OPINION

Capitalisation of expenditures in respect

of projects under construction.
The following is the opinion given by the Expert Advisory Committee of the Institute in response to a query sent
by a member. This is being published for the information of readers.

A. Facts of the Case

1. A government company is engaged in
the construction and operation of thermal
power plants in the country. The company
has also diversified into hydro power
generation, coal mining and oil & gas
exploration, etc. The company is registered
under the Companies Act, 1956 and being
an electricity generating company, is
governed by the provisions of the Electricity
Act, 2003. The company prepares its annual
financial statements as per the provisions
of the Companies Act, 1956. The company is
listed with the Bombay Stock Exchange and
the National Stock Exchange.
2. The company has a three-tier organisation
structure consisting of projects/stations,
regional headquarters and corporate office.
The company has six regions with the
regional headquarters located across the
country and also a hydro region headquarter
located centrally. The projects/stations
are grouped under different regions and
report to the corporate office through
the regional headquarters. The regional
headquarters provide various services to
the projects under construction and the
operating stations under their jurisdiction.
The company has also established two
transport and customs clearance (T&CC)
offices to facilitate the timely receipt of
imported goods for the projects/stations.
3. The company is undertaking construction
of a number of new power projects at the
greenfield sites as well as expansion of
existing projects. Some of the key activities
related to the construction projects,
such as, design & engineering, award of
major contracts, post-award contract
management, project monitoring, etc., are
performed centrally at the corporate office.
The company has seven coal mining blocks
and similar activities for the development
of these mines are also performed
centrally at corporate office. The company
has established departments mainly
for performing these activities for the
construction/expansion of power projects
and development of mining projects at its
1

corporate office with a view to benefit from

the pooling of highly skilled manpower in
these areas and also to achieve economy in
expenditure. As a result, according to the
querist, certain expenditures required for
construction/expansion of the projects are
incurred centrally instead of at individual
project locations.
4. The querist has stated that till the financial year 2007-08, in accordance with
paragraph 5 read with paragraph 7 of the
Guidance Note on Treatment of Expenditure
during Construction Period1 , issued by the
Institute of Chartered Accountants of India
(ICAI), expenses of the corporate office,
regional headquarters and T&CC offices
were allocated to the operating stations
and projects under construction in the
proportion of sales to annual capital outlay.
The amounts allocated to the operating
stations were recognised in the profit and
loss account. The amounts allocated to
the projects under construction, along
with the projects expenses considered as
incidental expenditure during construction,
were apportioned to different assets in the
proportion of accretion to capital work-inprogress during the year and capitalised. The
accounting policies of the company in this
regard for the year 2007-08 were as under:
Expenses common to operation and
construction activities are allocated
to profit and loss account and incidental expenditure during construction in proportion of sales to annual
capital outlay in the case of corporate office and sales to accretion to
capital work-in-progress in the case
of projects.
Incidental expenditure during construction (net) including corporate office expenses (allocated to
the projects prorata to the annual
capital expenditure) for the year,
is apportioned to capital work-inprogress on the basis of accretions
thereto.

Note on Treatment of Expenditure during

Construction Period by the Institute of
Chartered Accountants of India (ICAI) during
the year 2008-09, the company constituted
a committee comprising members from
cross functional areas to:
(a) identify the expenditures of the related
departments of corporate office, regional headquarters (RHQs) and T&CC
offices whose services are specifically
attributable to construction of projects
considering the provisions of Accounting Standard (AS) 10, Accounting for
Fixed Assets, notified under the Companies (Accounting Standards) Rules,
2006, and
(b) allocate such expenses to the projects
under construction/expansion.

5. The querist has also stated that consequent to the withdrawal of Guidance

The Guidance Note on Treatment of Expenditure during Construction Period has since been withdrawn pursuant to the decision of the Council at
its 280th meeting held on August 7-9, 2008.

THE CHARTERED ACCOUNTANT

JUNE 2010

1937

OPINION

As per the querist, the said committee

was guided by the provisions of paragraph
9.2 of AS 10 which states that expenses
which are specifically attributable to the
construction of a project or incurred for
acquisition of a fixed asset or incurred for
bringing the asset to its working condition,
can only be included as a part of the cost of
construction project or as a part of the cost
of the fixed asset. Paragraph 9.2 of AS 10 is
reproduced as below:
9.2 Administration and other general overhead expenses are usually
excluded from the cost of fixed assets because they do not relate to
a specific fixed asset. However, in
some circumstances, such expenses
as are specifically attributable to
construction of a project or to the
acquisition of a fixed asset or bringing it to its working condition, may
be included as part of the cost of the
construction project or as a part of
the cost of the fixed asset.
6. Considering the above mentioned provisions, the said committee reviewed the
services rendered by various departments
located at the corporate office to the
construction/expansion projects. Based on
such review, the committee identified that
the following departments provide services
mainly for construction/execution activities
of the projects:
(a) Corporate Monitoring Group (CMG)
(b) Corporate Engineering Department
(c) Corporate Contract Services Department
(d) Finance Concurrence Department
(e) Hydro Region Headquarter for construction of hydro projects; and
(f) Coal mining department rendering services to coal mining projects.
According to the querist, the committee
recommended that the expenditure of the
above departments be allocated to the
projects under construction/expansion
on the basis of annual capital expenditure
for the period considering the following
principles:
Sl

