A. Facts of the Case
1. A company, whose entire equity share capital is held by a
State Government, purchases Indian made foreign liquor (IMFL)
and beer and sells the same through retail vending shops run by
it. It has also run bars during the year 2003-04, and from February
2004 the right to sell eatables and collection of empty bottles in
the bars attached to the retail shops has been leased to private
persons.
2. The company sold IMFL and beer to the customers, some of
whom consumed them in the bars run by it. While leaving the bar,
the consumers left the empty bottles in the bars and the company
came into the possession of these empty bottles. These empty
bottles are disposed off by the company. The company has laid
down detailed procedures for the maintenance of records, tenders
to be called for the disposal of empty bottles, etc.
3. During the year ended 31.3.2004, when the company was
running the bars, the stock of empty bottles had been brought into
accounts as closing stock in the profit and loss account at net
realisable value and had been disclosed as inventories in the
balance sheet as on 31.3.2004. With regard to this stock of empty
bottles remaining unsold, the company is following this accounting
policy consistently and has disclosed the value of stock of empty
bottles remaining unsold as on the date of balance sheet as closing
stock as on 31.03.2005 and 31.03.2006.
4. The querist has informed that the C&AG is of the opinion that
the stock of empty bottles is not the property of the company since
it sold IMFL and beer and the sale proceeds include the price for
empty bottles of IMFL and beer also. Hence, the company is not
the legal owner of the empty bottles. As per the querist, the C&AG
contends that this stock of empty bottles should not be brought
into the books of account as an asset and should be disclosed by
way of notes. The C&AG further contends that even if the stock of
empty bottles is brought into the books as an asset, it should be
shown as stock suspense on the liabilities side and should be
accounted for as income only when such stock is sold (emphasis
supplied by the querist).
5. In this connection, the querist has stated that as per paragraph
49 of the ‘Framework for the Preparation and Presentation of
Financial Statements’, issued by the Institute of Chartered
Accountants of India, an asset has been defined as follows:
“(a) An asset is a resource controlled by the enterprise as a
result of past events from which future economic benefits
are expected to flow to the enterprise.”
6. The querist has further stated that as per paragraph 17 of
Accounting Standard (AS) 1, ‘Disclosure of Accounting Policies’,
issued by the Institute of Chartered Accountants of India, one of
the major considerations governing the selection and application
of accounting policies is as under:
“b. Substance over Form
The accounting treatment and presentation in financial
statements of transactions and events should be governed by
their substance and not merely by the legal form.”
7. On the basis of paragraphs 5 and 6 above, the querist has
submitted that, in substance, the stock of empty bottles belongs to
the company since it is a resource controlled by the company
arising out of past events and from which future economic benefits
are expected to flow to the company.
8. The querist has further reproduced the definition of income as
per paragraph 69 of the ‘Framework for the Preparation and
Presentation of Financial Statements’, issued by the Institute of
Chartered Accountants of India, as below:
“(a) Income is increase in economic benefits during the
accounting period in the form of inflows or enhancements
of assets or decreases of liabilities that result in increases
in equity, other than those relating to contributions from
equity participants.”
According to the querist, in other words, if an event results in
an enhancement of assets, it should be considered as increase in
economic benefits during the accounting period and treated as
income.
9. Considering the foregoing, the querist has stated that the
value of the stock of empty bottles as on the date of balance sheet
results in an increase in economic benefits during the accounting
period in the form of enhancements of assets and hence, the
value of stock of empty bottles should be considered as income as
per the above definition (emphasis supplied by the querist).
10. The relevant details and particulars for the accounting year
2005-06 for which the opinion is sought are furnished hereunder:
Rs. (in crore)
(a) Sales for the year 7314.66
(b) Stock of Empty Bottles as on 31.03.2006 1.24
(c) Net Profit for the year (after tax) 0.78
(after considering the stock of empty bottles)
11. The querist has provided a copy of the reply of the company
to the preliminary comments of the C&AG on the accounts for the
year 2004-05 for the perusal of the Committee. The relevant
paragraphs are reproduced below:
“10. Regarding the valuation of stock of empty bottles, the
cost of procuring the bottles in the bar can not be determined
with substantial accuracy and hence the stock of empty bottles
has been brought into accounts at estimated net realisable
value.” Querist has also referred to the opinion published at
page IV-8 of Volume IV of the Compendium of Opinions,
issued by the Expert Advisory Committee.
“18. As per Accounting Standard (AS) 5, ‘Net Profit or Loss
for the period, Prior Period Items and Changes in Accounting
Policies’, “Ordinary activities are any activities which are
undertaken by an enterprise as part of its business and
such related activities in which the enterprise engages in
furtherance of, incidental to, or arising from, these
activities”.”
