Expert Advisory Committee

1.5 Query:

Accounting for MODVAT.

1. Under an agreement, ‘Y’ Ltd. has agreed to convert Billets received from ‘X’ Ltd. into Rounds. To and fro freight will be borne by ‘X’ Ltd. The yield would be 85% and the remaining 15% (which may contain scrap etc.) may be retained by ‘Y’ Ltd., unconditionally. The conversion charges have been fixed @ Rs. 750/- p.m.t. of Billets processed.

2.‘X’ Ltd. has supplied 4000 M.T. of Billets during January ’90 which have not been processed by ‘Y’ Ltd. till 31.3.90. ‘Y’ Ltd. has issued a custodian certificate for holding these Billets physically. ‘X’ Ltd. has valued this stock in its books as on 31.3.90.

3. The following entries were passed by ‘Y’ Ltd. in its books of account:

(a) At the time of receipt of Billets from ‘X’ Ltd., supported by excise gate pass:

MODVAT Receivable A/C Dr. Rs. 21,00,000.00

(Grouped under current assets)

Excise Duty A/C Cr. Rs, 21,00,000.00

(credited to profit and loss account)

(Being the receipt of 4000 M.T. Billets under MODVAT scheme duly supported by G.P. No. 115 dated 31.3.1990, involving excise duty @ Rs. 525/- p.m.t. as per details shown in RG-23 A (PART II) of Rule 57A)

(b) At the time of utilisation of amount retained under MODVAT scheme:-

Excise Duty A/C Dr. Rs. 21,00,000.00

MODVAT Receivable A/C Cr. Rs. 21,00,000.00

(Being the utilisation of the amount laying in RG- 23A (PART II) under MODVAT scheme as per the following details: -

(i) Total excise duty payable Rs. 51,00,000.00.

(ii) Excise duty paid in cash Rs. 30,00,000.00.

(iii) Excise duty paid by utilising MODVAT credit earned as per GP No. 115, dated 31.1.1990, received from ‘X’ Ltd., Rs. 21,00,000.00.

4. The auditor of ‘Y’ Ltd. is of the view that if the Billets received during January, 1990, are rolled as Rounds within 31.3.1990 and also despatched to ‘X’ Ltd. within 31.3.1990, then the entries referred to in para 3 above are sufficient. But since these Billets are lying in stock as on 31.3.1990 (which are valued by ‘X’ Ltd. during the closing of accounts as on 31.3.1990) and the MODVAT earned on ‘X’ Ltd’s goods has been utilised during the despatch of output produced from inputs other than ‘X’ Ltd’s Billets, a provision is required to be made for the equivalent amount inspite of the fact that:

(a) Under MODVAT scheme, there is no restriction that duty involved in input, can only be utilised for the output produced from the same input.

(b) Excise department has not objected to this earning and utilisation of MODVAT during assessment of their return of March, 1990.

(d) Billets have not been removed from the factory as on 31.3.1990.

(e) ‘Y’ Ltd., is public sector company incurring huge losses and there is no question of releasing funds as dividends, etc.

(f) Such Billets have been rolled to Rounds in May, 1990, and removed on payment of duty in cash under cover of Excise Gate Pass of May, 1990, and charged to revenue account in May, 1990 (Accounting year 1990-91)

5. The querist has expressed the following views in this respect: -

(a) As per section 3 of the Central Excises and Salt Act, 1944, excise duty is to be levied and collected in the prescribed manner on all excisable goods produced or manufactured in India. This basic principle follows from that the duty liability occurs only after the ‘Manufacture’. There is no scope in excise laws to create liability for excise duty, excepting on the ‘Manufacture’. A product can be construed as manufactured if it emerges as a result of changes in the inputs and such changes have brought in new characteristics, use, or name, as against the inputs themselves. Since Billets (received from ‘X’ Ltd.) remain Billets as on 31.3.1990, there has been no ‘Manufacture’ and accordingly, no liability to pay or to provide for excise duty liability on 31.3.90. The fact that ‘Y’ Ltd. has been holding the Billets as the custodian as on 31.3.1990 and ‘X’ Ltd. has valued these Billets in its books as on 31.3.1990, are of no significance with respect to creation of ‘Provision’.

