Treatment of capital expenditure on land not belonging to the

company and not represented by tangible assets.

1. A Government of India enterprise, formed and registered under the Companies Act, 1956, is maintaining and rendering accounts as per the provisions contained in the said Act. The main objectives of the corporation are to plan, investigate, construct, operate and maintain hydroelectric power stations. The corporation also undertakes construction of inter-state transmission lines and transmission of power.

2. Most of the projects of the corporation are at different remote hilly areas without having any infrastructure and communication facilities. The corporation, therefore, requires to spend a considerable amount in different projects at their construction stage, for building-up and maintenance of roads, bridges, culverts etc. on land not belonging to the corporation. These infrastructure facilities built up/maintained are most essential for transportation of heavy equipments for construction, generation and transmission. These facilities are also continued to be used by the projects throughout their useful life of operation. In addition to that, sometimes, compulsory afforestation is also required to be done in certain areas as a pre-condition for taking-up construction of hydroelectric power projects. The capital expenditure incurred by the projects for this purpose is not represented by any tangible asset in the accounts of the projects since these remain the property of the relevant state authorities/local bodies/Forest Departments as per their rules and laws.

3. The corporation is following the undernoted accounting practice for classifying and capitalising such expenses during construction period, not represented by any tangible assets: -

(i) Expenditure incurred during construction period, by the projects, on roads, bridges, culverts and other communicational facilities on the land not belonging to the corporation are classified under the head “Communication”, and has been clubbed with the expenditure on “Building & Civil Engineering Works and Communication”, forming part of the capital work-in-progress and is exhibited as fixed capital expenditure in the balance sheet.

(ii) Total of such expenditure incurred and included in the capital work-in-progress is also disclosed by way of a note on accounts forming part of the balance sheet, as below:

“Rs. 1583.43 lakhs included under “Communication” in “Capital Work-in-progress” relates to expenditure incurred on Roads, Bridges, and Culverts on land not belonging to the Corporation and will be allocated in terms of Accounting Policy No. 10.”

(iii) On completion of the construction of a project, the total of such expenditure relating to that project is being allocated pro-rata along with other ‘Incidental Expenditure During Construction’ (IEDC) on the tangible fixed immovable assets excluding land.

(iv) Extract of the accounting policy (No. 10) which forms a part of the accounts is given below:

“The total amount of incidental expenditure during construction and intangible expenditure incurred on the project which has been put to commercial operation during the year have been allocated on the tangible fixed immovable assets excluding land on the basis of cost appearing/adjusted as on 1^st day of the start of commercial production.”

4. During finalisation of accounts for 1987-88, the Government auditors had expressed certain doubts on the policies being followed by the corporation in this regard. The auditors maintained that (a) such expenditure should have been shown distinctly under heading “Capital Expenditure” and (b) should have been written-off over a period of utility not exceeding 5 years by charge to IEDC, pending allocation as per the standard accounting practice.

5. The corporation contended that classification of expenditure, its presentation and disclosure in the balance sheet as being done by the corporation, is as per para 10 of ‘Guidance Note on Treatment of Expenditure during Construction Period’, issued by the Research Committee of the Institute of Chartered Accountants of India. The depiction of this specific item in the balance sheet indicates quite clearly that the capital expenditure is not represented by any asset owned by the corporation. As regards the requirement to write-off such expenses over the period of utility or over 5 years, whichever is less, the corporation feels as under: -

(i) Such write-off during construction period by charge to IEDC Account, as suggested by the auditors, does not serve any purpose, as the net accumulated IEDC is again allocated on completion of the projects to the different fixed capital components of the projects.

(ii) The construction period of projects generally ranges between 7 to 10 years and incurring expenditure on land not belonging to the corporation, either directly or through State Governments/local bodies, is a continuous process during the construction period. The total quantum of such expenditure can, thus, be ascertained only at the final stage of construction.

(iii) Write-off of such expenditure over a period of 5 years by charging the same to the Consolidated Revenue Account of the corporation as a whole is also not proper. As per the policy declared by the Government of India, the tariff for power charges is to be determined power-station-wise. Total expenditure chargeable to the Revenue Account of that particular project plus a return on investment at a specified rate determine the power tariff of that project. Thus, if the part of the capital expenditure of the project is charged to the Revenue Account of other sister projects, the beneficiaries of one project will be unduly burdened with the cost of beneficiaries of other projects.

