A. Facts of the Case
1. A company was incorporated on 16th August, 1984 and is
mainly in the business of procuring, transmission, processing and
marketing of natural gas. The company has an authorised share
capital of Rs. 1,000 crore and the paid up capital is Rs. 845.65
crore. The Government of India holds approximately 57% equity
of the company at present.
2. The company owns and operates (i) over 6,000 Kms of gas
pipeline which currently transmits about 79 MMSCM per day of
natural gas, (ii) seven gas based LPG manufacturing plants in
different parts of the country with an annual installed capacity of
more than 1 million MT of LPG, (iii) an integrated gas based
petrochemical plant for producing polymers and, (iv) LPG pipelines
of over 1,800 Kms for transmission of LPG. The company has a
number of accounting units which record and maintain the accounts
for the respective business activities carried out by them. The
company has also integrated its business activities and is involved
in the projects and operations, such as, city gas distribution, oil &
gas exploration and production, and telecom business for sale of
bandwidth. The company has recently implemented SAP- ERP
and divided its business activities into 10 business segments and
reports its financial results as per Accounting Standard (AS) 17,
‘Segment Reporting’, under the following business segments:
(i) Gas transmission
(ii) LPG transmission
(iii) Gas trading(iv) LPG & other liquid hydrocarbons production
(v) Petrochemicals production
(vi) City gas distribution
(vii) Power sector
(viii) Exploration and production activities for oil and gas
(ix) Telecom (sale of bandwidth)
(x) Un-allocable (includes corporate office, zonal offices,
etc.)
3. The company purchases natural gas from a company and
joint venture companies in various states which is transmitted
through gas pipelines for sale to various gas consumers, such as,
power and fertiliser plants. Besides sale of gas to its customers,
the gas is also used by the company (a) as feed stock in its gas
processing plants for production of LPG and polymers and (b) as
fuel for running its compressors installed along the gas pipelines
(for transmission of gas to long distance) and generation of power
in its processing plants for captive needs.
4. The querist has stated that the natural gas received is
processed in the LPG and petrochemical plants where higher
fraction of hydrocarbon is extracted for production of LPG and
other petrochemical products. The balance gas having lower
hydrocarbon fractions goes back in the gas pipeline and is sold to
various customers. The LPG, the liquid hydrocarbon products and
other petrochemical products produced are sold at market price.
The quantity of natural gas consumed (having higher fraction of
hydrocarbons to produce the LPG, liquid hydrocarbons and other
polymer products) is accounted for in the books as mentioned in
paragraph 7 below.
5. The gas activity is related to the following four business
segments as under:
(a) Gas Transmission, i.e., business of transportation of
gas through gas pipelines by way of transmission
charges revenue.
(b) Gas Trading, i.e., business of purchase and sale of gas
activity.
(c) LPG and Liquid Hydrocarbon (LHC) processing, i.e.,
business of manufacture and sale of LPG and LHC by
consuming gas as feed stock and fuel.
(d) Polymer processing, i.e., business of manufacture and
sale of polymer by consuming gas as feed stock and
fuel.
6. According to the querist, at the time of purchase of natural
gas from the suppliers, the account ‘Purchase of Gas’ is debited
with corresponding credit to supplier. The purchase is disclosed
separately on the face of profit and loss account. This purchase
account is debited by the concerned accounting unit purchasing
and receiving the natural gas from the gas suppliers under the
business segment ‘Gas Trading’.
7. As mentioned above, the company consumes natural gas as
feed stock (i.e., raw material) for its processing plants (LPG and
Polymer) and as fuel in the compressor stations along the gas
pipelines and in the plants. The natural gas consumed as feed
stock by LPG and polymer plants for production of LPG and polymer
respectively, is debited to raw material cost under the business
segments ‘LPG’ or ‘Petrochemicals’, as the case may be, with a
corresponding credit to internal consumption account under
business segment ‘Gas Trading’. Similarly, natural gas consumed
as fuel in compressor stations along gas pipelines (to push gas),
in ‘LPG’ or ‘Petrochemical’ plants is debited to fuel cost under the
business segments ‘Gas Transmission’, ‘LPG’ or ‘Petrochemical’,
as the case may be, with a corresponding credit to internal
consumption account under business segment ‘Gas Trading’.
