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Query No. 7
Subject:
Allocation
of cost to joint products.1
A. Facts of the
Case
1. A public
sector company is engaged in the business of extraction of iron
ore/diamond/limestone from various mines in
India. The iron ore is mined, processed
and sold in
the form of
lump ore and
fine ore of different sizes, Ferrous (Fe) content,
etc.
2. As per the querist, Run of Mine (ROM) is the raw material extracted from the mine
comprising of Boulders
and Fines. ROM is
fed to the crushing plant to
get the required
size. The crushed
material is passed through the
screening plant for
separation/segregation into lumps
and fines. No further
costs are incurred
on the process
after the point
of separation. Based on the need
of specific customers,
the lump ore
is,sometimes,
processed to desired calibration and sold
as calibrated ore along with lumps and fines. The selling
prices of lump ore and fine ore are approximately in the proportion of 1.5:1
and generally based on size
(calibration), Fe content, chemical
composition, etc.
3. The production
quantities of lump
and fine ore,
for the last
five years, are given below:
Production
Year Lump Fines
Lakh M.T % Lakh M.T %
1995-96 7.51 54.20 65.49 45.80
1996-97 72.43 54.23 61.14 45.77
1997-98 76.94 52.36 70.01 47.64
1998-99 60.84 52.24 55.62 47.76
1999-2000 75.24 54.51 62.78 45.49
4. As per the querist, to arrive at
the production cost for the purpose of
valuation of closing stock of iron
ore, the company considers the following expenses which are related to
production:
(a) Raising
and transportation charges.
(b) Consumption
of Stores and Spares.
(c) Power.
(d) Payments and
benefits to employees.
(e) Repairs and
maintenance.
(f) Other
expenses related to production.
5. The company
has apportioned the
joint cost of
production, so determined, between
lump ore and
fine ore in
the proportion of the
quantity of each
type of ore
produced during the
accounting period consistently
over the years. Accordingly, the stocks of lump and fine ore lying unsold at
the end of the accounting period are valued at lower of cost of production
arrived at as above or net realisable value. The
following accounting policy has been disclosed in the notes to accounts with
respect
to valuation of finished goods,
i.e., lump ore and fine ore:
“Accounting Policy Items of inventories as certified by the management are
valued on the basis mentioned below:
Finished Goods – Iron
Ore At Cost or Net Realisable
Value
(Lump, Graded Ore & Fines) whichever is lower.”
6. The net realisable
value adopted by
the company for
the above purpose is the least
of the selling
prices for each
of the products
on conservative basis as
these products may be fetching
different selling prices from
different customers. The querist has
submitted details of selling prices applicable for the year
2000-01 enclosed as Annexure I.
7. The company
has given the following reasons for adopting the above method of joint cost
apportionment:
• The
production cost is attributable to lump and fines uniformly, as the process
involved in production of these products is the same and
no further processing
costs are incurred
after separation of each.
• There is
difference in selling prices of lump and fines (i)
for export and (ii) to different domestic customers.
• Product differentiation based on parameters such as size, chemical composition,
etc., fetch different selling prices.
• Apportionment of joint costs based on relative sales value would result in unwarranted loading of
cost on lump ore; and
• Any
apportionment of joint cost on the basis of realisable sale value may possibly lead to difficulties in fixing the relative selling prices.
8. The querist has also made reference to paragraph 10 of
Accounting Standard (AS) 2
(revised), ‘Valuation of
Inventories’, issued by the
Institute of Chartered Accountants of India, which, inter-alia,
states the following:
“10. A production
process may result
in more than
one product being produced
simultaneously. This is the case, for example, when joint products are produced
or when there is a main product and a by-product. When the costs of conversion
of each product are not separately identifiable, they are allocated between the
products on a
rational
and consistent basis.
The allocation may
be based, for example,
on the relative
sales value of
each product either
at the stage in the production
process when the products become separately identifiable, or at the completion
of production.”
According to the querist, as per
the above paragraph, when the costs of conversion of each product are not
separately identifiable, the common cost is allocated to the products on a
rational and consistent basis. As per the
querist,
AS 2 (revised)
suggests allocation based
on relative sale value of each of the products at
different stages as one of the acceptable methods as an example only and is
more relevant to process industry.
9. The querist is, therefore, of the view that the extant
procedure for allocation of costs being followed by the company consistently
over the years is quite
suitable to the
products of the
company under the circumstances explained above which
conforms to the rule of rationality and is considered to be in accordance with
AS 2 (revised).
