Ind AS Treatment of Partially Completed Pipeline

1. Query

A company, say X Ltd. (hereinafter referred to as “the company”), has been incorporated to develop and operate a natural gas pipeline grid in the North-Eastern region of India. The pipeline project is planned to be executed in phases and includes several sections of pipeline along with associated infrastructure such as dispatch terminals, intermediate pumping stations, sectional valve stations, telecom systems, and monitoring facilities.

One of the major sections under Phase I of the project is a pipeline stretch of approximately 392 km connecting a dispatch terminal at G to a refinery at N, which has been identified as the anchor customer for the project. The pipeline network is intended to transport natural gas from the existing national pipeline network to the refinery for its operational requirements.

During the construction phase, the project was divided into multiple parts for ease of execution. As of the reporting date, approximately 195.898 km of the pipeline has been mechanically completed, and the relevant infrastructure facilities for this section, such as sectional valves, control systems, and monitoring equipment have also been installed. The necessary inspection by the relevant safety authority has been completed and a mechanical completion certificate has been issued for this portion.

However, the remaining portion of the pipeline is still under construction, and the entire 392 km pipeline stretch is expected to be completed and commissioned next year. According to the project plan and feasibility report, commercial operations of the pipeline will commence only when the full pipeline stretch is completed, as the pipeline is designed to deliver gas to the refinery only after the entire system becomes operational. The partially completed portion of the pipeline cannot independently transport gas to the refinery and therefore cannot operate on a standalone basis.

The costs incurred for the project, including material costs, construction costs, infrastructure costs, and borrowing costs, are currently recognised as Capital Work in Progress (CWIP) in the financial statements.

In this context, X Ltd. sought opinion from the Expert Advisory Committee of ICAIas to whether the company should capitalise the cost incurred on the mechanically completed portion of the pipeline (195.898 km) as Property, Plant and Equipment (PPE), or whether such expenditure should continue to be recognised as Capital Work in Progress until the entire pipeline stretch is completed and ready for use.

2. Relevant Provisions

2.1 Ind AS 16, Property, Plant and Equipment

Para 6

Property, plant and equipment are tangible items that:

(a) are held for use in the production or supply of goods or services, for rental to others, or for administrative purposes; and

(b) are expected to be used during more than one period

Para 7

The cost of an item of property, plant and equipment shall be recognised as an asset if, and only if:

(a) it is probable that future economic benefits associated with the item will flow to the entity; and

(b) the cost of the item can be measured reliably.

Para 16

The cost of an item of property, plant and equipment comprises:

(a) its purchase price, including import duties and non-refundable purchase taxes, after deducting trade discounts and rebates.

(b) any costs directly attributable to bringing the asset to the location and condition necessary for it to be capable of operating in the manner intended by management.

(c) the initial estimate of the costs of dismantling and removing the item and restoring the site on which it is located, the obligation for which an entity incurs either when the item is acquired or as a consequence of having used the item during a particular period for purposes other than to produce inventories during that period.

Para 20

Recognition of costs in the carrying amount of an item of property, plant and equipment ceases when the item is in the location and condition necessary for it to be capable of operating in the manner intended by management. Therefore, costs incurred in using or redeploying an item are not included in the carrying amount of that item. For example, the following costs are not included in the carrying amount of an item of property, plant and equipment:

(a) costs incurred while an item capable of operating in the manner intended by management has yet to be brought into use or is operated at less than full capacity;

(b) initial operating losses, such as those incurred while demand for the item’s output builds up; and

(c) costs of relocating or reorganising part or all of an entity’s operations.

Para 22

The cost of a self-constructed asset is determined using the same principles as for an acquired asset. If an entity makes similar assets for sale in the normal course of business, the cost of the asset is usually the same as the cost of constructing an asset for sale (see Ind AS 2). Therefore, any internal profits are eliminated in arriving at such costs. Similarly, the cost of abnormal amounts of wasted material, labour, or other resources incurred in self-constructing an asset is not included in the cost of the asset. Ind AS 23, Borrowing Costs, establishes criteria for the recognition of interest as a component of the carrying amount of a self-constructed item of property, plant and equipment.

2.2 Ind AS 23, Borrowing Costs

Para 8

An entity shall capitalise borrowing costs that are directly attributable to the acquisition, construction or production of a qualifying asset as part of the cost of that asset. An entity shall recognise other borrowing costs as an expense in the period in which it incurs them.” “A qualifying asset is an asset that necessarily takes a substantial period of time to get ready for its intended use or sale.”

Para 22

An entity shall cease capitalising borrowing costs when substantially all the activities necessary to prepare the qualifying asset for its intended use or sale are complete.”

Para 24

When an entity completes the construction of a qualifying asset in parts and each part is capable of being used while construction continues on other parts, the entity shall cease capitalising borrowing costs when it completes substantially all the activities necessary to prepare that part for its intended use or sale.

3. Expert Advisory Committee Opinion

The Expert Advisory Committee (EAC) in this case opined that the accounting treatment of the above matter should be evaluated with reference to the requirements of Ind AS 16, Property, Plant and Equipment, and Ind AS 23, Borrowing Costs.

Under Ind AS 16, the cost of an item of property, plant and equipment is recognised as an asset only when it is probable that the future economic benefits associated with the item will flow to the entity and the cost can be measured reliably. The cost of an asset includes its purchase price and all directly attributable costs necessary to bring the asset to the location and condition required for it to operate in the manner intended by management.

Further, the standard clarifies that recognition of costs in the carrying amount of PPE ceases when the asset is in the location and condition necessary for it to be capable of operating as intended. Determining this point requires an assessment of the specific facts and circumstances, including technical readiness and the ability of the asset to perform its intended function.

In the present case, although a portion of the pipeline has been mechanically completed and certain related infrastructure has been installed, the pipeline is intended to transport gas from the dispatch terminal to the refinery located at the end of the full 392 km stretch. Since the partially completed portion cannot independently transport gas to the refinery and therefore cannot be operated in the manner intended by management, it cannot yet be considered ready for its intended use.

In addition, Ind AS 23 requires that borrowing costs directly attributable to the construction of a qualifying asset be capitalised until substantially all the activities necessary to prepare the asset for its intended use are complete. In integrated projects, capitalisation of borrowing costs may cease for individual components only if those components are capable of being used independently while construction continues on other parts of the project.

In the present case, the completed pipeline segment is not capable of operating independently of the remaining pipeline stretch and therefore does not meet the condition of being ready for its intended use.

Accordingly, the cost incurred on the mechanically completed portion of the pipeline should continue to be recognised as Capital Work in Progress until the entire pipeline stretch is completed and brought to the condition necessary for operation as intended. Borrowing costs directly attributable to the project should also continue to be capitalised during this period.

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