Accounting Treatment for Acquisition and Borrowing Costs of Exploratory Wells

A company has acquired the assets of a project and accounted for the value of assets and liabilities of the project on the date of transfer and the difference between the purchase consideration and net book value of assets was accounted for as ‘Intangible Assets under Development’. Further, the company has capitalised directly associated borrowing costs to the qualifying assets of this project.

But confusion arises when the auditor raised an issue of separate treatment of acquisition cost in financial statements and for taxation purposes. The auditors questioned why the company is treating acquisition cost as ‘Intangible Assets under Development’ in the financial statements while claiming depreciation on acquisition cost under income tax. Moreover, no further addition was being made to the acquisition cost and the company treated it as an asset already put to use for income tax purposes, therefore, borrowing cost should be charged off to the Statement of Profit and Loss instead of capitalising.

The Expert Advisory Committee (EAC) of ICAI has noted that as per para 22 of the Guidance Note, till the exploratory well is ready to commence production, acquisition cost of intangible assets is to be classified as intangible asset under development, the treatment made by the Company to account for and classify the mineral rights as ‘intangible asset under development’ appears to be appropriate. Further, Committee feels that the company is engaged into E&P business, and the intended use of acquisition of mineral rights appears to be extraction and production of minerals i.e. after the completion of development activities. Therefore, the Committee is of the view that the mineral rights would not be ready for their intended use of extraction and production of minerals until substantially all the development activities on Project are complete.

Accordingly, capitalisation and classification of the acquisition cost of mineral rights as ‘intangible asset under development’ by company is appropriate and treatment of the said acquisition cost as a qualifying asset and capitalising interest on borrowings made for the acquisition of such asset in its financial statements is appropriate.

Click Here To Read The Full Story