(iv) To write-off such heavy amount of construction expenditure over a period of 5 years from the date of starting commercial operation of the project is also not feasible. If that is done, the power charges during the earlier period will be abnormally high which may not be economically beneficial to the recipients of power during that period.

6. It is, therefore, considered necessary to spread the recovery of such capital expenditure (not represented by any tangible asset) over the entire estimated life of the project and that can be done by capitalising such expenditure along with tangible fixed immovable assets of the projects and charging depreciation on such assets at an appropriate rate during the estimated life span of the project.

7. In view of the above facts, the opinion of the Expert Advisory Committee is sought on the following matters: -

(a) Whether the classification, depiction and disclosure of such expenses in the balance sheet, as is being done by the corporation, is proper.

(b) Whether the capitalisation of such expenses by way of pro-rata allocation of these to the value of tangible immovable assets constructed in the project and recovery of these expenses at the normal rate of depreciation over the useful life span of the project, as being done by the corporation, is proper.

Opinion September 13, 1989

1. The Committee notes para 10 of the ‘Guidance Note on Treatment of Expenditure During Construction Period’, which is as follows:

“Sometimes, circumstances force a project to incur capital expenditure which is not represented by any specific or tangible asset. For example, a project may have to pay the cost of laying pipelines in order to facilitate the supply of its products or raw materials to or from a seaport, but the Port Trust or other similar authorities may insist that the pipelines belong to them even though the cost thereof is paid by the company. In other cases, a project may have to agree with a local authority to pay the cost or part of the cost of roads to be built by that authority in the vicinity of the project for the purpose of facilitating the business of the project. In this case also, the capital expenditure incurred by the project for this purpose would not be represented by any actual assets, since the roads would remain the property of the relevant state authorities even though the whole or a part of their cost may have been defrayed by the company in order to facilitate its business. In all such cases, the expenditure so incurred would have to be treated in the books of account as capital expenditure. There seems to be no valid objection to disclosing the same in the balance sheet under the general heading of ‘Capital Expenditure’ subject to two conditions. In the first place, the description of specific item on the balance sheet should be such as to indicate quite clearly that the capital expenditure is not represented by any assets owned by the company. In the second place, the capital expenditure should be written off over the approximate period of its utility or over a relatively brief period not exceeding five years, whichever is less. In fact, having regard to the nature of the expenditure and the purpose for which it is incurred, it is suggested that it would be more appropriate and realistic to classify such expenditure in the balance sheet under the heading of “Capital Expenditure” rather than either, write off the expenditure to revenue or classify the expenditure under the heading of ‘Miscellaneous Expenditure’ or ‘Deferred Revenue Expenditure’”. (Emphasis supplied by the Committee)

2. The Committee notes that the expenditure on building-up and maintenance of roads, bridges, culverts etc. on the land not belonging to corporation has been shown by the corporation under the group heading of ‘Capital Work-in-progress’. However, it has been clubbed with the expenditure on “Building & Civil Engineering Works and Communication”. Thus, on the balance sheet, it has not been separately disclosed, although explanatory note no. 4 and Accounting Policy No. 10, which form part of the accounts indicate the fact that the expenditure under the head ‘Communication’ relates to assets not belonging to the company. The Committee is, accordingly, of the view that the disclosure is not in accordance with the recommendations, in this regard, of the aforesaid Guidance Note, although it has been correctly classified as capital expenditure.

3. In view of the above, the opinion of the Committee, on the issues raised by the querist in para 7 of the query, is as below:

(a) The capital expenditure on land not belonging to the corporation has been correctly classified as ‘Capital Expenditure’ in the balance sheet. However, it should have been separately disclosed under that head, appropriately indicating the nature of the said expenditure.

(b) Capitalisation of the said capital expenditure by allocating the same to the immovable assets constructed in the project is not in accordance with the Guidance Note on Treatment of Expenditure During Construction Period. The Committee is further of the opinion that the amount of the capital expenditure should not be charged to the Incidental Expenditure During Construction Account but should be accumulated in a separate account until the commencement of commercial operations of the project. Thereafter, it should be written-off to the profit and loss account as recommended in the Guidance Note, i.e., over the approximate period of its utility or over a relatively brief period not exceeding five years, whichever is less.