1.3 - Query
Accounting treatment of interest and ground rent for land during construction period.
1. A corporate body was allotted a commercial plot for the construction of an office building on lease hold basis for 99 years. The consideration for the said allotment consisted of a certain premium (payable in lumpsum or in three annual equated instalments with interest at the rate of 7% per annum) and a yearly ground rent. The land has been allotted for the purpose of construction of office building which is likely to take some time.
2. According to the querist, the following two accounting treatments have been identified for dealing with interest and ground rent payable till completion of the office building:
(i) The whole of the premium payable (together with the interest due on the instalments, if any) in respect of the land may be charged-off in the accounts equally over a period of 99 years. The yearly rental may also be charged-off in the accounts on an yearly basis.
(ii) The interest accruing on the instalments of land together with the ground rent that is payable till completion of the office building may be capitalised and after the completion of construction and putting the same into use, the capitalised value of the land may be written off in the remaining period of lease, i.e., the commercial life of the property.
3. The querist has sought the opinion of the Expert Advisory Committee as to which of the above two alternatives is the correct accounting practice to be followed in the above mentioned case.
January 24, 1990
1. The Committee notes that the commercial plot of land is allotted to the enterprise on 99 years lease and therefore has to be disclosed as ‘lease hold land’, under the head ‘Fixed Assets’ as per the requirement of Part I of Schedule VI to the Companies Act, 1956. Regarding the elements which should comprise the cost of a fixed asset, the Committee notes that para 20 of AS-10 on ‘Accounting for Fixed Assets’ recommends as below:
“The cost of a fixed asset should comprise its purchase price and any attributable cost of bringing the asset to its working condition for its intended use. Financing costs relating to deferred credits or to borrowed funds attributable to construction or acquisition of fixed assets for the period up to the completion of construction or acquisition of fixed assets should also be included in the gross book value of the asset to which they relate.”
The Committee is of the view that since the intended use of the allotted land is to construct the office building, the incidental expenditure incurred on land till the completion of building would form part of the total cost of the land.
2. The Committee also notes that para 5.1 of the ‘Guidance Note on Treatment of Expenditure During Construction Period’, recommends the following in connection with indirect expenditure incidental and related to construction:
“This paragraph deals with the bulk of the indirect expenditure which would be incurred by a project during its construction period. A characteristic of this type of expenditure is that, for a running concern, it would be of a revenue nature. However, because the expenditure is incurred during the construction period and because, during that period, the expenditure is indirectly related to construction and is incidental thereto, it should be capitalised as part of the construction cost.”
The Committee also notes that the illustrative list of the possible items of such expenditure given after para 5.1 referred to above, includes expenditure on rent and financial expenses including interest.
3. The Committee also notes that para 4.3 of the above mentioned Guidance Note recommends that interest charges incurred during the period of construction should be added to the total capital cost of the project. The relevant part of para 4.3 is reproduced below:
“There is no doubt that interest charges incurred after the date of commencement of commercial production should be treated as revenue expenditure in the normal way. However, during the period of construction, these charges would represent indirect construction expenditure and should be added to the total capital cost of the period. (This view has already been accepted by the Institute vide paragraph No. 3.25 of the Statement on Auditing Practices). These remarks would apply with particular force in the case of loans which have been taken for the purchase of capital assets or for incurring capital expenditure.”
4. The Committee also notes that Accounting Standard 6 (AS-6) on Depreciation Accounting is applicable to land which has a limited useful life for the enterprise [Para 1 of AS-6].
5. On the basis of the above, the Committee is of the opinion that interest accruing during construction period on the instalments of land together with the ground rent payable during the construction period of the building should be capitalised. The capitalised value of the land may be written-off over the remaining commercial life of the land, i.e., the remaining period of lease.