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Query No. 37
Subject:
Valuation of
machinery and ship
equipments held for
installation on ships constructed under
contract.1
A. Facts of the
Case
1. A public
sector company is engaged in the business of construction
of ships and
ship repair activities
on contract basis.
The company has adopted
the following accounting
policy in respect
of valuation of inventory
consisting of machinery
and ship equipments
intended to be used for specific ships under
construction:
“Machinery and other
ship borne equipment
when installed are charged
to products at
actual cost and
the remaining uninstalled items are
taken in inventory
and valued at
actual cost. Ship machinery/equipments acquired for
installation exclusively on certain ships and not installed have been included
in inventory and valued at cost as per the accounting policy. No provision has been
made for reduction in value of the said items based on realisable values of the
respective ships for which they are intended.”
2. According to
the querist, the machinery and equipments are charged to consumption when
they are installed
on the ship.
The uninstalled machinery/equipments are shown in inventory at
actual cost as per the above accounting policy. Generally, the ship
building contracts are loss making and the unincurred estimated future losses
on such contracts are fully provided for
in the
accounts as per
Accounting Standard (AS) 7, ‘Accounting for Construction Contracts’.
3. As per
the querist, the
government auditors, during
the audit of accounts for the year 1999-2000, have pointed out that these
uninstalled machinery/equipments are to be shown at net realisable value (as if
these equipments are installed on the ship) based on the percentage of
realisation arrived at for a specific ship under construction.
4. The company
is of the
view that the
valuation of machinery
and equipments which are
in inventory and
not yet installed
on the ship, should not be based on the estimated
realisable value of the ship under construction. The total loss estimated on
completion of the ship including ship equipments has already been provided
under “Provision for Future Losses”.
Hence, the reduction
in value of
machinery and equipments before completion of the specified
ship may not be proper. According to the querist, the disclosure of such items
of machinery and ship equipments at actual/market value
under the head
‘inventories’ would be
a better presentation.
Hence, the provisions
of Accounting Standard
(AS) 2 (revised), ‘Valuation of Inventories’, are fully complied
with.
B. Queries
5. The querist
has sought the opinion of the Expert Advisory Committee on the following
issues:
(a) Whether the
treatment adopted by the company in respect of valuation of machinery and
ship equipments and
calculation of future losses is correct.
(b) Whether by adopting the above treatment, the company is complying with AS 2.
(c) If not so, whether any change is required in the accounting policy of the company and
disclosure thereof.
C. Points
considered by the Committee
6. The
Committee notes that paragraph 1(a) of AS 2 states as below:
“1. This
Statement should be applied in accounting for inventories other than:
(a) work in
progress arising under
construction contracts, includi
ng directly related
service contract s (see Accounting Standard (AS) 7, Accounting
for Construction Contracts)” .
7. The
Committee notes from the facts of the case that the inventory of machinery and
ship equipments is intended to be used for specific ships under construction. The Committee is of the view that if any
inventory of machinery and ship
equipment can be
used only in connection with a
specific ship under
construction and it
is intended to
be used in
that specific ship under construction, its cost should be added to the
cost of the work-in-progress of the ship under
construction. The Committee is
accordingly, of the
view that for
the purpose of
valuation of the
said machinery and ship equipments provisions of AS 7 and not AS 2 would
apply.
8. The
Committee is of the view that work-in-progress of the contracts which are
expected to result
into loss on
an overall basis,
should be valued by derating the
cost incurred on the contract to date, to its estimated realisable value.
9. The
Committee is of the view that once the cost of machinery and ship equipments
is added to
the cost of
work-in-progress of the
ship under construction and
the cost of
work-in-progress is derated
as per paragraph 8 above, the foreseeable
losses on the contract to be provided for should not include the amount of loss
already recognised by way of derating of work-in-progress.
D. Opinion
10. On the basis of
the above, the Committee is of the following opinion on the issues raised in
paragraph 5:
(a) The cost of
machinery and ship equipments, that can be used only in connection with a specific
ship under construction and
is intended to be used in that specific ship, should be
added to the cost of
work-in-progress of the
ship under construction. The valuation of
work-in-progress of the contracts which are expected to
result into loss
on an overall
basis, should be made by derating the cost incurred on the
contract to date, to its estimated realisable
value. The company
should provide for the
foreseeable losses as per paragraph 9 above.
(b) The provisions
of AS 7
and not AS
2 would apply
for the purpose of
valuation of inventory
of machinery and
ship equipments that can be used only in connection with a specific
ship under construction
and is intended
to be used
in that specific ship under
construction.
(c) Refer to
paragraph (a) above.
1Opinion finalised
by the Committee on 28.9.2001.
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