1.15     Query

Accounting and other issues related to Advance

Licence under Duty Exemption Scheme.

1.As part of the scheme of export promotion and also to make available necessary inputs for export production at international prices without payment of customs duty so as to make the export products competitive in the international market, the Government of India has announced Duty Exemption Scheme which is covered in Chapter XIX of the Import Policy for the period 1988-91. The scheme envisage issue of Advance Licence to registered exporters for importing materials required by them for such export production. Such imported materials can also be utilised for replenishment of materials consumed for exports effected. The licence period is for 18 months and the exports obligation has to be competed within 18 months which will be accounted 30 days after receipt of first consignment of imported materials under this licence. Apart form this, the exporter will have to give a legal undertaking to fulfil the export obligation which may be required to be supported by a bank guarantee depending on the status of the exporter as also the nature of item. Apart form this, there is also a provision that there must be a minimum value addition of 33% on the c.i.f. value of imports for the purpose of counting export value.

2. Against this Scheme, the exporters obtain licence to import materials based on exports already made or anticipated exports or orders received from time to time. When such imports are effected, in terms of the scheme, they are exempt from payment of Duty and the materials can be completely cleared without payment of Duty. It is not possible to tie-up imports or exports in line with the account closing of the exporter. Therefore, at the time of year end accounts closing, there will be pending export obligations against imports made or exports made for which imports are yet to take place.

3. The querist has referred the following issues for the opinion of the Expert Advisory Committee:

(a)        What should be the accounting treatment for such duty free imports with specific reference to Duty benefit?  

(b)        Whether the benefits arising out of imports already made for which exports are to be completed, have to be accounted for and taken to profit and loss account.

(c)        Whether such benefits are to be pro-rated to the exports effected and the balance of the export obligation/benefits pending to be availed of be carried forward as a liability in the books.

(d)        What methodology should be adopted for valuation of closing stock of materials already imported under the Advance Licence Scheme?

(e)        Whether such liability for export obligation as referred to in para 3(c) above should be treated as contingent liability and suitable note to be incorporated in the accounts.

(f)         What should be the treatment as far as tax audit is concerned for such benefits/contingent liability?

(g)        Whether the accounting of benefits related to imports, where commensurate exports have not taken place, amount to accounting on cash basis and is in violation of the amended section 209 of the Companies Act.

4.The querist has furnished the accounting policy followed by the company in question and alternative accounting policy followed by some other companies which are given in the Annexure to this query.

                                                                                      Opinion                                                                                 November 30, 1989

1.The Committee notes paras 220, 235, 243 and 244 of Chapter XIX of the Import Policy for the period 1988-91, which inter alia state:

“220 …..Advance licences are issued to Registered Exporters for import of duty free materials in terms of Department of Revenue Notification No. 44 – Customs dated 19^th February, 1987 (as reproduced in appendix 13-A) as amended, for manufacture and export of the resultant products or to replenish the materials which have gone into the production of the resultant products already exported in anticipation of the grant of Advance licence……

235 A licence issued under this scheme shall bear a suitable export obligation. The export obligation period will commence from the expiry of 30 days from the date of import of first consignment. Initially, on a provisional basis, the date of execution of bond/legal undertaking will be treated as the date from which export obligation begins. The exact date of commencement of export obligation will, however, be determined on submission of the actual Bill of Entry or the DEEC book.

243 If a licence holder fails to discharge the prescribed export obligation within the permitted time, the licensing authority shall initiate action against the licence-holder on the lines indicated in Chapter XIX of the Handbook of Procedures, 1988-91. This shall, however, be without prejudice to any other action that may be initiated by the Customs authorities for recovery of Customs duty or other duties and interest thereon under section 142 of the Customs Act, 1962.

244 (1) Exempt materials imported against a licence under this scheme shall be utilised for the manufacture of the resultant products specified in the DEEC except where it is by way of replenishment. The replenishment would be on account of exports/supplies made between the date of receipt of application by the licensing authorities and the date of first import. The exempt materials shall not be loaned, sold, or transferred or disposed of otherwise under any circumstances. In cases where the export obligation has been partially or fully met before making any import against the licence, the manufacturer exporter after fulfilment of export obligation imposed against the licence, may utilised the replenished materials for further export/domestic production and subject to actual user conditions. Similarly, the licensing authority………”.

2.The Committee also notes para 13.16 of the ‘Guidance Note on Terms Used in Financial Statements’, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India, which defines, inter alia:

            “Prudence

A concept of care and caution used in accounting according to which (in view of the uncertainty attached to future events) profits are not anticipated, but recognised only when realised, though not necessarily in cash. Under this concept, provision is made for all known liabilities and losses, even though the amount can not be determined with certainty and represents only a best estimate in the light of available information.”

