Académique Documents
Professionnel Documents
Culture Documents
Volume XXVI
Expert Advisory Committee
The Institute of Chartered Accountants of India
The
Institute of
(Set up by an Act of Parliament)
Chartered
New Delhi
www.icai.org Accountants
of India
June / 2010 (Reprint)
Compendium of Opinions
(Volume XXVI)
of the
Published in 2009
Committee/
Department : Expert Advisory Committee
November/2009/1000 copies
Foreword
Today’s ever-changing economic climate is pushing enterprises to
adopt new business models incorporating multiple business
transactions, and forcing financial executives to address complex
and intricate management issues. As the complexity in business
grows, so do generally accepted accounting principles (GAAPs)
as these principles attempt to measure the economic impacts of
intricate business transactions. These GAAPs cover in their ambit
various relevant legal requirements, accounting standards, guidance
notes, and other authoritative pronouncements of the Institute of
Chartered Accountants of India.
The complexities and intricacies involved in business transactions
also sometimes make the application and implementation of the
GAAPs difficult. To address these issues, the Expert Advisory
Committee has been constituted to provide its independent and
objective opinion on such issues. The opinions provide an insight
to various accounting and auditing related real life practical problems
faced by the industry and members in practice.
I am pleased to note that the Committee has brought out this new
volume of the Compendium of Opinions which is twenty-sixth in its
series and contains the opinions finalised by the Committee between
February 2006 and January 2007. I am sure that like other volumes,
this volume would be of great significance and use for all concerned.
Preface
Query No. 1
Subject: Treatment of engineering fee paid to a lumpsum
turn key contractor.1
A. Facts of the Case
2. The querist has stated that the LSTK agreement with the
contractor provides for residual process design, detailed
engineering, procurement, supply, transportation, storage,
fabrication, construction, installation, testing, pre-commissioning,
commissioning and performance guarantee test run, and handing
over of the plant to the company in lieu of one lumpsum amount
agreed to by both the parties.
3. According to the querist, in order to facilitate payments, the
LSTK agreement segregates the lumpsum price in the following
categories:
1
Opinion finalised by the Committee on 27.3.2006
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B. Query
9. The querist has sought the opinion of the Expert Advisory
Committee on the following issues in respect of accounting for
expenses incurred towards engineering and design of the plant
under the LSTK agreement:
10. The Committee notes that the basic issue raised in the query
relates to the treatment of expenditure incurred on process design
and engineering cost in respect of various assets under the LSTK
agreement. The Committee has, therefore, answered only this
issue and has not touched upon any other issue arising from the
Facts of the Case, such as, accounting treatment of payments
made to contractor based on stages of completion.
11. As far as the expenditure relating to detailed engineering and
design of the plant is concerned, the Committee notes paragraph
20 of AS 10 and paragraph 10 of AS 26, which state, respectively,
as follows:
AS 10
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AS 26
“10. In some cases, an asset may incorporate both intangible
and tangible elements that are, in practice, inseparable. In
determining whether such an asset should be treated under
AS 10, Accounting for Fixed Assets, or as an intangible asset
under this Statement, judgement is required to assess as to
which element is predominant. For example, computer software
for a computer controlled machine tool that cannot operate
without that specific software is an integral part of the related
hardware and it is treated as a fixed asset. The same applies
to the operating system of a computer. Where the software is
not an integral part of the related hardware, computer software
is treated as an intangible asset.”
12. From the above, the Committee is of the view that the
expenditure on detailed engineering and process design consisting
of layout of the equipments is an integral part of the related fixed
asset and is also attributable to the cost of bringing the related
asset to its working condition for its intended use. Hence, the
expenditure on detailed engineering and process design should
be allocated to various related fixed assets on the basis of benefit
derived by these assets in this regard.
D. Opinion
13. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 9 above:
(a) Yes, the accounting treatment of capitalising the
expenditure incurred on process design and engineering
cost as a component of the total asset is correct.
(b) Since the answer to (a) above is not in the negative, this
question does not arise.
(c) The accounting treatment should be as stated at (a)
above.
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Query No. 2
Subject: Accounting treatment of expenditure incurred on
licence fee (including user licences) for SAP
software.1
A. Facts of the Case
1. A public sector undertaking is engaged in refining and
marketing of petroleum products having its marketing network
spread throughout the country. During the year 1999-2000, the
company decided to implement SAP ERP system in a phased
manner so as to cover all its units spread throughout the country
over an expected period of 5 to 6 years.
2. Accordingly, the company budgeted for the estimated total
expenditure likely to be incurred for implementation of SAP system
throughout the company and actions were initiated in this regard.
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Subsequent Expenditure
59. Subsequent expenditure on an intangible asset after
its purchase or its completion should be recognised as
an expense when it is incurred unless:
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B. Query
6. The querist has sought the opinion of the Expert Advisory
Committee with respect to the expenditure incurred for acquiring
the user licences for right to use of the SAP software, on the
following issues:
(a) Whether the accounting treatment of charging subsequent
expenditure on SAP licence fee (including user licences)
incurred on or after 1.4.2003 to the profit and loss account
is correct in view of the fact that the initial expenditure
incurred on SAP software including licence fee prior to
1.4.2003 (i.e., before AS 26 became mandatory) has
already been charged to revenue in the year of incurrence.
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12. The Committee does not agree with the contention of the
querist that previous expenditure which should have been
capitalised but which was expensed can not be capitalised in view
of the requirements of paragraph 58 of AS 26 reproduced in
paragraph 4 of the Facts of the Case. In the view of the Committee,
paragraph 58 of AS 26 is related only to that expenditure which
could not qualify to be recognised as an intangible asset as per
the requirements of the said Standard, at the time of incurrence
and, therefore, was charged as an expense, but later it qualified to
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D. Opinion
15. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 6 above, subject to the
consideration of materiality stated in paragraph 14 above:
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Query No. 3
Subject: Accounting treatment of lease premium received
on lease of industrial plots as industrial estates.1
A. Facts of the Case
1
Opinion finalised by the Committee on 27.3.2006
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lease rent of Re. 1/- per annum was charged from the
lessees besides recovery of service and maintenance
charges towards maintenance of the industrial estate.
(b) The lease premium was accounted as income at 1/60th
each year and the balance lease premium was shown as
‘lease premium received in advance’ under the head
‘current liabilities’. The leasehold land, and the land
development expenditure were shown as ‘Fixed Assets’.
On objections raised by statutory auditors, the company
started amortising the proportionate land development
expenditure during the operative period of lease and
included the same under the head ‘Depreciation’.
(c) Considering the above basic facts, the Expert Advisory
Committee was of the view that in respect of the lease
agreements for long periods, e.g., 60 years and 99 years,
it is generally expected that on the expiry of the lease
term, either the lease period would be extended or the
title will pass to the lessee at some agreed amount. This
amounts to passing of the significant rights of ownership
in the land to the lessee. Thus, it would be in the nature
of sale of plots and should be accounted for, accordingly.
This requirement, according to the Committee, is
recognition of the principle of ‘substance over form’.
(d) The cost of land along with development expenditure
should be reflected as a current asset and should be
expensed in the same year in which the revenue from
the lease of plots is recognised as income keeping in
view the matching principle.
(e) Also, as per Accounting Standard (AS) 9, ‘Revenue
Recognition’, issued by the Institute of Chartered
Accountants of India (ICAI), the following three conditions
are laid down for recognition of revenue:
(i) Performance of the act giving rise to revenue
(ii) Measurability of the revenue
(iii) Collectability of the revenue
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13. The querist has further stated that accounting of the lease
income fully in the year of receipt will also not be in accordance
with the principles of recognition of revenue laid down in AS 9,
viz., measurability of revenue, as the lease income is paid in
advance for 99 years and if accounted in one year, will lead to
lopsided presentation of income and non-matching of income with
relevant expenditure like depreciation on amenities and other
infrastructure. In the view of the querist, this accounting treatment
will not reflect a true and fair view of the financial statements and
would invite a qualification thereon by the auditors.
14. The querist has reproduced the professional opinion of the
statutory auditors on this issue which is as follows:
“(i) … we are of the professional opinion that the accounting
system followed by the company, i.e., accounting for the cost
of acquisition of land and development costs thereon and
other infrastructure costs as fixed assets and accounting for
the lease premium received in advance as current liabilities
and proportionate lease premium (1/99th) as income for the
financial year and charging off depreciation for the relevant
assets to profit and loss account, is as per the generally
accepted accounting principles and relevant accounting
standards.
(ii) Besides, we are of the professional opinion, that the
opinion of the Expert Advisory Committee of the ICAI should
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B. Query
15. Considering the above factors, the querist has sought the
opinion of the Expert Advisory Committee as to whether, on
consideration of the facts and circumstances of the case concerned,
it is right for the company to continue its accounting practice of:
(a) recognising the cost of land as well as the development
expenditure of the industrial estates as ‘Fixed Assets’,
(b) recognising the lease premium under ‘Current Liabilities’,
17. The Committee notes from the above that the transactions
and events are accounted for and presented in accordance with
their substance, i.e., the economic reality of events and transactions
and not merely with their legal form. The Committee notes from
the ‘Facts of the Case’ that the plots of land are given by the
company on lease for a period of 99 years, which is renewable for
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18. The Committee also notes that the querist has argued in
paragraph 9(iii) above that the company can take back the
possession of the leased land, in case the lessee violates the
conditions of the lease deed, or causes the land to be sold or
attached, or keeps the land unutilised, etc. The Committee is of
the view that such terms and conditions under the lease deed are
generally inserted so as to regulate the use of industrial plots for
specified purposes only and for their optimum utilisation. The
Committee also notes that the company also reserves the right of
taking the possession of factory buildings and other construction
on land, which are not even owned by the lessors. In the view of
the Committee, this does not represent the intention of the company
to hold them as its fixed assets. Similarly, the Committee is of the
view that the above-mentioned conditions in case of lease of land,
in no way, represent the intention of the company to hold the plots
as its own fixed assets as defined in Accounting Standard (AS)
10, Accounting for Fixed Assets, issued by the Institute of Chartered
Accountants of India. Accordingly, the contentions of the querist,
as stated in paragraphs 11 and 12 above are also not tenable as
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Query No.4
(i) Clarifiers
(iv) Pipelines
1
Opinion finalised by the Committee on 27.3.2006
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(iii) Drains
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B. Query
8. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(i) Whether the capitalisation of civil works in Water
Treatment Plant (WTP) and Effluent Treatment Plant
(ETP) as ‘Factory Buildings’ is correct? If not, what should
be the treatment for the above civil works?
