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Query No. 26
Subject:
Classification of ‘Tooling’ as inventory or fixed asset. 1
A. Facts of the Case
1. A company is engaged in the business of manufacturing, trading and sale of refractories that are used for manufacture of steel using the continuous casting route. Other industries, like cement, aluminium, etc., also use these refractories in their manufacturing process. There are several types of refractories. The major type of refractories are shapes given by isostatically pressing a mixture of powder raw material bound by resin. These shapes are then fired, cured and finished before packing for despatch.
2. The process for giving shape to refractories entails filling the mix into a set of ‘Tooling’ which comprise of an outer jacket made by polyurethane and a specially designed steel/aluminium mandrel. In addition to these, there are top and bottom closure for holding the mix. Toolings are used for the manufacture of refractories according to the required specification. Manufacture of toolings requires specialised technology. Since such technology is not available in India, most of such toolings are imported from the group company in UK. In addition, there is a small portion of the tooling which is in the nature of moulds used by the Slide Gate business, Precast shapes and Crucibles. Such moulds are made of iron or wood and they are used either for casting of castables into various shapes or which enables jiggering of mix to form Crucibles. All the items of tooling have limited useful life which is approximately three years from the date they are procured and put into production process.
3. The querist has stated that the query relates to classification of ‘tooling’ used by the company in its manufacturing process as inventory or fixed assets, consequent to which the classification of charge for its use as tooling charges or depreciation would also get affected.
4. The ‘tooling’ is shown by the company as ‘inventory’ net of amortisation, in the balance sheet prepared by the company for statutory purposes. The accounting policy followed in respect of tooling by the company is as below:
“Tooling are amortised on a straight line basis over a period of three years based on their estimated useful lives.”
5. According to the querist, the company has taken into account the relevant provisions of Accounting Standards, company law, nature of the product, industry practice, etc., while determining the classification to be done for ‘tooling’. The querist has mentioned that paragraph 3.1 of Accounting Standard (AS) 2, ‘Valuation of Inventories’, defines ‘inventories’ as follows:
“3.1 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.”
Further, paragraph 4 of AS 2, inter alia, states, “Inventories also encompass…consumables and loose tools awaiting use in the production process. Inventories do not include machinery spares which can be used only in connection with an item of fixed asset and whose use is expected to be irregular; such machinery spares are accounted for in accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets”. The querist has also mentioned that Schedule VI2 to the Companies Act, 1956, under Part I, ‘Form of Balance Sheet’, includes ‘loose tools’ under ‘current assets’.
6. According to the querist, toolings are in the nature of loose tools as stated in AS 2 and Schedule VI to the Companies Act, 1956. These are in the nature of consumables which are consumed in the production process, like other consumables, though over a relatively longer period of 3 years and accordingly, amortised over such period. Also, ‘toolings’ are not in the nature of machinery spares, which are used in connection with an item of fixed asset. Consequently, these are classified by the company as inventories since inception and not as fixed assets.
7. The company’s statutory auditors are of the view that such ‘tooling’ should be considered as fixed assets and depreciated over their useful lives in view of the following:
(i) Toolings are in the nature of moulds that are repeatedly used over their estimated useful lives averaging 36 months for manufacture of refractories as per the required specification. Use of toolings is critical to the production of refractories as per the required specifications. As against this, loose tools will generally comprise of sundry small tools and equipments that are used as aids in the manufacturing process and are consumed over relatively short periods. Consequently, such loose tools are considered as current assets. In this regard, attention has been drawn to Query No.10, published in the Compendium of Opinions – Volume XVIII, issued by the Expert Advisory Committee of the Institute of Chartered Accountants of India.
(ii) Toolings depreciate through repeated use in the manufacturing process and are not consumable in nature.
B. Query
8. The querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the accounting treatment followed by the company consistently over several years would meet the requirements of the Companies (Accounting Standards) Rules, 2006.
(ii) Whether the statutory auditors’ contention regarding treatment of the relevant items as fixed assets and charging depreciation thereon is the only correct accounting method to be followed.
C. Points considered by the Committee
9. The Committee notes that the basic issue raised in the query relates to the classification of ‘tooling’ as inventory or fixed asset. The Committee has, therefore, considered only this issue and has not touched upon any other issue that may arise from the Facts of the Case, such as, depreciation/amortisation policy in respect of tooling, etc.
10. The Committee notes the definition of the term ‘inventories’ as reproduced by the querist in paragraph 5 above. The Committee further notes the definition of the term ‘fixed assets’ contained in paragraph 6.1 of Accounting Standard (AS) 10, ‘Accounting for Fixed Assets’, and the definition of the term ‘depreciable assets’ contained in paragraph 3.2 of Accounting Standard (AS) 6, ‘Depreciation Accounting’, as notified by the Central Government under the Companies (Accounting Standards) Rules, 2006:
AS 10
“6.1 Fixed asset is an asset held with the intention of being used for the purpose of producing or providing goods or services and is not held for sale in the normal course of business.”
AS 6
“3.2 Depreciable assets are assets which
(i) are expected to be used during more than one accounting period;
and
(ii) have a limited useful life; and
(iii) are held by an enterprise for use in the production or supply of goods and services, for rental to others, or for administrative purposes and not for the purpose of sale in the ordinary course of business.”
11. The Committee notes from the above that the toolings in the present case are being held for their use in the production of refractories and are not held for sale in the normal course of business. These are expected to be used for more than one accounting period and have a limited useful life. Thus, tooling meets the definition of the terms ‘fixed asset’ and ‘depreciable asset’. The Committee is of the view that tooling is not a consumable item, like loose tools, as argued by the querist. Unlike loose tools, the life of ‘tooling’ is comparatively enduring in nature and is used in manufacturing activities for more than a year. The Committee is of the view that the loose tools or consumables are generally used up/consumed in the process of production whereas toolings, like an item of plant and machinery facilitates the production. Accordingly, in the view of the Committee, it is not appropriate to classify ‘toolings’ as inventories. These are of the nature of fixed assets on which depreciation should be charged as per the requirements of AS 6 and the Companies Act, 1956. The Committee also notes that although the company in the instant case is classifying ‘tooling’ as ‘inventories’, the accounting treatment followed by the company in respect thereof is of the nature of the accounting for a fixed asset as cost of the ‘tooling’ is being amortised over its expected useful life.
D. Opinion
12. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 8 above:
(i) The company’s accounting treatment of treating the ‘toolings’ as inventories is not appropriate and does not meet the requirements of the Companies (Accounting Standards) Rules, 2006.
(ii) The statutory auditors’ contention regarding treatment of the ‘toolings’ as fixed asset and charging depreciation thereon is the correct accounting treatment and that should be followed by the company as discussed in paragraph 11 above.
1Opinion finalised by the Committee on 15.12.2009
2Schedule VI has since been revised. Revised Schedule VI came into force for the Balance Sheet and Profit and Loss Account for the financial year commencing on or after 01.04.2011.
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