1.9 Query
Inclusion of interest in valuation of inventories of finished goods and inventories of raw materials purchased in exchange of steam generated by a company.
1.A company engaged in the production of paper, uses “Bagasse” as the main raw material. Bagasse is a sugarcane waste. For procuring bagasse the company has set up coal-fired boilers near the sugar mills at a cost of Rs. 23.75 crores in order to produce steam and supply the same to sugar mills in exchange of bagasse released by them on the basis of a predetermined ratio under an arrangement. As such, the cost of bagasse for the company is equivalent to the cost of production of steam supplied to the sugar mills as per the arrangement, and freight and handling charges. The company is valuing the stock of raw material, viz., bagasse at ‘cost of production’. In case of finished goods, the company has adopted the policy of valuing the stock at the lower of ‘cost of production’ and market price. The ‘cost of production’ for this purchase means the cost of production of steam which includes the cost of fuel consumed, power, labour, repair and maintenance of the boilers, depreciation, and interest on investment made on the boilers.
2.The inclusion of interest in the cost of production, and therefore
in the valuation of inventories of raw material and finished goods, is being
done on the basis that interest is a major item of expenditure in the case of
the company and if it is excluded in arriving at the cost of production, the
financial statements may not reflect a true and fair view as far as inventories
are concerned, besides distorting the operational results of the company for the
year.
3.The querist has sought the opinion of the committee as to whether
the policy adopted by the company, of including interest in the cost of
production, is appropriate or not. In this regard, the querist has observed that
paragraph 16 of Accounting Standard (AS)2, “Valuation of Inventories” recognises
that, in exceptional situations, interest may be regarded as relating to putting
the inventories in their present location and condition and may, therefore, be
included in valuation of inventories.
Opinion July 31, 1989
1.The Committee notes that valuation of inventory of raw material, i.e., bagasse, obtained in exchange of steam produced by the company and valuation of inventories of its finished goods are two separate issues.
2.The Committee also notes that para 24 of Accounting Standard 2 (AS2) recommends that “subject to the exception stated in para 29.1 to 29.4 inventories should be valued at lower of historical and net realisable value”. The Committee further notes that this principle is applicable, inter alia, to raw materials and finished goods.
3. With regard to bagasse, the Committee notes that the transaction can be viewed as sale of steam by the company to the sugar mills and, in return, purchase of bagasse by the company from the said mills. The Committee is of the view that if the company is recording the said sale and purchase in its books of account then the purchase price of bagasse is the sale price of steam, which, in this case, is cost of production of steam, including interest. The Committee is, therefore, of the opinion that historical cost of bagasse would be the cost of purchase consisting of aforesaid purchase price of bagasse plus other expenditure directly attributable to acquisition such as duties and taxes, and freight inwards.
4. With regard to valuation of inventories of finished goods, the Committee notes that according to paragraph 28 of AS 2, “Overheads other than production overheads should be included as part of inventory cost only to the extent that they clearly relate to putting the inventories in their present location and condition”. Paragraph 16 of the said standard recognizes that interest is usually considered not to relate to putting the inventories in their present location and condition and is therefore excluded from determining the valuation of inventories.
5.The Committee is of the view that while AS 2 does recognize that
in exceptional situations interest may be included in valuation of inventories,
the circumstances cited by the querist are not of an exceptional nature. The
main argument of the querist in support of including interest in cost of
production and, therefore, in valuation of inventories, is that the company is
engaged in a highly capital intensive project and the incidence of interest is
quite significant. However, these grounds do not by themselves make the
situation exceptional. Interest cannot be considered as relating to putting the
inventories in their present location and condition merely on the basis that
interest expense is significant. If the argument of the querist is accepted, it
would mean that interest should be treated as part of value of inventories in
all cases where the interest expense is quite high. This would not be in
consonance with the generally accepted accounting principles.
6.In view of the above, the Committee is of the opinion that the practice followed by the company of including interest in the cost of production, and, therefore, in the valuation of finished goods inventories is not appropriate. _______________________ |