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A. Facts of the Case
1. A company is a public sector enterprise under the administrative control of Ministry of Mines, Government of India and is engaged in mining of Bauxite, manufacturing of Alumina and Aluminium, generation of power at Captive Power Plant for use in Smelter, and selling of Alumina and Aluminium both in domestic and international market. The company has four production units (i) fully mechanised open cast Bauxite Mine having excavation capacity of 48,00,000 tonnes per annum (ii) Aluminium Refinery having production capacity of 15,75,000 tonnes per annum (iii) Captive Power Plant having 8 units of 120 MW each to generate power and (iv) Smelter Plant of 3,41,000 tonnes per annum capacity.
2. Mines Division, which is located on hills, serves feed-stock to the Alumina Refinery located 16 KM downhill. The Refinery provides alumina to the company’s Smelter Plant which is about 600 KM away by a specially designed alumina wagon by rail transport. For production of 1 MT of Alumina at Smelter, 13,600 KWH of power is required, which is met by generation of power at Captive Power Plant situated at a distance of 4 KM. Cost of power constitutes about 30% of cost of production of Aluminium. Captive Power Plant is set up exclusively to supply uninterrupted power to Smelter. It is also connected to State grid to take care of the supply of emergency power to Smelter in case of any break-down or failure at Captive Power Plant. Any surplus power after meeting the requirement of Smelter is automatically transmitted to State grid and treated as sale, as per agreement with company ‘G’, which is a State Government undertaking.
3. The company has identified the following three reportable segments on the basis of the type of products:
(i) Chemical Segment – For Bauxite Mining and Alumina Plant
(ii) Power Segment – For Captive Power Plant
(iii) Aluminium - For Smelter Plant
4. The company has entered into an agreement dated 30th August, 2004, valid upto 31st August, 2009 with company ‘G’ for sale and purchase of power.
(a) For sale of surplus power, the base price is:
(i) Upto 40 MU/month - @ 110 paise/kwh
(ii) Beyond 40 MU/month upto 60 MU/month - @ 112 paise/kwh
(iii) Beyond 60 MU/month upto 80 MU month - @ 114 paise/kwh
(iv) Beyond 80 MU/month upto 100 MU month - @ 118 paise/kwh
(v) Beyond 100 MU/month - @ 122 paise/kwh
The agreement provides for escalation in case of increase in prices of ‘F’ grade coal obtained domestically and fuel oil, and has a provision for supply of emergency power and back-up power by company ‘G’.
The above escalation does not take into account the higher impact on cost due to use of e-auction coal and imported coal.
(b) Rate for emergency power and back-up power
For supply of emergency power and back-up power, company ‘G’ charges at a rate three times the weighted average rate of power for the month injected by the company, as mentioned at (a) above.
5. The querist has stated that explanation on ‘inter-segment transfers’ given at the end of Appendix III (termed as Illustration-III in the notified Accounting Standard) to Accounting Standard (AS) 17, ‘Segment Reporting’, reads as follows:
“Segment revenue, segment expenses and segment result include transfers between business segments and between geographical segments. Such transfers are accounted for at competitive market prices charged to unaffiliated customers for similar goods. Those transfers are eliminated in consolidation.” [Emphasis supplied by the querist.]
The querist has stated that at present company ‘G’ is the only unaffiliated customer for the company. Accordingly, the average of rates as mentioned at paragraph 4(a) charged to company ‘G’ is considered as transfer price for the purpose of inter-segment transfer of power, i.e., power exported to Smelter division, and to Aluminium Refinery by way of wheeling of power through company ‘G’.
6. In the event of short supply of linkage coal from domestic sources, the company is forced by the circumstances to consume imported coal, which results in higher cost of generation of power. The sale price, as detailed in paragraph 4(a) above is not remunerative as compared to the cost of generation and as such, management decided to generate power only to meet the internal consumption of Smelter and Aluminium Refinery, thereby avoiding sale of power to company ‘G’ at loss. However, this cannot be avoided in totality and hence, most of the sales are made only @ 110 paise/kwh.
7. As per the querist, even though, the cost of generation of power is higher, as per AS 17, as stated at paragraph 5 above, transfer price of power for the purpose of segment reporting is considered only at 110 paise/kwh, which results in segment loss in case of Captive Power Plant (even though the unit is functioning efficiently and upto the satisfaction of the management) and higher revenue for Chemical and Aluminium segments.
8. Segment report for the quarter ended 31st December, 2008 was examined by the statutory auditors at the time of limited review and they were of the opinion that though the unit is performing well, as a result of compliance with the provisions of AS 17 for inter-segment transfers, as stated hereinbefore, the power segment reveals loss, which does not appear to be a proper disclosure.
