1.37 Query
Accounting treatment for income arising on sale of an intermediary product during the construction period of a project.
1. A chemical manufacturing unit, involving a capital investment of about Rs. 80 crores, was having a prolonged construction period.
2. As stated by the querist, the production process of the plant consists of the following:
(a) Recovery of propylene from LPG – in propylene recovery plant.
(b) Manufacturing of cumene from propylene and other chemicals – in cumene plant.
(c) Manufacturing of phenol and acetone from cumene – in cumox plant.
Besides the processing plants listed above, the project envisaged other utilities like boiler plant, hydrogen plant, cooling tower, DM water plant, compressed air and main power receiving station. Although, the propylene recovery plant, cumene plant and cumox plant are separately identifiable, the process is a continuous one up to the end product, namely, phenol and acetone which are joint products.
3. The company is following the financial year as its accounting year. During the year 1985-86, it capitalised the entire utilities. During the year 1986-87, the propylene recovery plant and cumene plant were completed and started producing commercially viable quantities of their respective products, i.e., propylene and cumene. As such, the company has capitalised these two plants during the year 1986-87. Although, the mechanical completion was over, the cumox plant could not be capitalised during the year 1986-87 since no production was achieved nor the trial run was completed.
4. Having started production, the propylene plant and cumene plant were operated from March 1987 onwards. The cumene so produced could not be utilised for captive consumption for producing phenol and acetone since the cumox plant was not ready. 8*51Moreover, the cumene tank had its limited capacity. This has necessitated the sale of cumene produced. There was no intention to produce cumene for sale nor was it envisaged in the project report. The entire cumene produced was expected to be used for captive consumption.
5. Since the utilities, along with propylene recovery plant and cumene plant, have been capitalised in the previous year as mentioned earlier, depreciation has been charged for these assets in accordance with the company’s depreciation policy. Such depreciation, in the absence of any effective operation during the previous years, stands debited in the closing stock-in-process of the product cumene.
6. The cumox plant was completed during the year 1987-88. It was decided to adopt 8.3.88 as the cut-off date for capitalisation of cumox plant; that being the date on which the trial guarantee run was completed.
7. Out of the total production of cumene amounting to 18,489 MT up to 8.3.88 (i.e. cut-off date forcapitalising the cumox plant) 7,038 MT was sold in the circumstances as explained above, and 10,684 MT was used for captive consumption for the trial production of phenol in the cumox plant.
8. The querist has requested for the Expert Advisory Committee’s opinion as to which of the following two alternative accounting treatments should be used in this particular case:
(i) Can the company consider the sale of cumene up to the date of capitalisation of cumox plant as revenue earned during pre-production period and treat the same as per the ‘Guidance Note on Treatment of Expenditure During Construction Period’, under para 11.4 read with para 15.2?
In this case, the entire expenditure for the production of cumene including depreciation on utilities, propylene recovery and cumene plants are proposed to be treated as pre-production expenses.
(ii) Should the sale of cumene be treated purely as a revenue since cumene plant was capitalised in the previous year itself?
In this case, the cost of producing cumene has to be apportioned between the quantity sold and the quantity actually used for trial production of phenol/acetone on pro-rata basis.
Opinion December 5, 1988
1. From the facts stated by the querist, the Committee notes that the propylene recovery plant and cumene plant were completed and started producing commercially viable quantities of their respective products (i.e. propylene and cumene) in the year 1986-87. The company capitalised these two plants during the same year. On the other hand, the cumox plant was completed during 1987-88 and was in a position to start commercial production, w.e.f., 8th March, 1988.
2. The Committee also notes that para 11.4 of the above mentioned Guidance Note recommends as follows:
“During the period of test runs and experimental production it is quite possible that some income will be earned through the sale of the merchandise produced or manufactured during this period. The sale revenue should be set off against the indirect expenditure incurred during the period of test runs and treated as suggested in para 15.2”.
3. The Committee feels that para 11.4 would be applicable to only that part of income which was earned through sale of output produced during “the period of test runs and experimental production”. Since the income under consideration relates to a period when the propylene recovery plant and cumene plant had already started giving “commercial production”, income arising from the sale of cumene can not be treated as pre-production income.
4. The Committee wishes to state that it has not gone into the question of valuation of stock of cumene, since it is not a subject matter of the query.
5. On the basis of the above, the Committee is of the opinion that the sale of cumene should be treated as a revenue income and the cost of producing cumene should be apportioned between the quantity sold and the quantity used for trial production of phenol/acetone. Accordingly, the manner of treatment suggested by the querist in para 8(i) of the query, is not correct. ______________________ |