8. The amount credited to ‘internal consumption’ is shown
separately under ‘Income’ in the profit and loss account. The amount
of internal consumption is not clubbed with or included in ‘Sales’
and is shown separately.
9.The gas consumed by the company as feed stock (raw
material) and as fuel is included under ‘Expenditure’.In Schedule10,“Manufacturing, Transmission, Administration, Selling and
Distribution and other Expenses”, the cost of natural gas consumed
as feed stock is separately shown as ‘Raw Material consumed’
and the cost of natural gas consumed as fuel stock is separately
shown under ‘Power, Fuel and Water charges’.
10. The querist has also stated that an entry tax is levied by the
State Government on consuming the natural gas at a Petrochemical
Plant and a Compression Station and the cost of natural gas
booked as raw material in the said plant is inclusive of entry tax.
Therefore, raw material and internal consumption will not match to
the extent of entry tax paid by the Petrochemical Plant and the
Compression Station.
11. The querist has stated that during the course of limited review
for the quarter ended 30.09.2006, the statutory auditors have made
the following observation with respect to depiction of internal
consumption under ‘Income’ in the profit and loss account vide
their letter dated 24.10.2006 as follows:
“The inter branch transfers do not result in inflow of cash,
receivables, etc., from sale of goods or from rendering of
services and thus are not revenue within the definition of AS
9, ‘Revenue Recognition’. Simply because it is not included in
sales and shown separately, it does not, in our opinion, bring
it within the spirit and substance of the definition of the word
“Revenue” of AS 9. While interpreting the same, it should be
seen whether the same falls under the definition and not the
explanatory words.
The management is of the view that since it is not included in
sales, they have complied with the recognition of revenue as
per AS 9.
We, as submitted above, do not subscribe to the view taken
by the management and are of the opinion that it does not
comply with the definition of revenue. The management wishes
to take opinion from the Institute of Chartered Accountants of
India on the same. We have, therefore, agreed that the matter
be thrashed out before the next quarter.”
12. The company, in response to the above observations, has
clarified as under:
(a) Disclosure of internal consumption of gas is shown
separately from sales as income in the profit and loss
account with corresponding disclosure under ‘Raw
Material Consumption’ and ‘Power, Fuel and Water
Charges’ in Schedule 10- Manufacturing, Transmission,
Administration, Selling and Distribution and other
Expenses.
(b) The company is following this practice consistently and
disclosure of each item of income / expenses is made
separately. It also helps in preparation of segment-wise
financial reporting according to the provisions of AS 17,
‘Segment Reporting’, as internal consumption is the
income of ‘Gas Trading’ business segment, while gas
consumed for the production of LPG, liquid hydrocarbons
and petrochemicals as feed stock (raw material) is shown
as raw material consumed in Schedule 10. Similarly, gas
consumed as fuel to compress gas and/or generate power
for running the plant is a fuel expense and is clubbed
and shown under power, fuel and water charges and
also shown in Schedule 10. Both the raw material cost
and fuel cost are expenses of the Gas Transmission,
LPG and Petrochemical business segments.
(c) This practice is being followed since quite a long time by
the company and the statutory auditors and the C&AG
had not objected to this disclosure ever before.
13. The querist has stated that subsequently, the statutory auditors
in their letter dated 16.11.2006 have, inter alia, stated as below:
“The natural gas received is processed in the LPG and
petrochemical plants and higher fraction of hydrocarbon is
extracted to produce LPG and petrochemicals. LPG,
Petrochemicals and other liquid hydrocarbons are sold at
higher values after processing. The gas with the lower
hydrocarbons goes back to the pipelines and is sold to the
customers. As per your letter dated 14th November, 2006, it is
the higher fraction of natural gas extracted which constitutes
the shrinkage which is accounted for as raw material for
production of LPG etc. which is shown as internal consumption
with the corresponding entries in the expenses. Since the
shrinkage utilised has already been accounted for as sale of
LPG and other petrochemical products, accounting for the
same as internal consumption amounts to double booking of
income and expenses. However, gas consumption as fuel for
power generation to run the processing plant and compressor
station and HVJ and other pipe system will continue to be
accounted as fuel. Transportation charges, which is a main
income of the company, includes profit elements. The profit
element should be excluded in arriving at the prices at which
the same is to be accounted for as fuel. Since the higher
fraction of hydrocarbon is not internal consumption, the same
is also not liable to be included in the segment reporting
except and to the extent it is used in fuel for plants’ operations”.
