|
Query No. 21
Subject:
Valuation
of closing stock.1
A. Facts of the
Case
1. A public
sector company has operations spread all over
India. The company is in the
business of refining, transportation through pipelines and marketing of
petroleum products. All the
operations and pricing were under administrative control
upto 31.03.1998. From 1.04.1998, the government has started deregulating the oil
sector in a phased manner. To start with, the refinery operations have been
partially deregulated.
2. The finished
products are classified as controlled and decontrolled products. The five controlled products, viz., ATF,
HSD, MS,
SKO and LPG constitute about 70% of the
total sales. The prices of these controlled products are
fixed monthly by the
government on
the basis of
import parity. The company is
free to fix
the prices of
decontrolled products.
Accordingly, the
marketing operations for only the
controlled products have been
retained under Administered Pricing Mechanism (APM). The pipeline operations
are retained under the APM.
3. According to
the querist, as per the existing mechanism, the refineries have to bear the
actual cost of the raw material, i.e., crude oil. The price for indigenous
crude oil is fixed based on import parity on monthly basis. The refineries
transfer the finished products to the marketing operations
at Refinery Gate Price fixed on
monthly basis by the government. Due to steep
fluctuations in the prices of
crude oil and
finished products, the monthly prices thereof are fluctuating
over a wide range.
4. The refineries
are set up
near the market
far from the
ports. The
imported/indigenous crude oil is
transported up to the refineries through dedicated pipelines.
As a result,
substantial crude oil
stock is always blocked in
the pipelines. Separate tanks
are required for
each type of crude oil. The refineries are producing
wide range of products which are also transferred through pipelines and stored
product-wise in dedicated tanks. Due to operational reasons there is always
some stock which cannot be pumped and,
therefore, considered as
dead stock. The products are sourced from own/other refineries and
through imports.
5. The imported/indigenous crude
is transported through
the same pipeline in batches.
Therefore, the composition of the crude oil in pipelines changes from one
period to another. Similarly, in case of product pipelines, four to
five products are
transported in batches
and, therefore, the composition of the products in pipelines
also changes from one period to another. The prices of imported/indigenous crude and various
products are different.
6. According to
the querist, the stock in pipeline system and tanks is valued in
accordance with Accounting Standard
(AS) 2, ‘Valuation
of Inventories’, and the
company’s accounting policy
in this regard
is as under:
“Crude oil is valued at cost on First In
First Out basis”, and
“Finished
products are valued
at cost or
net realisable value, whichever is lower.”
On an annual basis, the increase/decrease in value of stock
is substantial due to steep fluctuations in the prices of crude oil and
finished products as the market thereof is volatile.
7. In view
of the strategic
requirement for storage
of crude oil
and finished products, additional tanks at refineries/marketing
locations have been constructed. These facilities are
not accounted for
separately. Therefore, the quantities stored are merged with the normal
storage and treated as normal inventory.
B. Queries
8. The querist
has sought the opinion of the Expert Advisory Committee on the following
issues:
(a) Whether the
stock in pipelines and dead stock in tanks can be capitalised. In case the
pipelines are not owned by the company, what treatment shall be given.
(b) Whether dead stock in tanks can be valued at fixed price
(freezed from the date of
implementation) and no changes be made for the changes in day-to-day prices.
(c) Whether the stock in pipelines, the composition of which changes from period to period, can be valued at standard cost
for each type of crude/products (freezed from the date of implementation) and no changes be made for
the changes in day-to-day prices.
(d) Whether the
increase/decrease in value of stocks due to changes in the respective prices
can be maintained as a reserve/deferred losses to be
adjusted against such increase/decrease in future or spread over a period of
3-5 years.
(e) Whether the
same treatment can be followed for valuation of inventories of raw materials as
well as finished products.
(f) Whether the quantities in strategic tanks can be valued at a fixed price (freezed from the date of implementation).
Whether the treatment should be different in case the quantity of the inventories is changing
frequently.
C. Points
considered by the Committee
9. The Committee
notes the definition
of the term
‘inventories’ as given in
AS 2 and
the definition of
the term ‘fixed
asset’ as given
in Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, which are
reproduced below:
AS 2
“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.”
