Expert Advisory Committee
ICAI-Expert Advisory Committee
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1.6            Opinion

 

Valuation of physician’s samples and method of exhibition of samples issued and

those in stock in the annual accounts of a drug manufacturing unit.

 

1. In every drug company, issue of free physicians’ samples is a common practice; purpose being to acquaint the doctors with the different products made by the company. The packs containing physicians’ samples are stamped with the words “Physicians’ samples not to be sold”. These have a cost of production but their sale value is NIL as they are distributed free to the doctors and are not meant for sale. Samples produced during one accounting year are not necessarily consumed during the same year and usually some stock is left as at the end of the year.

 

2. The querist has referred to Accounting Standard No. 2 on ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, according to which, inventory has been defined as tangible property held:

 

                        (i) for sale in the ordinary course of business, or

 

                        (ii) in the process of production for such sale, or

 

(iii) for consumption in the production of goods or services for sale, including maintenance supplies and consumables other than machinery spares.

 

3. The company has a system of specifying different rates for sale of its products viz., (i) to its stockists (ii) from stockists to wholesalers (iii) from wholesalers to retailers and (iv) from retailers to consumers, which are called Col. I, II, III and IV prices respectively. The company also has, for some products, fixed special rates for sales to hospitals which are lower than the Col. I price for those products. As a policy matter, the manufacturing units of the company transfer saleable stocks produced by them, to its Marketing Division at lower of Col. I price (price to be charged from stockists) or hospital price and sample stocks are transferred to Marketing Divisions at 80% of Col. I price. Both these transfer prices have an element of profit for the unit manufacturing them. The closing stocks are valued, in the accounts of the holding unit, at lower of cost or selling price. Consequently, stocks of physicians’ samples are valued at lower of cost or 80% of Col. I price.

 

4. At present the following system of exhibition is adopted by the company in the annual published accounts of the company. Value of samples issued to the sales force for distribution (transferred to Marketing Division) are exhibited on the income side to Trading A/c as “Stock issued for free samples” and as a contra entry by showing on the expenditure side under the head “Samples”. Closing stock of samples is included under “Inventory” under “Current Assets” and valued at lower of cost or 80% of Col. I price.

 

5. In the Income-tax assessment of the company, whereas the I.T.O. has disallowed the expenses under the head samples, the income under the heading stocks issued as free samples has been included. Reasons given for disallowance being that issue of free samples is not a “Business expenditure” as it is not obligatory for the company to issue free samples. The I.T.O. treats this expenditure as advertisement and deals with this expense in the assessment accordingly.

 

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

 

(i) Whether the system of exhibition in its annual accounts as followed by the company in regard to “physicians’ Samples” is correct;

 

(ii) Whether the I.T.O. is justified in disallowing the expenditure on “Physicians’ Samples” on the grounds that it is not a business expenditure.

 

(iii) Whether stock of “Physicians’ Samples” falls under the category of inventory, as defined by the Accounting Standard No. 2.

 

                                                                              Opinion                          December 21, 1987

 

1.The Committee is of the view that since physicians’ samples are not meant for sale in the ordinary course of business these cannot be strictly considered as ‘inventories’ as defined in Accounting Standard 2, “Valuation of Inventories”, (reproduced in para 2 of the query) issued by the Institute of Chartered Accountants of India. The Committee is of the view that the amount spent on samples is in the ordinary course of business. The essential difference between an item meant as sample and an item as finished inventory lies only in its packing and labeling. Accordingly, unissued quantity of such samples should be valued at cost if this is the consistent policy followed by the company in this regard provided, however, that the corresponding saleable stock has a value on realisation in the ordinary course of business at least equal to the amount at which they are valued. Needless to say any difference will be charged to revenue. The stock of physicians’ samples should also be disclosed separately, if material, under the head current assets after ‘stores and spares’. Regarding the disclosure thereof in the profit and loss account, the Committee is of the view that it was proper to debit the profit and loss account, with the value of free samples, as a selling expense and credit the profit and loss account, with a contra entry, as the ‘stocks issued as free samples’.

 

2.The Committee is of the view, as stated earlier, that the expenditure incurred by the company on samples is a business expenditure keeping in view the nature of business of the company. However, whether the said expenditure will be considered a sales promotion expenditure for the purpose of section 37 (3B) of the Income-tax Act, 1961, is a question involving interpretation of law on which the Committee does not express a view as per Rule 2 of the Advisory Service Rules.

 

3.On the basis of the above, the opinion of the Expert Advisory Committee on the issues raised by the querist in para 6 of the query, is as below:

 

       (i) The unissued quantity of physicians’ samples should be valued at cost if this is the consistent policy followed by the company in this regard, provided however that the corresponding saleable stock has a value on realisation in the ordinary course of business at least equal to the amount at which they are valued. Any difference between the cost and the net realisable value so arrived at should be charged off to revenue. The stock of physicians’ samples should also be disclosed separately, if material, under the head current assets. Regarding the disclosure therof in the profit and loss account, it was proper to debit to the profit and loss account, the value of free samples, as a selling expense and credit the profit and loss account, as a contra entry, the ‘stocks issued as free samples’.

 

       (ii) Expenditure on physicians’ samples is a normal business expenditure. However, whether the said expenditure will be considered as sales promotion expenditure for the purpose of section 37 (3B) of the Income-tax Act, 1961 is a question involving interpretation of law on which the Committee does not express a view.

 

           (iii) Stock of physician’s samples does not fall within the definition of “inventories” as per AS-2 issued by the Institute of Chartered Accountants of India.

 

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