Facts: A public sector undertaking was established in the year 1976 under the administrative control of the Ministry of Steel, to develop the mine and plant facilities to produce 7.5 million tons of concentrate per year. The mines and plant facilities were commissioned in the year 1980 and the first shipment of concentrate was made in October, 1981. A pelletisation plant with a capacity of 3 million tons per year was commissioned in the year 1987 for production of high quality blast furnace and direct reduction grade pellets for export. However, in view of the Hon’ble Supreme Court verdict, the mine of the company was closed w.e.f. 31st December, 2005. After the closure of the mine, the company’s activities are restricted to production of pellets on bought out ore from outside source.
Since 1st January 2006, the mining activities of the company were stopped and hence, the production facilities of the pellet plant are wholly dependent on iron ore bought from external sources. It is, therefore, felt that under the circumstances, the average production during past five years can be considered as normal capacity for allocation of fixed overheads, in accordance with AS-2.
Expenses such as general expenses, welfare expenses, interest, advertisement and publicity, opportunity costs of loans and other income (interest recovered from employees on their loans), etc. are considered for valuation of inventories.
The company is of the view that all the expenses and other income related to the pellet plant unit only can be considered for the valuation of inventories (i.e. pellet). Such costs and other income are accumulated separately which are entirely connected to and arising from the production activity of the unit. Thus, according to the Company, the valuation of finished goods is as per AS 2.
Query:
Based on the above background, the Company has sought the opinion of the EAC regarding valuation of closing stock of finished goods as to (a) whether the average production for the last five years is to be reckoned as normal production or the budgeted production for the year under review is to be taken as normal production for the purpose of valuation of inventory? (b) Whether the expenditure on staff welfare, i.e. expenditure on township maintenance, health centre, etc. which are being maintained exclusively for the employees of that unit, general expenses, tender notice advertisement expenses and other income (interest recovered from employees on their loans) are to be considered for the purpose of valuation of inventory?
Opinion:
(i) After considering paragraph 9 of AS 2, the EAC is of the opinion that the normal capacity may be determined at the average of production of the last five years, provided it approximates the production expected to be achieved in the future periods also. However, if there are significant changes in circumstances, then such estimation would not be appropriate. In such a situation, budgeted production should be considered for determining normal capacity.
(ii) After considering paragraphs 6,7,11 & 13 of AS 2, EAC is of the view that the test for determining whether or not the cost for carrying out a particular activity should be included in the cost of inventories is whether the particular activity contributes to bringing the inventory to their present location and condition or not. Further, administrative overheads which do not contribute to bringing the inventories to their present location and condition are not to be included in the cost of inventories and are to be expensed when incurred. The overheads that are incurred to administer the factory in relation to production activities are factory or production overheads which contribute to bringing the inventories to their present location and condition and therefore such costs should be included in the cost of inventories.
The staff welfare expenditure i.e. expenditure on township maintenance and health centre, to the extent these are used by the employees of factory/production unit who render their services in relation to production activities, should be considered for inclusion in the cost of inventories. General expenses may be considered for the purpose of valuation of inventory only if these are incurred in bringing the inventories to their present location and condition. Tender notice, advertisement expenses cannot be included in the cost of inventories, as these expenses are incurred for exploring the possible supplies of materials and services and accordingly, cannot be considered as cost of purchase of inventories or other costs that are directly attributable to the acquisition. As regards interest income recovered from the employees, it is clarified that these are part of ‘other income’ and, therefore should not be adjusted in the cost of inventories.
