Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.18     Query

 

Accounting treatment for MODVAT .

 

1.A public sector company is engaged in the manufacture and sale of heavy earthmoving equipment, rail coaches, heavy duty trailers, heavy duty vehicles etc. The company also renders after sales service of the equipment both during and outside warranty and also supplies spare parts.

 

2. The Government, vide Finance Act, 1986, introduced MODVAT, under which, the company is entitled for input duty relief (of both countervailing duty in respect of imported items and excise duty in respect of other items).

 

3.The sales turnover of the company is inclusive of excise duty and exhibited as such on the credit side of the profit and loss account. The expenditure on account of excise duty is exhibited on the debit side of the profit and loss account. Till the introduction of MODVAT benefit, vide Finance Act 1986, the company was enjoying Proforma Credit on certain inputs and such benefits where accounted as abatement of expenditure of excise duty. Consequently, in the relevant profit and loss account, the expenditure on excise duty is exhibited as net.

 

4. During 1985-86, the input duty relief arising to the company, as a result of the introduction of MODVAT benefit from February 1986, was accounted as abatement of expenditure against excise duty. During the year 1986-87 also, the company adopted the same method of exhibition of the MODVAT benefit. However, Government Audit objected to the method of exhibition and suggested that the same should be taken as abatement of cost of inventory/consumption/work-in-progress/finished goods. Finally, the accounts of the company were cleared by the Government Audit after addition of the following Note in the Accounts:

 

“MODVAT credit availed/available during the year on purchases has been set-off against excise duty paid/payable on output. No adjustment has been made against inventory/consumption of materials”.

 

5. The querist has mentioned that the following courses of action are available for exhibition of MODVAT benefit:

 

                        (1) Reduce the cost of inventory/consumption;

 

(2) At the end of the year, exhibit the total MODVAT benefit as abatement of expenditure viz., excise duty;

 

(3) At the end of the year, exhibit the total MODVAT benefit availed by the company as abatement of expenditure, viz., material cost;

 

6. The advantages/disadvantages in adopting the above methods of exhibition have been stated by the querist as below:

 

            (A) Reducing the cost of inventory

 

Since the MODVAT credit is availed on all inputs received inside the factory, whether such inputs are actually consumed or not, it will be prudent to reduce the same from the cost of inventory so as to exhibit appropriately the inventory consumption, work-in- progress and finished stock. However, there are certain inherent difficulties in reducing the cost of inventory at the time of initial accounting of the purchase. These are as under:

 

(a)        If, after the entry of the credit in RG-23A Register and after reducing the cost of inventory, the Excise Department were to reverse the credit for some reason or the other (in fact it has happened very frequently during 1986-87), the company will have to carry out frequent revision of the Materials Ledger and the Work Order/work-in-progress, so as to nullify the cost reduction already effected.

 

(b)        Comparison of per unit cost of material/final product between the previous year and the current year will be vitiated if the MODVAT benefit is taken to reduce the cost of inventory.

 

(c)        The MODVAT benefit is only a regularisation and an extension of the existing Proforma Credit and hence the accounting method should be the same as that adopted for accounting of Proforma Credit.

 

(d)        The real input cost of material to the company is inclusive of the countervailing duty/excise duty and that fact cannot be altered.

 

(e)        The benefit is really available to the company only upon sale of final product and not otherwise. Till such time the amount is available only for adjustment against future payment of excise duty.

 

(f)         By reducing the MODVAT benefit from the cost of inventory etc., the amount for which the inventory has to be insured will come down and thus affect the amount for which the insurance company has to settle the claim in case of loss to the company as a result of fire etc.

 

(g)        Accounting for MODVAT benefit as reduction in the value of inventory will reduce the borrowing power of the company from banks for meeting the working capital needs. This is particularly so in cases like the company in question where the production is resorted to in anticipation of orders and where sales normally get bunched-up during the last quarter/month of the year.

 

           (B) Exhibition of MODVAT benefit as abatement of excise duty expenditure

 

This is the method presently followed by the company and the method adopted is considered as correct, for various reasons mentioned against the accounting of the same under (A) above.

 

           (C) Exhibition of MODVAT benefit as abatement of material cost

 

This will be a slight refinement of the method suggested at (B) above and will facilitate computation of the value added by the company on a realistic basis.