3.The Committee also notes paragraph 6.3 of AS 2 on ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, which recommends, inter alia:

“6.3 ‘Cost of Purchase’ consists of the purchase price including duties and taxes, freight inwards and other expenditure directly attributable to acquisition, less trade discounts, rebates, duty drawbacks and subsidies, in the year in which they are accounted, whether immediate or deferred, in respect of such purchase.”

4. The Committee notes that where imports are made against the Advance Licence under the Duty Exemption Scheme, there are two types of duty free imports, namely:

                        (i)            Imports which bear an export obligation.

                        (ii)            Imports which do not bear an export obligation.

The issues raised by the querist in para 3 of the query have been dealt with separately in respect of the above two types of imports.

Imports which bear an export obligation.

5.The Committee notes that in case of imports which bear an export obligation, the imports are made after the Advance Licence has been issued. The material imported against the Advance Licence can be used only for the purpose of production/manufacture of goods which are to be exported, i.e., these imports bear an export obligation. Where the imports made bear an export obligation, the following situations can arise:

sa) Export obligation is completed in the same year in which import is made. In this case, the imported material will be consumed in the same year.

(b) No exports are made, as per the obligation, in the year in which the import is made. In this case, the imported material will be carried forward to the next year as stock-in-trade, whether as raw material, work-in-progress or finished goods, since it can not be used for any other purpose.

(c) Export obligation is partially completed in the year in which import is made and the remaining export obligation is completed in the succeeding year. In this case, the imported material to the extent it has to be utilised for the purpose of exports which have not been made shall be carried forward to the next year (as raw material, work-in-progress or finished goods), since it can not be used for any other purpose.

6.The Committee is of the view that saving made by the exporters in the form of non-payment of customs duty is not in the nature of revenue but is in the nature of reduction in the cost of purchase of raw material. The cost of purchase of imported material should, therefore, be shown net of customs duty, i.e., the actual price paid for the import.

7.The Committee is of the view that non-recording of the benefits related to imports will not result in violation of the matching concept of accounting. This is because, the imported material can be utilised for the purpose of production/manufacture of products which are to be exported and in case the exports do not take place in the accounting year in which the imports take place, the imported material shall be carried forward to the next year at cost (i.e., actual price paid for import) and the benefit will be automatically accounted for in the year in which exports take place. The Committee is also of the view that by not specifically recording the benefit arising out of non-payment of customs duty, there is no violation of accrual concept of accounting. This is in view of the fact that the benefit of the saving in customs duty gets automatically accounted for as and when it accrues, i.e., at the time when exports take place. This is explained below:

(a) In the situation mentioned in 5(a) above, the benefit of customs duty will be accounted for in the same year, i.e., in the year in which import takes place. For example, in case the raw material is imported at a price of say Rs. 100/- (saving in customs duty is of say Rs. 180/-), then if the entire export obligation is completed say at Rs. 400/-, then the profit of Rs. 300/- includes the benefit of customs duty saved to the extent of Rs. 180/-.

(b) In the situation mentioned in 5(b) above, the benefit of customs duty will be automatically accounted for in the year in which export is made. The imported material shall be carried forward to next year at cost, i.e., net of customs duty. Continuing the example in (a) above, the imported material will be carried forward to next year as closing stock at Rs. 100/-. The opening stock of next year will be Rs. 100/-. If exports are made in the next year, then the profit of Rs. 300/- will be accounted for in the next year which will include the benefit of customs duty saved, i.e., Rs. 180/-

(c) In the situation mentioned in 5(c) above, the benefit of customs duty to the extent of saving in the duty on imported material used for the production of goods exported in that year will be accounted for in the same year. The benefit of customs duty to the extent of saving in the duty on imported material to be used in the production of goods to be exported next year will be deferred to the next year. Continuing the example in (a) above, let us say 40% of the imported material has been used for the production of goods exported in that year, the export price of which is Rs. 160/-. The profit of Rs. 120/- in this year will include the benefit of customs duty to the extent of Rs. 72/-. The imported material will be valued in the closing stock at Rs. 60/-. Next year, the exports are completed at a price of Rs. 240/-. Therefore, next year profit of Rs. 180/- will include the benefit of duty saved to the extent of Rs. 108/-.

Note:            In the examples cited in (a) to (c) above, the cost of indigenous raw material which has to be used has not been considered since it shall remain the same in all the cases.

