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A. Facts of the Case
1. A company is a public sector company under the administrative control of the Ministry of Mines, Government of India and is engaged in mining of bauxite, manufacturing of alumina and aluminium, generation of power in captive power plant for use in Smelter Plant and selling alumina and aluminium both in domestic and international markets. It has a capacity to produce 15,75,000 M.T. of calcined alumina, 3,45,000 M.T. of aluminium ingots per annum, and 960 M.U. of power.
2. For production of 3.45 lakh M.T. of aluminium per annum, the company has installed a smelting plant having 720 pots. According to the querist, the pots are nothing but aluminium reduction cells in which metallic aluminium is produced commercially by the electrolysis of alumina in a liquid bath cryolite. Each pot consists of a steel shell set up on substantial foundation and a carbon lining. The space within the lining is usually about half a metre deep. For electrolytic process, electric current is passed through anodes suspended from above and partly dipped in the liquid bath of cryolite. The pot cells act as cathode.
3. The querist has stated that 480 pots were capitalised in a phased manner during the period 1987-88 to 1995-96. In line with the provisions of the Guidance Note on Treatment of Expenditure during Construction period2 , issued by the Institute of Chartered Accountant of India, the expenses incurred on start-up and commissioning of the pots including the expenditure incurred on trial runs and revenue earned out of sale of metal produced during the trial run were accumulated under ‘Incidental Expenditure During Construction (IEDC) Account’. Once the process started giving stabilised production, the net of expenses/income under IEDC were capitalised along with the cost of plant. It has been further clarified by the querist that the debit to the IEDC on account of trial production are of two types, i.e., the cost of raw-materials incurred one time and the cost of raw materials which is recurring. Similarly, the credit to IEDC Account are of two types, i.e., sale and accretion of stock of metal produced out of trial run. However, the in-process materials available inside the pot on the date of declaration of commercial production were neither valued nor credited to IEDC Account. In other words, the cost of in-process materials (i.e., heel metal) formed part of capital cost.
4. In the process of electrolysis, alumina (AL 203) is decomposed and reduced to molten aluminium which is known as hot metal. During the course of pot start–up, either molten metal is poured into new pots or the pots are directly heated to enable decomposition of dry alumina.
5. The contents within the lining of a pot can be divided into three layers. The bottom (approx. 20 cm.) contains the hot metal which is required to be maintained in the pot for maintaining the temperature and other technical balances. This may be called as minimum level of hot metal. The middle layer consists of metal which can be tapped and taken out. In other words, when the hot metal exceeds the minimum level in the production process, the excess quantity is the metal produced and tapped. The third and top layer consists of cryolite bath which is approximately 20 cm. The approximate quantity of hot metal per cm depth is 0.5 M.T. Hence, approximately 10 M.T. of hot metal is the minimum level always lying in the pot for its lifetime.
6. The querist has stated that the metal in the pot is assessed by dip measurement process by technical team as on 31st March each year for the purpose of valuation of in-process stock.
7. The accounting policy followed by the company in respect of hot metal prior to financial year 1995-96 is given below:
“In-process materials are not valued in view of the fact that the entire initial fill for the process has already been capitalised, the quantum thereof at the opening and closing date of the year remaining more or less at the same level and such stocks are not measurable accurately.”
8. During the audit of accounts for the financial year 1995-96, Comptroller and Auditor General of India (C&AG) auditors differed and observed that “It is not a fact that quantum of in-process material at the opening and closing date of the year remain at the same level and that such stock are not measurable. The quantum of in-process material varies with fluctuations in the number of pots actually in operation”.
9. The querist has stated that in response to the aforesaid observation of the C&AG auditors, the company undertook to seek an opinion from the Expert Advisory Committee of the Institute of Chartered Accountants of India, and the Committee opined as below:
“ (i) The accounting policy on valuation of work-in-progress followed by the company
is not proper.
(ii) The work-in-progress has to be valued at the end of a financial year irrespective of
the fluctuations in the opening and closing number of pots.”
10. Accordingly, as per the querist, for pots capitalised after 1995-96, the value of entire in-process material (heel metal) lying in pots at the time of capitalisation were not capitalised on the basis of the aforesaid opinion.