 

7. In view of the foregoing, the querist is of the view that alternative at (C) above, viz., accounting of the total MODVAT benefit at the end of the year as abatement of cost of materials will be most suited and appropriate.

 

8.The querist has sought the opinion of the Expert Advisory Committee as to which of the above is the proper method for accounting for MODVAT benefit availed by the company.

 

                                                                            Opinion                                         July 5, 1988

 

1. The Committee notes that the Research Committee of the Institute of Chartered Accountants of India has issued a Guidance Note on Accounting for MODVAT (published in March 1988 issue of ‘The Chartered Accountant’). Paras 4.1 and 4.2 of the Guidance Note recommend as below:

 

“4.1….. MODVAT is a procedure whereby manufacturer can utilise credit for input duty against duty payable on final products. Duty credit taken on input is of the nature of set-off available against the payment of excise duty on the final products. There are two alternative methods of treatment of MODVAT credit in accounts:

 

(a)        Duty paid on inputs may be debited to a separate account, e.g., MODVAT Credit Receivable Account. As and when the MODVAT credit is actually utilised against payment of excise duty on final products, appropriate accounting entries will be required to adjust the excise duty paid out of MODVAT Credit Receivable Account to the account maintained for payment/provision for excise duty on final product. In this case, the purchase cost of the inputs would be net of input duty. Therefore, the inputs consumed and the inventory of inputs would be valued on the basis of purchase cost net of input duty. The debit balance in MODVAT Credit Receivable Account should be shown on the asset side under the head ‘advances’.

 

(b)        In the second alternative, the cost of inputs may be recorded at the total amount paid to the supplier inclusive of input duty. To the extent the MODVAT credit is utilised for payment of excise duty on final products, the amount could be credited to a separate account, e.g., MODVAT Credit Availed Account. Out of the MODVAT Credit Availed Account, the amount of MODVAT credit availed in respect of consumption of inputs would be reduced from the total cost of inputs consumed. The balance amount standing to the credit of MODVAT Credit Availed Account representing MODVAT credit in respect of inputs not consumed but lying in stock could be shown in the balance sheet as deduction from the value of inventory. It will have to be ensured that the set-off for MODVAT credit on input not yet consumed is carried forward and there is no accounting of double income, firstly, as set-off adjusted as reduction in the cost of input and secondly, as credit taken in the profit and loss account by inclusion of input duty as part of value of inventory of the input.”

 

“4.2 It may be appropriate to quote the definitions of ‘historical cost’ and ‘cost of purchase’ from Accounting Standard-2 (AS-2) on ‘Valuation of Inventories’ issued by the Institute of Chartered Accountants of India:

 

‘Historical Cost represents an appropriate combination of the

 

(a) Cost of purchase;

 

(b) Cost of conversion; and

 

(c) Other costs incurred in the normal course of business in bringing the inventories up to their present location and condition.’

 

            ‘Cost of Purchase consists of purchase price including duties and taxes, freight inwards and other expenditures directly attributable to acquisition, less trade discounts, rebates, duty drawbacks and subsidies, in the year in which they are accounted, whether immediate or deferred, in respect of such purchase’.

 

            Particular attention is invited to the term ‘cost of purchase’ according to which, ‘rebates’ and ‘duty drawbacks’ are to be reduced from purchase price in determining the actual cost of purchase under the historical costing system. Therefore, MODVAT credit, when availed of can be described as similar to duty drawback which will reduce the cost of purchase.”

 

2. On the basis of the above, the Committee is of the opinion that the purchase cost of inputs should be net of input duty (i.e., MODVAT credit) utilised for payment of excise duty on final products. Therefore, the inputs consumed and the inventory of inputs would be valued on the basis of purchase cost net of input duty. Alternatively, the amount of MODVAT credit availed in respect of consumption of inputs could be reduced from the total cost of inputs consumed and the amount of input duty paid to the supplier but not yet availed, representing MODVAT credit in respect of input not consumed but lying in stock, could be shown in the balance sheet as deduction from the value of inventory. The other accounting adjustments suggested in para 4.1 (a) and (b) of the said Guidance Note [reproduced in para 8 above] should also be followed.

 

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