1. A multi-unit cooperative society is registered under the Bombay Cooperative Societies Act (Act VII of 1925) as extended to the Union Territory of Delhi. The society is governed by the provisions of Multi-State Cooperative Societies Act, 1984, and the rules framed thereunder. The society is engaged in the business of manufacturing and distribution of chemical fertilisers, viz., nitrogenous fertiliser, and complex phosphatic and potassium fertilisers (NPK/DAP).
2. The Government of India introduced a retention price scheme for the fertiliser industry in November 1977 for nitrogenous fertiliser and w.e.f. February 1979 for complex phosphatic and potassium fertilisers. Under the retention price scheme a price called retention price is fixed for each product manufactured by each plant in such a manner that the manufacturer is assured of a 12% post-tax return based on a normative capacity utilisation and certain conditions regarding consumption of raw material and other inputs.
The Government fixes a uniform subsidised price (selling price) of fertilisers for the farmers and the difference between the retention price and the selling price is paid to the manufacturer as subsidy. In case the retention price happens to be lower than the selling price, then the manufacturer has to make a contribution to the Government for the difference. The subsidy is allowed on movement of fertiliser material from the factory. However, the manufacturer has to give an undertaking that the fertiliser moved out of the factory will be sold for agricultural purposes. Of all quantities of fertiliser moved out but which are lost in transit or lost in storage or not used for agricultural purposes, the manufacturer has to refund the subsidy.
The Government fixes a uniform subsidised price (selling price) of fertilisers for the farmers and the difference between the retention price and the selling price is paid to the manufacturer as subsidy. In case the retention price happens to be lower than the selling price, then the manufacturer has to make a contribution to the Government for the difference. The subsidy is allowed on movement of fertiliser material from the factory. However, the manufacturer has to give an undertaking that the fertiliser moved out of the factory will be sold for agricultural purposes. Of all quantities of fertiliser moved out but which are lost in transit or lost in storage or not used for agricultural purposes, the manufacturer has to refund the subsidy.
3. The character of receipt may be taken as an income or a subsidy to cost. The receipt of subsidy may be taken to profit and loss account on clearance of the goods from the factory or on ultimate sale. In the view of the querist, the accounting treatment to be followed depends upon the perception as to whether the subsidy may be viewed as subsidy to the consumer (farmers) or subsidy to the manufacturer. It is seen that however one regards the nature of subsidy, the profit figures differ only to the extent that production moved out is different from product sales. That is, when there is no inventory build-up, or inventory liquidation, both methods give identical results. But when there are inventory differences, the profits are different to the extent of inventory profit.
In deciding in favour of any of the above methods, consistency, convenience and accuracy are the key factors in the view of the querist.
4. The society has adopted the following basis for accounting of subsidy and valuation of stock of finished goods:
(a) Profit and loss account is being credited for subsidy including freight subsidy on quantities moved out of the factory since, as per the retention price scheme, the manufacturer is entitled to subsidy on quantities despatched.
(b) Since the credit for subsidy is taken on despatch in the profit and loss account, the valuation of stock of finished goods moved out of the factory but unsold on the balance sheet date is made after subtracting the element of retention price subsidy from the cost of production. Freight subsidy and expenditure are excluded from the purview of the valuation of stock of finished goods since freight subsidy is separately determined and allowed by the Government for controlled fertilisers. In respect of decontrolled fertilisers, the freight expenditure is taken as an element of cost for the purposes of valuation of finished goods since in respect of these fertilisers freight subsidy is not allowed by the Government. Thus, effectively, subsidy is taken credit on the basis of sales. At the same time in order to ensure simplicity of accounting, the society has been taking credit of subsidy on the basis of despatches. The method followed by the society has been illustrated by the querist in Annexure ‘A’ to this query.
(c) The above basis of accounting for subsidy and valuation of stock of finished goods has been consistently adopted by the society for about 15 years (since 1980-81) and the same has also been disclosed in the significant accounting policies of the society which form part of the published accounts.
5. The statutory auditors of the society, while finalising the accounts for the year 1995-96, have expressed their views on the accounting treatment given by the society for accounting of the subsidy under the retention price scheme and the valuation of stock of finished goods. The statutory auditors have opined that the recognised subsidy as income/expenditure should be on the sale of fertiliser as the subsidy accrues to the society only on sale and not on despatches of materials.
6. The querist has sought the opinion of the Expert Advisory Committee on the following issues arising from the above:
(i) Whether the accounting treatment consistently given by the society for the accounting of subsidy receipts from the Government under the retention price scheme conforms to the accepted accounting practices/principles.
(ii) Whether the basis of valuation of stock of finished goods consistently followed by the society in respect of controlled and decontrolled fertilisers in transit from the plant and those lying at the warehouse is in accordance with the accepted accounting practices/principles or requires a change.
