|
A. Facts of the Case
1. A government company is incorporated under the Companies
Act, 1956. The shares of the company are listed with recognised
stock exchanges. The company is engaged in the business of
refining and marketing of petroleum products. It has refineries for
processing crude oil and Lube blending / Filling plants. The
company also has depots, installation and LPG plants across India,
besides having administrative offices at Delhi, Chennai, Kolkata,
Mumbai and other major cities. The main raw material for
processing in the refineries is crude oil which is both imported and
indigenously procured. At any period end, a few shipments of
crude oil are in transit. The company imports products which can
also be in transit at period ends.
2. According to the querist, crude oil cargos are generally lifted
from load port on FOB basis and consequently the ownership of
the goods shipped vests with the company. The querist has stated
that under normal circumstances, once a tanker is loaded from the
port, liability for associated expenses like freight, insurance, customs
duty, survey fees, wharfage and handling charges becomes part
of the cost of purchase. The shipments subsequently reach the
port where the refinery is situated within a few days’ to a month’s
time.
3. As per the querist, at any period end, the company values the
crude oil-in-transit inclusive of customs duty, survey fees, and
wharfage and handling charges which are generally applicable as
soon as the loading is completed and bill of lading (B/L) date is
finalised (as the ownership vests with the company). The
corresponding liabilities, such as, customs duty, wharfage, survey
fees, etc., are provided. This is irrespective of whether the materialin-
transit has entered the Indian territorial waters or not. This has
been the consistent policy followed by the company.
4. The government auditors have expressed their views that the above method of accounting results in overstatement of stock-intransit
and overstatement of liabilities to the extent of provisions
made towards customs duty, wharfage, etc. They have also stated
that provisioning made towards customs duty is not warranted as
the tanker has not entered the territorial waters of India.
5. The querist has drawn attention to paragraphs 6 and 7 of
Accounting Standard (AS) 2, ‘Valuation of Inventories’, which are
reproduced below:
“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.
Costs of Purchase
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.”
As per the querist, the company has been consistently taking into
account customs duty, survey fees, wharfage and handling charges
which are generally applicable as soon as the loading is completed
and B/L date is finalised (as the ownership vests with the company)
by providing the corresponding liabilities. By the time the accounts
of the company are finalised for any period end, these cargos
generally reach the refinery ports and these expenses are incurred.
Providing or not providing for these liabilities does not have any
impact on the profit and loss account of the company.
B. Query
6. Considering the above facts, the querist has sought the opinion
of the Expert Advisory Committee on the following issues:
(a) Whether the accounting policy followed by the company
in respect of materials-in-transit at period ends is in order.
(b) If not, then for each of the following, at what point of
time the liability should be recognised in the books of
account in respect of in-transit shipments as at the period
end:
(i) Freight expenses.
(ii) Insurance expenses.
(iii) Survey fees paid at the load port and at the disport.
(iv) Handling expenses at the load port / disport.
(v) Customs duty on imported cargos. Whether
provision should be made only when the cargos
reach the Indian territorial waters as at the period
end.
(vi) Wharfage. Whether provision should be made only
when the cargos reach the port at the period end.
C. Points considered by the Committee
7. The Committee, while answering the query, has addressed
only the issues raised in paragraph 6 above and has not touched
upon any other issue arising from the Facts of the Case, such as,
the point of time when the significant risks and rewards of ownership
of crude oil-in-transit vest with the company etc. The Committee
presumes that the significant risks and rewards of ownership of
the crude oil-in-transit vest with the company.
8. The Committee notes paragraphs 6 and 7 of AS 2 reproduced
by the querist in paragraph 5 above. The Committee also notes
the following paragraphs from AS 2:
“11. Other costs are included in the cost of inventories only
to the extent that they are incurred in bringing the inventories
to their present location and condition. For example, it may be
appropriate to include overheads other than production
overheads or the costs of designing products for specific
customers in the cost of inventories.”
“13. In determining the cost of inventories in accordance with
paragraph 6, it is appropriate to exclude certain costs and
recognise them as expenses in the period in which they are
incurred. Examples of such costs are:
(a) abnormal amounts of wasted materials, labour, or other
production costs;
(b) storage costs, unless those costs are necessary in the
production process prior to a further production stage;
(c) administrative overheads that do not contribute to
bringing the inventories to their present location and
condition; and
(d) selling and distribution costs.”
9. From the above, the Committee notes that as per AS 2, the
cost of inventory would include costs, apart from the cost of
purchase, that are incurred in bringing the inventories to their
present location and condition. The Committee is of the view that
the test for determining whether or not the cost of carrying out a
particular activity should be included in the cost of inventory is
whether the activity contributes to bringing the inventory to their
present location and condition. Also, the Committee notes that the
expenses of the nature of administrative overheads are not included
in the cost of inventory and are expensed when incurred.
10. From the above, the Committee is of the view that with respect
to each shipment of crude oil-in-tranist, the company will have to
determine as to which expenses have been incurred for bringing
the crude oil to its present location and condition. Accordingly, the
expenditure which is yet to be incurred should not form part of the
cost of such inventory. Thus, expenses like freight, handling
expenses at load port, etc. may form part of the inventory of crude
oil-in-transit if they have been incurred. The handling expenses
yet to be incurred at the destination port cannot be included in the
cost of inventory as such expenses have not been incurred as yet.
With respect to customs duty and wharfage, the company will
have to determine the point of time when these are levied and
depending upon the location and condition of the crude oil-in transit, such expenses may/may not form part of the cost of
inventory in transit. The Committee is further of the view that
insurance expenses and survey expenses may form part of cost of
inventory if these are of the nature of mandatory expenses, i.e.,
without which the inventory cannot be moved or transported.
D. Opinion
11. On the basis of the above, the Committee is of the following
opinion on the issues raised by the querist in paragraph 6 above:
(a) The accounting followed by the company in respect of
materials-in-transit at period ends is not in order.
(b) Only those expenses which contribute to bringing the
inventory to their present location and condition can
form part of the cost of inventory. Accordingly, the liability
for the expenses mentioned at (i), (iv) (v) and (vi) of
paragraph 6(b) above should be recognised in the books
of account in respect of in-transit shipment only when
those expenses are incurred/the liability in respect thereof
has arisen (the payment for the same may have yet to
be made). The insurance expenses and survey fees
(mentioned at (ii) and (iii) of paragraph 6(b) above) may
form part of the cost of inventory if these are mandatory
in nature as discussed in paragraph 10 above.
|