1.69 Query
Valuation of Finished Stock—when selling price is in excess of cost.
An engineering company values its finished stocks at selling price, which is also the contract price. This figure is in excess of its cost. This method of valuation is being adopted by the company since its inception in 1957.
In our Audit Report to the company, we have commented under para 3 of the manufacturing and Other Companies (Auditor’s Report) Order, 1975, that the valuation of stocks, with the exception of finished goods, is in accordance with the normally accepted accounting principles.
In our view, the normal basis of valuation should be cost or market value/realisable value, whichever is lower, except in the case of certain industries e.g. Plantations, Mining etc. where inventories may be valued at market value or at prices subsequently realised. This basis of valuation finds support from the following:
(1) The Institute of Chartered Accountants of India, in its “Statement on Auditing Practices”—1968 edition on page 27, para 4.12 had included market value as one of the basis on which inventories could be valued. However, in its 1977 revised edition onpage 32, para 5.12 it is stated that the normal basis is cost or net realisable value whichever is lower,thereby deleting the market value as one of the normal bases of valuation.
(2) In paras 9 and 10 of the Institute’s publication—207—Statement on Valuation of Stocks for the purposes of Financial Accountants, in cases where Cost Accounting Records Rules have been prescribed under the Companies Act, it is mentioned that (a) the Financial Accounts are prepared on the generally accepted principle of conservatism. (b) The normal basis for valuing stocks of goods produced should be the lower of cost and net realisable value.
(3) The International Accounting Standard (I.A.S.) has also recommended that inventories should be value “at lower of the historical cost and net realisable value”.
(4) Any reference to benefits expected from contracts to the extent not executed shall not be made in the balance sheet but shall be made in the Board’s report as mentioned in Notes (g) of Schedule VI Part I of the Companies Act.
However, our client does not agree with our view-point and puts forth the following objections:
(1) On page 32 para 5.12 of the 1977 revised edition of the Statement on Auditing Practices, the Institute has also recognised the method of valuing inventories at market value in appropriate circumstances having regard to the industry.
(2) The Institute’s publication 207—‘Statement on valuation of Stocks’ for the purposes of Financial Accounts in cases where Cost Accounting Records Rules have been prescribed under the Companies Act is not as such applicable to this company, as the maintenance of cost records has not yet been prescribed for its products.
(3) The adoption of the I.A.S. in India, having been postponed, is not presently applicable.
Further, as per the Institute’s guidance on the subject of the Statement on the Manufacturing and Other Companies (Auditor’s Report) Order 1975—vide page 12—the I.A.S. has application only when inventories are valued at historical cost and will not have application where other methods (e.g. market value) are adopted.
Thus it is clear that the market value is a recognised method of valuation.
(4) The company has been valuing the finished stocks consistently at market value.
(5) The Supreme Court of India has observed in the case of “Investment Ltd. Vs. C.I.T. Calcutta” reported in (1970) 77 ITR 533, on page 537 as under: -
“A tax payer is free to employ, for the purpose of his trade, his own method of keeping accounts and for that purpose to value his stock-in-trade either at cost or market price”.
In the light of the foregoing, we give below our views about the objections raised by the Company: -
(1) The exception made to certain industries will not apply to this company, since this is an engineering company, where cost of its finished goods can well be ascertained. Moreover, this method of valuation is not adopted by all other Companies in the same industry. For instance a large company in the same industry of over 40 years standing, values its stock at cost or lower market value.
(2) Although the statement refers only to the products manufactured for which Cost Records Rules apply, in our view, this principle is applicable to all the products manufactured irrespective of the fact whether or not the Cost Records Rules apply. Especially the accounting principles do not suddenly change, when the rules become applicable to the company’s products also at a future date.
(3) Accounting principles are universal and the International Accounting Standards evolved in the recent years are an attempt to formalise and refine these principles, rather than change the basic principles of accounting. Thus the deferment of applicability of the I.A.S. to our country would not tantamount to exemption from compliance with accepted accounting principles.
The Institute’s recommendation with regard to application of I.A.S. on inventory valuation “only when inventories are valued at historical cost and will not apply where other methods are adopted”, should also, in our opinion, be considered as applicable to limited industries/business (e.g.) Mining, Plantation etc.
(4) Although consistency has been generally accepted as one of the fundamental accounting assumptions, in our opinion, it should also be consistent with the basic principles of accounting.
(5) The Supreme Court observation refers to an Income-tax case. We have no comments to offer as it does not directly deal with the subject matter on hand.
Opinion April 30, 1981
The Committee is of the opinion that the issue should be resolved on the basis of the “normally accepted accounting principle” applicable in the case. The normally accepted basis in this regard has been spelt out by the Institute of Chartered Accountants of India, in paragraph 5.12 of the Statement on Auditing Practices (1977 edition) as “Cost or net realisable value, whichever is lower” and this pronouncement presents a deliberate and conscious departure from the pronouncement earlier contained in the same publication on the same subject, which recognised “Market value” as a normal basis.
The Committee did not find any merit in the argument of the company that it can value finished goods inventory at selling price on the basis of the exception provided in the last sentence of paragraph 5.12 of the 1977 edition of the Statement on Auditing Practices. According to the Committee, on the basis of information available from the query, there is not special circumstance attached to the company to justify a departure from the normally accepted basis. The cost of the finished goods under consideration can be determined in the normal way without undue difficulty or uncertainty and the special features associated with plantation industry are not present.
The Committee also felt that the pronouncements on general principles of accountancy contained in the special purpose booklet “Statement on valuation of stocks for purposes of financial accounting in cases where Cost Accounting (Records) Rules, have been prescribed’, issued by the Institute, cannot be ignored as they reflect the generally accepted principles, even though a particular company may not fall directly within the purview of the booklet.
Since International Accounting Standards do not apply in our country, the Committee feels that any discussion based on the International Standard would not help the Committee in arriving at its view; similarly any judgement in a Court of Law based on consideration of the taxation statutes is considered not to be directly relevant when the Committee is to decide the issue on the consideration of accounting principles.
On the basis of the foregoing, and having regard to the principle of conservatism in accountancy the Committee is of the opinion that the inventory of finished goods under reference should be valued at “Cost or net realisable value, whichever is lower” basis notwithstanding the consistency of the method being presently followed by the company. _________________________ |