1.1 Query
Application of Clause 4C of Part II of Schedule VI to the Companies Act, 1956, to a company where goods are produced by third parties from raw materials supplied by the company.
1.A company is engaged in the manufacture and marketing of consumer goods of mass consumption. It has its own manufacturing unit and also gets part of the sales requirement manufactured by third parties [henceforth called ‘Contract Manufacturing Units’ (CMU)].
2.The modus operandi in case of manufacture of goods by CMU is that the company supplies raw materials and packing materials to the CMU and the CMU processes these materials and converts them into finished goods which are sold by the company. The CMU is paid processing charges for the job. All the legal requirements, i.e., Excise, ISI, etc., are complied with by the CMU. The company’s personnel are stationed at CMU for supervision of the activities and quality control.
3.According to the auditors of the company, actual production disclosed in the company’s balance sheet should include production of the CMU for the company or an appropriate disclosure of the fact of non-inclusion of such production should be given in the balance sheet. The points in support of this view, as mentioned by the querist, are as follows:
(i) The product manufactured bears the company’s name.
(ii) The company supplies the raw materials and packing materials.
(iii) The company’s officers for quality control are stationed at the contract manufacturing unit.
(iv) By non-inclusion of production, the parity between the quantity of raw materials and packing materials consumed and the quantity of actual production gets distorted. By including the production of CMU in actual production of the company, it would become possible to tie-up the figures of opening stock, production, sales and closing stock, as reported in the balance sheet.
4. The company’s contention is that production by the CMU can not be regarded as the production of the company for reporting in the balance sheet. If it is established that it is not the company’s production (for reporting in balance sheet), then the question of further disclosure by way of a note regarding exclusion is not warranted. As per the querist, the points in support of this contention are as follows:
(i) As per Schedule VI to the Companies Act, 1956, the manufacturing units are required to report the actual production. Production means an act of producing. This act involves use of labour, machinery, power, etc., in an organized manner for converting raw materials into the finished products. Since all these activities are carried out by the CMU, the production of CMU can not be considered as the company’s production.
(ii) Under various regulations, viz., Central Excise, Indian Standards, Industrial Licensing, DGTD Registration, Register with Director of Industries, Factories Act, etc., it is treated as CMU’s production.
(iii) The company’s officers are stationed at the CMU for quality assurance only.
(iv) While including production of the CMU as part of the company’s actual production may restore parity of raw material consumption to production, it will distort the parity of wages, power, fuel and other manufacturing costs of the company to the actual production.
(v) Consider a case of a hypothetical company not having licenced capacity or set-up to carry out any manufacturing activity. Such a company can get products with its brand name manufactured by a third party. It would not be in order to report such production in a marketing company’s balance sheet as its own production.
(vi) It is not a requirement of the Companies Act to tie-up the figures of opening stock of finished products as reported in the balance sheet. This is merely an audit check.
5. In light of the above, the opinion of the Expert Advisory Committee has been sought on the following:
(i) As per the provisions of Part II of Schedule VI to the Companies Act, 1956, is it necessary to include production of the contract manufacturing units as part of the production of the company for the disclosure purposes?
(ii) If not included, is it necessary to give note to that effect in the accounts?
(iii) Is it necessary to disclose raw materials and packing materials supplied by the company and consumed by third party (CMU) as consumption of the company?
(iv) Is it necessary that tally of the opening stock, production, sales and closing stock should be apparent from the balance sheet? Or, is it only an audit check?
Opinion August 22, 1990
1.The Committee notes that the Institute of Chartered Accountants of India has issued ‘Statement on the Amendments to Schedule VI to the Companies Act, 1956’. Para 16 of the Statement deals with “Disclosure of licensed capacity and installed capacity and the actual production (under clause 4C of Part II, Schedule VI to the Companies Act, 1956)”. Although, it does not directly deal with the issue raised by the querist with regard to goods produced by third parties from the raw materials supplied by the company, the recommendations made in the following paragraphs of the Statement are indicative of the manner of disclosure in this case also:
“16.15 There may be cases when the industrial licence is held by one company but the manufacturing operations have been delegated or assigned to another company. In such a case, each company should furnish the requisite details relating to the licensed capacity and the installed capacity as may be appropriate to it, based on its own facts and circumstances. However, because there may be duplication of information between two or more companies, an explanatory note would be desirable indicating the relevant circumstances.