14. In this regard, in addition to the views expressed in paragraph
12 above the following points are also submitted by the querist for
consideration of the Committee:
(a) Clause 2 of Part II of Schedule VI to the Companies Act,
1956 states, inter alia, as follows:
“2. The profit and loss account –
(a) shall be so made out as clearly to disclose the
result of the working of the company during
the period covered by the account”
(b) Clause 3 of Part II of Schedule VI to the Companies Act,
1956 states as follows:
“3. The profit and loss account shall set out the various
items relating to the income and expenditure of the
company arranged under the most convenient heads;
and in particular, shall disclose the following information
in respect of the period covered by the account:
(i) …
(ii) (a) In the case of manufacturing companies,—
(1) The value of the raw materials consumed,
giving item-wise break-up and indicating the
quantities thereof...”
(c) The consumption of raw material during the financial
year 2005-06 was Rs. 1,476 crore, out of the total
‘Manufacturing, Transmission, Administration, Selling and
Distribution and other Expenses’ of Rs. 2,894 crore which
is more than 50% of cost of expenses. If the cost of gas
consumed as fuel is added, the share of cost of gas
used as raw material and fuel will be approximately 70%
of total ‘Manufacturing, Transmission, Administration,
Selling and Distribution and other Expenses’. Considering
the substantial materiality aspect, it is felt that it is prudent
as per the provisions and spirit of the Companies Act,
1956 and AS 17 to disclose it separately.
B. Query
15. In view of the facts explained above, the querist has sought
the opinion of the Expert Advisory Committee on the following
issues:
(i) Whether the disclosure of internal consumption of gas
separately from ‘Sales’ on the ‘Income’ side of the profit
and loss account with corresponding debit to ‘Raw
Material consumed’ and ‘Power, Fuel and Water
Charges’ on the ‘Expenses’ side of the profit and loss
account by the company as deliberated above in
paragraphs 6 to 9 is correct and in compliance with
AS 9.
(ii) In case the answer to (i) above is in the negative, an
appropriate method of accounting and disclosure to be
followed by the company for such internal consumption
of gas which will comply with the requirements of AS 9,
AS 17 and clause 2 of Part II of Schedule VI to the
Companies Act, 1956, may kindly be suggested.
C. Points considered by the Committee
16. The Committee, while expressing its opinion, has considered
only the issues raised in paragraph 15 above and has not touched
upon any other issue arising from the Facts of the Case, such as,
valuation of internal consumption, etc.
17. The Committee notes that the basic issue involved in the
query is whether the natural gas used by the company in the
manufacture of various products and as fuel can be separately
shown on the income side of the profit and loss account with
corresponding debit to raw materials consumed and power, fuel
and water charges on the expense side of the profit and loss
account.
18. The Committee notes from the Annual Report of the company
for the financial year 2005-06 that it exhibits opening stock,
purchases and closing stock of inventory on the face of the profit
and loss account. To the extent these items relate to natural gas,
their net effect represents total of (i) cost of gas resold ‘as such’
and (ii) consumption of gas used as (a) feed stock in the production
of LPG and petrochemical products and (b) fuel in compressor
stations for transmission of gas to long distance and generation of
power in processing plants for captive needs.
19. In the view of the Committee, gas used in the production of
LPG and petrochemical products can be termed as ‘consumption’
and not as ‘internal consumption’, since in these cases, as a result
of such consumption, finished products emerge.
20. The Committee notes that there are two methods of
presentation of material consumption in the profit and loss account.
One method would be to present opening stock, purchases and
closing stock and to depict the net effect as consumption. The
other method would be to depict the consumption directly under
appropriate heads like raw materials, fuel, etc. However, both
methods cannot be simultaneously adopted with a compensating
credit for consumption in the profit and loss account, which the
company is presently doing. In the view of the Committee, this
amounts to double booking of consumption in the profit and loss
account, the effect of which is nullified by the compensating credit
to the profit and loss account.
