Treatment of Advance paid for Acquring the Fixed Assets
CA.Altaf Husain
When advance is paid for acquiring a capital item, such an advance cannot form part of ‘current assets, loans and advances’. Substantial advances are often paid for supply of plant and machinery. Construction of the asset, to the specifications of the entity, is commenced after the advance is received by the supplier. Supply of such machinery may take more than one accounting year. Some machinery, such as turbines, take a couple of years to be manufactured and supplied. A question that arises is: How to deal with such advances for capital goods and where to disclose them in the balance-sheet o f a company? WHAT IS AN ADVANCE? By general interpretation, an advance is a payment made towards part of the expenditure on a running basis and on an estimate. Travel advance, staff advances, festival advance, rental advance, are some common examples. In the case of a lending institution such as a bank, any finance given to a customer of the bank (constituents) would be a housing loan. But any such facility provided to their employees is classified as “House Building Advance” (HBA). The difference is that in the case of a constituent, there is a repayment into the account whereas in the case of an employee, there is no payment into the account but recovered from the salary of the employee. Only the amount remaining after deduction of such advance is paid to him by way of a salary. Such HBA is included in total advances of the institution. This is because of the fact that it is recoverable over a period of time. An advance is not returnable and is often adjusted against the expenditure against which such advance is paid. Generally, advances of a business entity are for meeting revenue expenses, such as on travel, purchase of goods, etc. Hence, it is proper to disclose such advances under the broad head of ‘current assets, loans and advances’. Format of the balance-sheet of a company carries a broad head ‘Current assets, loans and advances’. Thus, advances should form part of current assets in the normal course. It can be argued that an advance is an advance and should be carried under the head ‘Current assets, loans and advances’. Advance for capital goods stands on a totally different footing. The expenditure is specifically laid out for acquiring capital equipment as opposed to the normal advances for purchases. Thus, the transaction is more capital than revenue in nature. The concept of “Substance over form” should be applied. AS 1 requires the entity to consider the substance of the transaction over its form for laying down accounting principles and for accounting treatment. Since the advance is paid for acquiring a capital item, such an advance is capital in nature and consequently cannot form part of ‘Current assets, loans and advances’. It should rather be shown as a part of fixed assets. A separate head, ‘Advances for capital goods’, may be created and disclosed after capital work-in-progress. CAPITAL GOODS Advance for capital goods is paid to supplier of capital equipments. Capital work-in-progress denotes works undertaken by the entity itself. Mostly it relates to civil construction, erection of equipments, laying of pipelines, etc. Capital work-in-progress commences once the equipment is supplied. As 10 on accounting for fixed assets permits such accounting only if an identifiable asset is created. Merely paying an advance does not create an identifiable asset. The amount should continue to be disclosed as advances for capital goods till such time the asset is delivered. Once the equipment is supplied, the vendor is relieved of the supply contract, unless it is a composite contract of supply and erection. If it is only a supply, the advance to capital good is either transferred to the asset account or to capital work-in-progress account, depending on whether the equipment is in a usable condition or it is further to be assembled, erected, tested and commissioned. Entry in the fixed register should be made only upon the asset being complete in all aspects. Advance for capital goods and capital work-in-progress are not entered in the fixed assets register. ACCOUNTING BY VENDOR Notwithstanding the fact that the purchaser treats the advance or capital goods as a part of fixed assets, the vendor should invariably treat it as advance for goods (or advances from customers) and disclose the same under current liabilities. If the advance is for the supply of multiple numbers of the same asset, and first lot of ‘n’ numbers is delivered, the vendor should recognise proportionate amount of the advance for goods as his sales as required by the AS 9 on revenue recognition. DEPRECIATION Creation of the asset and “putting the asset to use” is the criterion for charging depreciation on an asset. Payment for the asset is of no consequence. Irrespective of the quantum and percentage of the advance paid, the entity cannot claim depreciation on such advances since there is no asset created. But in case the advance is paid for delivery of multiple numbers of the same machinery, say, six machines, and if the delivery of one machine is made, this one machine can be charged to depreciation, provided it has been put to use. There is no need to wait for the delivery of all the six units to commence charging depreciation. With Regards,
CA.Altaf Husain
9871838732 |
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