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premises in which the work is carried on; these are rather the
means with which and through which the activities of treatment of
water and effluent are carried on. Hence, in the view of the
Committee, the civil works directly involved in the treatment of
water and effluent should be capitalised as ‘Plant and Machinery’
instead of ‘Factory Buildings’ and accordingly, depreciation as per
the rates applicable to ‘Plant and Machinery’ should be provided
on these items, taking into account the rates given in Schedule
XIV to the Companies Act, 1956.
11. As far as depreciation on other civil works, i.e., which are not
directly involved in the process of treatment of water and effluent,
such as, intake well sumps, de-mineralisation plant, softening plant
and filter house building is concerned, the Committee notes from
the Facts of the Case that these civil works only act as the setting
or structure containing various equipments and are not directly
involved in the process of water treatment and effluent treatment.
Hence, the Committee is of the view that these civil works should
be classified as ‘Factory Buildings’ and accordingly, depreciation
on these items should be provided as per the rates applicable to
‘Factory Buildings’ under Schedule XIV.
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15. From the above, the Committee is of the view that the change
in the depreciation rates due to change in the classification of
assets arising from an error, as discussed in paragraph 13 above,
is a prior period item and, therefore, excess/short depreciation
charge pertaining to prior periods should be disclosed separately
in the current year’s profit and loss account in a manner that its
impact on the current year’s profit or loss can be perceived.
D. Opinion
16. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 8 above:
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Query No. 5
Subject: Determination of net selling price of a cash
generating unit incurring losses.1
A. Facts of the Case
1
Opinion finalised by the Committee on 27.3.2006
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2. The querist has stated that the company has mainly three
different businesses controlled by three separate business groups
as under:
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arrive at the net realisable value of the assets. On the basis of the
valuers’ reports, the company had tested the impairment of assets
of the B.G. (Explosives) and B.G. (Cryogenics) and found that the
carrying amounts of the assets are less than the recoverable
amount (net realisable value) of the assets. Hence, as per the
querist, no impairment of assets was warranted.
4. The querist has further stated that while considering the net
selling price as recoverable amount of the above two business
groups, the company has placed reliance on the following: (a)
definition of recoverable amount as per paragraph 4 of AS 28 –
since these two business groups are making losses, net selling
price of the assets will always be higher than the value in use. (b)
paragraph 15 of AS 28, which, inter alia, states that it is not
always necessary to determine both assets’ net selling price and
value in use.
B. Query
6. The Committee notes that the basic issue raised in the query
relates to the calculation of impairment loss in case of B.G.
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Query No. 6
1
Opinion finalised by the Committee on 27.3.2006
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B. Query
4. The querist has sought the opinion of the Expert Advisory
Committee as to whether while calculating deferred tax assets/
liability for the company as a whole, provision for doubtful advances
and provision for doubtful claims need to be considered for
calculation of deferred tax assets.
C. Points considered by the Committee
5. The Committee notes that the basic issue raised by the querist
relates to creation of deferred tax asset/liability in respect of
provision for doubtful advances and doubtful claims. Hence, the
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Committee has considered only this issue and has not examined
any other issue arising from the Facts of the Case, for example,
creation of provision in respect of doubtful debts against sundry
debtors and treatment of deferred tax assets/liabilities in respect
thereof, etc.
6. The Committee notes that Part III of Schedule VI to the
Companies Act, 1956 states in paragraph 7(2) as below:
“(2) Where –
(a) any amount written off or retained by way of
providing for depreciation, renewals or diminution in
value of assets, not being an amount written off in
relation to fixed assets before the commencement
of this Act; or
(b) any amount retained by way of providing for any
known liability;
is in excess of the amount which in the opinion of the directors
is reasonably necessary for the purpose, the excess shall be
treated for the purposes of this Schedule as a reserve and
not as a provision.”
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D. Opinion
12. On the basis of the above, the Committee is of the opinion,
on the issue raised in paragraph 4, that in the present case, the
provision for doubtful advances and provision for doubtful claims
should be written back in the financial statements as a ‘prior period
item’ as explained in paragraph 11 above and hence, the question
of treatment of deferred tax asset/liability against such provisions
does not arise.
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Query No. 7
Subject: Rates of depreciation on various assets involved in
mass rapid transport system.1
A Facts of the Case
1
Opinion finalised by the Committee on 27.3.2006
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(i) Rolling Stock – The trains are of modern design and are
light weight made of stainless steel with three phase AC
drive having VVVF control regenerative braking and
suitable for automatic train protection and operation
system. The coaches are provided with automatic door
closing mechanism to ensure passenger safety. The
coaches have been built, meeting international standards
of safety, reliability and maintainability. They are designed
and constructed for a service life of at least 30 years of
normal usage, without major repair.
(ii) Escalators and elevators – They are provided at elevated
and underground stations for passenger transportation.
These heavy duty public escalators comply with
international and national standards. The design,
manufacture, supply, installation, testing and
commissioning of the escalators meet the state of the
technology in the area. The life of these escalators and
elevators is estimated at a minimum of 30 years.
(iii) Trackwork – With a view to obtain optimum life for various
components, a sturdy track structure has been selected,
such as 60 kg. head hardened rails, ballast less track on
viaduct/tunnel and structurally strong turnouts. A life of
58 years is estimated for the same.
4. As per the querist, the estimates made by the company are
based on technical evaluation and suppliers’ assertions. These
estimates are prudent and would represent true and fair commercial
depreciation. The querist has separately provided technical
evaluation reports of suppliers in this regard for the perusal of the
Committee. Comparative depreciation rates/lives of assets adopted
by the companies carrying similar operations, along with the
corresponding lives under the Companies Act, 1956 and that as
estimated by the company, are also provided separately by the
querist for the perusal of the Committee. According to the querist,
a perusal of the comparative analysis of depreciation rates/useful
lives highlights the following in respect of the said assets:
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supplied by the querist). The querist has also drawn the attention
of the Committee to paragraph 22 of AS 6, which states as follows:
“22. The useful life of a depreciable asset should be
estimated after considering the following factors:
(i) expected physical wear and tear;
(ii) obsolescence;
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B. Query
10. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(a) Assuming that (i) it can be demonstrated that the useful
life of rolling stock and escalators and elevators is 30
years and that of track work is 58 years and (ii) there are
no legal stipulations as to rate of depreciation, whether
charging depreciation at 3.17% and 1.63% (respectively)
per annum as per straight line method (SLM) would result
in a true and fair view.
(b) Since the company, as per the querist, has been able to
adduce sufficient evidence regarding the above estimates
of useful life, whether depreciation at 3.17% and 1.63%
(SLM) per annum would be a proper charge, if this rate
is allowed by the Ministry of Company Affairs under
section 205(2) of the Companies Act, 1956.
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D. Opinion
15. The Committee is of the following opinion on the issues raised
in paragraph 10 above:
(a) Assuming that (i) the useful life of rolling stock and
escalators and elevators is 30 years and that of track
work is 58 years determined in accordance with the
provisions of AS 6 and (ii) there are no legal stipulations
as to the rate of depreciation, charging depreciation as
per SLM at the rates determined on the basis of the
afore-mentioned lives of the respective assets would result
in a true and fair view, provided provisions of section
205(2) of the Companies Act, 1956 are complied with.
(b) Charging of depreciation as per the SLM rates, based on
estimated useful lives of the assets as per the provisions
of AS 6 would be a proper charge, provided such rates
are allowed by the Ministry of Company Affairs under
section 205(2).
Query No. 8
Subject: Segment reporting for sale of power to the State
grid.1
A. Facts of the Case
1. A listed company is engaged in the business of manufacturing
paper for newsprint, printing and writing. The turnover from the
sale of newsprint, printing and writing paper during 2004-05 was
Rs. 671.29 crore.
2. The querist has stated that the company has installed four
turbo generators. The entire power requirement is met through
captive generation. Surplus power is sold to the State grid. In
1
Opinion finalised by the Committee on 27.3.2006
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have to first fall within the definitions of the term ‘business segment’
or ‘geographical segment’ before being considered as ‘reportable
segment’. In this context, the Committee notes the definitions of
the terms ‘business segment’ and ‘geographical segment’ as per
paragraph 5 of AS 17, which are reproduced below:
“A business segment is a distinguishable component of
an enterprise that is engaged in providing an individual
product or service or a group of related products or
services and that is subject to risks and returns that are
different from those of other business segments. Factors
that should be considered in determining whether
products or services are related include:
(a) the nature of the products or services;
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Query No. 9
Subject: Disclosure of partly secured Bonds.1
A. Facts of the Case
1
Opinion finalised by the Committee on 27.3.2006
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D. Opinion
9. On the basis of the above, the Committee is of the opinion,
read with paragraph 6 above, that partly secured Capital Gains
Tax Exemption Bonds should be disclosed under ‘secured loans’
along with a proper disclosure of the nature of security, as stated
in paragraph 8 above.
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Query No. 10
Subject: Applicability of AS 3 and AS 18.1
1
Opinion finalised by the Committee on 27.3.2006
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attention of the Committee to the fact that the company is also not
covered under the definition of ‘Public Financial Institution’ as per
the Companies Act, 1956.
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11. The Committee notes from the Facts of the Case that the
company in question is a state controlled enterprise. In view of
this, no disclosure is required in its financial statements in respect
of related party relationships and related party transactions with
other state controlled enterprises.
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D. Opinion
12. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 6 above:
(a) AS 3 and AS 18 are applicable to the company.
Query No. 11
Subject: Accounting for Minimum Alternative Tax (MAT)
under section 115JB and credit available in respect
thereof.1
A. Facts of the Case
1. A company is a public sector undertaking engaged in refining
of crude oil. The company was earning profits till the financial year
1998-99. Due to withdrawal of Administrative Pricing Mechanism
(APM), additional interest, and depreciation burden on account of
substantial capacity expansion of the refinery from 3 million metric
ton per annum (MMTPA) to 9 MMTPA in April 2001, coupled with
drop in refinery margins, the company incurred losses till the
financial year ending 31st March, 2003. This has resulted into
substantial carried forward losses and unabsorbed depreciation
under the Income-tax Act, 1961.
