Query No. 19
Subject:
Valuation
of stock of coal used as fuel for power generation.1
A. Facts of the
Case
1. A public
sector company was registered as a company in the year
1975 under the Companies Act, 1956. The company is a
Government of
India undertaking.
One of the
objectives of the
company is to
set up thermal power plants at
various geographical locations in the country and to supply bulk power to various State Electricity Boards.
The company, being an electricity generating company, is governed by the
provisions of the Electricity (Supply)
Act, 1948. According
to the querist,
since the Government has not
prescribed any specific formats for the statement of accounts for the central
undertakings engaged in generation of electricity, the company is preparing its
accounts in the format prescribed in Schedule VI to
the Companies Act,
1956. These accounting
formats have been adopted by the company since its
inception and have been accepted by various audit agencies.
2. The terms
and conditions and tariff for sale of energy by the company, consequent upon
promulgation of the Electricity Regulatory Commissions Act, 1998, are regulated
by the Central Electricity Regulatory Commission. The tariff for sale of energy
comprises two parts, i.e., fixed charges and variable charges.
Fixed charges are
in the nature
of capacity charges payable per annum towards operation
and maintenance costs, depreciation, interest
on loan/working capital
and return on
equity for operation
at specified levels. Variable charges are fuel charges applicable for
energy sold which are
arrived at on
the basis of
various operating parameters and
fuel cost, with a provision for adjustment on account of variations in
calorific value and price of fuel.
3. The company
operates coal based power plants at various locations either near the coal
mines (called Pit Head Stations) or away from the source of
coal (called Non-Pit
Head Stations). The
Pit Head Stations have
their own circular
railway track (called
merry-go-round or MGR system) for transportation of coal from
the loading point of the mine to the power
plant. Coal in case
of Pit Head Stations
is transported from delivery
point to the station premises using the company’s own rolling stock. In the
case of Non-Pit Head Stations coal is transported through Railways. The coal
received at the power plant through MGR system or railways, is unloaded in the
track hopper. Further handling of coal within the plant is done by conveyor
belts. The coal is conveyed to a crusher house for crushing up to a size of 25
mm and the crushed coal is conveyed
to the coal mills for pulverisation and firing in the
boilers. Crushed coal exceeding the immediate operational requirement is stored
in the stockyard.
4. The company
has valued the coal at purchase price including taxes and duties, cess,
royalties, surface transportation charges at the mine end, railway freight and
unloading cost, if any, upto the power plant end. The
weighted average cost method for pricing of coal is followed
for valuation of issues for consumption and closing stock.
5. During the
audit of accounts
of the company
for the year
1999-2000, the statutory
auditors expressed the
view that according
to the requirement of
paragraph 6 of
Accounting Standard (AS)
2 (revised),‘Valuation of Inventories’,
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. They were
further
of the view
that the value
of crushed coal
included in the
inventories should also include
all costs relating
to MGR (where
it exists), coal handling plants, etc.
6. According to
the querist, the
company is of
the view that
the procedure followed by the
company for valuation
of coal stock
is in compliance with paragraph 6
of AS 2 (revised). The company includes in the
value of coal,
the purchase price
of coal, taxes
and duties, cess, royalties, surface transportation
charges at mine end, freight and handling charges up to the point of unloading,
i.e., the track hopper at the power station end. Thus, the total cost of
purchase of coal is taken into account. The movement of crushed coal from the
track hopper to the stockyard is
in the nature of shifting the material within the plant for
storage and it will not be correct to add any cost on this account to the
inventory.
7. The company
is further of the view
that costs of
conversion as stipulated in AS 2
(revised) are costs incurred in converting material into work-in-progress or
finished goods. Coal for a power station is not a raw material, since
no part of
it is included
in its finished
product, i.e., electricity. It is
a fuel used for generation of electricity and is thus in the nature of a
consumable. Coal is crushed and then pulverised to facilitate its burning in
the boiler. Neither any value addition in terms of calorific value is
made to coal
on crushing, nor
is there any
change in its
net realisable value on
account thereof. In
view of this,
it will not be
appropriate to load other elements of overheads in the cost of inventory
of coal. Such loading of overheads is more appropriate in
valuation of work-in-progress in a process industry or manufacturing industry,
where raw material undergoes
value addition at
successive stages before conversion into finished material.
