Query No. 16

Subject:         

   Excise duty liability in respect of inventories.¹

A. Facts of the Case

1. A government company refines crude oil and manufactures a wide range of petroleum and petrochemical products.

2. According  to  the  querist,  as  per  the  revised  Accounting  Standard (AS)  2,  ‘Valuation  of  Inventories’,  read  with  the  ‘Guidance  Note  on Accounting  Treatment  for  Excise  Duty’,  issued  by  the  Institute  of Chartered Accountants of India, the following position emerges:

(i) Excise duty liability arises as soon as the manufacturing process is  completed,  even  though  its  payment/collection  is  deferred till the time the product is actually cleared from the factory/ warehouse.

 

(ii) Excise duty liability on finished products is to be considered as a manufacturing expense and as such to be considered as an element of cost for inventory valuation.

 

(iii)   Wherever the liability of excise duty has been incurred, but its payment is deferred, provision for the unpaid liability is to be made.

3. The company clears products from the refinery partly on payment of excise duty and partly without payment of duty either as warehouse to warehouse  removal  as  provided  for  under  Chapter  VII  of  the  Central Excise  Rules,  1944,  or  as  clearance  totally  exempted  from duty  under specific  exemption  notification  subject  to  satisfaction  of  specified conditions like clearance for defence, for fertiliser manufacture, etc. The year-end inventory of finished products of the company may fall in any of the following categories:

(a) Quantity  subsequently  removed  to  customers/oil  marketing companies  on  payment  of  duty.  In  this  case,  the  excise  duty liability at the time of subsequent removal is discharged by the company.

 

(b) Quantity subsequently removed without payment of duty, for export out of India . In this case, no duty is payable if conditions for export are fulfilled. The company is liable to pay duty only if the goods cleared for export are not fully exported.

 

(c) Quantity  subsequently  removed  without  payment  of  duty, availing  benefit  of  exemption  from  duty  based  on  end-use, e.g., clearance  for use  in fertiliser  manufacture. In  this case, neither the company nor the recipient customer is liable to pay any duty. The customer, however, will be liable to pay duty, in case the end-use conditions are not satisfied/cleared goods are not fully accounted for.

 

(d)  Quantity subsequently removed to installations of Oil Marketing Companies (OMCs), without payment of duty by the company under warehousing procedure provided for under Chapter VII of Central Excise Rules, 1944. In this case, no duty is payable by the company at the time of removal from the refinery; the recipient  Oil  Marketing  Company  is  to  discharge  the  duty liability as and when the product received from the company is  subsequently cleared  from their  installation.  However,  the company is liable to discharge excise duty liability on transit loss involved in the movement of the product from the company to  the  OMC  installation,  subject  to  the  loss  exceeding condonable limits as prescribed by the Department.

4. According  to  the  querist,  while  the  requirement  for  provision  for unpaid excise duty liability and its inclusion in inventory valuation can be adhered to for stock falling under category (a), the following problems arise in the remaining cases:

(i) For category (b) and category (c) stock, there will be no liability to pay any excise duty by the company, if the goods are duly exported or the procedure prescribed for effecting the clearance is adhered to, as the case may be. As such, no provision can be made by the company for unpaid excise duty liability since no such liability exists. It automatically follows that it may not be appropriate to include excise duty element in the valuation of the stock falling under these categories.

 

(ii)  For category (d) stock, even though the excise duty liability is considered to have arisen once the manufacture is completed,it cannot be considered as an expense incurred by the company.Once  the  goods  are  re-warehoused  at  the  recipient  OMC’s installation, the liability gets shifted to the recipient company. Thereafter, this liability is not to be and cannot be discharged by  the  company.  Under  these  circumstances,  this  liability,  if provided  for  as  unpaid  expense  by  the  company,  will  be disallowed by income tax authorities under section 43B while computing the taxable income. As per the querist, this problem is peculiar to petroleum products, which are the only products eligible for  the warehousing procedure under  Central Excise Rules at present.

5. The company has suggested adoption of the following methodology which, according to the querist, will satisfy the requirements of revised AS 2 and the Guidance Note:

(a)  Unpaid excise duty liability to be provided for and included in stock valuation, only in respect of stock falling under category (a).

 

(b)  In  respect  of  stock  falling  under  category  (b),  wherever completion of export formalities are pending, the appropriate amount to be disclosed as contingent liability.

 

(c)  In respect of stock falling under category (c), no provision to be made for unpaid liability, nor any amount towards excise duty to be included in valuation of inventory.

 

(d)  In respect of stock falling under category (d), no provision to be made for any unpaid liability nor any amount towards excise duty  to  be  included  in  valuation  of  inventory.  In  respect  of inventory  for  which  re-warehousing  particulars  are  not available, an appropriate amount to be disclosed as contingent liability.

 

(e)  Segregation of inventory as on the balance sheet date and the estimate of such unpaid excise duty liability on stock on the above lines to be made on a reasonable basis after taking into consideration the pattern of sales/removals including the pattern of removals after the balance sheet date out of stock held on the balance sheet date to the extent possible.

B. Query

6. The querist has sought the opinion of the Expert Advisory Committee as to whether the accounting treatment of excise duty on year-end stocks of finished products as stated in paragraph 5 above is correct in the light of  acceptable  accounting  treatment  for  excise  duty  and  the  mandatory AS 2.

