1.35 Query
Accounting treatment of loss of a fixed asset.
1.A Government of India Corporation, registered under the Companies Act, 1956, took over the construction of a hydro-electric project from Central Government in 1977. The project has a generation capacity of 105 MW. The total estimated cost of the project is Rs. 126 crores.
2.The project has four major components; (i) Barrage, (ii) Water Conductor System, (iii) Power House, and (iv) Power Transmission Line, besides other supporting services. The project components are part of an integrated system and are inter-dependent. The project was completed in April, 1983, except for some minor important capital works, and had trial run during April-May, 1983. In June, 1983, the project was put on commercial operation. However, on 26th July, 1983, the generation had to be stopped following a massive landslide in Head Race Tunnel (HRT) – a part of the Water Conductor System. Due to this landslide, 35 meters of the tunnel portion under the hill collapsed out of the total of 6,903 meters long HRT. This tunnel was part of 10,268 meters long water conductor system. The Enquiry Committee, after due enquiry, has held that this damage was due to natural calamity, mainly due to heavy rainfall, resulting in movement of unstabilised portion of the hill.
3.The corporation subsequently undertook hill stabilisation and other protection works and measures costing approximately Rs. 10 crores in consultation with various advisory authorities. This expenditure has been incurred so that there is no such collapse in future. Under additional hill stabilisation work, 111 meters of the existing tunnel, including 35 metres damaged portion, was discarded and a new re-routing portion of the tunnel of 137 metres was constructed. Similarly, other stabilisation works were also carried out. The project was re-commissioned in August 1984 after about 13 months.
4. The discarded portion of 111 meters of tunnel is part of 10,268 meters long water conductor system and only constitutes a negligible percentage of the total length of the system. Moreover, this portion itself is not an independent asset which can be put to use separately.
5.The expenditure incurred on re-routing of 137 meters of tunnel along with the hill stabilisation measures was capitalised.
6.A doubt has now arisen whether this 35 meters damaged portion and 76 meters of discarded portion, which form a negligible percentage of the total cost as well as the total length of the water conductor system should be treated as revenue loss or it should be continued to be shown as an asset and no accounting adjustment should be made in this regard.
7. In this context, the querist has informed that the value of 111 meters of the tunnel cannot be separately and actually determined but can only be estimated on proportionate basis. The cost of this portion so worked out comes to Rs. 71 lakh out of the total cost of the tunnel of Rs. 44.49 crores. The corporation has decided that this cost may not be treated as a revenue loss and may be allowed to remain as a part of the capital cost. The main reasons, according to the company, are as below:
(i) The loss is only a small percentage of the total cost and the length of the water conductor system.
(ii) The portion damaged and discarded is not an independent asset and cannot be put to use separately.
(iii) The loss occurred within 12 months from the date of start of commercial operation of the project.
(iv) The discarded portion and re-routed tunnel is expected to have an uninterrupted generation in the project and the chances of collapse due to natural calamities will be reduced to a great extent.
8.The statutory auditors as well as the Government auditors have maintained that as loss took place after the start of the commercial operation of the project, this loss should be charged to revenue income.
9.In view of the facts mentioned above, the opinion of the Expert Advisory Committee has been sought by the querist on the following issues:
(i) Whether the non-writing off of the cost of this small portion of the damaged and discarded tunnel is in conformity with the sound accounting policies and practices, keeping in view the facts and circumstances of the case;
(ii) If not, whether the value of the loss is to be charged to the profit and loss account or it should be treated as a capital loss and value of the assets to be reduced from the capital cost of the project, i.e., net additional works capitalised and balance amount to be adjusted against reserves and surplus.
(iii) If the amount of the loss is to be charged to profit and loss account, whether the loss is to be written-off in one year or may be written-off in the next 10 years.
Opinion March 17, 1989
1.The Committee notes that the normally accepted accounting principle where a part of a fixed asset is replaced is to treat the cost of replaced part as a charge to profit and loss account. However, since the circumstances of the present query are peculiar, viz., the replacement cost of the part of tunnel is substantially higher than the cost of the discarded portion of the tunnel and the replacement cost includes cost for hill stabilisation, it would be appropriate in this case to capitalise the replacement cost of the part of the tunnel. However, in the view of the Committee, the cost of the discarded portion of the tunnel is to be written off.
2.On the basis of the above, the opinion of the Expert Advisory Committee on the issues raised by the querist in para 9, is as below:
(i) In view of the peculiar circumstances of the query, it would be appropriate that the replacement cost of the tunnel should be capitalised and the cost of discarded portion of the tunnel should be written off.
(ii) The loss should be charged to the profit and loss account.
(iii) The loss should be charged to the profit and loss account of the year in which the loss was incurred. In case it is not so charged, it should be charged as a ‘Prior period item’4 in the profit and loss account of the subsequent year in which it is decided to write it off.
__________________________ 4 See Accounting Standard 5 ‘Prior Period and Extra-ordinary Items and Changes in Accounting Policies’. |