Name of the
Department

Allocated to

CMG, Engineering,
Contracts
and Finance
Concurrence Group

Thermal, Gas,
Hydro & Coal
Mining Units

Hydro Region

Hydro Units

Coal Mining

Coal Mining
Units

As regards other departments, the

committee noted that other departments
are either providing common services to
projects under construction/expansion and
projects in operation or providing services
for operating stations only and hence, the

1938

JUNE 2010

committee recommended that expenses of

these departments may be charged to the
statement of profit and loss. Accordingly,
the expenditure of engineering, contracting, project monitoring, hydro region
headquarter, coal mining and finance
concurrence departments were considered
as expenditure during construction
and for allocation to the projects under
construction/expansion on a systematic
basis, i.e., capital expenditure incurred
during the year at these projects. Expenses
of other departments providing common
services were charged to the statement
of profit and loss. Further, accounting
policy of the company for allocation of
administration and general overhead
expenses to the units for the financial year
2008-09 was as under:
Administration and general overhead expenses attributable to construction of fixed assets incurred till
they are ready for their intended use
are identified and allocated on a systematic basis to the cost of related
assets.
7. During supplementary audit of accounts
under section 619(3)(b) of the Companies
Act, 1956, the government auditor observed
as below:
With the withdrawal of Guidance
Note on Treatment of Expenditure
During Construction Period by the
ICAI, the accounting is to be done as
per AS 10, which stipulates that administration and other general overhead expenses are usually excluded
from the cost of fixed assets since
they do not relate to a specific fixed
asset. In some circumstances, such
expenses as are specifically attributable to construction of a project or
to the acquisition of a fixed asset or
bringing it to its working condition,
may be included as part of the cost
of the construction project or as a
part of the cost of the fixed asset.
The company has allocated expenses relating to five divisions on the
ground that they perform functions
relating to construction only. However, the expenses do not pertain to
any one project. Hence, allocation
of the expenses was not in accordance with AS 10.

activities for the construction of projects/

coal mine development. Since the activities of the identified departments were
directly related to the construction of
projects, capitalisation of these expenses
is in accordance with the requirements
of AS 10. The fact that these activities are
performed centrally at the corporate centre
does not change their basic character
which is that such expenditure is incurred
for the construction of fixed assets.
The allocation to the individual projects
based on the capital expenditure incurred
during the year is a reasonable basis and
is not prohibited under AS 10. Charging
of the expenditure of the departments
engaged in project engineering, design,
procurement,
contract
management
and project monitoring activities, etc. to
profit and loss account merely because
they are involved with more than one
project would not be in accordance
with paragraph 9.2 of AS 10.
B. Query
9. Considering the above facts, the querist
has sought the opinion of the Expert Advisory
Committee as to whether allocation and
capitalisation of expenses related to the
identified departments of corporate office
and the regional headquarters which are
engaged in project engineering, designing,
contract
management
and
project
monitoring activities etc. to/at the projects
under construction/expansion is correct.

8. The company is of the view that the

employees posted in engineering, contracts, project monitoring, hydro region
headquarters, coal mining and finance
concurrence departments at corporate
centre are engaged in the activities of
project engineering and design, procurement, contract management and
project monitoring, etc. which are essential

THE CHARTERED ACCOUNTANT

OPINION

C. Points considered by the Committee

10. The Committee notes that the basic issue
raised in the query relates to the accounting
treatment of expenditure incurred at
various departments performing centralised
functions identified by the company for the
construction/expansion of power projects.
The Committee has, therefore, considered
only this issue and has not examined any
other issue that may arise from the Facts of
the Case, such as, specific basis of allocation
of the common expenditures incurred at
these departments over various projects/
assets, propriety of accounting treatment
followed by the company before financial
year 2008-09, accounting for expenditure
incurred by other departments providing
common services to projects under
construction/expansion and projects in
operation, etc. The Committee has also not
considered the issue with respect to the
development of mining projects as special
considerations may apply to those projects.
Further, as the querist has referred to only AS
10 in the context of construction/expansion
and development of power projects, the
Committee presumes that the underlying
assets in all cases are fixed assets covered
under the provisions of AS 10. As the exact
nature of the activities being performed
by various departments is not clear from
the nomenclature of the departments, the
Committees opinion contained hereinafter
is based on the general principles to be
followed while accounting for expenditure
incurred at departments engaged in
providing services to the construction/
expansion of power projects. The exact
expenditures that are to be capitalised will
have to be determined on the basis of the
said principles. The Committee also notes
that while the querist has enumerated six
departments that are stated by the querist
to be engaged in the functions relating to
construction activities, the government
auditor has made his observation in respect
of allocation of expenses relating to five
divisions. However, that does not affect
the opinion of the Committee expressed
hereinafter.