“10. The amount of contingent loss should be provided for by a charge in the Statement of Profit and Loss if:

(a) It is probable that at the date of the financial statements events subsequent thereto will confirm that (after taking into account any related probable recovery) an asset has been impaired or a liability has been incurred as at that date, and

(b) a reasonable estimate of the amount of the resulting loss can be made.

11. The existence of a contingent loss should be disclosed in the financial statements if either of the conditions in paragraph 10 is not met, unless the possibility of loss is remote.”

9.The Committee is accordingly of the view that there is no need of providing or disclosing the unfulfilled export obligation as a contingent liability if the possibility of loss arising due to non-fulfilment of export obligation is remote. The unfulfilled export obligation should be provided for if both the conditions specified in para 10 of AS 4 are fulfilled and it should be disclosed as a contingent liability if one of the aforesaid conditions is not met.

10.In view of the above, the Committee is of the following opinion in respect of the issues raised by the querist in para 3 of the query:

(a) There is no need to record the Duty benefit arising out of import of material. The imported raw material should be recorded at the cost at which it is procured.

(b) The benefit arising out of imports already made for which exports are to be completed should not be accounted for and taken to profit and loss account. The benefit is related to exports and it can not accrue till the exports have taken place. In case the exports have not taken place, the imported material, to the extent it is to be utilised for the purpose of manufacture of goods in respect of which exports are yet to take place, will be carried forward as closing stock and the benefit will be reflected in the accounts of the year in which the exports take place.

(c) Since the imported material is recorded at cost (net of customs duty) and the imported material, which has not been utilised for the purpose of manufacture of goods in respect of which exports are yet to take place, is carried forward as closing stock, the need for pro-rating the customs duty benefit by means of accounting entries does not arise. This is because it automatically gets prorated.

(d) The closing stock of material imported under the Advance Licence Scheme should be valued at actual purchase price paid, i.e., exclusive of saving in customs duty.

(e) In case export obligation is not fulfilled before the end of accounting year and the exporter has no reasons to believe that he will not be able to fulfill the export obligation, the duty benefit should not be treated as a contingent liability. However, the unfulfilled export obligation should be provided for if both the conditions specified in para 10 of AS 4 are fulfilled and it should be disclosed as a contingent liability if one of the aforesaid conditions is not met.

                        (f)            This query does not require any answer in view of the above.

(g) The above approach will not amount to accounting on cash basis because the benefit gets accounted for only in the year in which exports take place. Therefore, there will not be any violation of section 209 of the Companies Act.

Imports which do not bear an export obligation

11.The Committee notes that where the exporter has made certain exports between the date of application for Advance Licence and the date of grant of Advance Licence, he is entitled to import raw materials free of Duty in respect of such exports after the Advance Licence has been issued. These imports are in form of replenishment of material that would have gone into production of goods already exported. These imports do not bear any export obligation but are subject to ‘actual user conditions’.

12. The Committee is of the view that since in the case of imports which do not bear any export obligation and the imported goods are subject to ‘actual user conditions’, the benefit of the exemption of customs duty will not materialise unless and until the products manufactured from such imports are sold out. Thus, the amount of benefit of exemption of customs duty can not be related to the cost of materials that have been consumed for the purpose of exports.

13.The Committee also notes that one of the major considerations governing the selection and application of accounting policies is ‘prudence’, according to which profits are not anticipated but recognised only when realised in view of uncertainty attached to future events. (AS 1, ‘Disclosure of Accounting Policies’). The benefit arising out of import of material free of customs duty can be realised only when goods manufactured from these are sold. If the company keeps the imported raw material in its stock for a period of say ten years, then the company will not realise any benefit from non-payment of customs duty for the period of ten years.

14. The present case can be compared with a quantity discount situation. For example, a supplier agrees to supply goods to a purchaser at the terms that first 1 lakh tonnes of a material will be supplied at Re. 1/- and goods purchased above 1 lakh tonnes but upto 2 lakh tonnes will be supplied at Rs. 0.90. In this case, the benefit of reduction in price of goods purchased beyond 1 lakh tonnes is resulting because of the purchase of first one lakh tonnes. If the purchase of first one lakh tonnes is made in one year and the purchase of next one lakh  tonnes is made in a subsequent year, then it will not be prudent to account for the benefit of Rs. 1,000/- (being discount on next 1 lakh tonnes) in the year in which first one lakh tonnes are purchased.

