Ind AS Treatment of PSU Quarters on Railway Land

1. Question

A public sector undertaking (PSU), incorporated under the Companies Act, 1956, jointly owned by the Ministry of Railways (MoR) and the Government of Maharashtra, has been set up as a project implementing agency for execution of suburban railway infrastructure projects under the Mumbai Urban Transport Project (MUTP). The Company operates without profit motive and is registered under section 12A of the Income-tax Act, 1961.

In the course of its operations, the Company has constructed residential quarters on land owned by Indian Railways in accordance with Railway Board guidelines, which permit PSUs to construct houses on railway land at their own cost. The total construction cost incurred by the Company for 78 residential units (72 in Mumbai and 6 in Pune) amounts to Rs. 5,547 lakhs.

As per the arrangement with Railways, 50% of the constructed quarters (i.e., 39 units) are licensed to the Company for a period of 30 years at a nominal lease rent of Rs. 1,000 per annum per unit, while the remaining 50% are retained by Railways. The ownership of both land and structures continues to vest with Indian Railways at all times, and upon expiry of the lease term, the Company is required to hand over the quarters without any compensation.

The Company has the right to use the licensed quarters for residential and official purposes, primarily for its employees and railway officers on deputation. The allotment and usage of these quarters are governed by Railway rules, and the Company is responsible for maintenance during the lease period. Further, although Railways retain a right to substitute or interchange quarters, such substitution is limited and does not affect the Company’s entitlement to use 39 units at any given time.

The construction of these quarters has been executed partly through direct funding to Railways (in certain cases) and partly by the Company through contractors, thereby involving both funding arrangements and provision of construction services.

The Company has capitalised the entire construction cost as “Tangible Assets under leasehold premises” under Property, Plant and Equipment (PPE) and is amortising it over the 30-year lease period, as the expenditure results in future economic benefits in the form of leasehold rights.

However, during audit, it has been contended that since ownership of the assets rests with Railways and the Company merely has a limited right to use the premises, such assets should not be recognised as PPE, and the expenditure should be treated differently in accordance with applicable accounting standards.

In this context, an issue has arisen regarding the appropriate accounting treatment of the construction costs incurred on such residential quarters under Indian Accounting Standards (Ind AS), specifically whether such costs should be capitalised as PPE and amortised over the lease term, or accounted for as right-of-use assets under lease accounting principles or in any other manner. Additionally, it is necessary to determine the correct presentation of such transactions in the financial statements.

2. Relevant Provisions

Ind AS 116, Leases

Para 9 – At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Paragraphs B9–B31 set out guidance on the assessment of whether a contract is, or contains, a lease.

Para 22 – At the commencement date, a lessee shall recognise a right-of- use asset and a lease liability.

Para 23 – At the commencement date, a lessee shall measure the right-of-use asset at cost.

Para 26 – At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.

Ind AS 115, Revenue from Contracts with Customers

Para 31 – An entity shall recognise revenue when (or as) the entity satisfies a performance obligation by transferring a promised good or service (i.e., an asset) to a customer. An asset is transferred when (or as) the customer obtains control of that asset.

Para 46 – When (or as) a performance obligation is satisfied, an entity shall recognise as revenue the amount of the transaction price (which excludes estimates of variable consideration that are constrained in accordance with paragraphs 56–58) that is allocated to that performance obligation. Determining the transaction price.

Para 47 – An entity shall consider the terms of the contract and its customary business practices to determine the transaction price. The transaction price is the amount of consideration to which an entity expects to be entitled in exchange for transferring promised goods or services to a customer, excluding amounts collected on behalf of third parties (for example, some 14 sales taxes). The consideration promised in a contract with a customer may include fixed amounts, variable amounts, or both.