Pre-operative Expenses
Pre-operative Expenses
Pre-operative Expenses:
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Meaning of fixed assets
Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business.0
Cost to be included in fixed assets
The cost of an item of fixed asset includes any directly attributable cost of bringing the asset to its working condition for its intended use. Examples of directly attributable costs are:
- site preparation;
- initial delivery and handling costs;
- installation cost, such as special foundations for plant; and
- professional fees, for example fees of architects and engineers.
Meaning of Pre-operative Expenses
Administration and other general overhead expenses are usually excluded from the cost of fixed assets because they do not relate to a specific fixed asset.
However, in some circumstances, such expenses as are specifically attributable to construction of a project or to the acquisition of a fixed asset or bringing it to its working condition, may be included as part of the cost of the construction project or as a part of the cost of the fixed asset.
These Administration and other general overhead expenses identified for capitalisation is called as pre-operative expenses.
Accounting Treatment of Pre-operative Expenses
The Pre-operative Expenses incurred on start-up and commissioning of the project, including the expenditure incurred on test runs and experimental production, is usually capitalised as an indirect element of the construction cost.
However, the Pre-operative Expenses incurred after the plant has begun commercial production, i.e., production intended for sale or captive consumption, is not capitalised and is treated as revenue expenditure even though the contract may stipulate that the plant will not be finally taken over until after the satisfactory completion.
If the interval between the date a project is ready to commence commercial production and the date at which commercial production actually begins is prolonged, all expenses incurred during this period are charged to the profit and loss statement.
However, the expenditure incurred during this period is also sometimes treated as deferred revenue expenditure to be amortised over a period not exceeding 3 to 5 years after the commencement.
Various Pre-operative Expenses of a revenue nature which are incurred during the construction period are either capitalised as part of the indirect cost of construction, or are carried forward as deferred revenue expenditure, as may be appropriate.
However, from the moment the plant is completed and commissioned and is ready for commercial production, all expenditures of revenue nature must be charged to the profit and loss account. It is for this reason that it is so important to determine the “cut-off date” based on the date when the plant is ready for commercial production, with a great degree of precision.”
The cut-off date is determined on the basis that the testing of the operation of the plant and trail-runs are completed and it is satisfied that the plant is set-up and is ready to commence commercial production. The satisfactory operation of the plant is to be ensured while determining the cut-off date. If there had been any doubt that there would be problems in the commercial operations of the plant, the cut-off date should be extended.
Once the cut-off date is correctly determined, the expenditure of revenue nature incurred after the cut-off date should be charged to the relevant profit and loss account.
Expenses incurred after the cut-off date for commencement of commercial production cannot be capitalised since such expenditure does not add to the value or utility of the fixed assets; it is incurred merely to ensure that the plant is running smoothly after commencement of commercial production.
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