Query No. 15 Subject: Cost formula to be used for valuation of inventories of catalyst. 1
A. Facts of the Case
1. A company is engaged in transmission, processing and marketing of natural gas. Besides sale to different customers, natural gas is also used internally by the company as a major raw material for the manufacture of LPG, polymers and other value added products and also as a fuel.
2. The query relates to applicability of paragraphs 14 and 16 of revised Accounting Standard (AS) 2, ‘Valuation of Inventories’, to a catalyst used by the company in its production process. Paragraph 14 of AS 2 requires the use of specific identification method in determining the cost of those items of inventories that are not ordinarily interchangeable. For other items of inventories, paragraph 16 of AS 2 requires the cost to be assigned using the first-in first-out (FIFO) or weighted average cost formula, as appropriate.
B. Query
3. The querist has sought the opinion of the Expert Advisory Committee on the issue whether specific identification method should be used in the case of items of inventories of a catalyst which can be used only in connection with the manufacture of a particular product and which is procured in different lots based on its consumption, or whether the cost should be assigned using FIFO or weighted average cost formula.
C. Points Considered by the Committee
4. AS 2 defines the term ‘inventories’ as follows (paragraph 3):
“Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services.”
The Committee presumes that the nature of the catalysts in question is such that it meets the above definition of the term ‘inventories’.
5. Paragraph 14 of AS 2 requires that “the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs”. Paragraph 15 of AS 2 notes that specific identification of costs is “an appropriate treatment for items that are segregated for a specific project, regardless of whether they have been purchased or produced. However, when there are large numbers of items of inventory which are ordinarily interchangeable, specific identification of costs is inappropriate since, in such circumstances, an enterprise could obtain predetermined effects on the net profit or loss for the period by selecting a particular method of ascertaining the items that remain in inventories". Paragraph 16 of AS 2 requires that the cost of inventories other than those dealt with in paragraph 14 of the Standard “should be assigned by using the first-in, first-out (FIFO), or weighted average cost formula. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition”.
D. Opinion
6. On the basis of the above, the Committee is of the opinion that the cost of different batches of catalyst that can be used interchangeably in the manufacturing process should be assigned using first-in, first-out (FIFO) or weighted average cost formula as is appropriate under the circumstances. For example, where catalyst is physically issued on a first-in, first-out basis (i.e., lots of the catalyst received first are issued to production first), FIFO formula should be used.
1Opinion finalised by the Committee on 22.4.2000. ________ |