1.20  Query:   

Valuation of salt inventories as per requirements of Accounting

Standard (AS) 2 on ‘Valuation of Inventories’.

1. A Public Sector Undertaking is engaged in the business of manufacture and sale of salt. The salt production is seasonal and operations are mostly carried out manually. The brine, i.e., the mother liquor containing salt, is obtained from the main lake with the help of high powered pumps. Subsoil brine is collected by sinking borewells. The brine is pumped from the main lake to the crystallizers, i.e., Kyars/Pans. The company’s operations are scattered over a vast area. The company, with a view to discharge its day-to-day functions expeditiously, maintains its own workshop, power house (stand-by), permanent way (Rail Track), locomotives, rolling stock, township, and hospital as part of its essential infrastructure. Salt produced is collected in the Kyars/Pans, heaped, washed and dried before it is transported to the company’s central stores, in the rail wagons owned by the company. Normally, salt thus stored is taken as the company’s production of salt. Salt crust which remains unextracted in the Kyars/Pans at the close of the financial year is taken as W.I.P.

2. The company is presently considering the following expenditure for the purpose of valuation of inventory: -

                        (i)         Direct expenditure incurred on the production of salt.

(ii)        Expenditure on the extraction and storage of salt, i.e., loading of salt in the rail wagons, transportation, unloading, heaping etc.

                        (iii)       Works overheads.

                        (iv)       Share of administrative overheads.

                        (v)        Interest on working capital.

The company, since its inception, is consistently valuing its inventory at cost taking into account/the expenditure detailed above.

3. The company’s indirect/administrative expenditure is quite heavy and is apportioned to production/sales as per the policy consistently followed by the company over the years and its impact on per ton cost is quite sizeable. In case this expenditure is excluded from cost for purposes of valuation of finished goods inventory/W.I.P., the cost per ton will stand reduced substantially and will leave a big gap between actual cost and cost thus arrived at on the one hand and between cost of production and the selling price on the other and thus in the view of the querist, the cost may not reflect a true and fair view of the value of the salt inventory and may tantamount to undervaluation of finished goods inventory/W.I.P. The break-up of cost for 1993-94, as per the audited accounts for the year, is given below: -

The company is presently valuing its inventory at this cost. Apart from the expenditure detailed above, the company incurs expenditure on the selling and despatch of salt which, as per the audited accounts for the year 1993-94, was Rs. 90.06 per ton. This expenditure is excluded from cost for purposes of valuation of finished goods inventory/W.I.P. Further, in case the share of administration and other overheads is excluded from cost for purposes of valuation of finished goods inventory/W.I.P., it may lead to distortion of financial working results from year to year insofar as the year in which the sales are high, it will show unduly high profit and the year in which the sales are less, it will show less profits whereas, as per the existing method of valuation, the profit for the year is shown more equitably whatever be the quantum of sale.

4. As an added safeguard for compliance with Accounting Standard (AS) 2, the company is appending the financial note as under: -

“Salt stocks are being valued at cost/net selling price whichever is less. As per the policy consistently being followed by the company since its inception and keeping in view the heavy incidence of general administrative & other overheads not directly attributable to production which the company incurs in the normal course, the valuation of opening & closing stock of salt and W.I.P. has been done taking into account these general overheads and interest charges to show the salt inventory/ W.I.P. at realistic value. The old stocks are being valued at cost/selling price of that year or current net realisable value whichever is less.”

5. The opinion of the Expert Advisory Committee is solicited as to whether in view of the position stated above and the peculiar nature of the industry, the existing method of valuation of finished goods inventory/ W.I.P. consistently being followed by the company since its inception with above financial note continued to be appended, will meet the requirements of Accounting Standard (AS) 2.

                                                           Opinion                                             November 17, 1995

1. The Committee notes that the basic issue raised by the querist relates to the inclusion of administrative overheads and other overheads, e.g., interest charges in the historical cost for inventory valuation purposes in financial accounts. The Committee, therefore, does not offer its opinion on other accounting matters stated in the query. For instance, the Committee does not give its opinion on valuation of old stocks at cost/selling price of that year or current net realisable value, whichever is less.

2.  The Committee notes Para 16 of AS 2 which states 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.”

3. The Committee also notes para 28 of AS 2 which states as follows: -

“Overheads other than production overheads should be included as part of the inventory cost only to the extent that they clearly relate to putting the inventories in their present location and condition.”

4. The main argument of the querist is that the amounts of administrative overheads and other overheads like interest charges included in the cost for the purpose of valuation of inventory is quite heavy and if excluded from cost will lead to distortion in financial statements. The Committee is of the view that the principles of inventory valuation as laid down in AS 2 would apply notwithstanding the magnitude of administrative overheads and interest. The Committee is, therefore, of the view that share of administrative overheads and interest on working capital should normally be excluded from the cost for the purpose of inventory valuation.

5. Subject to para 3 above, the Committee is of the opinion that in the facts and circumstances of the query, share of administrative overheads and interest on working capital should be excluded from the historical cost for the purpose of inventory valuation.

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