1.24     Query

Consideration of idle capacity costs in inventory

valuation of a sugar manufacturing unit

 1. A sugar manufacturing unit, situated in U.P., has a licensed and installed capacity of 2750 tons of crushing sugarcane per day. The querist has furnished a statement giving licensed capacity, for the last 10 years of the company. The said Statement in summarised form is given below:

2.The querist has made the following submissions regarding the nature of sugar industry:

(i) The total sugar produced by a sugar factory is dependant on the total sugarcane crushed by the factory in the relevant period as also the recovery percentage obtained by the factory in that period. It has been mentioned that the recovery varies according to the quality of the sugarcane as also the month in which crushing operations are carried on.

(ii) The total sugarcane supplied to and crushed by a factory is further dependant on various climatic, environmental and economic factors such as the area under cane, the quality of the crop and the yield of sugarcane in the fields, the extent of diversion of sugarcane to other uses such as gur manufacturing, illicit distillation, Khandsari etc., as also rain fall and the price of sugarcane vis-à-vis other crops.

(iii) A sugar manufacturing unit in Uttar Pradesh cannot stop crushing sugarcane without the permission of the State Government. This permission is granted only when most of the standing crop is crushed. As such, the State Government can extend the season to any length of time on the above considerations.

(iv) Due to the above reasons, the production of sugarcane in the demarcated zone of a sugar mill fluctuates, thereby affecting the crushing of sugarcane by the mills and consequently sugar production. The length of the period for which crushing operations by a sugar mill are carried on therefore depends on the aforesaid factors.

3. The querist has also furnished a statement of the cost of production of sugar for the year 1985-86 for the purpose of valuation of the closing stock of sugar. Cost per ton has been calculated on the basis of actual production of sugar during the year as per this Statement. According to the querist, seasonal industries like sugar are committed to keep the bulk of their labour as seasonal. This labour normally works when the crushing operations in the factory are in progress. They are on the regular rolls of the company. In addition to this, there is a set of permanent workers who are in the employment of the company throughout the year and whose nature of job during the season is to assist and operate various machines of the plant and in the off-season, i.e., when the crushing operations are closed, to overhaul and repair the factory so that it is kept ready for operation in the next season. The querist has further informed that the Bureau of Industrial Costs and Prices have taken the view that the wages paid during the season, i.e., when the crushing operations are in progress, to seasonal and permanent workers, should be considered as variable expenses.

4. The querist has also furnished a statement giving the normal production levels fixed as per guidelines adopted by the Central Government for calculating the normal duration and recovery for sugar mills in different states. According to the said statement, the normal period of crushing for a sugar factory in U.P. is 130 days and the recovery rate for sugar factories in U.P. is 9.5%. The sugarcane crushing capacity and sugar production on the above basis is discounted by a factor of 22/24 i.e. 11/12 to account for a normal 22 hours crushing in a day.

5. The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from the above:

(i) Whether there was any appreciable shortfall in the utilisation of capacity of the sugar mill in the year 1985-86 as per the data given in the statement mentioned in para 1?

(ii) In case there was any shortfall of capacity utilisation what should be the criteria to be kept in mind to consider whether it is material or not?

(iii) What level of capacity utilisation is considered normal?

(iv) What should be the basis for calculating the capacity utilisation for industries where the capacity is based on daily operation as in the case of sugar and the total period of operation may vary for factories within the same zone depending upon the efficiency, climatic conditions, government policies and other factors? The querist has supplied data showing calculation of capacity utilisation based on various parameters viz, (a) actual sugar production as a percentage of sugar production as per Government norms (b) actual crushing of sugarcane in terms of gross days as a percentage of installed/licensed capacity (c) actual crushing in terms of net days (22 hrs) as a percentage of installed/licensed capacity (d) actual crushing in terms of total hours (24 hrs. per day) as a percentage of installed/licensed capacity.

(v) What should be the basis adopted for absorption of certain overhead expenses on production? Whether it should be normal or actual overheads. Whether the wages of the permanent workers for the period for which the crushing operations are closed should only be taken as overhead for absorption or their entire year’s wages should be considered for absorption.

                                                                                            Opinion                     August 21, 1987

1. The point-wise opinion of the Expert Advisory Committee is as below:

(i) The Committee is of the opinion that in case of a sugar mill, capacity utilization should be measured in terms of input since the output, as mentioned by the querist, is a factor of a number of variables. Thus, the capacity utilisation of the mill should be in terms of rate of sugarcane crushing in terms of net days (TCD) or excluding stoppages (MT/Days). Accordingly, on a perusal of the statement mentioned in para 1 of the query, there is no significant fall in capacity utilization of sugarcane crushing in terms of net days (column 3) and in terms of rate per day excluding stoppages (MT/Days) (Col.4) in comparison with past crushing levels.

(ii) The materiality of a shortfall in capacity utilization has obviously to-be seen with reference to capacity of the plant, the production achieved in the earlier years and that in the current year. In the year under question, the rate of crushing in terms of net days (TCD) or excluding stoppages (MT/Days) falls well within the rates achieved in the immediately past three years.

(iii) & (iv) With regard to what level of capacity utilization should be considered normal, the Committee wishes to draw the attention of the querist to para 15 of Accounting Standard 2 (AS 2) on ‘Valuation of Inventories’ issued by the Institute of Chartered Accountants of India, which states as below:

“In applying the absorption costing method, regard should be had to the normal level of production. The normal level of production depends on the facts of each case having regard to such factors as available capacity of the plant, production achieved in the earlier years and in the current year”.

The Committee is therefore of the opinion that normal capacity of the plant, in terms of per day sugarcane crushing, should be arrived at keeping in view the above factors.

(v) In view of the recommendation made in para 15 of AS-2 (reproduced above), if absorption costing system is followed for valuation of inventories then production overheads should be absorbed on the basis of normal level of production. Wages paid to permanent workers, during the period the crushing of sugarcane is not carried on, should be treated as an item of production overhead as the said workers are doing repairs and maintenance of plant, as informed by the querist. Consequently, wages paid to permanent workers, who are directly involved in the production activities, during the crushing season, should be treated as ‘direct labour cost’ as a part of the ‘conversion cost’.