A fire broke out in the factory premises of Manufacture Limited (the company), destroying 40% of its major plant. At the date of fire, the carrying amount of the plant (including destroyed portion) was 2160 million. The company needs to incur an amount of 2100 million to restore the destroyed portion. At the reporting date, the restoration work is in progress. The management believes that the company has not followed the component accounting under Indian GAAP and it will therefore apply the subsequent expenditure-related guidance. The application of this guidance will require the company to write off any subsequent expenditure incurred on the asset. Therefore, there is no need to write off the damaged portion of the plant.
The company has filed an insurance claim of Z90 million toward the damage. The management believes that considering the potential recovery, it need not write off the expenses incurred on the restoration work to the extent they are covered under the claim. Do you agree with the management views?
As stated by the management, AS 10 Accounting for Fixed Assets does not provide any specific guidance on expenses incurred in the extant scenario. Therefore, the treatment suggested by the management for restoration expenses may be one possible view. However, in our view, this may not be the most appropriate treatment in the given scenario.
The damage caused by the fire has resulted in an impairment/ partial loss of the plant, which should be recognized in the profit or loss. After the fire, the plant may be in a non-working condition or its output will reduce significantly. The restoration expenses are incurred to bring the plant back to its normal working condition. This effectively increases the benefit of the plant from its previously assessed standard of performance, i.e., the post-fire scenario. As such, the company should capitalize 2100 million incurred to restore the destroyed portion of the plant.
We believe that the recovery of the insurance claim is a separate economic event, from the damage caused by the fire and restoration expense. The company cannot treat these events together. It should treat three events as below:
(a) Write-off the portion destroyed by the fire when this loss takes place
(b) Capitalize the cost of restoring damage caused by the fire in accordance with the generic requirements of the standard
(c) Include the insurance claim in the profit or loss when it becomes receivable