11. The Committee notes that the accounting

principles for determination of the cost of a
self-constructed fixed asset, have been laid
down, inter alia, in paragraph 10.1 of AS 10
which provides as follows:
10.1 In arriving at the gross book
value of self-constructed fixed assets, the same principles apply as
those described in paragraphs 9.1
to 9.5. Included in the gross book
value are costs of construction that
relate directly to the specific asset
and costs that are attributable to
the construction activity in general
and can be allocated to the spe-

1940

JUNE 2010

cific asset. Any internal profits are

eliminated in arriving at such
costs.
The Committee further notes paragraphs
9.1 and 9.2 of AS 10 reproduced below:
9.1 The cost of an item of fixed asset
comprises its purchase price, including import duties and other nonrefundable 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;
(iii) installation cost, such as spe-
cial foundations for plant; and
(iv) professional fees, for example
fees of architects and engineers.
9.2 Administration and other general overhead expenses are usually
excluded from the cost of fixed assets because they do not relate to
a specific fixed asset. However, in
some circumstances, such expenses
as are specifically attributable to
construction of a project or to the
acquisition of a fixed asset or bringing it to its working condition, may
be included as part of the cost of the
construction project or as a part of
the cost of the fixed asset.
From a wholesome reading of the above
paragraphs of AS 10, the Committee is of the
view that the basic principle to be applied
while capitalising an item of cost to a fixed
asset/project under construction/expansion
is that it should be directly attributable to
the construction of the project/fixed asset
for bringing it to its working condition for
its intended use. The costs that are directly
attributable to the construction/acquisition
of a fixed asset/project for bringing it to
its working condition are those costs that
would have been avoided if the construction/
acquisition had not been made. These are
the expenditures without the incurrence
of which, the construction of project/
asset could not have taken place and the
project/asset could not be brought to its
working condition, such as, site preparation
costs, installation costs, salaries of engineers engaged in construction activities,
etc.The avoidance of costs as the basis
of
identifying
directly
attributable
cost for the purpose of capitalisation
is also supported by Accounting
Standard (AS) 16, Borrowing Costs.
In the extant case, the Committee is of the
view that it should be seen that whether
the expenses incurred on the activities
of the various departments are directly

attributable to the construction as discussed

above. Accordingly, if the expenses incurred
at the various departments are directly
attributable to construction, these can be
capitalised with the cost of the concerned
fixed asset(s)/project(s).
12. As regards basis of allocation of the
expenses of these departments that can
be allocated and capitalised to various
projects or assets under construction, the
Committee is of the view that the same
should be allocated selecting an appropriate
basis that reflects the extent of usage of
service rendered by the department to the
construction of the project.
D. Opinion
13. On the basis of the above and subject to
the considerations contained in paragraph
10 above, the Committee is of the opinion
on the issue raised in paragraph 9 above
that capitalisation of expenses related to
various departments of corporate office and
the regional headquarters to the projects/
assets under construction/expansion would
be correct provided the expenses incurred
on the activities of these departments can
be considered to be directly attributable to
the construction of project(s)/ fixed asset(s)
for bringing it(them) to its(their) working
condition as discussed in paragraph 11
above.

1. The Opinion is only that of the Expert

Advisory Committee and does not
necessarily represent the Opinion of the
Council of the Institute.
2. The Opinion is based on the facts
supplied and in the specific circumstances
of the querist.
3. The Compendium of Opinions
containing the Opinions of Expert
Advisory
Committee
has
been
published in twenty six volumes. A CD
of Compendium of Opinions containing
twenty five volumes has also been
released by the Committee. These are
available for sale at the Institutes office
at New Delhi and its regional council
offices at Mumbai, Chennai, Kolkata and
Kanpur.
4. Recent opinions of the Committee are
available on the website of the Institute
under the head Resources.
5. Opinions can be obtained from EAC
as per its Advisory Service Rules which
are available on the website of the ICAI,
under the head Resources. For further
information, write to eac@icai.org.

THE CHARTERED ACCOUNTANT