Query No. 23 Subject: Valuation of inventories to be sold at different selling prices.1 A. Facts of the Case
1. A public sector company wholly owned by a state government has the main objective of market intervention to control the prices of pulses, spices and other essential commodities in the open market in the state and ensure distribution of all essential commodities throughout the state. Other activities of the company are to act as wholesale ration dealer, running medical stores, marketing of tea, coffee, curry powders, etc. Special operations like onam fairs/markets, christmas fairs/markets are also conducted by the company during festival seasons. The company also keeps buffer stock of certain items (e.g., chillies). The state government allows grant to the company through budget allocations for these activities.
2. The company’s distribution network is as below: Suppliers
Depots
Retail Noon Feeding Authorised
Government Outlets (to schools) ration dealers Hospitals Societies and Jails
Maveli Stores (i.e. government Super Markets owned fair price shops) Public
Public Schools (Noon Feeding)
3. The pricing of the goods is done as below:
4. As per Accounting Standard (AS) 2, ‘Valuation of Inventories’ (revised), inventory should be valued at the lower of cost and net realisable value. As per the querist, considering the nature of business there are different schools of thought on how to value the inventory located at different points such as retail outlets, depots, buffer stocking godowns, etc. The different schools of thought are as follows:
(a) One school of thought is that the stock should be valued at the cost or lowest selling price whichever is less. The logic of this method is that the selling price of items which is usually fixed by the government is the ‘net realisable value’. As per the accounting standard the stock has to be valued at cost or net realisable value whichever is less. In this case selling price will normally be less than the cost and the market price as it is subsidised.
(b) Another school of thought is that the stock should be valued at cost or market value whichever is less. The logic of this method is that according to the matching principle, cost and revenue are matched in the year in which the revenue arises rather than the year in which the cost is incurred. If the stock is valued at the selling price at the close of the financial year, the entire loss incurred will be accounted for in that year rather than the year in which the revenue is realised. Further, if the selling price is increased in the next year, which is likely, there will be a profit during the next year for the same item.
(c) (i) Stock kept in depots and other stocking points should be valued at cost since the stock is meant for distribution through different channels.
(ii) Stock kept at retail outlets (maveli stores) should be valued at retail-selling price.
(iii) Stock kept at super markets should be valued at cost or selling price whichever is less.
B. Query
5. The querist has sought the opinion of the Expert Advisory Committee on the correct method of valuation of stock.
C. Points Considered by the Committee
6. The Committee notes that Accounting Standard (AS) 2, ‘Valuation of Inventories’, states that "inventories should be valued at the lower of cost and net realisable value" (paragraph 5). The Standard defines net realisable value as "the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale" (paragraph 3).
7. The Committee also notes paragraph 22 of AS 2 which states as below:
"22. Estimates of net realisable value are based on the most reliable evidence available at the time the estimates are made as to the amount the inventories are expected to realise. These estimates take into consideration fluctuations of price or cost directly relating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date."
8. From the above, the Committee is of the view that for the purpose of determination of net realisable value, it is necessary to consider the price at which the particular items of inventories are expected to be sold in the ordinary course of business. Therefore, in respect of inventories held by the company at various stocking points in the distribution network, the net realisable value should be determined considering the prices at which the inventories are likely to be sold through the respective channels. The net realisable value of respective inventories so arrived at should be compared with the cost of inventories and the lower of the two should be considered for valuation of inventories held at various stocking points in the respective channels.
9. In respect of the buffer stocks held in godowns, the Committee is of the view that an estimation should be made about the stocks likely to be directed to each channel of distribution in the subsequent year, on the basis of factors such as past experience, likelihood of sales, etc. Events occurring after the balance sheet date like actual channelisation and consequent sale of the inventories, should also be considered for this purpose. The net realisable value should be determined according to the principles enunciated in paragraph 8 above.
10. The Committee notes that in respect of sales through maveli stores, the loss on account of prices fixed below cost is compensated by the state government through budget allocation. The Committee is of the view that the net realisable value in this case would be based on the selling price fixed by the government. The government subsidy would be accounted for separately in accordance with Accounting Standard (AS) 12, ‘Accounting for Government Grants’, which provides that “government grants should not be recognised until there is reasonable assurance that (i) the enterprise will comply with the conditions attached to them, and (ii) the grants will be received” (paragraph 13). The Committee also notes paragraph 15 of AS 12 in this respect which states as under:
“15. Government grants related to revenue should be recognised on a systematic basis in the profit and loss statement over the periods necessary to match them with the related costs which they are intended to compensate. Such grants should either be shown separately under ‘other income’ or deducted in reporting the related expense.”
The Committee is of the view that since the subsidy received does not relate to the costs incurred, it should be recognised as ‘other income’ in the profit and loss account, provided the conditions stipulated in paragraph 13 of AS 12 are met.
D. Opinion
11. On the basis of the above, the Committee is of the opinion that the general rule of valuation of inventories at the lower of cost and net realisable value should be applied. The net realisable value for inventories held in stock at various stocking points should be determined on the basis of the estimated selling price that will be realised through the respective channels in the ordinary course of business. The loss compensated by the government in respect of sales through maveli stores should be accounted for in accordance with paragraph 10 above. The buffer stocks held in godowns should be valued in accordance with paragraph 9 above.
1Opinion finalised by the Committee on 8.8.2000. |