1
Opinion finalised by the Committee on 27.3.2006
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(c) Treat MAT paid as current tax and also provide deferred
tax without considering such MAT paid as timing
difference, for the purpose of deferred tax calculation, in
the year.
8. The querist has further stated that Accounting Standard (AS)
22, ‘Accounting for Taxes on Income’, issued by the Institute of
Chartered Accountants of India, does not specifically provide for
timing differences arising out of tax credits. However, this standard
envisages recognition of tax on the book profit. The current tax
provision and deferred tax provision shall be equal to tax computed
on book profit (excluding permanent difference) at the enacted tax
rates. Hence, according to the querist, in case of virtual certainty
of absorption of tax credit, if either of the accounting treatments
(a) or (b) stated in paragraph 7 above, is not followed, it may
result in excess provision to the extent of MAT paid in the current
year and also under provision to the extent of set-off/absorption of
tax credit in the subsequent year(s). The querist has also stated
that Accounting Standards Interpretation (ASI) 6, ‘Accounting for
Taxes on Income in the context of Section 115JB of the Income-
tax Act, 1961’ was issued by the Institute before the introduction of
sub-section (1A) of section 115JAA with effect from 1st April, 2005,
i.e., when credit in respect of MAT paid was not available, meaning
thereby that tax paid under MAT was not allowed to be set-off
against regular tax payable in later years.
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B. Query
9. Considering the Facts of the Case as explained above, the
querist has sought the opinion of the Expert Advisory Committee
on the following issues:
(i) Whether MAT paid under section 115JB of the Act for
the year ending 31st March, 2006, is to be considered as
current tax to be absorbed as tax expense in the profit
and loss account for the year or treat the same as
advance tax under current assets.
(ii) Whether MAT paid under section 115JB of the Act is to
be considered as timing difference resulting in deferred
tax asset for deferred tax computation purposes under
AS 22 and reduce the same from the deferred tax liability
in the current year, to the extent of tax credit available.
(iii) Whether MAT payable under section 115JB of the Act
needs to be considered as current tax but should not be
considered for the purpose of deferred tax calculation
inspite of it being eligible for carry forward and set-off in
the subsequent year.
C. Points considered by the Committee
10. The Committee notes that the basic issue raised in the query
relates to the accounting treatment of MAT paid under section
115JB of the Income-tax Act, 1961 and credit available in respect
thereof. The Committee has, therefore, considered only this issue
and has not touched upon any other issue arising from the Facts
of the Case.
11. The Committee notes that the issue raised by the querist has
been dealt with in the Guidance Note on Accounting for Credit
Available in respect of Minimum Alternative Tax under the Income-
tax Act, 1961, issued recently by the Institute of Chartered
Accountants of India. Paragraphs 4 to 15 of the said Guidance
Note suggest the accounting treatment in respect of MAT and
credit available in respect of MAT, as follows:
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specified period.
Presentation of MAT credit in the financial statements
Balance Sheet
13. Where a company recognises MAT credit as an asset
on the basis of the considerations specified in paragraph 11
above, the same should be presented under the head ‘Loans
and Advances’ since, there being a convincing evidence of
realisation of the asset, it is of the nature of a pre-paid tax
which would be adjusted against the normal income tax during
the specified period. The asset may be reflected as ‘MAT
credit entitlement’.
14. In the year of set-off of credit, the amount of credit
availed should be shown as a deduction from the ‘Provision
for Taxation’ on the liabilities side of the balance sheet. The
unavailed amount of MAT credit entitlement , if any, should
continue to be presented under the head ‘Loans and Advances’
if it continues to meet the considerations stated in paragraph
11 above.
Profit and Loss Account
15. According to paragraph 6 of Accounting Standards
Interpretation (ASI) 6, ‘Accounting for Taxes on Income in the
context of Section 115JB of the Income-tax Act, 1961’, issued
by the Institute of Chartered Accountants of India, MAT is the
current tax. Accordingly, the tax expense arising on account
of payment of MAT should be charged at the gross amount,
in the normal way, to the profit and loss account in the year of
payment of MAT. In the year in which the MAT credit becomes
eligible to be recognised as an asset in accordance with the
recommendations contained in this Guidance Note, the said
asset should be created by way of a credit to the profit and
loss account and presented as a separate line item therein.”
D. Opinion
12. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 9 above:
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Query No. 12
Subject: Recognition of revenue in respect of long production
cycle items.1
A. Facts of the Case
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4. The querist has further stated that the marketing policy of the
company is in line with the accounting policies being pursued. For
instance, the revenue from sale of equipments, aggregates,
components and attachments are recognised based on valid sales
contracts. Further, the revenue is recognised in respect of these
products only on the basis of pre-despatch inspection. This is
applicable in the case of products and aggregates having a
production cycle time of less than one year. Some of the products,
like Walking Draglines are highly import intensive coupled with
multiple manufacturing technologies. Further, the manufacturing
of these equipments warrant fabrication and manufacture of heavy
duty steel structures, integrating the multiple electrical and electronic
assemblies, sub-assemblies and transporting them in dis-
aggregated structures to customer site for erection and
commissioning. All these activities, right from commencement of
production to final erection take more than one year. Recognising
the long production cycle time as well as assembling the structures
at site, the company has evolved a specific marketing policy in
respect of such products. The policy calls for production of these
goods only on firm sale orders. Further, in case of these products,
invariably advances are received from the customers before the
commencement of production. In addition, the customer order
provides for billing details, with respect to pre-identified and mutually
agreed modules, assemblies and structures. Based on the billing
details, invoices are raised as and when the modules, assemblies,
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structures, as the case may be, are despatched as per the terms
of the sale order and payments are also received as agreed.
5. According to the querist, it may be seen from paragraph 4
above, that revenue is recognised based on reliable data regarding
physical completion. Both the parties to the contract agree to the
terms of sale and also payment in respect of modules despatched.
Further, both the parties are clear in understanding the rights,
obligations, risks and rewards as well as the terms of payment. In
fact, in many of the transactions of this kind, the buyer pays not
only advance but also to the extent of agreed percentage of value
of invoices raised at the point of delivery at site or ex-works, as
the case may be.
6. The querist has stated that considering the nature of business,
the type of product and the long production cycle time involved,
the method adopted by the company is in order. This also
synchronizes the revenue recognition with occurrence of
performance or event and is well within the realm of the principle
of matching concept (emphasis supplied by the querist). According
to the querist, US GAAPs also recognise revenue on the basis of
percentage of completion method in respect of long production
cycle items/products (the querist has referred to US GAAP 2002
by Siegel, Levine, Qureshi and Shim published by Prentice Hall).
On the other hand, if revenue is recognised only after the final
delivery of such equipment, it will lead to distortion of the financial
performance and position of the company for earlier years.
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“Objective
The objective of this Statement is to prescribe the accounting
treatment of revenue and costs associated with construction
contracts. Because of the nature of the activity undertaken in
construction contracts, the date at which the contract activity
is entered into and the date when the activity is completed
usually fall into different accounting periods.”
12. On the basis of the above, the Committee is of the view that
in case of contracts of manufacture and supply of long production
cycle items which are complex pieces of equipment and which are
manufactured under a contract with the customer, AS 7 (revised
2002) is applicable because the date on which the contract is
secured and the date when the contract activity is completed fall
into different accounting periods. In view of this, the principles of
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D. Opinion
15. The Committee is of the opinion on the issues raised in
paragraph 9 above that in the present case, AS 7 (revised 2002)
is applicable rather than AS 9. Accordingly, the revenue of the
company from sale of products having long production cycle time,
i.e., more than a year, that are manufactured under a contract with
the customer, should be recognised following the percentage of
completion method as per the provisions of AS 7 (revised 2002).
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Query No. 13
Subject: Segment reporting by a finance company.1
S. Particulars % of (Rs. in
No. total crore)
revenue
1 Income from financing activities 94.15 2,661.38*
(interest on housing, infrastructure
loans and investment in bonds/
fixed deposits)
2 Other income on loans (i.e., 2.40 67.75
advisory income and other fees)
3 Closing-work-in-progress (constru- 2.94 83.20
ction activity)
4 Other income (balance) 0.51 14.38
Grand Total 100.00 2826.71
* Includes income of Rs. 374.74 crore from loan under retail finance
scheme, i.e., Rs. 328.75 crore on account of bulk loans and Rs. 45.99 crore
on account of direct loan to individuals.
3. The querist has informed that the financing activity, i.e., housing
and infrastructure financing business, is shown as a single segment
since the rates of interest at which loans are advanced, the
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10. The querist has informed that since the above disclosure in
the balance sheet is required to be given by every housing finance
company (HFC), the principal outstanding and provision as on the
date of the balance sheet for housing business and non-housing
business were classified under standard, sub-standard, doubtful
and loss assets in the notes to accounts (note no. 27 of annual
accounts for 2003-2004).
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13. The querist has also informed that the NHB norms dealing
with the provisions for Non-Performing Assets (NPA) etc., are the
same for housing and infrastructure loans. The main business of
the company is to make available finances for housing as well as
for infrastructure projects. Maintenance of account books/various
records and calculation of profit and loss account of the company
is made in a consolidated manner irrespective of the type of
schemes.
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B. Query
14. The opinion of the Expert Advisory Committee has been sought
on the issue as to whether financing for housing and infrastructure
activities are to be shown as separate business segments as
observed by C&AG for the purposes of AS 17, ignoring the fact
that risks and returns for financing, i.e., interest rate, security,
agency, treatment of the defaults with reference to provisioning
norms of NHB guidelines are the same for both the products.
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Query No. 14
Subject: Booking of export sales/purchases of wheat and
rice under subsidised quota of the Government of
India, purchased from another government
undertaking.1
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(ii) Receiving the material at the port town and moving them
to the godown/transit port area.
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(b) all the activities from lifting of the material to the shipment
are carried out by the associate; and
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According to the GAP, “the risks and rewards are with the associate
and there is an assignment of the contract to the associate”.
6. As per the querist, the company is of the view that AS 9 deals
only with the timing of recognition of revenue and does not deal
with the question of ownership which is more fundamental. Also,
AS 9 does not deal with accounting for purchases. The ownership
in the goods is passed on by the government undertaking to the
company and the company has to book the purchases. According
to the querist, the ownership rests throughout with the company
until it is transferred by the company to the foreign buyer and it
would be wrong if the company does not recognise the purchase
and sale. Restricting its trade margin, is the company’s decision
based on commercial considerations. The clauses for indemnity,
etc., in the contract only provide for recourse to the company in
case of loss but at first, the risk falls only on the company. AS 9
requires consideration of risks and rewards of ownership (emphasis
supplied by the querist). Risks and rewards cannot be separated
from ownership and AS 9 does not anywhere state that if there is
anybody who has been made responsible for the risks, he will
become the owner. The querist has argued that it should be
appreciated that if such be the case, since all the risks are covered
by insurance, the insurance companies would become the owner.
