1.11 Query: Inclusion of factory administration overheads in cost for the purpose of valuation of inventories.
1. A multi-product, multi-location organisation, having its Corporate Head Office at Bangalore and units all over the country, manufactures and sells a range of machine tools, watches, tractors, lamps, dairy machinery, etc. The corporate organisational structure is given hereunder:
CORPORATE OFFICE | _______________________________________________________________________________ | | | |M/C TOOLS WATCHES TRACTORS LAMPS BUSINESS BUSINESS BUSINESS GROUP GROUP GROUP GROUP
FACTORIES FACTORIES FACTORY FACTORY
All these factories are separate profit centres whose products are marketed through the concerned marketing divisions which are in turn separate profit centres. The factories are concerned only with production of their respective products based on the approved targets and have virtually no role in the policy formulating areas of corporate planning, organisational and personnel policies, finances, marketing, R & D etc., which are dealt with either by the Corporate Office or by the Business Group Directorate as would be evident from the above organisation chart.
2. The company follows the historical cost method of valuing its year-end inventory. The stocks of stores, spares, raw materials and components are stated at cost; work-in-progress is valued at lower of cost or estimated net realisable value; and stock-in-trade at lower of cost or selling price. The basis of valuation has been followed consistently and disclosed as an accounting policy of the company.
3. While arriving at the cost of production for valuing the year-end inventory of work-in-progress or stock-in-trade, all direct costs, viz., material, labour and direct expenses are considered. In addition to this, factory overheads and factory administration overheads are absorbed for the purpose of year-end inventory valuation through the machine hour rate. However, interest on borrowings and selling and distribution overheads are not considered for valuation of year-end inventory. Similarly, none of the expenses relating to the Marketing Division, Business Group Directorate and Corporate Office is considered for valuation of year-end inventory.
4. The auditors, while finalising the accounts of the company for the year ended 31st March, 1991, stated that inclusion of administration overheads of the factories for valuation of year-end inventory was not in order and was not in consonance with Accounting Standard (AS) 2. The company clarified that all expenses incurred by the factories were wholly and exclusively laid out to bring the inventories to their present form and location and, therefore, all factory overheads including factory administration overheads, other than those mentioned above, should form part of cost for valuation purposes and that this method was squarely in consonance with AS 2.
5. The querist has sought the opinion of the Expert Advisory Committee as to whether the method of valuation adopted by the company in view of the specific circumstances explained by the querist for inclusion of factory administration overheads as detailed hereinabove is in order.
Opinion March 31, 1992
1. The Committee’s opinion given hereafter is on the question of inclusion of factory administration overhead in the cost for the purpose of valuation of inventories. Thus, the Committee does not express any opinion on the propriety or otherwise of the other aspects of the accounting policy followed by the company with regard to valuation of inventories as the querist has not referred the same to the Committee.
2. The Committee notes para 16 of Accounting Standard (AS) 2 on ‘Valuation of Inventories’, which recommends as follows:
“Costs other than production overheads are sometimes incurred in bringing inventories to their present location and condition, for example, expenditure incurred in designing products for specific customers. On the other hand, selling and distribution expenses, general administration overheads, research and development costs and interest are usually considered not to relate to putting the inventories in their present location and condition. They are, therefore, excluded from determining the valuation of inventories.” [emphasis supplied]
3. The Committee notes from the above that as per AS 2, it is the general administration overhead which is usually excluded from cost for valuation of inventories. Thus, factory administration overheads, such as, the factory manager’s salary, are considered as production overheads for the purpose of valuation of inventories.
4. The Committee is, therefore, of the opinion that in the facts and circumstances of the query, factory administration overheads should be considered as a part of the factory overheads for the purpose of valuation of inventories. ____________________________ |