9. As per the querist, in case the company is allowed to sell power to parties other than company ‘G’, revenue earned will be at least three to four times more. However, since the company is largely dependent upon company ‘G’ for emergency power and back-up power, it will not be practicable to delink from company ‘G’. The present agreement with company ‘G’ is valid upto 31st August, 2009. Efforts have already been put in motion to get higher sales price per unit, which will recoup the higher cost of generation. In such a situation, power segment will again start showing profit in segment report.
10. From the aforesaid facts, according to the querist, it is revealed that the circumstances have arisen only because of non-remunerative sale price and will continue to be the same till the rate charged from company ‘G’ is revised.
11. Audit Committee of the company advised the management to seek opinion on the subject from the Expert Advisory Committee of the Institute of Chartered Accountants of India.
B. Query
12. The querist has sought the opinion of the Expert Advisory Committee as to whether in the circumstances explained above, the loss disclosed in the segment report can be explained by way of giving a note with reference to the provision of Accounting Standard or whether any other formula for transfer pricing can be adopted, which may necessitate revision of AS 17.
C. Points considered by the Committee
13. The Committee notes that the basic issue raised by the querist relates to pricing of inter-segment transfers for segment reporting under Accounting Standard (AS) 17, ‘Segment Reporting’. 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, e.g., whether reportable segments are properly identified by the company in accordance with AS 17, etc.
14. The Committee notes the following paragraphs of AS 17:
“5.10 Segment accounting policies are the accounting policies adopted for preparing and presenting the financial statements of the enterprise as well as those accounting policies that relate specifically to segment reporting.”
“18. While the accounting policies used in preparing and presenting the financial statements of the enterprise as a whole are also the fundamental segment accounting policies, segment accounting policies include, in addition, policies that relate specifically to segment reporting, such as identification of segments, method of pricing inter-segment transfers, and basis for allocating revenues and expenses to segments.”
“53. In measuring and reporting segment revenue from transactions with other segments, inter-segment transfers should be measured on the basis that the enterprise actually used to price those transfers. The basis of pricing inter-segment transfers and any change therein should be disclosed in the financial statements.”
15. From the above, the Committee notes that inter-segment transfer pricing is an accounting policy which relates specifically to segment reporting and that inter-segment transfers should be measured on the basis that the enterprise actually used to price those transfers. In other words, the price that is actually used in the books of account to reflect the transaction between different segments and the price that is used to reflect segment results for the purpose of segment reporting under AS 17, should be same. The Committee notes that AS 17 neither requires nor recommends that inter-segment transfers should be priced in any particular manner, such as, competitive market prices charged to unaffiliated customers for similar goods as stated by the querist. The portion from AS 17 quoted by the querist in paragraph 5 above is an extract from Appendix III (termed as Illustration III in the notified Accounting Standard), ‘Illustrative Segment Disclosures’. At the beginning of the said Appendix itself, it is clearly mentioned that the Appendix does not form part of the Accounting Standard and that its purpose is to illustrate the application of paragraphs 38-59 of the Accounting Standard. It is only by way of illustration that the basis of pricing inter-segment transfers is stated to be competitive market prices charged to unaffiliated customers for similar goods in the said Appendix. The Committee is of the view that as per AS 17, an enterprise is free to choose any appropriate pricing policy for inter-segment transfers, for example, at cost, or cost plus a fixed return, or market price of the product, etc. Thus, the question of explanation of the loss with reference to any provision/requirement of AS 17, if the existing policy is continued to be followed, by way of a note to the segment report, does not arise. However, if the company chooses, the loss may be explained by way of a note to the segment report; the note should not state that AS 17 requires adoption of that particular pricing policy. Also, revision to AS 17 with respect to the issue raised by the querist, is not required.
16. The Committee is of the view that the above views of the Committee are also relevant in the context of segment reports furnished along with unaudited quarterly financial results which are subject to limited review.
D. Opinion
17. On the basis of the above, the Committee is of the opinion that the company is free to choose any appropriate pricing policy for inter-segment transfers. Thus, the question of explanation of the loss with reference to any provision/requirement of AS 17, if the existing policy of transfer pricing is continued to be followed, by way of a note to the segment report, does not arise. However, if the company chooses, the loss may be explained by way of a note to the segment report; the note should not state that AS 17 requires adoption of that particular pricing policy. Also, revision to AS 17 with respect to the issue raised by the querist, is not required.
1Opinion finalised by the Committee on 24.08.2009
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