1.43 Query: Disclosure of stocks of inter-unit transfers in the financial statements of a company.
1. A state government company ‘X’ Ltd. is primarily engaged in the manufacture of fertilizers and has also diversified its activities in other fields like caprolactam, petrochemicals, plastic, gases, etc. As a part of the forward integration programme, the company had taken over a sick unit ‘Y’ Ltd., engaged in the manufacture of monomer, acrylic sheet, pellets, etc. After amalgamation, it has been working as a unit of ‘X’ Ltd. Recently, ‘X’ Ltd. has initiated a move to merge its subsidiary company ‘Z’ Ltd., which is engaged in the production of nylon yarn and chips from the raw material – caprolactam being supplied by ‘X’ Ltd. to ‘Z’ Ltd.
2. ‘X’ Ltd. has approached the High Court for amalgamation of ‘Z’ Ltd. and after amalgamation, the latter would also work as a unit of the former. Recently, the High Court had called the Extraordinary General Meeting of the shareholders of both the companies to approve the scheme of amalgamation and the querist expected that the High Court would approve the amalgamation. The annual accounts of ‘X’ Ltd., for the year ending 31st March, 1991, would incorporate the accounts of ‘Z’ Ltd., which would operate as a unit of ‘X’ Ltd., after merger. As stated by the querist, ‘X’ Ltd. is the only manufacturer of caprolactam and this caprolactam is the main raw material used by ‘Z’ Ltd., for the manufacture of Nylon Filament Yarn.
3. At present, in terms of the accounting practice followed by ‘X’ Ltd., the materials issued to other units like polymers are transferred at cost without any element of profit. No invoices are prepared for these transfers. In the light of this policy, ‘X’ Ltd. will also have to follow the same practice of transfer of caprolactam to ‘Z’ (after its amalgamation) at the transfer price at cost.
4. As per the provisions of para 3(ii)(2) of Part II of Schedule VI to the Companies Act, the companies engaged in manufacturing activities are required to disclose the value of opening and closing stocks of finished products by way of product-wise quantity and value. Some of the products manufactured by ‘X’ Ltd. are sensitive in nature from the view point of buyers and the company has taken the decision not to show the value of opening and closing stocks of finished products in the additional information required to be furnished pursuant to the provisions of para 3(ii)(2) of Part II of Schedule VI to the Companies Act. Instead, the value of opening and closing stocks of all the items of finished stock is shown for an aggregate amount so that product-wise cost of production is not conveyed in the interest of the company. In this regard, the company has made application to the Company Law Board (CLB) requesting permission for non-disclosure of product-wise values of opening and closing stocks and their approval is awaited. Further, according to the accounting practice followed by the company, cost/value of raw materials transferred from one unit to another is knocked off while consolidating the accounts of different unit and the value of such inter-unit transfers is not shown in the raw materials disclosed in additional information. A copy of the accounts for the year ended 1989-90 has been submitted for the consideration of the Committee.
5. In the light of the above practice and the facts, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(a) Whether it would be permissible under the Companies Act to transfer materials to other divisions at market price instead of at cost.
(b) If this is permissible under the law, whether any application is required to be made for permission of the Company Law Board.
(c) If this is permissible, whether it would be necessary to indicate the cost of various finished products transferred to other units for captive consumption in the additional information to be furnished pursuant to the provisions of paragraphs 3, 4-C and 4-D of Part II of Schedule VI. As per the present policy, the cost of such materials is knocked off while integrating the accounts.
(d)
Whether any disclosure is necessary in accounts either in the Accounting
Policies or in the Notes on Accounts. Opinion May 27, 1991
1. From the facts of the query, the Committee notes that after amalgamation of ‘X’ Ltd. with ‘Z’ Ltd., the finished product of one unit (namely, caprolactam produced by ‘X’ becomes the raw material for the other unit (namely, former subsidiary company ‘Z’ Ltd. for manufacture of nylon yarn and chips). In other words, it is a case of inter-process transfer of material.
2.The Committee also notes that there is nothing in the Companies Act, 1956, which prohibits a company from transferring its inter-process materials at transfer prices other than at cost. Thus, the company in question can transfer the product of one process to the other process at market price. However, while consolidating the accounts, the inter-process transfers of materials are to be knocked off and the stocks should be valued at cost to the company or net realisable value, whichever is lower.
3. The Committee notes that clause 3(ii)(2) of Part II of Schedule VI to the Companies Act, 1956, requires as follows:
“The opening and closing stock of goods produced, giving break-up in respect of each class of goods and indicating the quantity thereof.”
4. The Committee further notes that clauses 4-C and 4-D of Part II of Schedule VI to the Companies Act, 1956, require as under:
“4-C. In the case of manufacturing companies, the profit and loss account shall also contain, by way of a note in respect of each class of goods manufactured, detailed quantitative information in regard to the following namely: -
(a) The licensed capacity (where licence is in force);
(b) The installed capacity; and
(c) The actual production.