C. Points considered by the Committee

7. The Committee notes that the issue raised in the query relates to the provision  for  excise  duty.  The  Committee  has  not  touched  upon  any other  issue,  e.g.,  whether  the  excise  duty  liability  will  be  that  of  the company or of any other party as the Committee is prohibited to answer queries involving pure interpretation of law as per rule 2 of the Advisory Service Rules.

8. The Committee notes paragraphs 18 and 19 of the ‘Guidance Note on Accounting Treatment For Excise Duty’ which state as below:

“18. Since the liability for excise duty arises when the manufacture of the goods is completed, it is necessary to create a provision for liability  of  unpaid  excise  duty  on  stocks  lying  in  the  factory  or bonded warehouse. It is true that the recovery of the duty is deferred till the goods are removed from the factory or the bonded warehouse and the exact quantification will, therefore, be at the time of removal and that estimate of duty made on balance sheet date may change on account of subsequent events, e.g., change in the rate of duty and exports under bond. But, this is true of many other items also, e.g., provision for gratuity and this cannot be an argument for not making a provision for existing liability on estimated basis.

19. The estimate of such liability can be made at the rates in force on the balance sheet date. For this purpose, other factors affecting liability should also be considered, e.g., exemptions being availed by the enterprise, pattern of sales – export, domestic, etc. Thus, if a small scale undertaking is availing the benefit of exemption allowed in  a  particular  financial  year  and  declares  that  it  wishes  to  avail such exemption during next financial year also, excise duty liability should be calculated after taking into consideration the availability of  exemption  under  the  relevant  notification.  Similarly,  if  an enterprise  is  captively  consuming  all  its  production  of  a  specific product and has been availing of exemption from payment of duty on  that  product,  no  provision  for  excise  duty  may  be  required  in respect  of  non-duty  paid  stock  of  that  product  lying  in  factory  or bonded  warehouse.  An  auditor  must,  however,  apply  appropriate audit tests while verifying statements and declarations made by an enterprise in this regard.”

9. From the above, the Committee notes that the excise duty paid or payable on the finished goods inventories should be included in inventory valuation. In the estimation of the provision required for the purpose, the Committee is of the view that the factors stated in paragraph 19 of the Guidance  Note  reproduced  above  should  be  considered.  In  respect  of year-end inventories, factors such as whether the finished goods lying in stock in  the  current  year  would  form part  of  the  exempted  goods  next year and whether the exemptions will continue in the next year should also be considered. Thus, apart from any other relevant factor, in case it is stipulated that the finished goods in stock will continue to be exempted from the  payment of excise  duty, no  provision for excise  duty payable may be made. Due consideration should be given to the events occurring after the balance sheet date in the estimation of liability for excise duty on year-end inventories and inventories that have been removed from the factory  without  payment  of  excise  duty  although  the  liability  in  this regard remains with the company under certain circumstances.

10. With regard to category (a) of paragraph 3 above, the Committee is of the view that since the inventory of finished products is to be removed to  customers/oil  marketing companies  on payment  of  duty,  a  provision for unpaid excise duty on stocks lying in the factory or bonded warehouse should be made.

11. With  regard  to  categories  (b)  and  (d)  of  paragraph  3  above,  the Committee is of the view that the excise duty liability should be estimated keeping  in  view  the  factors  stated  in  paragraph  9  above.  Where  it  is probable  that  such  a  liability  would  arise,  a  provision  in  this  regard should be made. For instance, in respect of inventories of category 3(b), the  company should estimate,  as  on  the  balance  sheet date,  keeping in view the past experience and the aforesaid factors, the extent to which the exports will materialise. To that extent, the liability for excise duty should not be provided for, but in respect of remaining inventories in this category, liability should be provided for. The same manner of estimation should be followed in case of category 3(d) items also. The Committee is of the view that  in the aforesaid cases, the uncertainties  are not of the nature which characterise a contingency as the estimates suggested to be made aforesaid are in respect of on-going and recurring activities of the company, i.e., exports and removals to Oil Marketing Companies. In this context,  the  Committee  notes  the  following  paragraph  of  Accounting Standard (AS) 4, ‘Contingencies and Events Occurring After the Balance Sheet Date’, issued by the Institute of Chartered Accountants of India:

“4.2  Estimates are required for determining the amounts to be stated in the financial statements for many on-going and recurring activities of an enterprise. One must, however, distinguish between an event which is certain and one which is uncertain. The fact that an estimate is involved does not, of itself, create the type of uncertainty which characterises a contingency. For example, the fact that estimates of useful  life  are  used  to  determine  depreciation,  does  not  make depreciation a contingency; the eventual expiry of the useful life of the asset is not uncertain. Also, amounts owed for services received are not contingencies as defined in paragraph 3.1, even though the amounts  may  have  been  estimated,  as  there  is  nothing  uncertain about the fact that these obligations have been incurred.”

12. With regard to category (c) of paragraph 3 above, the Committee is of the view that, keeping in view the factors stated in paragraph 9 above, the company should estimate the extent to which the finished products lying  in  inventory  would  be  exempted  from  payment  of  excise  duty based on the end-use, e.g., clearance for use in manufacture of fertiliser. To that extent, provision for excise duty should not be made.

D. Opinion

13. On the basis of the above, the Committee is of the opinion that in respect  of  categories  of  inventories  stated  in  paragraph  3  above,  the company should make a provision for excise duty liability in accordance with paragraph 10 for category (a), paragraph 11 for categories (b) and (d) and paragraph 12 for category (c) of inventory of finished goods.

¹ Opinion finalised by the Committee on 26.5.2001