Capitalisation of certain expenses

This query is : Resolved

Querist : Anonymous

Querist : Anonymous (Querist)

02 July 2014 CWIP for opening automobile workshop

M/s PQR (hereinafter referred as “Licensor) is a tenant of and as such in exclusive use, enjoy possession of the premises being land admeasuring 6000 sq. yds, or thereabouts lying or being at Address , Mumbai together with certain buildings and structures thereon hereinafter called the "said premises").
The Company is entitled to use and occupy the said Premises (excluding an area of 6,000 sq. ft. appropriately occupied by Licensor and other Licensee) as Licensee under Licensor's Leave and License for a term of five years commencing from 25 March 2013.The license fee is to be paid Rs.750, 000 per month in the first three years of license period for the use of said licensed premises. The license fee for the remaining 2 years is increased to Rs.862, 500 per month. The first two months are fee free period of license.
Further, the Company is liable to pay Rs.1,900,000 per month during the first three years (except for fee free period of the license) for the use of equipment’s as mentioned in annexure A. The fee for the remaining two years is increased to Rs.2,185,000 per month.
The Company has started construction on said licensed premises in the year 2013-14 for setting up the new automobile workshop. The workshop was not ready for its intended use during the year and hence, the expenditure incurred in setting up the workshop are carried as CWIP as at 31 March 2014.
Total expenditure of CWIP includes Rs.51,792,435 (details mentioned below). Can Company carry the expenses in CWIP mentioned below? Kindly support your opinion with relevant accounting standard and GAAP.

The details of administration and general overheads included in CWIP as at 31 March, 2014.
Particulars Amount Remarks
Rent 26,900,000 Monthly (rent expenses paid for the use of premises and equipment's)

Electricity 525,305 (Electricity expenses incurred during the construction period)
Employee Cost 18,795,364 (The employee cost relates to the employees who has hired to work in the workshop after the same will be ready to its intended use).
Contract Labour 1,849,283 (Contract labour expenses are paid to the contractor whose labour should work after the workshop will be ready to its intended use.)
Interest 3,722,483 (Borrowing cost as per AS 16)

Total 51,792,435

Querist : Anonymous

Querist : Anonymous (Querist)

22 July 2014 No one has answered yet. awaiting reply

Asha Kanta Sharma

Asha Kanta Sharma

(Expert)
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18 July 2024 Based on the details provided regarding the capital work-in-progress (CWIP) for setting up an automobile workshop on leased premises, let's analyze whether the expenses incurred can be capitalized as per relevant accounting standards and generally accepted accounting principles (GAAP):

### 1. Rent
- **Treatment**: Rent paid during the construction period can generally not be capitalized as part of CWIP. Rent is typically considered as an administrative expense rather than directly attributable to the construction of the workshop.
- **Reference**: According to Accounting Standard (AS) 10 - "Accounting for Fixed Assets", rent incurred during the construction period is expensed as incurred and cannot be capitalized.

### 2. Electricity
- **Treatment**: Electricity expenses incurred during the construction period are usually considered as indirect costs and are not directly attributable to the construction of the workshop. Therefore, they are expensed as incurred.
- **Reference**: AS 10 does not permit capitalization of general overheads and administrative expenses, which include utilities like electricity.

### 3. Employee Cost
- **Treatment**: Employee costs related to personnel hired to work in the workshop after it is completed and ready for use cannot be capitalized as part of CWIP. These costs are considered as operating expenses incurred to generate future economic benefits after the asset is operational.
- **Reference**: AS 10 and GAAP require that only direct costs directly attributable to the construction or acquisition of an asset can be capitalized.

### 4. Contract Labour
- **Treatment**: Similar to employee costs, contract labour expenses incurred for work after the workshop is operational cannot be capitalized as part of CWIP. These are operating expenses and not directly attributable to the construction phase.
- **Reference**: AS 10 and GAAP guidelines do not allow for capitalization of indirect expenses such as contract labour during the construction period.

### 5. Interest
- **Treatment**: Borrowing costs (interest) incurred during the construction period can be capitalized under AS 16 - "Borrowing Costs", provided that specific criteria are met. These criteria include that the borrowing is directly attributable to the construction of the qualifying asset.
- **Reference**: AS 16 allows for capitalization of borrowing costs that are directly attributable to the acquisition, construction, or production of a qualifying asset.

### Conclusion
Based on the principles outlined in AS 10 and AS 16:

- **Rent**, **Electricity**, **Employee Costs**, and **Contract Labour** are typically not eligible for capitalization as they are considered as administrative expenses or indirect costs not directly related to the construction of the asset.
- **Interest** (Borrowing Costs) can be capitalized if it meets the criteria specified in AS 16.

Therefore, in the case of setting up the automobile workshop, while interest on borrowing can be capitalized, other expenses such as rent, electricity, employee costs, and contract labour should be expensed as incurred. This approach ensures compliance with accounting standards and GAAP, accurately reflecting the financial position and performance of the company.

For specific details and to ensure compliance with all applicable accounting standards and tax regulations, it is recommended to consult with a qualified accountant or financial advisor. They can provide tailored advice based on the specific circumstances and requirements of your company.

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