1.72     Query

Valuation of Closing Stock—3.

The query relates to the mode of comparing cost with market value (net realisable value) of items of stocks for the purpose of valuation in the context of the valuation basis “Cost or net realisable value whichever is lower”.  The company in reference before 1978-79 was engaged in the manufacture of synthetic yarn processing machinery.  In 1978-79 it diversified its activities and started two new divisions for texturising of synthetic yarn and manufacture of finished leather.

The company has been valuing inventories at “Cost or market value whichever is lower” basis.  In the year 1978-79 with the addition of two more divisions, the company followed what the querist terms as ‘global method’ of valuation of the stocks separately for the three divisions.  According to this method the stocks for each of the divisions are separately considered, classified as to raw materials, stocks-in-process and finished goods, their aggregate costs are compared with their aggregate market values and the lower ones taken.

 In 1980-81, in one division the market value of raw materials has been found to be lesser than the cost.  It has been seen that, if instead of making the cost and market value comparison on the basis of division of activities, as explained above, the comparison is one on a company-wide basis, the aggregate cost of raw-materials will be lower than the corresponding market value.

Kindly advise whether it would be proper to group all the items of stocks of the company on the basis of raw materials, stocks-in-process and finished goods disregarding the fact of divisional activity and proceed on with the comparison, keeping in view the fact that under Schedule VI of the Companies Act, there is no requirement to value stocks on the basis of separate undertaking or activity.

                                                            Opinion                                                                                                                         June 19, 1981

The Committee agrees with the view of the querist that under Schedule VI to the Companies Act, there is no requirement of classifying stocks on the basis of separate undertaking or division Nevertheless the Committee does not approve the mode of comparison on an aggregated basis of the cost with the market value whether on a company-wide basis or division-basis.  In the opinion of the Committee, comparison of the historical cost and the net realisable value can be made separately in respect of each item of inventory, or for groups of similar (or interchangeable) items.  However, to compare the aggregate of the net realisable value of all dissimilar and non-interchangeable items in a class of business, or all the inventories of an enterprise on an overall basis with the aggregate of the cost of all those items would not be prudent because it amounts to setting off loss against unrealised profit.

The Committee is further of the view that changeover from the division-wise determination of the lower of cost and net realisable value to the company-wide basis and also the determination of the lower of cost and net realisable value on the basis recommended in the previous paragraph would amount to a change in the method of accounting and accordingly, the provisions of paragraph 3(XV) of Part II of Schedule VI of the Companies Act, 1956, would be attracted.

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