1.19 Query: Treatment of advance licences.
1. A public limited company is engaged in the manufacture and trading of pharmaceuticals and chemicals. It also exports certain bulk drugs and formulations.
2. The company exports certain goods which are entitled to advance licences under the Duty Exemption Scheme – Standard Input/Output and Valuation Addition Norms issued by the Ministry of Commerce which enables it to import the raw materials required, duty-free. The exports made by the company using such duty-free materials should meet the value addition norms as prescribed in the above scheme.
3. The querist has informed that during the year a company has exported certain goods without availing the customs duty benefit available to it under advance licences and instead used local raw materials. This was done to meet the export deadline as applying for advance licence and importing the materials under it would have taken considerable time, which would have resulted in the company losing the export order. Later, the company applied and obtained the advance license against the exports already made. Against this advance license the company can import the raw materials duty-free and can utilise these materials for local sale or manufacturing for further exports.
4. The querist has further stated that at the year-end the company has in its stocks certain imported materials purchased against the advance licences, for which the exports have already taken place. Valuation of these stocks becomes important because for making the exports, the company has used local raw materials which were costlier than the raw materials imported duty-free. To this extent, the company has incurred a loss during the year exports, as illustrated below:
(I) Exports using local raw materials
(II) Exports using duty-free imported raw materials
(i) Value of exports made - Rs. 1,000
(ii) Cost of using duty-free imported materials - Rs. 600
(iii) Other costs - Rs. 200
(iv) Total costs - Rs. 800
(v) Profits - Rs. 200
5. The valuation of the stock assumes importance in view of the matching concept. The company has incurred a loss in the current year on account of using local raw materials. According to the querist, the company may make profits by using/selling these imported duty-free raw materials in the next year, which have been received out of the exports made in the current year. But, it is to be noted that the amount of such profits cannot be estimated as:
(a) The company would not be having firm export orders to definitely ascertain the use of such materials in future exports.
(b) In case the company sells such materials in the local market, the sale price cannot be ascertained as it will depend on the market conditions at the time of sale including the customs duty structure at that point of time. It may so happen that the price may fall and consequently, a loss may be incurred.
(c) These materials are basically commodities and, hence, subject to volatile price movements.
6.In view of the above, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) At the year end, should these materials be valued at their cost or should they include the duty element.
(ii) The company has also not got/applied for advance licences in respect of the goods which it has already exported during the year. Is it necessary that at the year end the company’s entitlements to these licences be valued and brought into the books? If so, at what value?
Opinion December 9, 1996
1. The Committee notes para 13.16 of the ‘Guidance Note on Terms Used in Financial Statements’, issued by the Accounting Standards Board of the Institute of Chartered Accountants of India, which defines, inter alia:
“Prudence
A concept of care and caution used in accounting according to which (in view of the uncertainty attached to future events) profits are not anticipated, but recognised only when realised, though not necessarily in cash. Under this concept, provision is made for all known liabilities and losses, even though the amount can not be determined with certainty and represents only a best estimate in the light of available information.”
2. The Committee notes paragraph 6.3 of Accounting Standard (AS) 2 on ‘Valuation of Inventories’, issued by the Institute of the Chartered Accountants of India, which states, inter alia:
“6.3 ‘Cost of Purchase’ consists of the purchase price including duties and taxes, freight inwards and other expenditure directly attributable to acquisition, less trade discounts, rebates, duty draw backs and subsidies, in the year in which they are accounted, whether immediate or deferred, in respect of such purchase.”
3. The Committee notes from above that one of the major considerations governing the selection and application of accounting policies is ‘prudence’, according to which profits are not anticipated but recognised only when realised in view of uncertainty attached to future events. In view of the various uncertainties involved as stated by the querist in para 5 of the query, the benefit arising out of import of raw materials free of customs duty can be realised, in the view of the Committee, only when these materials are sold or the goods manufactured therefrom are sold.
4. With regard to entitlements of advance licences, the Committee is of the view that the cost of such entitlements is not reliably ascertainable, and their net realisable values may fluctuate considerably since they would also depend on many uncertain factors such as demand for imported goods, change in prices of domestic goods, rate of custom duty prevailing at the relevant point of time etc.
5. On the basis of the above, the opinion of the Committee on the issues raised in para 6 of the query is as follows:
(i) The imported raw materials should be recorded at the cost at which they are procured.
(ii) The company’s entitlement to advance licences in respect of goods already exported should not be valued and brought into the books. _____________________________ |