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Impact of MCA circular on AS 10 on Indian Power Industry

The Power Sector in India and Impact of Ministry of Corporate Affairs Circular (MCA) on Accounting Standard 10- Accounting for fixed assets and 16- Borrowing costs

The Power Sector in India has been for some time facing uncertainties with respect to availability of gas supply for gas based plants in India. The Central Government was not able to allocate gas to the power sector due to shortage and first ranking of the priority sector such fertilizers. Because of non-availability of gas, various projects including of Lanco and GMR are lying idle after declaration of commercial operations. The construction activities in other gas based projects have been deliberately slowed down as there is no gas to generated electricity.

Since certain gas based plants in India were declared to be ready for commercial operations and were awaiting gas availability from the central government , the Companies had no option but to charge off the borrowing costs and other expenses incurred after the declaration of commencement of operations as per AS 10 and 16. Considering that this would impact there profitability, the Companies in the Power Sector approached the ministry of corporate affairs for relaxation of provisions of Accounting Standard 10 and 16 dealing with Accounting for fixed assets and borrowing costs. The recommendation was that since the events are beyond the control of the power companies, MCA should allow dispensation and permit them to capitalize the costs even if incurred after commencement of operation. Majority of the Companies capitalized the costs. The Independent auditors of these companies either qualified their opinion or issued in may cases an emphasis of matter to escape their reporting responsibility

Another issue facing the Power Industry was how to capitalize the power projects. Generally a power project is made of various plants/units (eg. 6 units of 660 MW each for an Ultra mega power project of 4000 MW total project capacity)  which can operate and generate electricity independently of the other units. Based on the guidance provided by various expert advisory committee opinions of ICAI and guidance available in Accounting Standard 16 on borrowings costs, a part which can function independent of the other parts of the whole asset should capitalized when that part is ready for use. Thus the point was whether for the the purpose of capitalization,  unit of measurement and completion is the inpidual unit/plant or the entire entire project.

The Power Sector made representations to MCA/ICAI to allow capitalization of entire project. This would mean that fully operational unit under the project would not be capitalized till the entire project is completed. Various companies represented to MCA/ICAI and followed innovative accounting to advantage as there was no clear guidance in AS 10. One example based on review of the annual reports is represented below:

Based on review of the annual report of  Reliance Power Limited, I understand the Company took the view that entire Sasan project is the unit of measurement for capitalization and did not capitalize the inpidual unit(s) despite that being fully operational. It is highly surprising that the Auditors accepted such innovative accounting and issued a clean opinion.

The MCA has finally put at rest to these innovative accounting by issuing a clarification on August 27, 2014 which is reproduced below in italics:

MCA has received number of representations seeking clarifications on capitalization of borrowing costs incurred during extended delay in commercial production for reasons beyond the developer's control and if the capitalization of power plant should be unit-wise or project-wise, in cases of Competitive Bid power projects. 

MCA in consultation with the Accounting Standards Board of ICAI has clarified that AS-10 and AS-16 prescribe the principles of capitalization of various costs based on the underlying concept that only such expenditure should be capitalized as form a part of the cost of fixed assets which increase the worth of the assets.

a. Cost incurred during the extended delay in commencement of commercial production after the plant is otherwise ready does not increase the worth of fixed assets. Such costs cannot, therefore, be capitalized.

b. In case one of the units of the project is ready for commercial production and is capable of being used while construction continues for the other units, costs should be capitalized in relation to that part once the part is ready for commercial production.

c. It is further clarified that AS 10 and AS 16 are applicable irrespective of whether the power projects are ‘Cost Plus projects’ or ‘Competitive Bid projects’

Refer link for the clarification: 

http://www.mca.gov.in/Ministry/pdf/circular_35_27082014.pdf

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