2.5  Query

Valuation of inventories of gold jewellery.

1.A firm of jewellers trading in gold and silver ornaments for past several years maintains the record of its stock in quantity (weight) as is required in excise records GS. 11 and GS. 12. The valuation is done on bd, i.e., LIFO. The firm started its business with 12 Kgs. of gold ornaments and every year there has been an increase of 1 Kg. in stock. The valuation haase stock methos been done as under:

* Less deduction for impurities

2.The querist has also stated that the base stock method in metal industries has been supported in Eric L Kohler’s book, ‘A Dictionary for Accountants’, at page 247.

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

(a) Whether the method of valuation of closing stock followed by the company is correct for income-tax purpose because for wealth tax purpose the valuation was to be adjusted as per market value till assessment year 88-89 vide Rule 2B(2) of the Wealth Tax Rules.

(b) In paras 10 and 30 of AS 2 on ‘Valuation of Inventories’, it is suggested that there must exist clear circumstances to permit use of base stock method. What could be the circumstances in the case of the firm to justify use of base stock method as every year with the rise in variety and competition one has to keep higher and higher stock?

(c) In paras 26 of AS 2 on ‘Valuation and Presentation of Inventories in the Context of Historical Cost System’, it has been suggested to disclose the difference between amount of inventories as shown in balance sheet under LIFO or base stock method and FIFO and current realisable value. Is it necessary in case of non-corporate assesses?

4.In the view of the querist, in gold jewellery trade the frequency of transactions is quite high and that too at very little margin over the current prevailing price. Therefore, the presumption is that whatever has been sold is out of latest purchases (LIFO). If the opening stock in terms of quantity remains the same and its current market price has gone up, then valuation of opening stock by any other method will result in higher valuation, i.e., showing extra income which has not been realised and paying taxes on it. Under the circumstances LIFO method of valuation appears to be reasonable and appropriate.

                                                                  Opinion                                                 April 12, 1990

1.The Committee notes that base stock method and LIFO method are two distinct methods of stock valuation. The opinion of the Committee is based on the presumption that the firm is following base stock method of valuation.

2.The Committee notes that in Patrick (Inspector of Taxes) v. Broadstone Mills Ltd. (1954) 25 ITR 377 (C.A.), it has been held that even though the base stock method of valuation of inventories is well recognised method of accounting for the business purposes, it should still be rejected by the Income Tax Officer if it does not afford a true picture of the profits in any one year of charge.

3. The Committee also notes that the above case has been affirmed by Madras Tribunal in the case of IAC v. Vummidi Bangaru Chetty & Co. [1988] 27 ITD 561 (Mad). In this case the assessee who was a dealer in silverwares and in silver, adopted base-stock method of valuation in respect of base stock of raw silver and silverware. The assessee placed reliance on AS 2 on ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India. The Tribunal held that the said Accounting Standard also provided that the base stock method may be used in exceptional circumstances only. The Tribunal held that the method of valuation of closing stock in respect of the base stock of silverware and raw silver, was not correct as it did not reflect the true income, profits and gains of the business.

4. The Committee notes para 10 of Accounting Standard (AS) 2 on ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, which states as below:

“10. The base stock formula proceeds on the assumption that a minimum quantity of inventory (base stock) must be held at all times in order to carry on business. Inventories upto this quantity are stated at the cost at which the base stock was acquired. Inventories in excess of the base stock are dealt with on some other basis, e.g., any one of the above mentioned formulae. The base stock formula requires a clear existence of the circumstances that a minimum level of inventory must be held at all times and therefore, has a limited application. Most enterprises customarily maintain certain minimum stock level at all times but that is not by itself a justification for use of base stock method because there must exist clear circumstances to permit use of base stock method.”  

5. The Committee also notes paragraph 3.10.5 of the ‘Monograph on Compulsory Maintenance of Accounts’, issued by the Institute of Chartered Accountants of India, which recommends, inter alia:

“3.10.5 Under-valuation or arbitrary valuation of stock is not permissible. The assessee is not entitled to value the stock at the replacement price. The determination of cost for purposes of being taken as the basis for valuing stock should be generally on first in first out basis or average cost basis. The last in first out method of determining cost is not recognised for income-tax purposes. Similarly, the base stock method is not also acceptance for tax purposes.”

6. The Committee is accordingly of the following opinion:

(a) Normally, the base stock method of valuation of stock is not accepted for income-tax purposes. The method of valuation of closing stock as is followed by the firm may not be accepted by the income-tax authorities.

(b) The circumstances in which base-stock method may be used will vary from case to case and have to be judged in respect of the facts of each case.

(c) AS 2 has been formulated by the Institute of Chartered Accountants of India after giving due consideration to the relevant International Accounting Standard in light of the conditions and practices prevailing in India. Para 30 of AS 2 recommends that where base stock method is used, the difference between the value at which it is carried and the value by applying the method at which stock in excess of the base stock is valued, should be disclosed. If base stock method is used for accounting purposes, the disclosure should be made in accordance with para 30 of AS 2 since it represents a good accounting practice to be followed by all types of entities.

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