11. The querist has further stated that the life of a pot is taken as 18 years and depreciation @ 5.28% on straight-line method is provided each year. Pot relining is a regular maintenance activity carried out every 4-5 years (2500 days). For relining, the closing heel metal available in the pot is evacuated (known as pot de-lining) and poured into the other live pot, where it is converted into finished goods and subsequently sold. Similarly, during relined pot start-up, molten metal is poured into the relined pot.
12. As per the querist, in the financial year 2008-09, 120 pots of 2nd phase expansion of Smelter Plants have been capitalised and the entire in-process material available in the pots has been considered as in-process stock. The statutory auditors are differing to such accounting treatment and are of the opinion that the minimum level of hot metal in the bottom layer of pot (approximately 10 M.T.) which is required to be maintained in the pot to manufacture aluminium from alumina till delining and acting as part of plant and machinery should form part of the capital cost and any stock beyond that only should form part of inventory.
B. Query
13. In the light of the above facts, the querist has sought the opinion of the Expert Advisory Committee on the following issues:
(i) Whether the accounting policy adopted by the company, based on the earlier opinion of the Expert Advisory Committee (published as Query No. 1.12 of Volume XVII of the Compendium of Opinions) on non-capitalisation of minimum level of heel metal required for producing aluminium from alumina (acting as part of plant and machinery) and considering it as stock in-process is correct.
(ii) Whether a separate treatment is required for the minimum level of heel metal during re-lining of pots in case the same is capitalised.
C. Points considered by the Committee
14. The Committee notes from the Facts of the Case that the basic issue raised in the query relates to the manner of recognition of the minimum quantity of hot metal (i.e., heel metal) which is required to be maintained in the pot due to technical reasons during the process of production of aluminium, i.e., whether such metal should be capitalised with the plant and machinery or should be considered as in-process material (inventory). The Committee has, therefore, considered only this issue and has not examined any other issue that may arise from the Facts of the Case, such as, valuation of the in-process heel metal at the close of the financial year, accounting treatment followed by the company in respect of pots capitalised upto the financial year 1995-96, depreciation of pots, accounting for other materials, such as, cryolite, etc. used during production, etc.
15. The Committee notes from the Facts of the Case that a minimum quantity of hot metal (heel metal) is always required to be maintained in a pot during the process of production for technical reasons (to maintain the desired temperature and other technical balances) in order to produce aluminium and the excess quantity of hot metal in the pot is the metal produced and tapped. Further, the Committee notes that during delining (which is a regular maintenance activity), such metal is evacuated and poured into another live pot where it is converted into finished goods and sold. Thus, it is not the same metal which stays in the pot for the life time, it is only the quantity of the metal which is to be maintained in the pot. Therefore, the initial level of heel metal poured into the pot may have been converted into finished goods and sold. The Committee also notes that during the course of pot start-up, either molten metal is poured into new pots or the pots are directly heated to enable decomposition of alumina (paragraph 4 above). Thus, in the view of the Committee, this minimum level of heel metal in the pot facilitates production. Although it is used in the production of aluminium, it cannot be considered of the nature of a plant and machinery, through which the raw material is converted into finished product. In this context, the Committee notes the definition of the term ‘inventories’ given in paragraph 3 of Accounting Standard (AS) 2, ‘Valuation of inventories’, and paragraph 4 thereof, which provide as follows:
“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.”
“4. …Inventories also encompass finished goods produced, or work in progress being produced, by the enterprise…”
From the above, the Committee is of the view that the minimum quantity of heel metal in the extant case is the material-in-progress which is being produced by the enterprise and accordingly, it should be shown and treated as ‘inventory’ in the books of account of the company.
D. Opinion
16. On the basis of the above and subject to paragraph 14 above, the Committee is of the following opinion on the issues raised in paragraph 13 above:
(i) The accounting policy of the company of non-capitalisation of minimum level of heel metal required for producing aluminium from alumina and considering it as stock-in-process is correct.
(ii) Answer to this question does not arise as the minimum level of heel metal is not to be capitalised in the extant case.
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