Query No. 7 Subject: Whether demurrage paid should form part of cost of inventory.1 A. Facts of the Case
1. A public sector company is engaged in refining, transportation and sale of petroleum products. The crude oil for the purpose of refining is sourced both indigenously and through imports. For the purpose of valuation of inventory of imported crude oil, the company considers the following cost elements:-
(a) FOB/C&F value;
(b) marine freight;
(c) marine insurance;
(d) port charges (including wharfage); and
(e) other landing charges.
2. All the storage locations including the cross-country pipelines are under bond and customs duty is paid by the company only at the time of actual processing of crude by refineries. Hence, the company is not adding customs duty element while valuing the inventory of imported crude.
3. Apart from the above, demurrage is also incurred on imported crude oil. Demurrage represents payment made for detention of crude oil tankers at discharge location for a period more than the period agreed with the supplier/transporter. In case of imports on C&F basis, demurrage is payable to the supplier of the crude oil and in case of FOB contracts, the same is payable to the transporter. The querist has stated the reasons for incidence of demurrage as follows:
(i) The company is the canalising agent for import of crude oil and petroleum products for other public sector oil companies as well. Generally, consignments of crude oil are shared among the refineries including the refineries belonging to other oil companies. In view of this, crude oil tanker has to call on more than one port resulting in detention of the tanker for a longer period of time.
(ii) Some ports do not have adequate facilities to berth large vessels due to draught restrictions, necessitating lighterage of crude from large vessels to smaller vessels. This results in detention of tanker for a longer period.
(iii) Sometimes, more than one tanker calls on a port simultaneously. In such a situation while one tanker is discharging the crude, the others have to wait, resulting in incidence of demurrage on vessels so waiting.
(iv) Sometimes, the discharge locations are not able to take delivery of the crude from the tanker due to some technical problems. One such usual problem is the absence of storage space to accommodate the crude. This leads to incidence of demurrage.
4. As per the querist, for the purpose of valuation of inventory, the demurrage payments are not considered on the basis that the same do not occur regularly for all consignments and also that such payments do not add value.
5.During the course of statutory audit for the year 1998-99, a query arose as to whether demurrage should form part of cost of crude oil.
6. The querist has stated that the refining sector has been deregulated w.e.f. 1.4.1998. During the period of administrative pricing mechanism, prevalent for refineries upto 31.3.1998, demurrage on imported crude oil was directly reimbursed by the Oil Pool and hence the same was not forming part of cost of crude oil in the books of refineries.
B. Query
7. The opinion of the Expert Advisory Committee has been sought on the issue whether demurrage should be considered as an element of cost for the purpose of valuation of inventory of imported crude oil, or whether it should be charged off to revenue in the year of incurrence.
C. Points Considered by the Committee
8. The Committee notes that its opinion has been sought only on the issue whether demurrage paid by the company should form part of the cost of inventory of crude oil. The Committee, however, notes that the company is not providing for the customs duty liability in respect of crude oil under bond. Even though the querist has not raised any query as to the treatment of such customs duty liability, the Committee wishes to draw the attention of the querist to an earlier opinion issued by it on this subject (Query No.1.11, Compendium of Opinions, Volume X). According to the aforesaid opinion:
(a) an enterprise should ordinarily provide for the customs duty liability for goods lying in the bonded warehouse; and
(b) an enterprise should provide for the customs duty liability for goods awaiting clearance at the port notwithstanding whether the bills of entry have been filed or not.
9. The Committee notes that paragraphs 6 and 7 of the revised Accounting Standard (AS) 2, ‘Valuation of Inventories’, state as below:
“6. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.
7. The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase.”
10. Paragraph 13 of AS 2 states as below:
“13. In determining the cost of inventories in accordance with paragraph 6, it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred. Examples of such costs are:
(a) abnormal amounts of wasted materials, labour, or other production costs; .........”
Thus, AS 2 recognises that abnormal losses (wasted materials, labour, or other production costs) do not form part of cost of inventories. Considering the nature of demurrage, the Committee is of the view that as a general rule, demurrage would represent an abnormal loss. However, the Committee also recognises that the incurrence of demurrage may sometimes represent a normal cost considering the specific facts and circumstances of the particular case. Further, in some cases, the incidence of demurrage may be directly related to a reduction in other costs which, if incurred, would qualify for inclusion in the cost of inventories. For example, an enterprise may, on cost-benefit considerations, take a conscious decision to bear demurrage rather than hire additional storage space. Accordingly, the Committee is of the view that if it can be clearly demonstrated that demurage represents a normal cost under the specific facts and circumstances of a case, it should be included in the cost of inventories; otherwise, it should be expensed in the year of incurrence.
11. Based on the above, the Committee is of the view that the issue whether, in the case of the company, demurrage represents an abnormal loss or a normal cost would have to be determined considering the specific facts and circumstances under which it is incurred.
D. Opinion
12. On the basis of the above, the Committee is of the opinion that as a general rule, demurrage would represent an abnormal loss. However, it may sometimes represent a normal cost considering the specific facts and circumstances of the particular case. The Committee is of the opinion that if it can be clearly demonstrated that demurrage represents a normal cost considering the specific facts and circumstances under which it is incurred, it should be included in the cost of inventories; otherwise, it should be expensed in the year of incurrence.
|