According to the querist, all the documents and the events as per
items (i) to (xv) of paragraph 2 above, confirm that the ownership
of the goods rests with the company and, accordingly, purchases
should be booked by the company.
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B. Query
8. The opinion of the Expert Advisory Committee is sought on
the following issues:
(i) Whether booking of the purchases and sales by the
company is in order.
(ii) If not, what should be the correct accounting treatment?
10. The Committee notes from the above that the transactions
and events are accounted for and presented in accordance with
their substance, i.e., the economic reality of events and transactions,
and not merely in accordance with their legal form. In other words,
it is the ‘economic reality’ that is important in accounting and not
only the ‘legal reality’. In the context of revenue recognition, the
principle of ‘substance over form’ is recognised by paragraph 6.1
of AS 9 as reproduced below:
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11. In the context of the query, the Committee notes that while
the legal form is that the title to the goods passes on to the
company, the substance of the transaction is that the company in
question is only an agent of the business associates because of
the following factors:
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D. Opinion
16. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 8 above:
(i) No, booking of the purchases and sales by the company
is not in order.
(ii) The correct accounting treatment would be to recognise
only service charges as its revenue.
(iii) Since the company should not recognise such purchases
and sales in its books of account, the question to disclose
the same as purchases and sales in the notes to accounts
does not arise. However, the company may, if it so
desires, disclose the gross amounts of the transactions
in the notes to accounts, but not as purchases and sales.
(iv) No, AS 9 is applicable in respect of revenue recognition
only. However, its principles can be extended to
recognition of purchases, as stated in paragraph 13
above.
(v) Since purchases and sales are made on behalf of the
business associates, the company in question is acting,
in substance, only as an agent.
Query No. 15
Subject: Overhead allocation for the purpose of inventory
valuation at quarter/year end.1
A. Facts of the Case
1. A company is having a “Continuous Process Plant” producing
a single product. The installed capacity, which has been reported
in the annual accounts, is 2,000 MT per annum. The actual
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production has been higher for the past few years, the quantities
produced have been in the range of 2,400 MT to 2,500 MT.
2. According to the querist, the company has been consistently
following the method of valuation of inventories, viz., finished goods
and work-in-progress, by arriving at the cost of production (COP).
In arriving at the cost, all the direct costs are considered and the
fixed factory overheads are allocated on the basis of actual
production. It is also considered whether the cost is greater than
net realisable value (NRV) or not.
3. During the 1st quarter ended June 2005, the plant was shut
down for 21 days for planned maintenance and later during the
quarter due to a break-down for a period of 6 days, thereby the
effective working days during the quarter were 64. The actual
production during the 1st quarter was 340 MT.
4. The querist has stated that during the course of the company’s
internal review, a view was expressed that since the plant has
produced 340 MT during the 1st quarter, and the normal quantity
produced over the past few years is about 2,400 MT, and
recognising that the quarterly accounts must follow the same
principles followed as at the year-end, there is a need to quantify
the production capacity on a quarterly basis. The suggestion was
to do the pro-rating of the capacity over 4 quarters. The base
figure so arrived is 600 MT per quarter. Considering the quantity
actually produced, i.e., 340 MT, a view was that the fixed overheads
to be inventorised on the closing stock should only be to the
extent of 56% (340/600) as per Accounting Standard (AS) 2,
‘Valuation of Inventories’, issued by the Institute of Chartered
Accountants of India, and the balance 44% should be charged off
as an expense and should not be inventorised. In this connection,
the querist has drawn the attention of the Committee to paragraph
9 of AS 2, as given hereunder:
“9. The allocation of fixed production overheads for the
purpose of their inclusion in the costs of conversion is based
on the normal capacity of the production facilities. Normal
capacity is the production expected to be achieved on an
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8. According to the querist, there was also a view that this issue
gets highlighted where there is a shortfall in quarter 1. In quarter 2
and quarter 3, the cumulative throughput normally brings the
average to an acceptable norm. As per the querist, the question
that needs to be addressed is whether this rule is to be for a
particular quarter or for the cumulative period.
B. Query
10. The querist has sought the opinion of the Expert Advisory
Committee on the following issues arising from the above:
(a) Paragraph 9 of AS 2, inter alia, states “actual level of
production may be used if it approximates normal
capacity”. At what percentage of production over each
quarter would trigger the application of this Standard? Is
it 50%, 60%, 75%, 80% or 95%?
(b) Whether the normal level of production for each quarter
is to be arrived at on the basis of equal production for 4
quarters. Is this a reasonable method for determining
the capacity utilisation (refer paragraph 4 of the ‘Facts of
the Case’)? In the case of the company under
consideration, the main demand will be during the 3rd
and 4th quarters and it is expected that the normal
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D. Opinion
16. On the basis of the above, the Committee is of the following
opinion on the issues raised by the querist in paragraph 10 above:
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(b) and (c) It is not always necessary to arrive at the normal level
of production for each quarter based on equal production
for all the quarters. Such a situation may arise only where
it is expected that there are no seasonal or quarterly
variations in production. In cases where quarterly/
seasonal variations in production are expected, the normal
level for the quarter(s) should be estimated based on the
average of past 3 to 5 years of that quarter(s). This may
be necessary in case of seasonal variations or where
otherwise the quarterly production is expected to be lower,
for example, the enterprise estimates that it will have to
shut down the plant for normal maintenance during the
quarter. In the case of the company in question, if the
main demand and, therefore, the production, is expected
rd th
in the 3 and 4 quarters, normal production should be
rd th
determined separately for the 3 and the 4 quarters as
explained above. Moreover, the above principles, as per
paragraph 27 of AS 25, will have to be applied on year-
to-date basis, i.e., cumulatively, as explained in paragraph
15 above.
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Annexure A
Example:
Fixed production overheads for the financial year = Rs. 9,600.
Normal expected production for the year, after considering
planned maintenance and normal breakdown, also considering
the future demand of the product = 2,400 MT. In this example,
it is considered that there are no quarterly/seasonal variations.
Therefore, the normal expected production for each quarter is
600 MT and the fixed production overheads for the quarter
are Rs. 2,400.
Actual production achieved
First quarter 500 MT
Second quarter 700 MT
Third quarter 400 MT
Fourth quarter 700 MT
Fixed production overheads to be allocated per unit of
production in every quarter will be Rs. 4 per MT (Fixed
overheads/Normal production).
First quarter
Actual production overheads = Rs. 2,400
Fixed production overheads based on the allocation rate of
Rs. 4 per unit allocated to actual production = Rs. 4x500
=Rs. 2,000
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Second quarter
Actual fixed production overheads on year-to-date basis Rs.
4,800
Fixed production overheads to be absorbed on year-to-date
basis 1200x4 = Rs. 4,800
Rs. 400 were not allocated to production in the Ist quarter. To
give effect to the entire Rs. 4,800 to be allocated in the second
quarter, as per paragraph 29(a) of AS 25, Rs. 400 are reversed
nd
by way of a credit to the profit and loss account of the 2
quarter.
Third quarter
Actual production overheads on year-to-date basis = Rs. 7,200
Fourth quarter/Annual
Actual fixed production overheads on year-to-date basis Rs.
9,600
Fixed production overheads to be allocated on year-to-date
basis 2,300x4 = Rs. 9,200
Rs. 400, i.e., [2,800(i.e., Rs.4x700) - 2,400] over allocable in
th
the 4 quarter, are to be reversed as per paragraph 29(a) of
AS 25 by way of a credit to the profit and loss account.
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Query No. 16
Subject: Accounting treatment in respect of side-tracking
costs of wells.1
A. Facts of the Case
1. An Exploration & Production (E&P) company established under
the Companies Act, 1956, has the core activities of exploration,
development and production of hydrocarbons in inland as well as
in offshore areas.
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D. Opinion
21. On the basis of the above, the opinion of the Committee on
the issues raised by the querist in paragraph 11 above are as
below:
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Query No. 17
2. The querist has stated that from the year 2000-01, it was
decided to charge 5% contingency charges from the participants/
outside agencies on the income received from them by the
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4. During the audit of accounts for the year 2002-03, the statutory
auditors of the company felt that provision against unknown liabilities
and the expenses of contingent nature, which are contingent/
unknown, is violative of the provisions of the Companies Act, 1956.
In other words, the statutory auditors were of the view that no
liability can be provided in the books of account unless the quantum
of the liability and the details of the payee are known.
5. The querist had drawn the attention of the auditors to
Accounting Standard (AS) 4, ‘Contingencies and Events Occurring
After the Balance Sheet Date’, issued by the Institute of Chartered
Accountants of India (ICAI), wherein the word ‘contingency’ had
been defined as a “condition or situation, the ultimate outcome of
which, gain or loss, will be known or determined only on the
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2
Query No. 12 of Compendium of Opinions — Vol. XXIV.
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(ii) No, the view taken by MAB office on the issue that the
provision for contingencies should be transferred to a
special reserve account is not correct.
Query No. 18
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8. Besides the above, as per the querist, the company has also
examined the matter and noted that in the various examples given
in the Standard, the items identified as timing differences are
capable of reversal subsequently themselves (emphasis supplied
by the querist), such as the difference in the method of depreciation
in case a company charges depreciation on straight-line method
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(SLM) basis in its books, which is different from the written down
value (WDV) method acceptable under the Income-tax Act. This
results in timing difference. In the books, the depreciation on SLM
basis would be spread evenly over the life of the asset while on
WDV basis under the Income-tax Act, depreciation would be more
in initial years and would reduce in the later years of life of the
asset. The total amount of depreciation would be the same under
both the methods and differences and tax effects on the timing
differences would square up themselves over the life of the asset.
Whereas, in case of special reserve, the difference would square
up only when the company utilises/withdraws the special reserve,
otherwise not. Till the time the company utilises the special reserve,
section 41(4A) of Income-tax Act does not become operative; thus,
the difference remains of permanent nature. It is not squared up
itself as in the case of revenue items.