10. During the
audit of accounts
of the company
for the year
1999-2000, the government auditors have commented that the
apportionment method of production cost followed by the company is not on the
basis
of the relative sale value of each product as envisaged in
(AS) 2 (revised) and consequently, the
closing stock of
finished goods is
understated/ overstated with a corresponding decrease/increase in profit
for the year.
11. In response to
the above, the
company informed the
government auditors that the relative sales value method of joint cost
apportionment indicated in paragraph 10 of AS 2 (revised) is only an example
and the method adopted by the company was in order.
B. Queries
12. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(a) Whether the
procedure/method being followed by the company for apportionment of
production cost between
lump ore and fine ore is in order.
(b) If the
procedure followed by the company for apportionment
is in order, whether adoption of
least of the selling prices for determination of net realisable value is also in order.
(c) If relative
sales value method is the only method that may be followed for apportionment of
joint costs then,
(i) how the relative
sale value is to be worked out based on selling price and the likely quantity
to be sold in the year
2000-01; and
(ii) which selling price/prices is/are to be considered for arriving at the
net realisable value for comparing with the cost for
the purpose of valuation of closing stock.
C. Points
considered by the Committee
13. The Committee
notes the relevant extracts from paragraph 10 of AS2 (revised) as
reproduced in paragraph
8 above. On the
basis of the paragraph, the Committee endorses the
view of the querist that as per AS2 (revised), cost of conversion of joint products, not
separately identifiable,is required to be allocated between
the products on a rational and consistent basis and that the relative sale
value method of apportionment is suggested by AS 2 only as an example.
14. The Committee is
of the view that rationality of a method should be determined keeping in view
the facts and circumstances of the case. For example, where a product is having
higher sales value for the reason of the superior material content, labour and overhead costs being the same, relatively higher
costs may be
required to be
allocated to the
product with higher sales
value. This is
because the superior
material content, which may carry
higher cost, may contribute towards higher sales value
of the product. In the present
case, since the material content of lump ore and fine ore is different, the
Committee is of the view that the relative sale values of the products along with
quantities produced, i.e., weighted average relative sales value may be the
more appropriate basis to allocate joint costs in this situation.
15. The Committee
notes that ‘net realisable value’ has been defined as
per AS 2 (revised) as below:
“Net realisable value is the
estimated selling price in the ordinary course
of business less
the estimated costs
of completion and
the estimated costs necessary to make the sale.”
16. The Committee is
of the view that net realisable value, as per AS 2(revised), is the estimated selling
price in ordinary course of business and not the least selling price. Such
selling price might be estimated for each product to be sold in different
market segments, viz., export and domestic, keeping in
view the orders
on hand, past
experience and such
other
relevant factors. Events occurring
after the balance sheet date may also be considered for the purpose.
D. Opinion
17. On the basis of
the above the Committee is of the following opinion on the issues raised in
paragraph 12:
(a) The procedur
e/method followed by
the company for apportionment of
the production cost
between lump ore
and fine ore may
not be appropriate.
In the present
case, the weighted average
relative sales value
method may be
more appropriate.
(b) The adoption
of least of the selling prices for determination of net realisable value is not in order.
(c) As stated in (a) above, the weighted average relative sales value method may be more appropriate. If the allocation of joint cost is to be made on weighted average relative sales value method in view of the factors mentioned in paragraph
14, the following may be considered:
(i) The sale values may be estimated using orders on hand, past
experience and such other relevant factors. Events occurring after the balance sheet date may also be considered for the purpose.
(ii) Selling price may be estimated for each product to be sold in different market segments, viz., export and domestic, keeping in view the orders on hand, past experience, etc.,
including the events occurring after the balance sheet date.
Annexure I
Party-wise Selling Prices and Sale Quantity for
the year 2000-01
Selling
Price Expected
(Rs. per
tonne) Sale Quantity(Lakh Tonnes)
Export Market
Bailadila Lump 392.61 25.00
Donimalai SHG-Lump 308.34 0.00
Donimalai Basic Lump 248.19 2.00
Donimalai JSM Lump (thro’ Chennai) 308.34 6.00
Donimalai JSM Lump (thro’ Goa) 245.94 2.00
Bailadila Fines 228.11 18.00
Donimalai JSM Fines (thro’ Goa) 180.96 19.00
Domestic Market
Bacheli Calibrated Lump 551.50 22.00
Kirandul Calibrated Lump 453.77 1.00
Bailadila Lump 381.50 15.00
Donimalai Lump 303.50 3.20
Bailadila Fines 315.50 60.50
Donimalai Fines 248.43 0.00
1
Opinion finalised by the Committee on
5.3.2001.
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