1.46 Query: Valuation of work-in-process – Diamonds.
1. A company is engaged in the business of iron ore mining and diamond mining having various mechanised iron ore/diamond mines in the country. The following process is involved in manufacturing diamonds:
(a) In the Diamond Mining Project, the ROM (run of mine) is extracted from the mine which is open cast mine.
(b) The good quality of ROM called as ‘tuff’ is mined and transported by dumpers and brought near to the plant and kept as stock (work-in-process) for further processing after weathering, say, for a period of 6 months or so.
(c) The weathered ‘tuff’ is fed to crushing plant and treated in the plant to get the finished product, viz., diamond which is sold in the market.
2. At the end of the financial year, the stock of ‘tuff’ remaining (work-in-process) is being valued and taken in the accounts. At the stage where the ‘tuff’ is kept for weathering, the mining cost including transportation upto the stock yard is incurred.
3. Total cost of finished diamonds comprises mining cost and treatment cost.
4. As per the normal accounting practice, the work-in-process has to be valued at cost or net realisable value whichever is lower. As per AS 2 the ‘net realisable value’ is the actual/estimated selling price less cost of completion and cost necessarily to be incurred in order to make the sale. In this case, the ‘treatment cost’ is incurred beyond the stage of ‘work-in-process’ cost.
5. For the purpose of valuing the ‘tuff’ (work-in-process), the company is considering the following for comparison:
(i) Direct material and direct labour of the mining cost;
(ii) Mining cost including administrative overhead, interest etc.
(iii) Total cost, i.e., direct material plus direct labour, overheads of the mining cost in proportion to (average sales realisation)/ total cost of production.
(iv) Average sales realisation minus treatment cost (excluding royalty, cess etc.)
6. A detailed statement showing the computation adopted in 1989-90 for working cost or net realisable value at the point of tuff mined has been submitted by the querist to the Committee for its perusal.
7. The government auditors, however, expressed the following opinion:
“Work-in-process is overstated due to valuation of closing stock at direct cost by comparing direct cost with net realisable value computed at a figure higher than the direct cost. The net realisable value was in fact lower than the direct cost when worked out after derating the same with the corresponding administrative and other overhead so as to bring the same on comparable position with that of the direct cost for the purpose of valuation.”
8. The details of cost/net realisable value of tuff (work-in-process) per tonne is as under:
The company while closing the accounts for 1989-90 valued tuff by very conservative method at Rs. 42.69 per tonne taking into account the direct labour and direct material which is less than the net realisable value. The government auditors are of the opinion that the NRV is to be derated with the corresponding administration and other overheads so as to bring the same on comparable position with that of direct cost, i.e., Rs. 42.69 per tonne for 1989-90. According to the querist, if this suggestion is considered, the NRV would work out to Rs. 32.94 per tonne (103.51 x 42.69/134.14) as against Rs. 103.51 per tonne arrived at by the company.
9. The querist has sought the opinion of the Expert Advisory Committee in regard to valuation of ‘tuff’ (work-in-process) as to whether for the purpose of comparison of the cost and net realisable value, the net realisable value is to be arrived at after derating the same with the corresponding administrative and other overheads so as to bring the same on comparable position with that of the direct cost for the purpose of valuation.
Opinion May 29, 1991
1. The Committee notes that para 5 of Accounting Standard (AS) 2, on ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, states, inter alia, as below:
“5. This statement applies to valuation of all inventories except inventories of the following to which special considerations apply:
(i) ……………….
(ii) Extractive industries such as mining, quarrying etc……”
2.The Committee notes that the querist has not stated whether the weathering and treatment of ‘tuff’ form integral parts of the mining operation of diamonds, i.e., whether ‘tuff’ can be commercially sold without weathering and treatment thereof. In case, these processes form integral parts of mining operation, AS 2 will not be applicable at all. Otherwise, once ‘tuff’ is extracted from the mine, the mining operation can be considered to be completed as a consequence to which the weathering and treatment of ‘tuff’ would be considered to be manufacturing operations. In the latter case, AS 2 will apply to the inventories from the stage ‘tuff’ has been extracted till the stage of completion of finished diamonds. In other words, AS 2 will not apply up to the mining stage, i.e., till the extraction of ‘tuff’. Since the querist’s question relates only to the propriety of deducting administration and other overheads from the estimated selling price for the purpose of determination of net realisable value of ‘tuff’, the Committee’s opinion given hereinafter deals with this question only keeping in view the sound accounting principles in this regard, irrespective of whether or not AS 2 is specifically applicable. For this purpose, the Committee has based its opinion on the concept of net realisable value as per AS 2 since that represents sound accounting principles in this regard.
3. The Committee notes that as per AS 2 “Net Realisable Value is the actual/estimated selling price in the ordinary course of business, less cost of completion and cost necessarily to be incurred in order to make the sale”.
4. The Committee is of the view that the determination of net realisable value of inventory is independent of the method followed for arriving at the cost of inventory, viz., direct costing and absorption costing. Whether the cost of inventory is determined on the basis of direct costing or absorption costing, the net realisable value will remain the same.
5. The Committee is accordingly of the opinion that the net realisable value of the tuff is the actual /estimated selling price of the tuff in the ordinary course of business less the tuff treatment cost and expenses necessarily to be incurred in order to make the sale. ____________________________ |