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11. The querist had earlier sought the opinion of the Expert
Advisory Committee on the issue as to whether the company is
required to create the deferred tax liability on the special reserve
created and maintained under section 36(1)(viii) of the Income-tax
Act, 1961 as of now, which will become chargeable to tax as per
section 41(4A) of the Act, only in the event of withdrawal therefrom
and which may or may not happen (emphasis supplied by the
querist). In response to the aforesaid query, the Committee had
expressed the following opinion:
“The Committee is of the opinion that the company is required
to create deferred tax liability on the special reserve created
and maintained under section 36(1)(viii) of the Income-tax
Act, 1961, irrespective of the fact that withdrawal of the reserve
may or may not happen since the company is capable to
withdraw the reserve resulting into reversal of the difference
between accounting income and taxable income (i.e., timing
difference).”
12. The querist has now submitted the following additional facts/
arguments in favour of not creating a deferred tax liability:
(i) The company has no intention whatsoever of making
any withdrawal from the reserve. It has been earning a
healthy profit, a large part of which has been retained
resulting in a healthy net worth, which act as a cushion
for any unforeseen losses. In this context, select data
relating to the performance of the company has been
submitted by the querist. The querist has also submitted
the Board Resolution to the effect that the company does
not have any intention of withdrawing from the reserve in
question.
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16. The Committee notes that in the period in which special reserve
is created, the accounting income remains unaffected as the same
is created below the line. However, the taxable income for the
same year gets reduced by the amount of the special reserve thus
resulting into lesser tax liability. Thus, a difference arises between
the accounting income and the taxable income for that period. The
Committee also notes that this difference is capable of reversal in
the period in which the special reserve is utilised or withdrawn as
in the year of utilisation or withdrawal, the amount of special reserve
would be added to taxable income thus resulting into a higher
taxable income than the accounting income of that period.
Therefore, the Committee is of the view that the creation of special
reserve results into timing differences as per AS 22.
17. The Committee also notes paragraph 14 of AS 22 which
states as below:
“14. This Statement requires recognition of deferred tax for
all the timing differences. This is based on the principle that
the financial statements for a period should recognise the tax
effect, whether current or deferred, of all the transactions
occurring in that period.” (Emphasis supplied by the
Committee.)
18. The Committee further notes paragraph 8 of Accounting
Standards Interpretation (ASI) 6, ‘Accounting for Taxes on Income
in the context of Section 115JB of the Income-tax Act, 1961’,
which, inter alia, describes one of the principal conceptual bases
of AS 22 as below:
“8. There are two methods for recognition and measurement
of tax effects of timing differences, viz., the ‘full provision
method’ and ‘partial provision method’. Under the ‘full provision
method’, the deferred tax is recognised and measured in
respect of all timing differences (subject to consideration of
prudence in case of deferred tax assets) without considering
assumptions regarding future profitability, future capital
expenditure etc. On the other hand, the ‘partial provision
method’ excludes the tax effects of certain timing differences
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D. Opinion
21. On the basis of the above, the Committee reiterates its earlier
opinion that the company is required to create deferred tax liability
on the special reserve created and maintained under section
36(1)(viii) of the Income-tax Act, 1961, irrespective of the fact that
withdrawal of the reserve may or may not happen since the
company is capable to withdraw the reserve resulting into reversal
of the difference between accounting income and taxable income
(i.e., timing difference).
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Query No. 19
Subject: Capitalisation of certain expenses related to
acquisition of an investment.1
A. Facts of the Case
INR in Lakh
(a) Travelling 200
(b) Legal 100
(c) Due Diligence 100
(d) Other Expenses 50
––––––
Total 450
––––––
3. The Indian company has remitted an amount of US$ “x” to its
subsidiary in the Netherlands for acquiring the shares. The
Netherlands subsidiary actually incurred only US$ “y” for the
acquisition of the shares of the European company and remitted
back the balance US$ (x-y) to the Indian company. On account of
this excess money returned, the Indian company has incurred an
exchange loss of Indian Rupees 200 lakh (approx).
B. Query
4. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
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should form part of the cost of investment only if and only to the
extent these costs meet the considerations for inclusion in the cost
of investment as stated in paragraph 6 above.
Query No. 20
1
Opinion finalised by the Committee on 18.9.2006
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B. Query
3. In the light of the above, the opinion of the Expert Advisory
Committee has been sought on how the gain/loss on cancellation
of the forward contract is to be accounted for in the books of
account of the company, i.e., (a) whether to be shown as an
income or an expense for the period, or (b) to be deducted from/
added to the capital work-in-progress for new ship.
5. The Committee notes from the Facts of the Case that the
company has placed an order for purchase of a ship, the payments
for which are to be made in future on completion of various stages
of construction of the ship and the transaction was hedged against
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Query No. 21
Subject: Accounting treatment of Duty Credit Entitlement
under the Target Plus Scheme.1
A. Facts of the Case
1. The querist has stated that the Ministry of Commerce and
Industry introduced the Target Plus Scheme (TPS) as part of its
foreign trade policy 2004-09. The objective of the scheme is to
accelerate growth in exports by rewarding Star Export Houses. All
high performing Star Export Houses are entitled to a duty credit
based on incremental exports substantially higher than the general
annual export target fixed. The TPS credit can be subsequently
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basis, i.e., in the period when the TPS credit is used to pay duty
on imports:
(i) Accounting Standard (AS) 9, ‘Revenue Recognition’,
issued by the Institute of Chartered Accountants of India,
lays down the principle that revenue should not be
recognised until its realisation is reasonably certain. Even
though TPS credit may not strictly fall within the definition
of ‘revenue’, the querist believes that the above principle
would still be applicable. The basic argument for
recognising TPS credit only at the time of utilisation is
that until its actual utilisation, there may not be a
reasonable certainty as to whether or not the company
would be able to utilise the aforesaid credit. This is on
account of the following factors:
(a) The Target Plus Scheme does not allow the sale/
transfer of the duty credit entitlement.
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(iv) The company imported major raw material items for the
production of colour TV in the year 2005-2006. The import
duty expense of the company is approximately Rs. 10-
15 million per month.
(v) It may also be mentioned that the company has been
receiving DEPB benefit and recognising it as income
when the exports (against which the credit has been
granted) are made.
10. The querist has stated that the Bank Realisation Certificate
not having been obtained by 31st March, 2006 and the application
not being made to DGFT by that date are not significant enough to
conclude that inflow of TPS benefit is not probable. Due to the
time factor, the aforesaid certificate cannot be obtained, and
application to DGFT cannot be made, before the close of financial
year. The issuance of these licenses depends on the policy of the
Government of India at the time when these are actually issued,
which is uncertain based on the above facts. The querist has also
mentioned that the Government notification regarding withdrawal
of the scheme is effective prospectively from 1st April, 2006 but
the Government has the power to withdraw the scheme as
mentioned above retrospectively.
11. The querist has also brought to the notice of the Committee
that vide DGFT notification No. 8(RE2006)/2004-2009 dated
12.06.2006, the Central Government has recently made an
amendment to the Target Plus Scheme for the period April 1,
2005 to March 31, 2006 which states as follows:
“The entitlement under this scheme would be contingent on
the minimum percentage incremental growth of 20% in the
FOB value of exports in the current licensing year over the
previous licensing year, and the rate of entitlement shall be
5% of the incremental growth”.
“This will take effect from 01.04.2005”.
With this notification, the Central Government has restricted the
benefit of Target Plus Scheme to a maximum of 5% of incremental
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12. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
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Query No. 22
Subject: Treatment of spares.1
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4. The querist has stated that the earlier opinion of the Committee
mentioned above, states that “the new spare purchased to replace
the capital spare so used should be capitalised separately and
depreciated over the remaining useful life of the principal asset”
(paragraph 18 of the Opinion). According to the querist, in order to
implement the views of the Committee, it is essential that the
original spares are capitalised separately, independent of the main
equipment and depreciated over the life of the parent asset.
However, the practice followed consistently over the years by the
company is that the main equipment, in combination with several
machinery spares together is treated as a single unit. Accordingly,
it is capitalised and depreciated as one unit. When some spares
of this main equipment need to be replaced, taking out the worn
out parts and replacing the same with a new spare is while possible
physically, dropping the spare from the fixed asset register is not
possible in view of the absence of separate identity for the individual
spares. In these circumstances, charging-off the carrying value of
these replaced spares (hitherto, held in warehouse) to the profit
and loss account is not feasible and consequently, replacement
spares (new spares) are being charged to revenue in the year of
purchase. Original spares not being dropped from the gross block,
continue to be depreciated even after replacement.
5. Accordingly, the querist has stated that the significant
accounting policy published by the company includes the following
clause:
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since 1985. If the company has not followed the principles contained
therein, it should rectify the error for the existing assets and account
for accordingly. In the view of the Committee, it would be incorrect
to apply the said principles prospectively, only for the assets that
are to be commissioned from the current financial year onwards,
as stated by the querist.
D. Opinion
11. On the basis of the above, the Committee is of the following
opinion on the issues raised by the querist in paragraph 7 above:
(i) No, the charging-off of the capital spares to the profit
and loss account in the year of purchase is not in order
in the light of accounting treatment prescribed in the
applicable Accounting Standard. Please refer to
paragraphs 8 and 9 above.
(ii) No, the company should implement the above-said
opinion for all the existing assets.
Query No. 23
Subject: Disclosure of interest on shortfall in payment of
advance income-tax in the financial statements.1
A. Facts of the Case
1. A company is a premier electronics company under the Ministry
of Defence, Government of India, having its shares listed at the
major stock exchanges in India. The turnover of the company for
the year 2005-06 was Rs. 3,536 crore.
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section 234B and section 234C of the Income-tax Act, 1961, should
not be considered as a part of tax expense. The Opinion further
states that this may, however, be separately provided for in
accordance with the requirements of Accounting Standard (AS)
29, ‘Provisions, Contingent Liabilities and Contingent Assets’, issued
by the Institute of Chartered Accountants of India. As per the
querist, the Opinion of the Expert Advisory Committee does not
indicate as to where the interest expenditure under section 234B
and section 234C should be disclosed in the profit and loss account,
i.e., whether as a part of ‘interest costs’, or as a separate item
above the line (i.e., before profit before tax (PBT)), or whether it
can be included in ‘other expenses’.
