A. Facts of the Case
1. A company has a turnover of Rs. 179 crore and is not listed
on a stock exchange. The company is engaged in the business of
manufacture and sale of conveyor belts. Two types of conveyor
belts are manufactured by the company, viz., steel and textile. The
company exports around 20 percent of its output of textile belts to
various countries. In respect of such exports, the company receives
export incentives that entitle the company to duty-free import of
input materials to replenish such materials that had been used for
manufacture of the exported belts. In fact, the export benefit
generally used by the company is in the form of Advance Licenses,
where the company is entitled to first, import duty free and export
later. But in the present case, the company is exporting first and
utilising those licenses afterwards. Textile (Industrial Fabric) is one
such input material, on which customs duty is around 16%.
2. The querist has informed that sufficient quantities of textiles
fulfilling the quality requirements are not readily available in the
international market and hence, the company had to purchase a
large quantity of its textiles requirements from the domestic market.
The domestic prices of such textiles (‘Domestic Price’) are generally
higher than the landed cost of imported textiles on which customs
duty has been paid (‘Duty Paid Landed Cost’) and, obviously, the
duty free import price is further lower.
3. The company has also entered into an arrangement with a
domestic textile supplier. Under the terms of the arrangement, the
company transfers its import entitlements of textile to the supplier
and receives equivalent quantities of textile at a price (‘Deemed
Export Price’) that is lower than the landed cost of duty free imported
textiles (‘Duty Free Landed Cost’).
4. The period-end unused licenses in hand represent the
entitlement to replenish inputs used in the manufacture of exported
belts through duty free import of such inputs or purchase of such
inputs from the domestic market on deemed export basis. This
benefit is given to exporters under the existing Export-Import (EXIM)
policy since duty free inputs (either by way of imports or purchase
from domestic market on deemed export basis) are to be used for
manufacture of finished goods that are to be exported. This export
benefit, which the company has earned fully during the year of
export, is accounted for in the year itself but physically those
licenses may be used in the subsequent years.
5. Year-end unutilised import entitlements are recognised by the
company at a value equivalent to the difference between the
Domestic Price and the Deemed Export Price on such quantitative
entitlements. Management believes that this is appropriate, since
most of the company’s textile requirements have to be procured
from the domestic market (equivalent quantities not being readily
available in the international market currently), and hence, the
aforesaid difference between Domestic Price and Deemed Export
Price is the amount of benefit that is ultimately derived from the
import entitlements.
6. For ease of understanding, the querist has given the following
example:
Year-end duty free import entitlements : 100 kgs
Domestic Price : Rs.155 per kg
Duty Paid Landed Cost : Rs.150 per kg
Duty Free Landed Cost : Rs.129 per kg
Deemed Export Price-Landed : Rs.125 per kg
According to the querist, at the year-end, the management intends
to value the unutilised import entitlements at Rs. 3,000, i.e., 100
@ Rs. 30 per kg (Rs. 155 - Rs. 125).
7. According to the querist, the management is of the view that
the above valuation policy is appropriate on the following grounds:
(i) Since the required quantities of textiles of specific quality
are not available from the international market readily
fulfilling the other commercial terms, the company
procured such textiles from the domestic market at Rs.
155/kg. However, the company will ultimately purchase
such materials from the domestic supplier at Rs. 125/kg
(Deemed Export Price). Textiles will be first procured
from the domestic market at Rs. 155/kg and used in the
manufacture of textile belts. Once the belt is exported,
the company receives an entitlement to replenish the
quantity of textiles used in the belt at a price of Rs. 125/
kg. Hence, the difference should be recognised as the
value of unutilised benefit.
(ii) The export products’ costing is done on the basis of the
duty free import or Deemed Export Price, whichever is
lower on the assumption that the licenses will be utilised
for bringing those textiles for manufacturing finished
products. It may be noted here that Advance Licenses
under Duty Exemption Entitlement Certificate (DEEC)
scheme are not saleable or transferable to any other
party like Duty Entitlement Pass Book (DEPB) scheme
or Duty Free Replishment (DFR) scheme. (Emphasis
supplied by the querist.)
(iii) If there are DEPB Licenses (which are readily saleable
in the market at face value) in hand, then, the value of
those licenses are recognised in the accounts on the
basis of their face value, whereas, it is known that the
DEPB value represents not only the customs duty but
the differences of Domestic and Import prices on an
average basis.
(iv) If such unutilised benefits are to be valued at Rs. 21/kg
(Rs. 150 – Rs. 129) (as suggested by the auditors), then
it will result in an additional benefit of Rs. 9/kg (Rs. 30 –
Rs. 21) in the following year. However, such benefit is
arising from the export activities and hence, should be
recognised in the year in which the belts are exported.