AS 10
“Fixed asset is an asset held with the intention of being
used for the purpose of producing or providing goods or services and is not
held for sale in the normal course of business.”
10. The Committee is
of the view that the stock of crude oil in pipelines and dead
stock in tanks
is not held
for the purpose
of producing or providing
goods and services
as contemplated in
AS 10. The
stock of crude oil in pipelines
and tanks is held in the process of production, and the stock
of finished products
in pipelines and
the stock in
tanks of finished products
is meant for
sale in the
ordinary course of
business. Accordingly, the stocks
of crude
oil and finished products in
pipelines and in tanks
is an inventory
as per AS
2 and not
a fixed asset.
The Committee is, therefore, of the view that the stock in pipelines and
the stock in tanks cannot be capitalised as a fixed asset. The Committee is
further of the view that the nature of the stocks does not change by the change
in the ownership of the pipelines. Thus, the accounting treatment of the stocks would be the same
whether or not the company owns the pipelines.
11. The Committee
notes paragraphs 5 and 16 of AS 2 which provide as follows:
“5. Inventories should
be valued at the lower
of cost and
net realisable value.”
“16.
The cost of inventories, ....., 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.”
12. The Committee
notes from the above that the inventories should be valued at the lower of cost
and net realisable value. The Committee also notes that the accounting policy
of the company in respect of inventory
of crude oil is not in accordance
with the aforesaid requirements of AS 2. For the purpose of determination of
cost for inventory valuation, the cost should reflect the fairest possible
approximation to the cost incurred in bringing the items of inventory to their
present location and condition. The
Committee is, accordingly,
of the view
that valuing the
stock in pipelines and
dead stock in
tanks at a
fixed price irrespective
of the actual cost incurred is
not proper.
13. The Committee
also notes paragraph 18 of AS 2 which provides as follows:
“18. Techniques for the
measurement of the
cost of inventories, such as the standard cost method
or the retail method, may be used for convenience if the results
approximate the actual cost. Standard costs take into account normal levels of
consumption of
materials and supplies,
labour, efficiency and
capacity utilisation. They are regularly
reviewed and, if
necessary, revised in the light of current conditions.”
14. The Committee notes
from the above that the standard cost method may be used if the results by
using the method approximate the actual cost and in case this method is used
the standard cost should be regularly reviewed and, if necessary, revised in
the light of current conditions. The Committee
is, therefore, of
the view that
applying the standard
cost method without reviewing it regularly, is not proper.
15. The Committee is
of the view that the increase/decrease in the value
of stocks due to changes in prices
will get automatically adjusted in the statement of profit and loss.
Accordingly, creating a reserve/deferred loss account for adjusting the
differences in valuation of stocks due to change in prices is not proper.
16. The Committee is
also of the view that whether the stock is of raw materials or
of finished goods,
the requirements of
AS 2 have
to be followed.
17. The Committee is
further of the view that stocks in strategic tanks cannot be valued at a fixed
price even though the quantities are changing frequently.
D. Opinion
18. On the basis of
the above, the Committee is of the following opinion on the issues raised in
paragraph 8:
(a) The stock
in pipelines and
dead stock in
tanks cannot be capitalised as a fixed asset irrespective
of the ownership of the pipelines.
(b) The dead
stock in tanks cannot be valued at a fixed price.
(c) The stock in pipelines can be valued at standard cost if the
results approximate the actual cost. In case this method is used, the standard cost should be regularly reviewed and if
necessary, revised in the light of current conditions. It would not be proper
to adopt the same standard cost without changing
it or revising it in the light of
current conditions.
(d) The increase/decrease in the value of stocks cannot be maintained as a reserve/deferred loss.
(e) The provisions of AS 2 are applicable to valuation of inventories of raw materials as well as to finished products. Accordingly, the above views are applicable to valuation of inventories of both raw materials as well as finished products.
(f) The
inventories in strategic tanks cannot be valued at a fixed price. The treatment
would not be different even if the quantity of inventories is changing
frequently.
1Opinion finalised by the Committee on 26.5.2001.
|