CMA. CS. Sanjay Gupta
( Expert )
09 August 2010
Valuation of closing stock requires consideration
Valuation of closing stock requires consideration of Income Tax, Cenvat, Accounting Standards and Company Law.
Stock should be valued at cost or market value, whichever is lower, as it is a prudent business practice. This principle has been accepted in Chainrup Sampatram v. CIT (1953) 24 ITR 481 (SC) * ALA Firm v. CIT (1991) 189 ITR 285 = 55 Taxman 497 (SC).
ICAI has introduced revised accounting standard AS-2 which is mandatory w.e.f. 1-4-1999. This standard closely follows IAS - 2. As per AS2 of ICAI, inventorires are assets (a) Held in ordinary course of business (b) In the process of production for such sale or (c) In the form of materials or supplies to be consumed in the production or in the rendering of services. Inventory is classified as (i) Raw materials and components (ii) WIP (iii) Finished goods (iv) Stores and spares and (v) Loose tools.
AS-2 does not apply to WIP in construction contracts and related service contracts, WIP of service providers, shares and debentures held as stock in trade. It also does not apply to live stock, agricultural and forest products and mineral oils, ores and gases, if it is measured as Net Realisable Value.
As per Part I of Schedule VI of Companies Act, inventories are classified as (i) Stores and spares (ii) Loose tools (iii) Stock-in-trade (iv) WIP for purpose of balance sheet. Itemwise breakup of raw materials, opening and closing stock etc. has to be given as provided in para 3(ii)(a) of Part II of Schedule VI.
As per section 145A of Income Tax Act, stock valuation should be inclusive of any tax, duty, cess or fee actually paid by assessee to bring the goods to the place of its location and condition as on date of valuation, even if such tax or duty is includible even if any right arises as a consequence to such payment. Thus, duty paid on inputs will have to be added while valuing stock, even if Cenvat credit availed of such duty paid. In respect of finished stock, excise duty payable should be added to the inventory valuation even if not paid as goods are still lying in the factory. Both opening as well as closing stock should be valued on same basis.
The amended section 145A is effective from 1-4-1999 and will apply to AY 1999-2000 and onwards.
However, as per Accounting Standard of ICAI (AS-2), inventory cost should comprise of all cost of purchases, cost of conversion and other costs incurred in bringing the inventories to the present location and condition. Cost of purchases should be exclusive of duties which are recoverable from the taxing authorities. (e.g. Cenvat). Inventory should be valued at lower of cost or net realisable value. Inventory should be valued on FIFO (First in First Out) method or weighted average method. [LIFO is not permitted]. The AS-2 has been made mandatory w.e.f. 1st April, 1999. [see Chartered Accountant - July 1999].
Thus, for purposes of Income Tax, inventory is required to be valued inclusive of excise duty, even if assessee is entitled to get Cenvat credit of duty. However, for purposes of balance sheet as per Companies Act, inventory should be valued exclusive of excise duty, if assessee is entitled to get Cenvat credit of duty paid on inputs. In view of this conflict, Institute of Chartered Accountant of India has advised that in the company accounts, inventory of inputs should be valued without considering Cenvat (i.e. first method should be adopted). For purposes of income tax section 145A, computation should be made outside the books, as made in case of some other items like depreciation. [Chartered Accountant - November 1999 - page 83]. [Note that depreciation for income tax and for company law are different and hence separate calculations have to be made while submitting income tax return. Same will have to be done for inventory valuation also].
Inventory valuation is responsibility of auditor also - A note in balance sheet of many companies states - 'Inventory - (As valued and certified by Management). This gives an impression that inventory valuation is not responsibility of auditor. Hence, ICAI has advised that these words should not be used in balance sheet, as auditor is required to perform audit procedures to check inventory. - Chartered Accountant - September, 1999 - page 66]. [Thus, auditor has responsibility of stock valuation also]
Section 145A is against accounting principles - According to method suggested by ICAI and made mandatory vide AS-2, inventory of raw materials should be valued at cost, without considering excise duty, as manufacturer has availed credit of the same. However, this reduces value of stock and hence profits are lower. In S. H. Kelkar & Co. Ltd. v. Dy. CIT - 44 ITD 170 (Tribunal), Lakhan Pal National 162 ITR 240 = 27 Taxman 462 (Guj) and ITO v. Food Specialities (1994) 206 ITR 119 (ITAT SB), it was held that stock should be valued without considering Cenvat credit. The amendment in Income Tax Act has been made to neutralise the effect of this decision, though the Court and Tribunal decisions are sound and correct as per accounting principles. - . - . - Really, in the long run, it does not make any difference, as long as same method of valuation is followed consistently. If Cenvat credit is added to value of stock, profit in first year will be higher, as closing stock valuation will be higher. However, in the subsequent period, profit will be correspondingly lower. In fact, according to income tax provisions, both opening and closing stock has to be valued on same basis. Thus, if, for AY 1999-2000, both opening and closing stocks are re-valued as per Income Tax section 145A, the difference in profits will be only marginal.
Stock valuation for balance sheet and income tax return can be different - In United Commercial Bank v. CIT (1999) 106 Taxman 601 = AIR 2000 SC 94 (SC), it was held that valuation of stock for balance sheet as per statutory requirement (at cost in this case) can be different from valuation for income tax purposes (at cost or market value whichever is lower in this case). It was also held that stock can be valued at cost or market value, whichever is lower. In CIT v. R Venkatachari (1999) 107 Taxman 438 (Mad HC DB) also, it was held that stock can be valued at lower of cost or market price.