1.2  Query:           

Accounting treatment of MODVAT credit on capital goods.

1. The querist has mentioned that Modvat on capital goods was introduced with effect from 1.3.94 by the annual budget. The salient feature of this benefit is that credit of excise duty/countervailing customs duty paid on capital goods used in the factory can be taken for payment of duty on any of the specified manufactured goods. No depreciation can be claimed on that much amount of MODVAT credit as has been availed on account of the excise duty paid on a capital asset.

2. The querist has stated that this raises the important question of the treatment to be adopted for accounting for MODVAT on capital goods, i.e.,

(a) whether assets are to be shown at gross cost and MODVAT credit taken to a deferred revenue reserve account, or

(b) whether the MODVAT credit availed should be deducted from the cost of the concerned asset and the net cost thus arrived at shown in the balance sheet.

3.  The querist has further stated that in his view the subject of gross accounting and net accounting have been touched upon by the Institute in some of the Accounting Standards. Briefly, the various Standards and other documents state as under:

                        (a)  Accounting of Fixed Assets- AS-10

                  This is to be done net of any duty draw backs.

            (b)  Accounting for Government Grants- AS-12

Extends option of accounting of assets on gross basis and/or on net basis.

            (c)   Valuation of Inventories – AS –2

                               Permits accounting only on net basis.

                        (d)  Guidance Note on Accounting Treatment for MODVAT

                               Permits accounting only on net basis

4. According to the querist, certain problems that appear to be involved intrinsically with the gross cost accounting method and the net cost accounting methods are as given below:

Gross Cost

(a) Since MODVAT credit availed would have to be credited to a separate reserve account made up of different entries for different purchases, each purchase of which could have been capitalised either fully or in part in the cost of different assets, attracting different rates of depreciation under the Income-tax Act, computing the amount that would have to be transferred to revenue on a recurring basis year after year can become almost as complicated an exercise as calculation of the basic depreciation to be claimed in each year.

(b) Display of an asset at a higher cost than that which has been actually been incurred by the company for procuring the same, would be in contravention of the Companies Act, 1956.

Net Cost

Asset based ratios will be affected. Quantum of term lending, which is evaluated on the cost of assets, will be reduced.

5.  The querist has sought the opinion of the Expert Advisory Committee on the method of accounting to be followed for accounting     of MODVAT credit.

                                                                           Opinion                                         April 15,1996

1. The Committee notes paragraphs 7.1 to 7.4 of the revised Guidance Note on Accounting Treatment for                                         MODVAT, issued by the Institute of Chartered Accountants of India, which read as follows:

                           “7.1 In case an enterprise does not avail MODVAT credit on capital goods obviously no accounting treatment                            would be necessary. The following paragraphs apply only to those situations where an enterprise avails of                                  MODVAT credit on capital goods.

                           7.2 Accounting Standard (AS) 10 on ‘Accounting for Fixed Assets’, issued by the Institute of Chartered                                  Accountants of India, states, inter alia, in para 9.1, as follows:

“The cost of an item of fixed asset comprises its purchase price, including input duties and other non-refundable taxes or levies and any directly attributable cost of bringing the asset to its working condition for its intended use; any trade discounts and rebates are deducted in arriving at the purchase price.”

MODVAT credit can be considered to be of the nature of a refundable tax. Therefore, MODVAT credit should be reduced from the purchase cost of capital goods concerned.

                           7.3 In view of the above, the specified duty on capital goods should be debited to separate account, e.g.,                                  MODVAT Credit Receivable (Capital Goods) Account. On actual utilisation, the account will be adjusted                                       against excise duty on final products. Accordingly, the purchase cost of the capital goods would be net of the                                specified duty on capital goods. The unadjusted balance standing in the MODVAT Credit Receivable (Capital                                Goods)  Account, if any, should be shown on the assets side under the head ‘advances’.

                           7.4 MODVAT credit in respect of capital goods should be recognised in the books of account when the                                  following conditions are satisfied: (i) The enterprise is entitled to the MODVAT credit as per the Rules. (ii)                                      There is a reasonable certainty that the MODAVT credit would be utilised.”

2. On the basis of the above, the Committee is of the opinion that the method of accounting treatment for MODVAT credit on capital goods should be the same as suggested in the paras 7.2 to 7.4 of the Guidance Note, reproduced above.

_____________________________