ACCOUNTING AND AUDITING PRACTICES

1.1       Query

Classification of manufactured components

into ‘raw materials’, ‘work-in-progress’ etc.

 1.A limited company in light-engineering industry manufactures certain components and purchases some others to be used in sub-assemblies and final assemblies. Some of the components are manufactured as well as purchased from outside. The components are normally manufactured for stock and there is no connection between the work-order for these components and the work-order for finished products.

 2.The querist has sought the opinion of the Expert Advisory Committee whether the manufactured components should be classified into ‘raw materials’, ‘work-in-progress’ or in some other category keeping in view the disclosure requirement of Schedule VI to the Companies Act, 1956. In this context, he has suggested the following alternatives for the consideration of Committee:

(i)The manufactured components may be classified as ‘raw materials’ as is done in the case of bought-out components since both go to the final assembly from common stores.

(ii) The manufactured components may be classified as ‘work-in-progress’ because these components are at the intermediate stage i.e. between the basic raw materials and the finished product from the final assembly. The argument given by the querist against this treatment is that these components are manufactured for stock and there is no direct connection between the work-order for finished products and the work-order for manufactured components.

(iii)These may be separately disclosed as ‘finished components’ as distinct from ‘finished products’. If this treatment is adopted, the consumption of such finished components will not be shown as consumption of raw materials but the increase/decrease in the stock of these components will be adjusted in the profit and loss account as is normally done in the case of finished products and work-in-progress.

                                                         Opinion                                                           January 25,1983

 1. The above alternatives were considered by the committee as follows:

(i) Regarding the classification of manufactured components as raw materials, the Committee notes that in the ‘Statement on Amendments to Schedule VI to the Companies Act, 1956’ (1980) issued by the Institute, it is stated in the chapter on ‘Classification of raw materials consumed’ that “…..Purchased intermediates and components are to be classified as raw materials….. However, intermediates and components which are internally manufactured are to be excluded from the classification”. [Para 6.4. Page27]. In view of this, the manufactured components should not be classified as raw materials.

(ii)According to the general commercial and accounting usage the term work-in-process  “includes all materials to which manufacturing services have been applied and upon which further production operation are necessary before the product is ready for sale”[1].Thus, the manufactured components which are to be used in the sub-assemblies or final assembly should be considered as work-in-progress. However, the components manufactured for the purpose of sale should be considered as finished stock. Therefore, the fact that these components are manufactured for stock and there is no direct connection between the work-order for finished products and the work-order for manufactured components, is not relevant in this context.

(iii) Schedule VI to the Companies Act, 1956 does not prohibit a separate disclosure of manufactured components in the profit and loss account and balance sheet of a company as ‘finished components’. Therefore, the company may adopt this practice as suggested by querist. If this practice is adopted, the basic raw materials used for the production of components should be included in ‘raw materials consumed’ and the increase/decrease in the stock of finished components should be adjusted in the profit and loss account as is normally done in the case of work-in-progress and finished products.

 2.On the above basis, the Committee is of the opinion that the finished manufactured components requiring further production operation should be shown as ‘work-in-progress’. In the alternative, these can be separately disclosed in the Profit and Loss Account and Balance Sheet as ‘Finished Components’. It should, however, be noted that whichever alternative is followed, the same should be consistently followed.

[1]   Rufus Wixon: Accountants’ Handbook (Ed.) Fourth Edition, p. 12.1

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