1.30     Query

Valuation of inventories in an extractive industry.

1.A government of India company is in the business of iron ore mining and diamond mining having various iron ore/diamond mines in the country.

2. Closing stock of finished product of iron ore and diamonds at the end of the accounting period is valued and accounted for at lower of net realizable value and the cost of production. For arriving at the cost of production, selling and distribution cost is excluded. Similarly, to arrive at the net realizable value, the selling and distribution cost is deducted from the selling price. The cost of production reckoned for the purpose of closing stock includes general administration overheads, research and development cost and financing charges. Accounting Standard  (AS) 2 on ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, specifically mentions, as per para 5, that the standard is not applicable to mining industry. The Government Audit is, however, of the view that for computation of cost of production for valuation of closing stock of iron ore/diamonds, general administration overheads and financing charges-interest on loan paid/payable – non-trading income earned by the company should be excluded.

3.It is clarified by the querist that administrative overheads of the company are incurred in the units and also in corporate office. The expenses incurred by the corporate office are allocated to the units and accounted as ‘Share of Head Office Expenses’ in the cost of production. In case AS 2 is to applied to the industry, the querist proposes to treat the administrative expenses incurred by the units as factory overhead and share of head office expenses as administrative overheads.

4. Prior period expenses/income is also taken into account while computing cost of production.

5. The querist has accordingly sought the opinion of the Expert Advisory Committee as to whether the following expenses should be included/excluded for computing cost of production for the purpose of valuation of inventories of iron ore/diamonds, keeping in view the fact that AS 2 is not applicable to the industry:

(a) General administration overhead, research and development cost, and financing charges- interest paid/payable- non-trading income earned by the company.

(b) Share of head office expenses as administration overhead.

(c) Administration expenses incurred by the units as factory overhead.

(d) Prior period expenses/income.

                                                                                         Opinion                                            May 2, 1989

1.The Committee notes that AS 2 on ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, does not deal with “extractive industries such as mining, quarrying etc.”, since special considerations apply to such industries. The Committee also notes that para 6.2 of AS 9 on ‘Revenue Recognition’, issued by the Institute of Chartered Accountants of India, specifically deals with some of the industries, including mineral ores, to which special considerations apply. The said para states as below:

“At certain stages in specific industries, such as when agricultural crops have been harvested or mineral ores have been extracted, performance may be considered to be substantially complete prior to the execution of the transaction generating revenue. In such cases when sale is assured under a forward contract or a government guarantee or where market exists and there is negligible risk of failure to sell, the goods involved are often valued at net realisable value. Such amounts, while not revenue as defined in this Statement, are sometimes recognised in the statement of profit and loss and appropriately described.”

2.The Committee notes that the company in question is valuing its inventories of iron ore and diamond at lower of net realisable value and cost of production. The Committee is of the view that the term cost of production cannot be generally considered to include selling and distribution expenses, general administration overheads, research and development costs, interest, prior period incomes/expenses etc.

3.On the basis of the above, the Expert Advisory Committee is of the opinion that the expenses mentioned in para 5 of the query, viz., general administration overhead, research and development cost, financing charges- interest paid/payable- non-trading income, share of head office expenses and prior period expenses/income should not be included in cost of production for the purpose of valuation of inventories since the said costs do not clearly relate to putting the inventories to their present location and condition. However, administration overhead incurred by units, at the site of mine, e.g., site manager’s salary, may be considered as factory overhead in case all such overheads are of this type.

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