Query No. 5

Subject: Valuation of work-in-process.^[1]

A. Facts of the Case

1. A public sector undertaking having a turnover in excess of Rs.450 crore is engaged in the manufacture of organic chemicals. One of its units, while producing various chemicals, also produces certain intermediate products.

2. As per the querist, the production of one of the intermediate products, viz., ‘Eutectic oil’, produced in the Nitrochlorobenzene plant is in excess of its immediate requirement for captive consumption. The excess quantity of Eutectic oil is being stored till such time it is used for future distillation for production of Orthonitrochlorobenzene (ONCB) and Paranitrochlorobenzene (PNCB). The estimated expenditure in further processing of Eutectic oil is Rs. 6,000 per ton (approx.). The proportion in which the two final products (ONCB/PNCB) are produced from further processing of Eutectic oil is dependent on technical factors and is more or less constant; it cannot be varied by the management.

3. The Eutectic oil is not marketable and therefore, the market price is unascertainable. The stored Eutectic oil does not deteriorate upto one year. The average period of storage of Eutectic oil is 2 to 3 months.

4. The company has been valuing the stock of Eutectic oil by theoretically converting it into equivalent units of finished products (ONCB/PNCB) and then valuing the same on the principle of ‘cost or net realisable value whichever is lower’. The querist is considering changing the policy and valuing the Eutectic oil stock at cost. The querist has stated that since Eutectic oil is a work-in-process and is not a marketable product, it would be prudent to change the policy to value the stock of Eutectic oil on ‘cost’ basis. The querist has argued that in case the same quantity of Eutectic oil remains in stock over different accounting periods, under the principle of ‘cost or net realisable value whichever is lower’, its value will undergo a change depending on the changes in market prices of ONCB/PNCB. However, on ‘cost basis’, the difference on account of fluctuation in market price would not be recognised in the books of account.

5. The querist has provided the details of the valuation of stock of Eutectic oil by theoretically converting it into equivalent units of ONCB and PNCB, for the last 5 years in the table given on page 28.

6. The querist has explained the difference in the input/output ratio between 1992-93 and 1993-94 onwards as below:

“The input/output ratio is more or less uniform from 1993-94 onwards, i.e., between 85% to 90%, the variations being not more than 5%. However, upto 1992-93 distillation of Eutectic oil was being carried out in batches and hence the output ratio was 65%.”

B.  Queries

7. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

(a)     Whether the present practice of valuing the Eutectic oil stock at the lower of cost and net realisable value of the end-products (ONCB/PNCB) by theoretically converting it into equivalent finished products is in order.

(b)     Whether the company can value the stock of Eutectic oil at cost since the Eutectic oil will have to undergo further processing to become marketable and the net realisable value of Eutectic oil in its present form cannot be ascertained.

C.  Points Considered by the Committee

8. The Committee notes that paragraph 6.1 of Accounting Standard (AS) 2, ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, defines the term ‘Inventories’ as follows:

“6.1   ‘Inventories’ means tangible property held

               (i)   for sale in the ordinary course of business, or

              (ii)   in the process of production for such sale, or

             (iii)   for consumption in the production of goods or services for sale, including maintenance supplies and consumables other than machinery spares.”

Thus, ‘inventories’ for purposes of AS 2 include work-in-process besides other forms of inventories.

9. The Committee notes that paragraph 24 of AS 2 states the following:

“24. Subject to the exceptions stated in paragraph 29.1 to 29.4, inventories should be valued at lower of historical cost and net realisable value.”

(The exceptions listed in paragraphs 29.1 to 29.4 are not relevant to the facts of the query).

10. The Committee also notes paragraph 6.9 of AS 2 reproduced below:

“6.9   Net realisable value is the actual/estimated selling price in the ordinary course of business, less cost of completion and cost necessarily to be incurred in order to make the sale.”

D.  Opinion

11. On the basis of the above, the Committee is of the following opinion on the queries raised:

(a)     The stock of Eutectic oil should be valued at cost or net realisable value whichever is lower. In determining the net realisable value, the estimated costs of further processing and marketing the finished products (ONCB/PNCB) will have to be deducted from their estimated selling prices.

(b)     No, the stock of Eutectic oil cannot be valued at cost. It should instead be valued as per the method mentioned in (a) above.

Valuation of inventory of eutectic oil by theoretically converting into ONCB & PNCB (existing policy)

(Values in Lacs)

Valuation of Inventory of Eutectic Oil on the basis of the changed policy

(Change in policy)

The readers are advised to refer to revised Accounting Standard (AS) 2, ‘Valuation of Inventories’ which has been issued subsequent to the finalisation of this opinion.

[1] Opinion finalised by the Committee on 13.8.1998.