“19. Hence, we wish to state that stock of empty bottles is
incidental to and in furtherance of and also arises out of
ordinary activities of the business of running bars as part of
the business of the company and any stock arising out of
carrying on any activity undertaken by the company as part of
the business can be considered as inventory. Hence, the stock
of empty bottles can also be considered as inventory and the
disclosures of the stock of empty bottles as inventory in the
profit and loss account and balance sheet are in accordance
with the Accounting Standards and the generally accepted
accounting principles.”
12. The querist has stated that for the various reasons/explanations
stated in the above paragraph,
(a) the stock of empty bottles has to be determined at net
realisable value, and
(b) the stock of empty bottles has to be disclosed as
inventories.
B. Query
13. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(a) Whether the stock of empty bottles is an asset of the
company.
(b) If so, whether the stock of empty bottles existing as on
the date of the balance sheet is to be considered as
inventories of the company.
(c) If the answer to (b) above is positive, whether the stock
of empty bottles existing as on the date of the balance
sheet is to be valued at net realisable value and
considered as income to be shown in the profit and loss
account or is to be considered as a stock suspense
account on the liabilities side of the balance sheet.
(d) If the answer to (a) above is in the negative, what would
be the accounting treatment to be given.
C. Points considered by the Committee
14. The Committee notes the definition of the term ‘asset’ as per
the ‘Framework for the Preparation and Presentation of Financial
Statements’, which has also been reproduced by the querist in
paragraph 5 above. The Committee also notes paragraph 51 of
the Framework that states as follows:
“51. In assessing whether an item meets the definition of an
asset, liability or equity, consideration needs to be given to its
underlying substance and economic reality and not merely its
legal form…”
15. Keeping in view the above and the facts of the case provided
by the querist, the Committee is of the view that the stock of
empty bottles is a resource controlled by the company arising out
of past events. The empty bottles left by the customers come into
the possession of the company during the course of running the
bars and though the customers are the legal owners of the empty
bottles, by leaving the bottles with the company after consuming
the contents thereof, the customers, in effect, waive their legal
rights. Having thus once come into the possession of the empty
bottles, according to the generally accepted accounting principle
of substance over form, the company has the control over the
future economic benefits that are expected to flow to it from the
sale of the empty bottles. In determining the existence of an asset,
the legal ownership of the asset is not essential; what is essential
is the economic ownership, i.e., the right to obtain the future
economic benefits flowing from the resource to the company. Thus,
the stock of empty bottles is an asset of the company.
16. The Committee notes the definition of the term ‘ordinary
activities’ as reproduced in paragraph 11 above. The Committee
also notes paragraph 3 of Accounting Standard (AS) 2, ‘Valuation
of Inventories’, that defines inventories 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.”
17. On the basis of the above, the Committee is of the view that
the stock of empty bottles falls within the meaning of the term
‘inventories’ as per AS 2, as the company holds the stock of empty
bottles for sale in its ordinary course of business of running bars.
18. The Committee notes paragraph 5 of AS 2 as reproduced
below:
“5. Inventories should be valued at the lower of cost
and net realisable value.”
19. In respect of the above, the Committee is of the view that the
practice of valuing the stock of empty bottles at net realisable
value in the absence of determination of the cost of procuring the
bottles with reasonable accuracy is not correct. According to AS 2,
the stock of empty bottles, which is the inventory of the company,
should be measured at the lower of its cost or net realisable value.
In the present case, it appears that the cost of purchase of IMFL
and beer is inclusive of the cost of bottles and the selling price
thereof is also not exclusive of the cost of bottles, because bottles
are the primary packing material without which their contents cannot
be sold in the type of sale activity described by the querist.
Accordingly, empty bottles do not appear to cost anything to the
company. In such a case, the generally accepted accounting
principles under historical cost accounting require that the asset
should be reflected at the nominal value of Re. 1. The Committee
is, therefore, of the view that if the cost of bottles is nil to the
company, the stock should be reflected at Re. 1. Further, since
the event of sale of empty bottles has not taken place on the
balance sheet date in respect of the bottles in stock, the income
recognition on that date would be inappropriate. Without examining
the appropriateness of the earlier opinion of the Committee referred
by the querist in paragraph 11 above, the Committee notes that
the facts and circumstances of that query are different from those
of the present query.
D. Opinion
20. On the basis of the above, the Committee is of the following
opinion on the issues raised in paragraph 13 above:
(a) The stock of empty bottles is an asset of the company
being a resource controlled by the company as a result
of past events from which future economic benefits are
expected to flow to it.
(b) The stock of empty bottles existing at the balance sheet
date is the inventory of the company.
(c) The stock of empty bottles should be valued at the lower
of cost and net realisable value. The same is not
considered as income. In case, the cost of empty bottles
is nil, as discussed in paragraph 19 above, the total
stock of bottles should be reflected at the nominal value
of Re.1.
(d) The correct accounting treatment of the stock of empty
bottles is as stated in (a), (b) and (c) above. No other
treatment is appropriate.
1 Opinion finalised by the Committee on 14.5.2007.
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