(b) Under Rule 57A of the Central Excises Rules, 1944, for the MODVAT scheme, the receiver-manufacturer of input has the right to take credit for the amount paid by the sender. In other words, the former gets a fund to pay duty which is created out of payment by the latter. Since the substantive law gives this permission to utilise the fund generated by the other, there is no scope at all to create a liability for payment of excise duty with respect to the output to be manufactured from the input material which has suffered a duty at an earlier stage, without one-to-one correlation. Duty benefit under MODVAT is not at all undue, since this is earned as per the law. So there is no question/scope for creation of any liability as per rule 57E, 57F (3), 57I of the Central Excise Rules, 1944, (provisions relating to disallowance of MODVAT credit) for outputs to be manufactured from the inputs on which MODVAT credit has been availed and utilised.

(c) The question of ‘provision/liability’ as pointed out by the auditors may be examined also with reference of the Companies Act. A benefit earned by the business may be of capital nature or of revenue nature; MODVAT benefit, as per the relevant Act, is of revenue nature. It is a benefit flowing to the business without any restriction that it has to be passed on to the outsiders. It is to be viewed as own fund and not as loan fund. It would be totally unfair to link the benefit, earned and enjoyed by the business unconditionally, with a hypothetical liability, as excise duty is a legal liability incurred on the basis of the substantive statute (i.e., The Central Excises and Salt Act and Rules, 1944). So, there is no scope to provide any hypothetical liability having no sanctity with references to the excise statute. In this context, it may be mentioned that the excise department has not issued any show cause-cum-demand notice, for wrong availment of the referred MODVAT credit. In other words, creation of duty liability, otherwise than as per the mother Act is truly and fairly, amounts to creation of a hypothetical liability having no place in the balance sheet, prepared under section 211 of the Companies Act, 1956, showing disclosures required by Schedule VI.

(d) Provision has two ingredients: (a) the basis or need of creation of such provision and (b) the extent/quantum of such provision. If (a) is not satisfied, mere ascertainment of extent, i.e., quantification as per (b), is of no use. An ascertained liability (which may or may not be quantified) must be provided for; but, mere quantification is of no material significance as far as the financial accounting is concerned. From the records it is seen that such Billets have been rolled as Rounds in May’90 and cleared to ‘X’ Ltd., on payment of duty at the rate prevalent in May’90 under cover of Gate Passes, all dated May’90.

(e) The point may be examined from commercial angle also. There is no express term in the agreement (i.e., the Works Order that ‘Y’ Ltd. received from X Ltd. within 31.3.1990). So, there is no contractual liability even.

6. In the course of audit, it has been revealed that, while receiving 4000 M.T. of Billets from ‘X’ Ltd., full credit for excise duty under MODVAT scheme @ Rs. 525/- p.m.t. amounting to Rs. 21 lakhs was taken by ‘Y’ Ltd. at the first instance by debiting ‘MODVAT Receivables’ (grouped under the head ‘Current Assets’ in the balance sheet) and crediting excise duty (credited to profit and loss account), without creating liability for the equivalent amount so as to off-set the undue income credited in the accounts for 1989-90. This has resulted in under-statement of loss to the extent of Rs.21 lakhs as on 31.3.90.

7.The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting treatment followed by the company is correct.

Opinion May 29, 1991

1. The Committee notes para 2.4 of the ‘Guidance Note on Accounting Treatment for MODVAT’, issued by the Research Committee of the Institute of Chartered Accountants of India, which recommends as under:

“2.4 The MODVAT scheme provides for instant credit of the input duty on goods used in or in relation to the manufacture of final products. The MODVAT credit is to be taken at the stage of receipt of inputs and can be utilised at any stage thereafter. In other words, credit can be availed of even before consumption of inputs (See Rule 57A).”

2. The Committee is of the view that under the scheme it is possible for ‘Y’ Ltd., to utilise the MODVAT credit received on Billets supplied by ‘X’ Ltd., for payment of excise duty on other finished products even though these Billets are lying in the stock.

3.The Committee notes that ‘Y’ Ltd. is not the owner of the Billets which it has received for processing from ‘X’ Ltd. and it is holding the Billets as a custodian. The Committee is of the view that although it is possible for ‘Y’ Ltd. to utilise the MODVAT credit received on Billets against the payment of excise duty for other finished products it is not correct to account for such MODVAT credit as income till the time the Billets are converted into Rounds. The Committee is also of the view that accounting of such MODVAT credit as income before the Billets are converted into Rounds is against the matching concept.

4. The Committee is of the opinion that the accounting treatment followed by the company is not correct. The company should make a provision of Rs. 21.00 lakhs in the accounts for the year ended 31.3.1990.

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