The unutilised value of the licenses are kept in
“Receivable Account” at the year-end and in the
subsequent years when those particular licenses are
utilised for bringing the textile (concerned material). Textile
costs are taken in the profit and loss account by loading
the actual purchase cost with the proportionate amount
of this benefit and simultaneously the Receivable Account
gets neutralised with the proportionate loading amount.
8. The statutory auditors are of the view that the year-end
unutilised import entitlements are to be recognised in the financial
statements at a value equivalent to the customs duty benefit to
which the company is entitled to on import of textiles in future. The
rate of customs duty to be considered for this purpose should be
based on the best estimate of the management regarding the
benefit to be derived in future from such entitlements. Based on
review of utilisation in the past and review of current orders in
hand, there is no concern that the company may not be able to
fully utilise such entitlements. Accordingly, as per the auditors, it is
appropriate to value year-end unutilised import entitlements at Rs.
2,100, i.e., 100 kgs @ Rs. 21 per kg (Rs. 150 – Rs. 129).
9. According to the querist, the auditors do not agree with the
views expressed by the management in paragraph 7 above on the
following grounds:
(i) The difference of Rs. 5 per kg between the Domestic
Price and the Duty Paid Landed Cost is not arising from
exports made by the company but from market conditions
existing at the time of purchase. Availability of sufficient
quantities of imported textiles is determined by market
conditions, and in case such sufficient quantities are
available, a user will generally prefer to import textiles
since Duty Paid Landed Cost is cheaper than Domestic
Price. Consequently, this difference should not be
considered for valuation of year-end unutilised export
licenses.
(ii) Difference of Rs. 4 per kg between the Duty Free Landed
Cost and Deemed Export Price considered by the
management for valuation of unutilised licenses at the
year-end is not only dependent on transfer of duty free
import entitlements to the domestic supplier but also on
the price to be negotiated with such supplier for purchases
in future and, as such, should not be considered for
valuation of year-end unutilised import entitlements. Also,
the price negotiated for purchases in future will be guided
by market conditions that will exist on the date of such
purchases. Consequently, at the year-end, the auditors
are unable to form an opinion that there are no significant
uncertainties regarding ultimate collectability of the
aforesaid difference. In accordance with Accounting
Standard (AS) 9, ‘Revenue Recognition’, issued by the
Institute of Chartered Accountants of India, the aforesaid
benefit should not be recognised till such significant
uncertainties exist.
(iii) From the above example, it is expected that the company
will be able to realise the customs duty benefit of Rs. 21
per kg of imported textiles and hence, year-end unutilised
import entitlements should be valued at that rate. DEEC
licenses that are not used for direct imports by the
company are generally transferred to a domestic textile
supplier for consideration. The consideration receivable
for such transfer may exceed the benefit that the company
would have derived by importing the textiles itself.
However, as explained in point (ii) above, such excess is
contingent upon future price negotiations with the
domestic supplier. Also, the treatment of unutilised import
entitlements that are intended to be transferred to a domestic textile
supplier for purchase of textiles at
Deemed Export Price should be similar to the treatment
when these are intended to be utilised for direct imports
by the company. Hence, year-end unutilised import
entitlements should be valued at Rs. 21 per kg, being
the benefit that is expected to be realised from direct
imports by the company. (Emphasis supplied by the
querist.)
B. Query
10. The querist has sought the opinion of the Expert Advisory
Committee on the following issues:
(i) Whether the basis of valuation of year-end unused export
licenses intended to be used for subsequent domestic
purchase on deemed export price, adopted by the
company is correct.
(ii) Whether the basis of valuation suggested by the statutory
auditors is correct.
(iii) If answers to (i) & (ii) above are in the negative, what
should be the correct basis of valuation of the year-end
unused export licenses.
C. Points considered by the Committee
11. The Committee notes that the basic issue raised by the querist
relates to valuation of year-end unutilised export licenses on hand.
Therefore, the Committee has examined only this issue and has
not examined any other issue that may be contained in the Facts
of the Case, such as, the timing of recognition of export benefit,
presentation of unutilised licenses in the balance sheet, accounting
for DEPB scheme, etc. The Committee has not examined the
matter as to whether the company can transfer the benefit under
import license to the supplier from whom the company is purchasing
the relevant input, since it is an interpretational issue and the
Committee is prohibited from giving opinions on such issues. The
opinion given hereafter is based on the presumption that such a
transfer can be made under the EXIM policy.
12. The Committee notes that in view of the non-availability of
sufficient quantity of textiles of specific quality in the international
market readily, the company procures them from the domestic
market on ‘deemed export’ basis. By transferring the import
entitlement to the domestic supplier, the company is able to
purchase the textile item at a cheaper price, i.e., ‘deemed export
price’. This deemed export price, according to the querist, is lower
than, not only the domestic price, but also the duty paid landed
cost as well as duty free landed cost.