16.18 It would be useful to prepare a reconciliation statement between the quantity produced and the quantity sold, so that reasonable checks can be established over any differences which conceal, or are likely to conceal errors in the information disclosed. For this purpose, it should be borne in mind that the present provision requires quantitative information to be furnished with regard to the actual production as well as with regard to the quantities of opening and closing inventories. While it is possible that the total quantity of saleable production on the basis of such reconciliation may be more than the quantity actually sold, the converse would be an unrealistic position. Consequently, if the reconciliation indicates that the quantity of saleable production is less than the quantity actually sold, a further check would be necessary in order to locate and correct the error in the information which has been furnished.
The following is a suggested outline of reconciliation between saleable production and actual quantity sold: -
16.19 The amendment requires disclosure of actual production meant for sale. There may be cases when licensed capacity and installed capacity may be utilized for manufacture of items for others. For example, in the case of a rolling mill, the licensed capacity may be for rolling 1,00,000 M.T. rolled product and within this capacity the company may roll customer’s materials for a service charge based on tonnage. What would be required for the purpose of disclosure is the gross income from service charge and not the tonnage of goods rolled out of customer’s materials. However, no objection could be taken if the company chooses to give more information of the tonnage of materials rolled out of customer’s materials, provided the disclosure is separately made of (i.e., not mixed up with production of goods meant for sale) the fact that such production is out of customer’s materials.”
2. The Committee also notes the following:
(i) One who makes himself, and the one who gets a thing made by others, both are manufacturers. The latter is a manufacturer because a person is deemed to make goods or apply a process if the goods are made, or the process is applied, by another person to his order under any form of contract other than a purchase (Halsbury’s Laws of England, 3rd Edition, Vol. 33, Para 407).
(ii) The expression ‘manufacture’ has in ordinary acceptation a wide connotation. It means making of articles or material commercially different from the basic components, by physical labour or mechanical process; and a manufacturer is a person by whom or under whose direction and control the articles or materials are made (Commissioner of Sales Tax v. Dr. Sukh Deo A.I.R. 1969 S.C. 499).
(iii) The term ‘manufacturer’ applies both to him who actually makes and to him who causes to be made [Corpus Juris Secundum, Vol. 55, para 1, page 671; Bablu Prasad Amarnath v. CST (1964) 15 STC 46 (All)].
(iv)One who gets the finished article prepared not by his own paid employees but by independent artisans paying for labour, is also a manufacturer [J. Srirangam Bros. V. STO (1959) 10 STC 257 (Ori.)].
3.The Committee is of the view that the third parties, viz., the contract manufacturing units (CMUs) are producing goods for the company. In other words, in return for processing charges, the CMUs are providing production facilities, i.e., men, machines etc., to the company. The production activities of CMUs are under the supervisory control of the company. Further, the question of distorting parity of wages, power, fuel and other manufacturing costs in relation to the company’s production is not relevant since processing charges paid to CMUs represent, inter alia, such costs which will, in turn, be related to actual production of CMUs included in the production of the company. The Committee is further of the view that merely because the said production is considered as the production of the CMUs for some statutory purposes, can not be taken to be a conclusive factor for the purpose of non-disclosure by the company under the Clause 4C.
4.The Committee also notes that it is a generally prevailing practice in the country that the goods processed by third parties are disclosed as the production of the company with disclosure of that fact.
5.On the basis of the above, the opinion of the Committee on the issues raised by the querist in para 5 of the query is as below:
(i) The production of the contract manufacturer should be included as part of the production of the company for the purposes of Clause 4C of Part II of Schedule VI. An appropriate disclosure of this fact should also be made.
(ii) A note disclosing the fact that a third party has processed products for the company, without making it a part of the actual production, would not be sufficient.
(iii) It is necessary to include the raw materials and packing materials consumed by CMU in the figure of consumption. However, a disclosure to this effect should be made.
(iv) It is desirable accounting practice, as indicated by para 16.18 of the aforesaid Statement, to tally the opening stock, production, sales and closing stock. The non-reconciliation of the same may raise a doubt about the correctness of the figures stated. _________________________ |