Accounting and Tax Treatment of Diesel in Construction Industry

Author’s note:

Recently I went for a Physical verification for a Real estate client, while reviewing the inventory I found that diesel was lying in the stock and was classified in “Inventory” but a thought came to my mind that Diesel should be classified as expense as “Power and fuel” hence it made me research on the topic to understand the things. Hope you will find this article useful. Happy Reading:)

Introduction

As we know that in Real estate industry where the construction takes place, diesel plays an important role relating to the operations and also it is used extensively for running heavy machinery, generators, as well as other equipment’s on sight. Unlike trading entities dealing in petroleum products, construction companies consume diesel as an operational input rather than holding it for resale, being aware of this still how diesel can be classified in current assets (Inventory)?

This was material aspect because it can impact the accounting classification, valuation, cost allocation, and tax treatment, especially in India where the GST act specifically exclude diesel from GST preview and VAT is charged increasing it’s overall cost.

Nature of Diesel in Real estate/construction business

In a Real estate or construction business like say STS ltd which is a listed entity, diesel is used for the power generation through DG sets, running heavy equipment’s like cranes, excavators, loaders, operating batching plants and site machinery and fuel for internal transport vehicles. Hence, diesel is neither a finished good, nor a stock-in-trade. Instead, it qualifies as a consumable item used in the execution of construction contracts.

Note: I am using STS Limited to hide the actual client’s name.

Accounting treatment

In accounting aspect, the diesel is classified as stores and consumables which is the part of current assets. Hence, it does not qualify as Property, plant & equipment, or inventory held for sale. So, diesel may be included within inventory only in the nature of stores and consumables, as it is held for consumption in operations. However, it is not inventory held for sale in the ordinary course of business.

Recognition and measurement in books in different stages

At the time of purchase

Diesel / fuel (consumables) A/C    Dr
To Bank / supplier A/C

At the time of consumption

Work-in-Progress (WIP) / project cost A/c    Dr
To Diesel / fuel A/c

Note: If it is directly related to project then it will be added to project cost else it will be classified as WIP

Let’s discuss the respective stage along with treatment with the help of table:

Ultimately both expenses and cost of construction give an impact on P&L but I am trying to discuss regarding accounting treatment, you may mail me in case you differ the opinion or your point of view on this item.

Valuation of diesel inventory

As per IND AS 2 inventories should be valued at cost or net realisable value, whichever is lower and in the case of diesel NRV is generally not relevant (as it is not held for selling the same). Therefore, valuation is primarily at cost.

Hence the cost includes purchase price, transportation and handling charges which is generally measured at FIFO or Weighted Average but business should maintain consistency in these methods in its accounting.

GST treatment of diesel

In India till it is notified further, theCentral Goods and Services Tax Act, 2017 had kept the diesel outside the preview of GST and instead of this, it is subject to VAT and excise duties.

Hence in practical world, no GST is charged on diesel purchases, hence Input Tax Credit (ITC) is not available and the entire diesel cost becomes part of Project cost and Work-in-progress as the case may be. This creates a cost escalation impact for construction entities, unlike other inputs where ITC is available.

Costing and allocation in construction projects

Diesel cost must be appropriately classified and allocated:

First component is in direct cost

Where diesel consumption is directly attributable like in case a specific machinery used for a project, or in the case of project-specific generators then the cost is directly charged to that project

Other component is indirect cost

Where diesel is used commonly for the site office generators and shared equipment’s used in the construction of same or different projects then it would be allocated on a rational basis such as machine hours, area developed or project value proportion as the case may be.

Internal controls and risk areas: Audit point of view

Talking with an angle of an audit or a forensic perspective as the case may be, diesel is highly sensitive due to high pilferage risk, the cash-based procurement in some cases, and due-to the lack of proper monitoring systems.

Hence being an auditor of STS Ltd, I expected the key controls like the maintenance of daily diesel consumption register, machine-wise usage tracking, reconciliation of diesel by using a standard formula i.e. opening stock + purchases – consumption = closing stock, but in my case, it was not equal to closing stock dueto issues like evaporation i.e. abnormal loss, hence this needs to be kept in a consideration while auditing this item. Also, we as auditor’s need to check its correlation with machine hours and generator logs.

Audit considerations

Now talking about the whole real estate or construction entities, we must give a special focus to the areas such as physical verification of diesel stock, reasonableness of consumption patterns, comparison with prior periods or industry benchmarks, identification of abnormal variances and verification of supporting documents such as invoices and logbooks.

Practical problems

Practical Issues which a company may face, based on my personal experience after conducting an audit of such a huge listed entity are like some recurring issues include absence of quantitative tracking, excessive consumption without justification, misclassification as general expenses instead of WIP, non-allocation across projects leading to distorted profitability.

Conclusion

Diesel in the construction industry (other than trading) is a consumable inventory item initially recognised as a current asset, and is ultimately absorbed into project cost or WIP, also it falls outside GST, resulting in no ITC availability that requires robust internal controls due to high leakage risk. So talking from a professional standpoint, proper accounting and control over diesel consumption is essential not only for true and fair financial reporting but also for cost optimisation and fraud prevention.

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Author can be contacted at aman.rajput@mail.ca.in