13. The Committee notes paragraph 4.1 of AS 9, which defines
the term ‘Revenue’ as follows:
“Revenue is the gross inflow of cash, receivables or other
consideration arising in the course of the ordinary activities of
an enterprise from the sale of goods, from the rendering of
services, and from the use by others of enterprise resources
yielding interest, royalties and dividends. Revenue is measured
by the charges made to customers or clients for goods supplied
and services rendered to them and by the charges and rewards
arising from the use of resources by them. In an agency
relationship, the revenue is the amount of commission and
not the gross inflow of cash, receivables or other consideration.”
The Committee is of the view that the benefit in the form of getting
a cheaper price from the domestic supplier as a result of foregoing
the right to make direct imports duty free with consequent
acquisition of that right by the domestic supplier is not meeting the
above definition of revenue. A saving, whether in the form of duty
free import or in the form of domestic purchase at a cheaper price,
is a reduction in the cost of inventory and is not revenue.
14. The Committee also notes the following paragraphs of the
‘Framework for the Preparation and Presentation of Financial
Statements’, issued by the Institute of Chartered Accountants of
India, in respect of the definition of the term ‘Asset’ and its
recognition criteria:
“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.” [Paragraph 49 (a)]
“An asset is recognised in the balance sheet when it is probable
that the future economic benefits associated with it will flow to
the enterprise and the asset has a cost or value that can be
measured reliably.” [Paragraph 88]
The Committee is of the view that though import entitlements may
meet the above cited definition of an asset, it does not meet the
recognition criteria cited above. The Committee notes that purchase
price is a matter of negotiation between the supplier and the buyer.
The mere fact that an intended transfer of an existing duty free
import entitlement to the domestic supplier may result in reduction
in the purchase price is not a sufficient ground for ascribing a
value to that entitlement and recognising the same as an asset.
This is because, ultimately, price obtained depends, among other
things, on the negotiating power of the parties and the demandsupply
position. Further, the Committee does not agree with the
querist’s contention that once the belt is exported, the company
receives an entitlement to replenish the quantity of textiles used in
the belt at a specific price (Rs. 125/kg for the example given by
the querist). Sometimes, a portion of the benefit, i.e., the customs
duty element may be retained by the domestic supplier also. For
this reason and for reasons stated above, the Committee does not
agree with the statutory auditors’ views that customs duty element
should be separately isolated and accounted for as revenue. Thus,
the value of the entitlement may fluctuate considerably, since it
would depend upon many uncertain factors such as demand for
imported goods, change in prices of domestic goods, rate of custom
duty prevailing at the relevant point of time, etc. Further, the cost
of the advance license is not reliably ascertainable.
15. The Committee notes that the examples of intangible assets
given in paragraph 7 of Accounting Standard (AS) 26, ‘Intangible
Assets’, include, among other things, licenses and import quotas.
The Committee also notes the following paragraphs from AS 26:
“20. An intangible asset should be recognised if, and
only if:
(a) it is probable that the future economic benefits
that are attributable to the asset will flow to the
enterprise; and
(b) the cost of the asset can be measured reliably.”
“23. An intangible asset should be measured initially at
cost”
As already mentioned in paragraph 14 above, the cost of the
advance license is not reliably ascertainable. Therefore, the
Committee is of the view that the import entitlements represented
by the advance licenses cannot be recognised as intangible assets
in the balance sheet.
16. The Committee also notes the following paragraphs from
Accounting Standard (AS) 2, ‘Valuation of Inventories’:
“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.
7. The costs of purchase consist of the purchase price
including duties and taxes (other than those subsequently
recoverable by the enterprise from the taxing authorities),
freight inwards and other expenditure directly attributable to
the acquisition. Trade discounts, rebates, duty drawbacks and
other similar items are deducted in determining the costs of
purchase.”
17. From the above, the Committee notes that the costs of
purchase includes, inter alia, purchase price. Separate accounting
of possible reduction in purchase price (or even actual reduction in
purchase price of items yet to be procured) as income and
subsequently neutralising the same by loading in the purchase
price is not permitted under AS 2.
18. Thus, the Committee is of the view that for the unutilsed
export licenses on hand, which are to be subsequently used for
domestic purchase at deemed export price, no value should be
ascribed. The actual purchase price will form part of costs of
purchase.
D. Opinion
19. On the basis of the above and subject to the presumption
stated in paragraph 11 above, the Committee is of the following
opinion on the issues raised in paragraph 10 above:
(i) The basis of valuation of year-end unused export
licenses intended to be used for subsequent domestic
purchase at deemed export price, adopted by the
company is not correct.
(ii) The basis of valuation suggested by the statutory
auditors is also not correct.
(iii) No value should be ascribed to the licenses mentioned
in (i) above.
1Opinion finalised by the Committee on 30.1.2008.
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