Opinion May 16,1997
1. The Committee notes that with regard to accounting for subsidy and accounting for valuation of inventories, the Institute of Chartered Accountants of India has issued authoritative pronouncements in the form of accounting standards, namely, Accounting Standard (AS) 12 on ‘Accounting for Government Grants’ and Accounting Standard (AS) 2 on ‘Valuation of Inventories’, respectively. The Committee is of the view that subsidy received by a fertiliser manufacturing enterprise, being of the nature of a revenue grant, and the valuation of inventories of fertilisers should be accounted for in accordance with the aforementioned standards issued by the Institute of Chartered Accountants of India.
2. The Committee notes that para 15 of AS 12 prescribes treatment of revenue grants as below:
“Government grants related to revenue should be recognised on a systematic basis in the profit and loss statement over the periods necessary to match them with the related costs which they are intended to compensate. Such grants should either be shown separately under ‘other income’ or deducted in reporting the related expense.”
3. The Committee notes that the subsidy on fertiliser is the difference between the retention price fixed by the Government in respect of the individual fertiliser unit and the selling price of the fertiliser fixed by the government. Unlike the freight subsidy which is paid to compensate the freight cost, the subsidy in respect of the retention price is not in relation to any specific expense incurred by a fertiliser manufacturing unit. Accordingly, the Committee is of the view that the second alternative allowed in para 15 of AS 12 above would not be appropriate in this case (since the subsidy is not against a particular head of expense). The subsidy should, thus, not be reduced from the cost of production of the fertiliser. The Committee is also of the view that in case the entire amount of subsidy is accounted on despatch from factory, the subsidy to the extent on inventories in warehouses should be reduced from the total amount and only net subsidy should be shown in the profit and loss account (the subsidy attributable to inventories being carried forward to the period in which the fertiliser is actually sold).
4. The Committee notes that AS 2 defines ‘Net Realisable Value’ as below:
“6.9 ‘Net Realisable Value’ is the actual/estimated selling price in the ordinary course of business, less cost of completion and cost necessarily to be incurred in order to make the sale.”
5. The Committee notes from the definition of net realisable value given above that it is to be arrived on the basis of, inter alia, the estimated selling price in the ordinary course of business. The Committee is of the view that from the point of view of a fertiliser manufacturing unit, the estimated selling price should comprise the realisations both from the customer as well as from the Government in the form of a subsidy, since that is the amount which is realised in the normal course of business. Thus, estimated selling price for the purpose of arriving at the net realisable value should be the retention price. Accordingly, in the view of the Committee, the cost of fertiliser should be compared with the retention price for the purpose of valuation of inventories.
6. With regard to freight subsidy on controlled items, the Committee is of the view that either it should be recognised in the profit and loss statement in the period in which the relevant freight cost is charged to the profit and loss account or it should be deducted from the freight expense as per the requirements of para 15 of AS 12 reproduced in para 2 above. In this case, for the purpose of net realisable value, freight subsidy would be added to the retention price of the fertiliser and the freight cost would be reduced therefrom since it is a cost necessarily to be incurred in order to make the sale. With regard to decontrolled items, the freight cost should be reduced from the relevant estimated selling price since it is a cost necessarily to be incurred in order to make the sale.
7. On the basis of the above, the opinion of the Committee on issues raised in para 6 of the query is as follows:
(i) The accounting treatment followed for the accounting of subsidy received from the Government under the retention price scheme should be in accordance with para 3 above.
(ii) Similarly, the basis of valuation of stock of finished goods in respect of controlled and decontrolled fertiliser in transit from the plant and those lying at the warehouse should also be in accordance with paras 5-6 above.
Annexure ‘A’
Year I | Year II | Year III | Year IV | Year V | |
Cost of Prodn. | 4800 | 5600 | 4400 | 5800 | 7000 |
Retention Price | 5470 | 6270 | 5070 | 6470 | 7670 |
Selling Price | 3170 | 3170 | 3170 | 3170 | 3170 |
Subsidy | 2300 | 3100 | 1900 | 3300 | 4500 |
Warehouse Stock Valuation Rate | |||||
(i) If Subsidy is to the Manufacturer | |||||
(a) Subsidy as a contribution to cost (the method adopted by the society) | |||||
i.e. Subsidy adjusted from cost or cost of Prodn. Subsidy | 2500 | 2500 | 2500 | 2500 | 2500 |
(b) Subsidy as a processing charge or processing income | |||||
i.e. Cost or selling price whichever is lower: | 3170 | 3170 | 3170 | 3170 | 3170 |
(ii) If Subsidy is to the Consumer i.e. Subsidy is taken to Profit on Sale (As suggested by Statutory Auditors) | |||||
Cost or Retention Price whichever is less Resouce:Opinion May 16,1997 (ICAI) | 4800 | 5600 | 4400 | 5800 | 7000 |
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