3. The querist has stated that the company has been including
this amount as a part of tax expense in the profit and loss account
after profit before tax and indicating the same as part of ‘Provision
for Income-tax’ and grouping the same under the head ‘Provisions’
in the balance sheet. The company is of the view that the interest
in question does not fall under the purview of AS 29 since AS 29
defines a provision as “a liability which can be measured ‘only
by using a substantial degree of estimation’.” As per the querist,
calculation of interest on the shortfall of advance income tax does
not call for a substantial degree of estimation.
4. According to the querist, interest costs generally reflect the
efficiency or otherwise with which an organisation is able to meet
its financing requirements. The expenditure on interest under
section 234B and section 234C does not reflect the above. On the
other hand, this amount is to be paid to the income tax department
at predetermined rates of interest, irrespective of the position of
the funds availability with the company. Moreover, this interest
amount is not in the nature of ‘borrowing costs’ as defined under
Accounting Standard (AS) 16, ‘Borrowing Costs’, issued by the
Institute of Chartered Accountants of India. The querist has stated
that the company is of the view that the ‘interest cost under section
234B and section 234C’ reflects the efficiency or otherwise with
which the company is able to estimate its taxable income, and
hence, should ideally form part of the ‘tax expense’. If required, a
separate disclosure can be made of the element of interest cost
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From the above, the Committee is of the view that the interest in
question should be disclosed as a separate sub-item under the
head ‘interest’ with a proper disclosure of its nature or as a separate
line item in the profit and loss account. It can be clubbed with
other items, if any, under the head ‘interest and penalties’, in case
it meets the requirements of paragraph 3(x)(i) of Part II of Schedule
VI to the Companies Act, 1956, as reproduced below:
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D. Opinion
11. On the basis of the above the Committee is of the following
opinion on the issues raised in paragraph 5 above:
(i) No, the treatment given by the company is not correct.
(ii) If the interest in question is a crystallised liability and no
substantial degree of estimation is required for estimation
of interest under section 234B and section 234C of the
Income-tax Act, 1961, the same should be accrued and
recognised as an expense in the profit and loss account
and disclosed as discussed in paragraphs 8 and 9 above.
The liability for such interest should be disclosed in the
balance sheet under the head ‘Current Liabilities’ (and
not as a ‘provision’).
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Query No. 24
Subject: Accounting for conversion of membership rights of
erstwhile BSE (AOP) into trading rights of BSEL
and shares.1
A. Facts of the Case
1. The querist has stated that the BSE had till recently been
functioning as an Association of Persons (AOP). Brokers/members
of the erstwhile BSE (a recognised stock exchange registered as
an association of persons) had been holding membership card
which gave them (a) the ownership rights in the AOP and (b)
exclusive rights to carry on business as a stock broker.
2. In the past, one could trade in this membership card with the
value being in the range of Rs. 7 million to Rs. 40 million. According
to the querist, before the introduction of Accounting Standard (AS)
26, ‘Intangible Assets’, issued by the Institute of Chartered
Accountants of India, as no specific guidance was available, this
membership card was classified as a fixed asset or as an
investment. In case it was classified as an investment, it was
evaluated for diminution other than temporary. Similarly, if it was
classified as a fixed asset, the same might or might not have been
depreciated as it was considered to have perpetual life.
3. With the introduction of AS 26, this membership right was
considered to fall under the purview of the Standard. Accordingly,
the same was classified as part of intangible assets (disclosed as
fixed asset). The membership right was considered to have
perpetual existence and there was no defined useful life. As there
is a presumption in AS 26 that the useful life of an intangible asset
is 10 years (unless substantiated otherwise), the stockbrokers were
amortising this intangible asset over a period of 10 years. This
treatment had been confirmed by an earlier opinion of the Expert
Advisory Committee of the Institute of Chartered Accountants of
India (published in the Compendium of Opinions – Volume XXIV,
Query No. 2).
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(i) View 1
As far as the trading right is concerned, there is no exchange
of assets and this should be continued to be carried forward
as an intangible asset. The shares of the BSEL received
under the corporatisation scheme of the BSE should be shown
as an investment at acquisition cost, i.e., Rs. 10,000. This
view is based on the premise that as a result of corporatisation
and demutualisation, the trading rights of a member of the
erstwhile BSE (AOP) remain unaffected, while he additionally
gets 10,000 shares at a price of Re. 1 each.
Proposed accounting treatment:
The WDV of the membership card of AOP in the books at the
effective date should continue to be carried forward as an
intangible asset and written off over its balance useful life out
of the original ten years (and not 10 years counted afresh).
The 10,000 shares of BSE should be shown as an investment
at Rs. 10,000, i.e., acquisition cost.
(ii) View 2
A cardholder of the erstwhile BSE (AOP) gets shares in BSEL
which is an entity totally separate and distinct from BSE (AOP).
He also gets trading rights which are otherwise available
against deposit. Thus, from a legal angle, the transaction
involves giving up the rights of one legal entity [BSE (AOP)]
and acquiring trading rights and shares of another legal entity
(BSEL). The membership card of BSE and shares of the new
company are two distinct and separate legal instruments and
holding thereof gives to the holder separate and distinctive
legal rights. From the angle of economic substance also, the
membership card of the erstwhile AOP now results in two
separate assets, viz., the trading right and the equity shares.
The new trading right and issue of shares are part of a single
package given to the existing members of the BSE (AOP) in
exchange of their old trading right. Acknowledging the fact
that the new trading right received by the existing member
may have a lower fair value (because there is no market for
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this trading right and the fair value will primarily reflect the
cost savings, i.e., the present value of the cost of deposit), it
appears that the loss in the value of the old right due to
corporatisation of BSE has been compensated through issue
of equity shares at a nominal price. Thus, the fair value of the
old trading right (before corporatisation) will now be available
to the member as gain through the fair value of the equity
shares so received. If this were not the business rationale,
the equity shares would not have been issued at a nominal
price. The present situation is one where the membership
card of the AOP was an intangible asset. Against this intangible
asset, two assets have been acquired. The first is the right of
trading which is no longer an exclusive right. The second is
an investment in the new company. As far as the shares of
BSEL are concerned, their allotment to members of AOP
recognises the fact that earnings of the AOP till date belong
to the members of the AOP. It is also evident that the
arrangement is such that the existing members are
compensated through the shares for the loss of their exclusivity
of trading rights. It is clear that allotment of shares at Re. 1
each is not representative of the economic reality. Thus, it
would not be proper to record these shares at Re. 1 each.
Proposed accounting treatment:
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The fair value of new trading right should reflect the differential
advantage that the BSE (AOP) holder has over a new trading
member, e.g., the erstwhile cardholder of BSE (AOP) does
not have to pay the required deposit. This value would be
ascribable to the present value of the cost of deposit, i.e., the
net interest payable plus other costs of the funds. In case the
aggregate fair value of shares and new trading right exceeds
the carrying amount of the card, excess should not be
recognised (effectively not recording any gain). If, on the other
hand, the carrying amount of the card exceeds the above-
mentioned aggregate, the excess would need an immediate
write-off. As far as the value of the shares is concerned, their
carrying amount and disclosure would depend upon the intent
whether they are being held as long term investments or
current investments.
B. Query
12. The querist has sought the opinion of the Expert Advisory
Committee as to which of the two views stated above should be
followed.
C. Points considered by the Committee
13. The Committee notes from the Facts of the Case that under
the BSE corporatisation and Demutualisation Scheme 2005, a
member of the erstwhile BSE (AOP) receives two assets, namely,
10,000 shares in the BSEL for a nominal value of Rs. 10,000 and
a trading right in the BSEL. Thus, a member of the AOP gets an
investment in the form of shares in BSEL and an intangible asset
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AS 26
“34. An intangible asset may be acquired in exchange or
part exchange for another asset. In such a case, the cost of
the asset acquired is determined in accordance with the
principles laid down in this regard in AS 10, Accounting for
Fixed Assets.”
AS 10
“11.1 When a fixed asset is acquired in exchange for another
asset, its cost is usually determined by reference to the fair
market value of the consideration given. It may be appropriate
to consider also the fair market value of the asset acquired if
this is more clearly evident. An alternative accounting treatment
that is sometimes used for an exchange of assets, particularly
when the assets exchanged are similar, is to record the asset
acquired at the net book value of the asset given up; in each
case an adjustment is made for any balancing receipt or
payment of cash or other consideration.”
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D. Opinion
19. On the basis of the above, the Committee is of the opinion
that the querist should not follow either of the views suggested in
paragraph 11 above; rather, the accounting treatment suggested
in paragraphs 16 and 18 above should be followed.
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Query No. 25
Subject: Recognition of duty credit entitlement under ‘Served
from India Scheme’.1
A. Facts of the Case
1
Opinion finalised by the Committee on 17.1.2007
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AS 10
“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;
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D. Opinion
12. On the basis of the above, the Committee is of the following
opinion on issues raised in paragraph 7 above:
(i) The benefit of duty credit entitlement should be
recognised as ‘other income’ at the time and to the extent
there is no significant uncertainty as to its measurability
and ultimate realisation as discussed hereinbefore.
(ii) The value of fixed assets/spares/consumables should be
inclusive of the duty payable whether by way of payment
in cash or by way of utilisation of duty credit entitlement.
Hence, there is no question of increasing the value of
fixed assets/spares/consumables separately by the
amount of duty credit entitlement utilised, as discussed
in paragraph 11 above.
Query No. 26
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3. At one of the projects where new units are being set up for
expansion of generating capacity, mementos were distributed to
all the employees, whether engaged in operations, construction or
other common services/functions, on the occasion of
synchronisation of a new generating unit ahead of the schedule.
Synchronisation is a major milestone preceding the readiness for
commercial operations. The expenditure on the mementos was
capitalised as incidental expenditure during construction. The
government auditor while reviewing the accounts observed that
the expenditure is not directly attributable to the construction of
the unit and should have been charged to revenue.
4. The company is of the view that the expenditure on distribution
of mementos on the occasion of synchronisation ahead of schedule
is an additional expenditure directly related to the construction of
the unit. Synchronisation before schedule results in significant
benefits to the company in terms of cost reduction and shorter
project construction schedule. The mementos were distributed to
the employees to enhance employee morale and team spirit.
B. Query
the asset under construction to its working condition for its intended
use, and hence, the same should not be capitalised. Further, in
case the cost of the mementos is to be capitalised on the
aforementioned basis, it should be capitalised only to the extent of
such benefit given to the employees who are engaged in the
construction activity. In this regard, the Committee notes from the
Facts of the Case that the company has distributed the mementos
to all employees, whether engaged in operations, construction or
other common services/functions.