Note 1. - The licensed capacity and installed capacity of the company as on the last date of the year to which the profit and loss account relates, shall be mentioned against items (a) and (b) above respectively.
Note 2. - Against item (c), the actual production in respect of the finished products meant for sale shall be mentioned. In cases where semi-processed products are also sold by the company, separate details thereof shall be given.
Note 3. - For the purpose of this paragraph, the items for which the company is holding separate industrial licences shall be treated as separate classes of goods but where a company has more than one industrial licence for production of the same item at different places or for expansion of the licensed capacity, the item covered by all such licences shall be treated as one class.
4-D. The profit and loss account shall also contain by way of a note the following information, namely: -
(a) ……………
(b) ……………
(c) Value of all imported raw materials, spare parts and components consumed during the financial year and the value of all indigenous raw materials, spare parts and components similarly consumed and the percentage of each to the total consumption……”
5. The Committee also notes that paras 6.10, 16.20 and 16.21 of the Statement on the Amendments to Schedule VI to the Companies Act, issued by the Institute of Chartered Accountants of India, provide as follow:
“6.10. In the case of industries where there are several processes, materials may move from process to process, so that the finished product of one department constitutes the raw materials of the next. Since the notification clearly requires consumption data to include only purchased intermediates or components and also having regard to the fact that the consumption of raw materials for production of such intermediates would have to be accounted as raw materials consumed, it follows that internal transfers from one department to another should be disregarded in determining the consumption figures to be disclosed.
16.20. For the purpose of the requirements relating to the disclosure of the licensed capacity and the installed capacity, it has been specified in a note under the aforesaid Clause 4C that all items for which the company is holding a separate industrial license should be treated as a separate class of goods, whereas any item covered by the same industrial license should be treated as one class of goods even though it is licensed for production at different places or for production by way of expansion. This clarification also applies to the disclosure relating to the actual production. However, it has been further specified, that separate details of actual production should be furnished in respect of semi-processed products, if such products are sold by the company. In other words, for example, if a textile mill produces yarn partly as a semi-processed product for further processing into cloth, and partly as finished product for sale to the public, the actual production of yarn should also be disclosed in addition to the actual production of cloth.
16.21. It is a slightly doubtful question whether the production of yarn in such a case should be stated by reference to the total quantity of yarn produced, or whether it should be restricted to the quantity of yarn produced for sale. The disclosure requirements in this context specifically state that the actual production is to be mentioned “in respect of the finished products meant for sale”. Thereafter, the requirements go on to state that details of production are also to be furnished in case semi-processed products are sold by the company. In other words, if semi-processed products are sold by the company, they are to be treated as finished products and, therefore, disclosed in compliance with the requirement to indicate the quantity of finished products meant for sale. On this line of reasoning, it may be suggested that if semi-processed products are manufactured partly for sale to the public and partly for internal use, the quantitative information in respect of such production is to be limited to the quantity produced for sale. On the other hand, such an interpretation may be difficult to apply in actual practice because at the time of producing semi-processed products, the company may not be able to ascertain the quantity intended for sale and the quantity intended for internal use respectively. Also, while the provision specifically requires the quantity of production of finished goods to be stated to the extent that such products are meant for sale, there is no such express statement in the case of semi-processed products for which it merely requires details to be furnished without stating specifically that such details are to be restricted to the quantity of semi-processed products meant for sale. It is, therefore, possible to interpret the requirement on the basis that the entire production of semi-processed goods is to be disclosed in case any of those goods are meant for sale. Because of the diversity of interpretation which is possible, it is suggested that both these methods may be regarded as acceptable alternatives. However, it would be desirable to indicate by way of footnote the basis on which the production of semi-processed goods has been disclosed, i.e., whether it has been disclosed on the basis of the entire production, or whether disclosure has been limited to the quantity of production meant for sale.”
6. The opinion of the Committee on the issues raised by the querist in para 5 of the query is as follows:
(a) There is no prohibition under the Companies Act to transfer materials to other divisions at market price instead of at cost. The inter-process transfers, whether at market price or at cost, will have to be knocked off for computing consumption of raw materials. Valuation of closing stocks of such materials should be at the lower of cost to the company and net realisable value, and not at the transfer price.
(b) No application is required to be made for permission of the Company Law Board for making transfer of materials to other divisions at market price.
(c) The internal transfers from one unit to another should be disregarded in determining the consumption figures to be disclosed as per the requirement of clause 4-D of Part II of Schedule VI to the Companies Act, 1956. The information as required in clause 3(ii)(2) and clause 4-C of the Schedule, in respect of the finished goods of the company which are also transferred to other units of the company for captive consumption, e.g., caprolactam, is to be given in respect of the quantity produced for sale. If in actual practice, at the time of producing such finished goods, the company is not able to ascertain the quantity intended for sale and the quantity intended for internal use, the entire production of the finished goods may be disclosed with appropriate note.
(d) The treatment as suggested above should be disclosed in the notes to the accounts. _______________________ |