for interest payable on deferred credit basis or to make an exception in the case of shipping companies. As clarified in this note, interest payable during the period of construction or installation of fixed assets can be capitalized. However, interest payable on fixed assets purchased on a deferred credit basis or on monies borrowed for acquisition of assets should not be capitalized after such assets are put to use. If such interest is treated as part of the cost of the asset on the basis of tax decisions referred to in para 6, adequate disclosure of this fact should be made as explained in para 11 above. As discussed in this note interest payable in respect of the asset purchased on deferred payment terms cannot be treated as “Deferred Revenue Expenditure” after commencement of production.”

The Council further reiterates that in cases where interest has been so capitalised and the amount involved is material, it will be necessary for the auditor to qualify his report accordingly. An example of the qualification is given below:

“Interest payable on borrowing related to the acquisition of fixed assets has been capitalized for the periods during which the assets were in use for commercial production. This is contrary to the accounting practice recommended by the Institute of Chartered Accountants of India. Consequently, the profit (after charging depreciation and provision for taxation) of the company has been overstated by Rs…….., the fixed assets have been overstated by Rs…. and reserves and surplus have been overstated by Rs…..  as compared to the position which have prevailed if the recommended practice had been followed.”

2.On the basis of the above, the Committee is of the opinion that the interest charged by the IDBI, in respect of the chasis of the vehicles purchased by the corporation, can be capitalized only relating to the period up to the date of commencement of commercial operations by the vehicle(s). In this regard, the Committee wishes to point out that what is significant for this purpose is the date when the vehicle is ‘ready’ for commercial production and not the date when the vehicle actually commences commercial operations.1

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  1   Published in “The Chartered Accountant”, March 1984, pp. 591.

1 Para 12.4 of the Guidance Note on treatment of Expenditure During construction Period, issued by the Research Committee of the Institute of Chartered Accountants of India.