1.10     Query

Treatment of equipment/plant used in construction activities,

after the completion of the construction period.

1. A public sector corporation, registered under the Companies Act, 1956, is engaged in construction and operation of hydroelectric power projects at different parts of the country. The construction period ranges between 4 to 8 years. The accounts of each project are being maintained and audited separately. Presently, tariff for each project is fixed on its construction cost. A large number of construction equipments, specially heavy earth moving equipments like bull-dozers, dumpers, shovels, cranes etc., are required for the construction purposes. On completion of construction of a project, these construction plants and equipments are either transferable to other projects/units or retired from active use depending upon their condition. Most of these equipments are not required for operation purposes. These equipments, therefore, await disposal at construction projects.

2. During the construction period, the depreciation on such equipments are charged to ‘Incidental Expenditure During Construction Account’, applying the normal rate and ultimately capitalised as part of the indirect construction cost. As these equipments are not usable/used in the operations, the depreciation on these cannot be charged, according to the querist, to revenue accounts of the projects. The corporation, therefore, has adopted the policy of not charging further depreciation on such construction equipments awaiting disposal. The profits/losses, if any, on disposal, are being accounted after the disposal of such items. The transfer to other projects/units is being made on book value. In this context, the querist has drawn the attention of the Expert Advisory Committee to Accounting Standard 10 (AS-10) on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered Accountants of India, which recommends as below:

“Items of fixed assets that have been retired from active use and are held for disposal are stated at the lower of their net book value and net realisable value and are shown separately in the financial statements. Any expected loss is recognized immediately in the profit and loss statement.”(para 14.2)

The querist has mentioned that the relevant International Accounting Standard has also made recommendations in this regard on the same lines.

3. In the above, context, the querist has sought the opinion of the Expert Advisory Committee on the following issues:

(i) Whether the policy adopted by the corporation, as stated above, is in conformity with the said Accounting Standard of the Institute.

(ii) Whether, the difference, if any, between the book value of such construction plant and equipments and value realised on their disposal can be charged to the profit and loss account of the operation project or the adjustments should be made in the capital construction account.

(iii) In case, the opinion of the Committee is in favour of carrying out adjustments in capital construction accounts, what should be the manner in which adjustments can be made on disposal of such equipments if disposals take place over a number of accounting years and the accumulated incidental expenditure during construction period has already been capitalised.

                                                                         Opinion                                    February 12, 1988

1. The Committee notes that para 17.18 of the Guidance Note on Treatment of Expenditure During Construction Period, issued by the Research Committee of the Institute of Chartered Accountants of India, recommends as below:

“It is recommended that depreciation should be charged during the construction period on any items of fixed assets or temporary construction facilities used during the period of construction ………..the depreciation provided during the construction period should ordinarily be treated as part of the indirect construction cost and capitalised accordingly. If any item of fixed assets used during the construction period is retained by the project for use after production, the residual book value of such assets should be depreciated in the normal way after the commencement of production.”

2.The Committee further notes that Accounting Standard 6 (AS-6) on ‘Depreciation Accounting’, issued by the Institute of Chartered Accountants of India, states in para 3.1 that “Depreciation is allocated so as to charge a fair proportion of the depreciable amount in each accounting period during the expected useful life of the asset”. The term ‘useful life’ is defined in the Standard as “either (i) the period over which a depreciable asset is expected to be used by the enterprise; or (ii) the number of production or similar units expected to be obtained from the use of the asset by the enterprise”. The Standard defines, ‘depreciable amount’ of a fixed asset as “its historical cost, or other amount substituted for historical cost in the financial statements, less the residual value”.

3. On the basis of the above, the Committee is of the view that depreciation on fixed assets used during construction period should be worked out at the rates worked out on the basis of the estimated residual value of the asset, and its useful life to the company, subject to the minimum of the rates prescribed in section 205 and 350 of the Companies Act, 1956, as recommended in para 13 of AS-6. In this way, the true commercial and technical charge of depreciation will be capitalised. After the commencement of commercial production, no depreciation should be charged on the retired assets held for disposal and “these should be stated at the lower of their net book value and net realisable value and shown separately in the financial statements. Any expected loss is recognized immediately in the profit and loss statement”(para 14.2 of AS-10). Any profit or loss arising on actual disposal of retired assets should also be recognized in the profit and loss account of the year in which the disposal takes place.

4. On the basis of the above, the opinion of the Expert Advisory Committee on the issues raised in para 3 of the query, is as below:

(i) The policy adopted by the company would be in conformity with the accounting standards of the Institute if-

(a) depreciation charged during construction period is worked out as recommended in para 3 above.

(b) after the completion of construction, the fixed assets in question should be stated at the lower of their net book value and net realisable value and shown separately in the financial statements. Any expected loss is recognized immediately in the profit and loss account.

(ii) Any profit or loss arising on disposal of retired assets should be recognized in the profit and loss account. No adjustment should be made in the capital construction account.

(iii) In view of (ii) above, this question does not arise.

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