8. According to
the querist, it is pertinent to mention that in the pricing mechanism governing
the tariff for sale of energy, recovery towards fuel charges does not provide
for any crushing costs or other overheads. In
case costs relating
to MGR (where
it exists)/coal handling
plant are allocated and included in
the value of coal on the premise that these are costs of conversion, it would
lead to overstatement of the value of coal because the
net realisable value
of the stock
in the form
of variable charges would be less
than cost so calculated. This
would be in direct contravention of AS 2.
Further, recovery of
depreciation and other overheads is made through fixed charges
and is also on annual basis. If a part of these are allocated to the stocks of
coal for valuation, it would lead
to overstatement of
profits in the
first year and
overstatement/ understatement in subsequent years. As per the querist,
in order to avoid such a situation
if the revenues
are adjusted to
that extent, it may
contravene Accounting Standard (AS) 9, ‘Revenue Recognition’.
B. Query
9. The querist
has sought the opinion of the Expert Advisory Committee on the issue whether in
view of the facts and circumstances, the company should consider the costs
relating to Merry-Go-Round System and coal handling plant for valuation of
inventories of coal.
C. Points
considered by the Committee
10. The Committee
has considered only the question relating to valuation
of inventory of
coal at stockyard
and has not
addressed any other accounting issue that may be contained
in the facts of the case.
11. The Committee
notes that the term inventories is defined by AS 2
(revised) as follows:
“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.”
12. The Committee
is of the
view that as
per the above
definition, inventories also include
consumables held for
consumption in the production process. Since coal is also a
consumable held for consumption in the production of electricity, requirements of AS 2
(revised) also apply to its valuation.
13. The Committee
notes that paragraph 6 of AS 2 (revised) provides 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.”
14. The Committee is
of the view that although coal is not of the nature
of raw material
to be converted
into work-in-progress and
then into finished product, yet
costs incurred to change the location of coal from one place to another even
within the plant and to change its condition to crushed coal
should be included
in inventory of
coal at the
stockyard. Thus, as the costs relating to Merry-Go-Round system and coal
handling plant are incurred to bring the coal to its present location and
condition at the coal stockyard, the same should be included in the
cost for valuation of coal inventories.
15. The Committee
also notes that
paragraph 24 of
AS 2 (revised)
provides as below:
“24. Materials and
other supplies held for use in the production of inventories are not written
down below cost if the finished products in which they
will be incorporated
are expected to
be sold at or
above cost. However, when there has been a decline in the price of materials
and it is estimated that the cost of the finished products will exceed net
realisable value, the materials are written down to net realisable value. In
such circumstances, the replacement cost of the materials may be the best
available measure of their net realisable value.”
16. On the basis of
the above, the Committee is of the view that value
of the inventory
of coal in
the coal stockyard
should be written
down below costs only if (a) the net realisable value on sale of electricity
is expected to be below the cost of producing the electricity, and (b) there is a decline in the price (replacement cost) of the coal. Thus,
in the view of the Committee, the fact
that the costs of
MGR/coal handling plant are not included as part of variable charges
for the purpose of tariff fixation of electricity, is not
of relevance to
determine the cost of
inventory of coal for the purpose of preparation of financial statements. In case the net
realisable value of electricity exceeds its cost of generation calculated from
the accounting point
of view and
the price (replacement
cost) of coal has not declined,
valuing inventories of coal at the coal stockyard at cost inclusive of
costs of MGR/coal
handling plant would
not be in contravention of AS 2.
D. Opinion
17. On the basis of
the above, the Committee is of the opinion that the company should
include the costs
relating to Merry-Go-Round system and
coal handling plant
for the purpose
of determining the
cost of inventories of coal at
the coal stockyard.
1 Opinion finalised
by the Committee on 26.5.2001.