21. While the methods described in paragraph 20 are the methods
of presentation, as regards ‘disclosure’ requirements of consumption
of materials in accordance with Part II of Schedule VI to the
Companies Act, 1956, ‘Statement on the Amendments to Schedule
VI to the Companies Act, 1956’ (hereinafter referred to as the
‘Statement’), issued by the Institute of Chartered Accountants of
India, gives detailed guidance. The Committee also notes the
following portion from the ‘Statement’:
“6.10 In the case of industries where there are several
processes, materials may move from process to process, so
that the finished product of one department constitutes the
raw materials of the next. Since the notification clearly requires
consumption data to include only purchased intermediates or
components and also having regard to the fact that the
consumption of raw materials for production of such
intermediates would have to be accounted as raw materials
consumed, it follows that internal transfers from one
department to another should be disregarded in determining
the consumption figures to be disclosed.”
The above portion of the ‘Statement’ also supports the principle
that inter-divisional transfers should not be considered for disclosure
of consumption.
22. Incidentally, the Committee notes that the company is engaged
not only in ‘manufacturing’ activity but also in ‘trading activity’,
since, a portion of gas is also sold. The Committee notes that
clause 3(ii)(b) of Part II of Schedule VI to the Companies Act,
1956 requires, in the case of trading companies, disclosure of the
purchases made and the opening and closing stocks, giving breakup
in respect of each class of the goods traded in by the company
and indicating the quantities thereof. The manner of disclosure in
respect of trading activities (opening stock, closing stock and
purchases) has also been explained in the ‘Statement’.
23. The Committee is of the view that requirements of clause 2 of
Part II of Schedule VI to the Companies Act, 1956 to the effect
that the profit and loss account shall be made out as clearly to
disclose the result of the working of the company during the period
covered by the account can be met only by avoiding double booking
of consumption. Similarly, the disclosure requirements of clause 3
of Part II of Schedule VI do not lead to the conclusion that there
should be double booking of consumption for the reasons stated
in paragraphs 20 and 21 above.
24. The Committee is of the view that inter-segment transfer entries
should be ignored while generating the financial statements of the
enterprise as a whole, even though these have to be considered
for segment reporting purposes under AS 17. This will ensure that
there is no double booking of the consumption and at the same
time statistical information required to be disclosed under Part II of
Schedule VI to the Companies Act, 1956 would be available without
including any profit element. For this purpose, depending upon the
basis of inter-segment pricing, some adjustments may be needed
so that apart from quantitative information, financial value of
information disclosed is proper. In this regard, ‘Statement’ gives
detailed guidance. In other words, the Committee is of the view
that merely for the purposes of AS 17, it is not appropriate to bring
various elements of inter-segment transfers in the financial
statements of the enterprise as a whole. Segment reporting can
be done on the basis of the information otherwise available with
the company.
25. The Committee is of the view that as per the definition of the
term ‘revenue’ as contained in AS 9 which is reproduced below,
inter-division transfers do not constitute revenue:
“4.1 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 notes that as per an Announcement issued in
2005 by the Institute of Chartered Accountants of India titled
‘Treatment of Inter-divisional Transfers’, the recognition of interdivisional
transfers as sales is an inappropriate accounting treatment
and is inconsistent with Accounting Standard 9. Since, the company
has not reflected the internal consumption as ‘revenue’, the
requirements of AS 9 are not violated. However, to show ‘internal
consumption’ on the income side of the profit and loss account is
not appropriate even otherwise as discussed in the above
paragraphs.
D. Opinion
26. On the basis of the above, the Committee is of the following
opinion on issues raised in paragraph 15 above:
(i) The disclosure of consumption of gas separately from
‘Sales’ on the ‘Income’ side of the profit and loss account
with corresponding debit to ‘Raw Material consumed’ and
‘Power, Fuel and Water Charges’ on the ‘Expense’ side
of the profit and loss account by the company is not
correct even though it is not shown as ‘revenue’ within
the meaning of AS 9.
(ii) An appropriate method of accounting and disclosure to
be followed by the company for such consumption of
gas, in compliance with the requirements of AS 9, AS 17
and clause 2 of Part II of Schedule VI to the Companies
Act, 1956, has been discussed in paragraphs 25, 24 and
23 above, respectively.
1 Opinion finalised by the Committee on 14.5.2007.
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