Enquiry:

The Company has been incorporated last year to establish two power plants. These projects are fully sponsored by the Federal Government. The Company has entered into EPC agreements with two different international companies. One of them has opted for 15% advance payment. After advance, all payments will be based on work completion certificates. Every subsequent payment will be subject to 15% adjustment on account of advance payment. This EPC agreement includes erection, procurement of machinery, turbines (whole plant equipment), construction and full commissioning of the plant.

We need your technical advice as to how these advances will be presented in the balance sheet of the Company on reporting dates where these advances represent millions of dollars and will be adjusted over a period of 27 months.

We have enquired from different sources and came up with different options, for example (i) to classify these advances in CWIP; or (ii) to present these advances as long term advance in balance sheet before current assets.

Opinion:

The Committee considered your query and would like to draw your attention to the following paragraphs of IAS 16 ‘Property, Plant & Equipment’:

Para 6 defines cost as follows:

“Cost is the amount of cash or cash equivalents paid or the fair value of the other consideration given to acquire an asset at the time of its acquisition or construction …… in accordance with the specific requirements of other IFRSs, e.g. IFRS 2 Share-based Payment.”

“Elements of cost

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.”

“17 Examples of directly attributable costs are:

(a) costs of employee benefits (as defined in IAS 19 Employee Benefits) arising directly from the construction or acquisition of the item of property, plant and equipment;
(b) costs of site preparation;
(c) initial delivery and handling costs;
(d) installation and assembly costs;
(e) costs of testing whether the asset is functioning properly, after deducting the net proceeds from selling any items produced while bringing the asset to that location and condition (such as samples produced when testing equipment); and
(f) professional fees.”

As per conceptual framework “asset” is recognized in the balance sheet when it is probable that the future economic benefits will flow to the entity and it is a resource controlled by the entity. Therefore, the Committee feels that presentation of advance to contractor either as CWIP or Advance in financial statements depends upon the specific terms of the contract. CWIP would normally correspond with physical completion of work in progress, whereas mobilization advance represents a payment to contractor to facilitate CWIP as per contractual terms. Risk and reward of ownership of “asset under construction” must be looked into with reference to terms of contract in order to determine the presentation. If risk and reward of ownership passes to Company with partial delivery then advance must be reclassified to CWIP accordingly.

4th and 5th Schedule of the Companies Ordinance 1984 requires CWIP (including significant item wise detail) to be presented as item of Property, Plant & Equipment (PPE). While para 74(b) of IAS 16 also requires disclosure of amount of expenditure recognized in the carrying amount of an item of PPE in the course of its construction.

In the light of above, the Committee is of the view that advances are required to be classified as long term Advance and they will be transferred to CWIP when the transfer of risk and reward in the under construction assets takes place and an identifiable asset is created. Such advance would remain as non-current till it is transferred to CWIP, as in the normal circumstances, it is not expected to realize into working capital of the company.

(July 04, 2016)