15. The Committee is accordingly of the view that although the benefit of non-payment of customs duty, which is on account of exports made before the grant of Advance Licence, can be quantified at the time when imports are made, yet the benefit is not realised unless and until the goods manufactured from these imported materials are sold out. The Committee is, therefore, of the view that by valuing the stock of imported material at cost, the benefit will automatically get accounted for as and when the goods manufactured from these imported materials are sold out.

16.Based on the above, the opinion of the Committee is here under:

(a) The benefit arising out of non-payment of customs duty on imported material which does not bear any export obligation, should not be recorded specifically. The benefit itself gets accounted for as and when the goods manufactured from the imported material are sold out.

(b) This query is not relevant for imports which do not bear any export obligation.

(c) This query is not relevant for imports which do not bear any export obligation.

(d) The closing stock should be valued at actual cost, i.e., without accounting for saving in customs duty.

(e) This query is not relevant for imports which do not bear any export obligation. However, if the ‘actual user condition’ is not expected to be fulfilled, the exporter should provide for the liability arising out of such non-fulfilment if both the conditions specified in para 10 of AS 4 are met and should disclose the same if one of the aforesaid conditions is not met unless the possibility of loss is remote.

(f) This query does not need any answer in view of the above.

(g) There will not be any violation of section 209 of the Companies Act by following the above approach. The benefit of non-payment of customs duty is accounted for as and when the goods manufactured from the imported material are sold out. The non-payment of customs duty is not in the nature of revenue but is in the nature of reduction of cost of raw materials.

ANNEXURE

 Accounting Policy Followed by the Company

(As explained by the querist)

            (a)            Fulfillment of export obligation is taken as the point of accrual of the benefit though actual benefit on cash basis would be available at the point of import.

            (b)            Since under the DEEC Scheme either imports can precede exports or vice-versa, the exporter can always maintain the quantum of benefits on the higher side by ensuring that the imports during the year are against the exports yet to be made. This is easily done because imports under DEEC scheme can be made even against anticipated exports and the licensed period is 18 months and therefore the transaction necessarily spreads over more than one accounting year.

            (c)            By adopting the method explained in (b) above, it is in effect possible to take credit of the benefit under the raw material consumption and inflate the profits. It would also amount to accounting of profit without actually having earned the revenue, i.e., without fulfilling the export obligation.

            (d)            In view of above, the accounting treatment followed by the company is based on the following: -

(i) To avoid distortion in profit and loss account due to accounting of DEEC Benefit on the basis of imports without actually having exported;

(ii) To ensure treatment of DEEC Benefit at par with other export incentives like CCS, Duty Drawback etc., (in fact DEEC Scheme is in lieu of Duty Drawback Scheme) which are available only after exports; and

(iii) To ensure the equitable accounting of benefit as related to exports since DEEC Benefit is an export incentive;

the company is accounting DEEC Benefit on the following formula: -

            Example

            Advance Licence ‘X’

Let us say during the financial year, the entire import of 105 kgs. is completed and only 75 kgs. is exported. The benefit accounted by the company will be:

Whereas actual benefit realised based on imports, i.e., on cash basis is Rs. 800/- during the year but since the export is not complete, the amount as related to export of 75 kgs., i.e., Rs. 600/- is taken as benefit during the year and balance benefit of Rs. 200/- will be considered during the year and balance benefit of Rs. 200/- will be considered during the next year when the balance 25 kgs. is exported and till such time this amount is retained in the books as a liability.

The amount of Rs. 600/- being the benefit quantified based on actual exports as shown in the above formula is deducted from the raw material purchases as raw material purchases under the DEEC Scheme also are accounted inclusive of Import Duty. Also the closing stock of raw materials pertaining to DEEC Scheme would be valued at cost inclusive of import duty. In effect, in terms of accounting entries the final position reflected in the financial account will be as follows: -

Raw Material under DEEC Scheme

            ALTERNATIVE POLICY FOLLOWED BY SOME OTHER COMPANIES 

            Continuing the above example, duty benefit on imports realised Rs. 800/- .

The entire benefit of Rs. 800/- is accounted during the year of import itself (whether export obligation completed or not) as follows: -

Raw Material under DEEC Scheme

Since the entire accounting is on the basis of C.I.F. without touching the Import Duty aspect, there is no need to quantify the benefit separately and higher the imports higher will be benefit and vice-versa. In accounting like this, the benefits pertaining to future exports are accounted at the time of imports and if imports are made in a financial year and exports made in the subsequent year, it will distort profit and loss position of both the years.

The above principle recognises cash basis of accounting. The export obligation to the extent not fulfilled is shown as a contingent liability.

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