D. Opinion
9. On the basis of the above, the Committee is of the opinion
that the capitalisation of the expenditure incurred on mementos
distributed to the employees would be in accordance with the
Guidance Note on Expenditure during Construction Period only if
it is part of a formal plan/informal practice of the organisation to
provide incentives to the employees for achieving certain
construction activity ahead of schedule, or it directly or indirectly
benefits the construction activity. In case it is to be so capitalised,
it should be capitalised only to the extent such expenditure is
related to the employees engaged in the construction/expansion
activity, as discussed in paragraph 8 above.
Query No. 27
Subject: Books of account of franchise business and
accounting implications thereof.1
A. Facts of the Case
1. A public limited company is engaged in the business of
manufacturing and marketing of country liquor, spirit and IMFL
(Indian Made Foreign Liquor). It is engaged in the business of
manufacturing of IMFL products of certain brand owners under an
arrangement with them.
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2. The querist has stated that the liquor is subject to state excise.
It involves import duty on purchase of goods from another state
and export duty implication on the sale of goods to the buyers
located in another state (within India). Such duties on purchases
and sales are called as import duty and export duty, respectively.
Hence, the brand owners are getting their products manufactured
and sold through manufacturing entities located in respective states.
Further, being non-excise licensees for the concerned states, the
brand owners are not allowed to do business in their name.
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13. On the basis of the above, the Committee is of the view that
since the significant risks and rewards related to the ownership of
IMFL products do not vest with the company, the sales and
purchases of the said products should not be recognised in the
books of account of the company; instead these should be
recognised in the books of account of the brand owners. Similarly,
the assets and liabilities of the said business should also not be
recorded in the books of account of the company as these are
being controlled by the brand owners, even though the supporting
documents in respect of the same are being maintained by the
company. The company should recognise its fixed charge/margin
as its income in its financial statements. Regarding the accounting
treatment of the brand owners’ entitlement, the Committee is of
the view that surplus from the business which is the brand owners’
entitlement and withdrawn by the brand owners, is merely a cash
outflow for the company and should, therefore be recorded as
such in the books of the company. Hence, any such entitlement
due to the brand owners should be credited to their respective
accounts in the books of the company.
14. As far as the books of account to be kept by the company is
concerned, the Committee notes that section 209(1) of the
Companies Act, 1956, provides as follows:
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On the basis of the above and considering the fact that sales,
purchases, assets and liabilities in respect of the business of IMFL
products should not be recognised in the financial statements of
the company, the Committee is of the view that for the purposes
of Companies Act, 1956, the books of account maintained that
enable the company to reflect various items of income (e.g. fixed
charge per case) and expense in the financial statements of the
company should be deemed to be the books of account of the
company. In this regard, the Committee also wishes to again point
out that the opinion expressed by the Committee is purely from
the accounting point of view without consideration of any
implications thereof, from the point of view of the provisions of
TDS/TCS, Income-tax Act, 1961, or any other legal/statutory
requirement.
D. Opinion
15. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 9 above:
(i) The correct accounting treatment of the said transactions
in the books of account of the company would be to
recognise only the fixed margin/charge received by it
rather than to recognise sales and purchases of the
business of IMFL products as discussed in paragraphs
12 and 13 above. The company should also not recognise
any asset or liability of the said business in this regard in
its books of account. The brand owners entitlement paid
by the company should be booked as a mere cash
outflow. On the other hand, the brand owners should
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Query No. 28
Subject: Capitalisation of establishment expenses of
Rehabilitation & Resettlement office after
commissioning of the project.1
A. Facts of the Case
1. A joint venture between a Government of India enterprise and
the Government of Madhya Pradesh was incorporated as a
company on 01.08.2000, with 51% stake being held by the former
and the rest by the latter, to exploit the hydroelectric potential of
the Narmada Basin. The company, having its headquarters at
Bhopal, Madhya Pradesh (M.P.), presently has two projects, viz.,
Indira Sagar Project (ISP) of 1,000 MW under operation and
Omkareshwar Project (OSP) of 520 MW under construction. Both
these projects are situated in the state of M. P.
2. The querist has stated that ISP is the mother project of the
Narmada Basin. It supplies water to three major downstream
hydroelectric projects, viz., Omkareshwar & Maheshwar Projects
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4. The queist has further stated that the work of Rehabilitation &
Resettlement (henceforth referred to as R&R) of the Project
Affected Families (PAFs) of the project is being carried out by the
R&R office situated at Khandwa. The work of R&R office includes,
inter alia, land acquisition, preparation and payment of land
compensation awards, development of infrastructure at various
resettlement sites and transportation of PAFs to these sites. As
per the approved cost estimate of ISP, the entire expenditure
incurred on the R&R activities is chargeable to the dam of ISP and
is to be capitalised therewith. A total number of 249 villages are
covered in the submergence area of the project, out of which 75
villages are being fully submerged and the balance 174 villages
are being partially submerged. In addition to these, some more
villages being submerged / families affected by the back waters of
the reservoir are also to be resettled. The original cost estimate
for R&R was Rs. 1,160 crore which was later revised to Rs. 1,570
crore vide the Cabinet Committee on Economic Affairs (CCEA)
clearance dated 28.03.2002. The total proportionate establishment
expenditure pertaining to R&R works of ISP incurred on R&R
office from 24.08.2005 to 31.03.2006 works out to Rs. 6.43 crore
which has been transferred to Incidental Expenditure During
Construction (IEDC) and thus got capitalised in the annual accounts
of 2005-06 of ISP, as the project is fully operational.
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(e) As per the CERC guidelines no. 34.4 for tariff fixation,
capital expenditure incurred after the completion of the
project is also to be considered for the fixation of tariff.
The generating company can file two revised tariff
petitions, apart from the original tariff petition, within a
tariff period, i.e., five years of the completion of the project,
to include the capital expenditure incurred after the
commissioning of the project in the total project cost and
consider the same towards tariff fixation of the project.
(f) Accordingly, the company is of the view that the treatment
of the expenditure of Rs. 6.43 crore incurred on R&R
works from 24.08.2005 to 31.03.2006 as IEDC and
capitalisation of the same is correct and as per the
provisions of Accounting Standard (AS) 10, ‘Accounting
for Fixed Assets’, the company’s accounting policy and
CERC guidelines.
B. Query
12. In view of the facts of the case, the querist has sought the
opinion of the Expert Advisory Committee on the following issues:
(i) Whether the treatment given to R&R expenditure for the
period from 24.08.2005 to 31.03.2006 is correct and as
per the relevant Accounting Standards and practices.
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14. The Committee further notes that the querist has mentioned
two dates as the date of reaching 100 percent rated capacity, viz.,
24.08.2005 and 25.08.2005. Also, at one place it is mentioned that
Full Reservoir Level and Maximum Water Level are one and the
same while at another place, they are stated to be different.
However, such matters do not affect the accounting treatment for
the issue involved.
15. The Committee notes that the last unit (i.e., 8th unit) of the
mother project (ISP) was commissioned on 30.03.2005 itself while
the rated capacity of 1,000 MW was achieved on 24.08.2005
(25.08.2005). There is huge unspent amount on account of balance
civil, electrical and finishing works of dam and power house, pending
claims of various contractors and remaining R&R works as well as
the balance expenditure on compensatory afforestation and
catchment area treatment. Further, the rated capacity is reached
against the water level of EL 255 M and not at the maximum level,
i.e., EL 262.13 M.
16. In the context of the comments of the C&AG contained in
paragraph 8 above, the Committee notes the following portions of
the Guidance Note on Treatment of Expenditure during Construction
Period, issued by the Institute of Chartered Accountants of India:
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21. The querist has not stated what incremental benefits will flow
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from raising the existing water level to the maximum level. However,
the querist has indicated in paragraphs 10 and 11(d) above that it
is probable that future benefits from the relevant asset will increase
beyond the previously assessed standard of performance. Thus, it
seems that the R&R expenditure is continued with a view to
exploiting the commercial benefits of the project fully by raising
the water level from the existing level of EL 255 M to the maximum
level of EL 262.13 M, after obtaining the Court’s approval. Though
the dam has already been raised to the maximum height of 262.13
M, to raise the water level to this height, Court’s permission is
necessary. It seems that for getting the Court’s permission, R&R
work must be complete, for which the R&R office is to be
maintained.
22. The Committee notes that R&R office is exclusively devoted
to R&R activities only. Hence, the expenditure incurred by the
R&R office can be reliably measured.
23. In view of the above, all the three conditions mentioned in
paragraph 18 above appear to be satisfied. Though the capacity
of the dam is not going to be increased further, the standard of
performance so far assessed in terms of benefits is related to
existing level of water only. Since it is probable that the raising of
existing water level to the maximum level will increase the future
benefits and the expenditure thereon can be measured reliably,
continued incurrence of the R&R expenditure, including R&R office
expenditure, which is a directly attributable cost in the case of the
querist, is eligible for capitalisation as part of cost of the relevant
asset.
24. The Committee is of the view that even if the continued
incurrence of R&R expenditure is to be capitalised on the
considerations mentioned in paragraph 23 read with paragraph 18
above, incidental expenditure, such as, establishment expenses of
R&R office should not be capitalised if no activity is in progress or
the delay in the progress of R&R activities is avoidable. In this
connection, the Committee notes the following paragraphs from
Accounting Standard (AS) 16, ‘Borrowing Costs’:
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(ii) In view of (i) above, this question does not arise. However,
in case R&R activities are not in progress or the delay in
R&R activities is avoidable, capitalisation of establishment
expenditure of R&R office is an error, the correction of
which should be accounted for as a prior period item in
accordance with Accounting Standard (AS) 5, ‘Net Profit
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Query No. 29
Subject: Accounting and reporting of interest in jointly
controlled entity.1
A. Facts of the Case
1. A company, which is a Government of India enterprise, having
a 3 MMTPA refinery, desires to purchase natural gas from M/s.
XYZ Limited and has already entered into an agreement with it for
the supply of natural gas for a period of 15 years for its use in the
refinery, with a provision to further extend the term of the agreement
by another 5 years by mutual consent.
