1.1       Query             

Mode of valuation of stocks having negative realizable value.

1.In an export/import organisation which exports minerals and imports metals, the well known principle ‘at cost or market value, whichever is lower’ has all through been applied in valuing the closing stocks. Since the minerals handled by the organisation have little internal demand (in some cases practically no demand) the market value adopted for the purpose of comparison with cost is the export price on F.O.B. basis at which the sales actually take place. The mineral stocks on the closing date are spread all over the country at different ports as also at rail-heads near to the mines wherefrom stocks are railed or transported by trucks. Depending upon the situation where they are dumped on the closing date, the stocks are valued port-wise (with rail-head stocks distributed pro-rata on the basis of movement to ports) and for this purpose, the F.O.B. market value is adjusted backward after deducting the railway freight and other elements of charges. To illustrate the point, if the F.O.B. value is Rs.65/- per ton, the purchase cost at rail head is Rs.20/-and the railway freight and other handling charges Rs. 40/- the valuation would be on the following basis:

Thus, it may be seen that the purchase cost of stocks at rail-heads is compared with the derived market value to permit a like comparison. So long as market value (and derived market value) was higher than cost, the basis of comparison of cost with market value and adopting the lower value did not pose any problem and had been accepted by all concerned. But with the progressive shrinkage in international price and internal rise in cost, a new situation has arisen where the derived market value of stocks when compared with the purchase cost in some cases has reached a negative value. To be explicit, the position is as follows:

2. Now the point which has come up for consideration is whether the minus value reached at rail-head should be considered and necessary deductions made from the overall value of stocks. Some are of the opinion that in accordance with the concept of realizable value which underlies the principle ‘at cost or market value, whichever is lower’, it is absolutely necessary that necessary deductions are made for negative value of stocks, more so when the practice of comparison of cost with the derived market value has been followed consistently in the past. But there are others who feel that no negative value can be considered and provided for and in a situation where any stock reaches a negative value the same should have ‘nil’ value.

3. In view of the divergent views expressed on the above method of valuation, the opinion of the Expert Advisory Committee is solicited on the following points:

(a) Whether the provision for negative value of stocks in the circumstances mentioned above is in line with the generally accepted accounting principles.

(b) If the answer to (a) is in the negative, would it be permissible to take the stocks at ‘nil’ value when a negative value is reached?

                                                                                      Opinion                          October 29, 1987

1. The querist has raised an important question on valuation of stock when certain items of stock-in-hand have a negative realisable value, that is to say, they will have to be exported, after incurring certain further expenses on them, at a price which will result in a loss larger than the cost incurred on them upto the balance sheet date. In other words, the price to be realised would be less than the further expenditure required to be incurred. The querist has stated that the company has to necessarily export these items at such price for reasons of Government policy, even though, on purely commercial consideration, it would perhaps be more economical to sell them locally, or even discard the said items, rather than to export them. Perhaps this question would be peculiar to an export industry which must export for augmenting the country’s exchange earnings or for other good reasons, even if the alternative of selling locally or even discarding the specific items of stocks would involve a lesser loss than would be incurred if the goods are exported.

2.The answer to the questions raised by the querist would be based on the application of the well-known principle of valuation of stock “at the lower of cost and net realisable value”, which is universally accepted. The principle underlying the valuation of stock at net realisable value when such net realisable value is lower than cost is to provide for any anticipated loss at the time of the sale of the inventories, either in the form in which they were at the end of the financial year, or after they are processed and covered into finished goods.

3. However, the querist has posed a problem in which the realisable value is a negative figure. The querist has clarified that the realisable value would be a negative figure, even after taking into consideration the value of the tax and other export incentives which might arise as a result of the export.

4.When, in valuing the stock, the principle of providing for the anticipated loss at the time of sale of the inventories is accepted, it follows that such provision should not be limited to the cost of the items incurred up to the date of the balance sheet. Unless the anticipated loss is fully provided for, it cannot be said that the balance sheet exhibits a true and fair view of the state of affairs of the Company.

5.Therefore, the answers to the questions posed by the querist would be as under:

(a) In accordance with correct accounting principles, where the estimated net realisable value, at any time of stock, is a negative figure, full provision should be made for the total anticipated loss. It would not be sufficient to value the stock at “Nil”.

(b) Does not arise.

6. A further point that may be considered in this connection is the mode of disclosure of the provision for anticipated loss in the financial statements.

7. If items with a negative realisable value constitute a material part of the total inventory, a note should be added to the balance sheet and the profit and loss account disclosing the value of the items of inventory which have a negative realisable value, explaining the reasons for such negative realisable value and giving other material facts, if any, in relation thereto.

8. If the items with a negative realisable value are such that the total inventory has a negative value, then on the credit side of the profit & loss account and in the balance sheet on the assets side, against the item “Stock-in-trade” no figure should be shown (Nil should not be shown) and instead “Negative figure as per contra” should be stated. The negative figure would appear on the debit side of profit & loss account, as “Provision for reduction in the value of stock” and also in the balance sheet under the head “Current Liabilities and Provisions”, sub head “Provisions”. The note explaining the reasons for the negative value earlier referred to would also be necessary in the case.

9. The Committee recognises that the above treatment is on the presumption that the stocks are meant strictly for export and not for sale in the domestic market at all and that the net realisable value in the ordinary course of business can be reasonably estimated in the context of the international market. For this purpose, actual contracts for export sales, the later movement of stocks and past experience may be considered.

_________________________