1.3 Query
Accounting treatment of shortfall in meeting levy quota obligation in cement industry
1.The Government of India introduced dual pricing policy for cement with effect from 28th February, 1982 according to which each cement factory has to sell 66.6% (or 50% in the case of new units commencing production on or after 1.1.1982) of the installed capacity towards ‘levy’ quota at a price fixed by the Government. Cement produced in excess of the levy quota can however be sold at a higher price as non-levy cement. Each cement factory is expected to fulfil its obligation regarding levy quota for the year otherwise it may attract penalty under the Cement Control Order although no specific penalty has been stipulated therein. Any shortfall in sale of cement in levy quota for a particular year is expected to be made good in the next year. Thus, a company manufacturing cement can earn extra profit in one year by selling less cement towards levy obligation and more in the free market at a higher price with the expectation of covering the shortfall next year. To recognize these aspects in accounts the querist has suggested the following approaches:
i)Irrespective of the violation of the norms for levy quota fixed by the Government, the profit may be allowed to appear on the basis of actual sales only and no adjustment to profit may be made. However, a suitable note disclosing the shortfall may be given.
(a) Debit the Sales Realisation Account by the aforesaid excess profit figure with a corresponding credit to Levy Adjustment Account grouped under the head ‘Other Liabilities’ in the balance sheet. This practice is being followed by one of the cement companies in India.
(b)Debit the Sales Realisation Account by the excess profit figure with a corresponding credit to the Levy Adjustment Account to be shown under the head ‘Provisions’ in the balance sheet.
(c) Debit the excess profit figure to a separate account say ‘Levy Adjustment Account’ and show the same as a distinct minus entry from “Sales Realisation” on the Income side of the Profit and Loss Account with a corresponding credit to “Provision for Levy Adjustment Account” to be shown under the head “Provisions” in the balance sheet.
2. The querist is of the view that the entry at 1 (ii) (a) above results in showing sales realization at a figure which is not actual and therefore may be open to audit objection. Showing the Levy Adjustment Account under “Other Liabilities” would also amount to a disclosure which is not true and fair, according to the querist, since this is not an actual liability to be discharged. The method at 1 (ii) (b) also suffers from the under-disclosure of sales figure. In the view of the querist the method at 1(ii)(c) is the most appropriate since the sales would appear at its actual value and the corresponding credit is given to a ‘Provision’ account instead of a liability account.
3.The opinion of the Expert Advisory Committee has been sought as to which of the suggested accounting treatments indicated in para 1 above would be proper.
Opinion* December 14, 1983
1.Assuming that each cement factory is expected to fulfill its obligation regarding the levy quota for each year and assuming that any shortfall in sale of cement in levy quota for a particular year is expected to be made good in the next year, the shortfall in meeting levy quota obligation should be accounted for in the following manner.
2.The stock of cement held in silos may be appropriated towards levy sales, since the future levy sales are expected to be made in the ordinary course of business. In other words, the adjustment may be made only for the net differential, i.e. actual shortfall in levy sales reduced to the extent of appropriated stock of cement held in silos. Consequenlty, the stock so appropriated may be valued at the lower of cost and the net realizable value computed with reference to the levy price.
3.A number of possibilities are there regarding the actual annual production/sale in the levy quota and sale in free market and cost of production etc. On the basis of the principle of prudence, the company should provide for all anticipated losses. The losses in the case of a going concern can be computed with reference to the possible replacement of the shortfall in the levy quota. This shortfall can be met either out of own production of the next year or from purchases in the market. If the shortfall is to be met from the own production of next year, the valuation of closing stock and the provisions of shortfall can be understood with reference to the following:
Data regarding costs and prices
Data regarding Actual Production
Valuation of Closing Stock & Provision
AX
Closing Stock - 70 X (Lesser of 10 and 11) - 700 Provision Nil
AY
50 X (Lesser of 10 and 11) - 500 Provision 10 X (excess of 10 over 11) - Nil BX 60 X (lesser of 12 & 11) - 660 10 X (lesser of 12 & 15 ) - 120 Provision - Nil
BY
50 X (lesser of 12 and 11) - 550 Provision 10 X (excess of 12 over 11) - 10
4.In the case of shortfall in the levy quota to be replaced by a purchase from the market then to the extent the shortfall is not represented by the stocks in hand, the provision for the shortfall should be worked out on the basis of the differential between the free price and the levy price. ______________________________ * The query was referred to the Research Committee of the Institute for its opinion as it was felt that the matter was of general interest to the members of the profession. The opinion given herein is therefore that of the Research Committee. |