2. The company has entered into an agreement with another
company, ABC Ltd., a State Government enterprise, on 27th June,
2005. According to the querist, there was an advantage available
in entering into this agreement with ABC Ltd., having a network of
gas pipeline and presently, operating in the business of gas
transportation in the State and other near-by areas. Under the
agreement, ABC Ltd. agreed to set up gas transportation system
to transport gas from XYZ Ltd.’s off-take point to the company’s
refinery for the use of the company in its refinery as per the terms
and conditions of the agreement. The tenure of this agreement
was initially meant for 15 years from the date of commencement
of gas transportation and renewal for a further period of 5 years
on terms and conditions mutually agreed to.
3. The above agreement with ABC Ltd. was entered into to
construct a gas transportation system with 2.00 MMSCMD of gas
(1.00 MMSCMD for the company and other 1.00 MMSCMD for the
consumers other than the company). The transmission charges
1
Opinion finalised by the Committee on 17.1.2007
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(iii) The estimated cost of the project is Rs. 320 crore and
the same will be shared by the two venturers on an
agreed debt/equity basis.
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B. Query
5. Having regard to the above facts and probability of the
company entering into an agreement with ABC Ltd. to be partner/
co-venturer in a JV under special purpose vehicle (S.P.V.)
arrangement, the querist has sought the opinion of the Expert
Advisory Committee with regard to accounting in the separate
financial statements of the company on the following matters, in
the context of the requirements of Accounting Standard (AS) 27
‘Financial Reporting of Interests in Joint Ventures’, issued by the
Institute of Chartered Accountants of India:
(i) Treatment in the books of account of contribution by the
company towards JV equity, and the borrowings and
liability taken by the company for funding the JV.
6. The Committee notes from the Facts of the Case that a joint
venture (JV) or a special purpose vehicle (S.P.V.) arrangement is
proposed to be entered into by the company with another company.
It is also mentioned in the Facts of the Case that the JV unit will
have the status of unincorporated jointly controlled entity. The
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8. The Committee further notes that the querist has raised the
query only in respect of accounting and reporting of financial interest
in the jointly controlled entity in the separate financial statements
of the company. Accordingly, the opinion of the Committee is only
on this aspect. In this context, the Committee notes the provisions
related to ‘separate financial statements’ as contained in paragraphs
27 and 28 of AS 27 reproduced as below:
“27. In a venturer’s separate financial statements, interest
in a jointly controlled entity should be accounted for as
an investment in accordance with Accounting Standard
(AS) 13, Accounting for Investments.
10. The Committee is also of the view that borrowings made and
the liabilities assumed by the company for funding the JV,
presumably by contributing to the equity of the JV will appear as
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D. Opinion
16. On the basis of the above, the Committee is of the following
opinion in respect of the issues raised in paragraph 5 above:
(i) The contribution made by the company towards the JV
equity should be accounted for as an investment in the
separate financial statements of the company as
suggested in paragraphs 8 and 9 above. The borrowings
made and the liabilities assumed by the company for
funding the JV, presumably by contributing to the equity
of the JV should appear as the borrowings and liabilities
of the company. However, if the company undertakes to
repay the borrowings and liabilities of the JV, the same
should be considered as a part of investment and treated
as suggested in paragraph 10 above.
(ii) The company should not account for such a share in the
assets of JV in its separate financial statements, only a
disclosure is required as discussed in paragraph 13
above. Further, the recognition principles will remain the
same for both, during the project period as well as after
commissioning, as discussed in paragraph 14 above.
(iii) Any share in the liabilities of the jointly controlled entity
should not be recognised in the separate financial
statements of the company, however, a disclosure in
respect thereof is required in the notes to accounts as
discussed in paragraph 13 above.
(iv) Any expense incurred by the company on behalf of the
jointly controlled entity should be accounted for as an
investment as per the requirements of AS 13. As far as
any transaction of sale and purchase between the
company and jointly controlled entity is concerned, it
should be recognised as a normal sale or purchase
transaction as discussed in paragraph 11 above.
However, any share in the income earned or expenses
incurred by the jointly controlled entity should not be
recognised by the company but only disclosed as per
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Query No. 30
1
Opinion finalised by the Committee on 17.1.2007
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Query No. 31
Subject: Treatment of conversion rights for calculation of
diluted EPS.1
A. Facts of the Case
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B. Query
7. On the basis of the above, the querist has requested the
Expert Advisory Committee to give its interpretation of this clause
vis a vis the covenant of conversion clause in the loan
documentation and give its opinion on inclusion of this covenant
for calculation of diluted EPS. Also, since the company has never
defaulted, the querist has argued that this condition of conversion
becomes superfluous for the company and has requested that the
stipulation regarding the disclosure of the diluted EPS be interpreted
in a manner that only companies which have defaulted in payment
of debt are required to disclose the same.
C. Points considered by the Committee
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D. Opinion
12. On the basis of the above, the Committee is of the opinion
that the disclosure of diluted EPS can not be interpreted in the
manner to include only those potential equity shares under the
conversion clause where the companies have either defaulted in
the past or will default in future, in the computation of diluted EPS.
Accordingly, the company should include all dilutive potential equity
shares, including those shares, which are issuable upon default of
payment of loan or interest under a loan agreement, in the
calculation of diluted EPS.
Query No. 32
1
Opinion finalised by the Committee on 17.1.2007
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(a) These certificates are valid for 2 years from the date of
issue.
(b) Duty credit entitlement may be used for import of any
capital goods including spares, office equipment and
professional equipment, office furniture and consumables,
provided it is part of the main line of business.
(c) The entitlement and the goods imported shall be non-
transferable (emphasis supplied by the querist.)
7. The querist has stated that during the year 2005-06, the
enterprise utilised duty credit certificates amounting to Rs.11.25
crore for use in the import of capital goods and Rs.7.21 crore for
import of spares, totalling Rs.18.46 crore. As the enterprise had
not paid any customs duty for capital items imported during the
year 2005-06 for its operation, only the cost paid by the enterprise
(i.e., without customs duty) was capitalised in the books of account.
Similarly, as no customs duty was paid for import of spares, the
cost actually paid by the enterprise was charged to the profit and
loss account without customs duty.
(i) Whether the amount of Rs. 70.84 crore being the value
of duty credit entitlement certificates obtained from DGFT
under the ‘Served from India Scheme’ is required to be
considered as income of the enterprise and booked as
income in the books of account.
12. The Committee notes that the basic issue raised in the query
relates to the recognition of duty credit entitlement certificates
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issued under the ‘Served from India Scheme’, i.e., how this benefit
should be recognised in the books of account, and whether the
balance of duty credit entitlement certificates lying unutilised at the
end of the year should be recognised as ‘current assets’, i.e., the
timing of recognition of the duty credit entitlement and presentation
thereof. In this regard, the Committee notes that even though the
entitlement received under the Scheme does not strictly fall within
the definition of the term ‘revenue’, as defined under Accounting
Standard (AS) 9, ‘Revenue Recognition’, issued by the Institute of
Chartered Accountants of India, such duty credit entitlement is of
the nature of revenue and accordingly, it should be recognised as
‘other income’ in the books of account of the enterprise provided
the conditions for recognition of revenue as discussed in paragraph
14 below are satisfied.
13. As far as the question regarding whether the duty credit
entitlement certificates, i.e., duty credit entitlement utilised for
payment of customs duty in respect of capital items and stores
and spares should be added/included in the cost of such items is
concerned, the Committee notes from paragraph 7 above that at
the time of purchase of these items, the enterprise is recording the
capital items, and stores and spares at the cost incurred net of
duty. In this regard, the Committee notes paragraph 9.1 of
Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, and
paragraphs 6 and 7 of Accounting Standard (AS) 2, ‘Valuation of
Inventories’, issued by the Institute of Chartered Accountants of
India, which state as follows:
AS 10
“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:
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recognise the duty credit entitlement in the profit and loss account
as its ‘other income’ on the above basis, by debiting the ‘duty
credit entitlement account’ and crediting the profit and loss account.
At the time of purchase of fixed asset or spares, etc., such credit
entitlement should be adjusted against the duty payable on the
import of these items. The balance of duty credit entitlement
standing in the books of account, remaining unutilised, if any, at
the end of the year should be disclosed under the head ‘Loans
and Advances’, on the ‘Assets’ side of the balance sheet since, it
is of the nature of pre-paid expenses which would be adjusted
against the customs duty expenses in future period.
15. As regards the commission/service charges payable to
consultant for utilising the duty credit entitlement certificates, the
Committee is of the view that these charges do not add any value
to the items so imported and are not directly attributable expenses,
i.e., the costs without the incurrence of which the transaction would
not have taken place. Accordingly, these should not be added to
the cost of the items; instead, these should be charged to the
profit and loss account when incurred.
D. Opinion
16. The Committee is of the following opinion on the issues raised
in paragraph 11 above:
(i) The revenue in respect of the duty credit entitlement
certificates should be recognised as income in the books
of account when and to the extent there is no significant
uncertainty as to their ultimate realisation, i.e., utilisation
of the credit under the Scheme as discussed in paragraph
14 above.
(ii) The capital items procured should be recorded at the
value inclusive of the customs duty payable thereon
whether by way of cash or by way of adjustment of the
duty credit entitlement. Please refer to paragraph 13
above.
(iii) The stores and spares should be recorded at the value
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The identity of the querist and/or the client will, however, not
be disclosed, as far as possible.
11. It should be understood clearly that although the Committee
has been appointed by the Council, an opinion given or a
view expressed by the Committee would represent nothing
more than the opinion or view of the members of the
Committee and not the official opinion of the Council.
12. It must be appreciated that sufficient time is necessary for the
Committee to formulate its opinion.
13. The queries conforming to above Rules should be addressed
to the Secretary, Expert Advisory Committee, The Institute of
Chartered Accountants of India, ‘ICAI Bhawan’, Indraprastha
Marg, New Delhi-110 002.
236
*
INDEX Vols. I to XXVI
*
Prefix ‘I’, ‘II’, ‘III’, ‘IV’, ‘V’, ‘VI’, ‘VII’, ‘VIII’, ‘IX’, ‘X’, ‘XI’, ‘XII’, ‘XIII’, ‘XIV’, ‘XV’, ‘XVI’, ‘XVII’, ‘XVIII’, ‘XIX’,
‘XX’, ‘XXI’, ‘XXII’, ‘XXIII’, ‘XXIV’, ‘XXV’ and ‘XXVI’ before the page numbers indicate the respective
volumes of Compendium of Opinions.
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