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15 August 2010 what is the implication of section 145A

CA Sanat Pyne

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15 August 2010
ANALYSIS OF SECTION 145A
Accounting treatment of central excise is mainly related to accounting in respect of Cenvat. Accounting for Cenvat needs following consideration (a) Since credit is available of excise duty paid while purchasing inputs, duty paid on inputs while purchase is not an expense but an asset. (b) Un-availed Cenvat is not available as refund (except when it is a case of exports). This may happen when duty paid on inputs is more than duty payable on final product. (c) Cenvat is available instantly on receipt of inputs and Cenvat credit may be utilised even before inputs on which Cenvat is availed are actually used in production. (d) Valuation of stock of finished goods also needs consideration.
Institute of Chartered Accountants of India has published a guidance note. It has been published in Chartered Accountant - September, 2000 issue. [earlier note was published in August 1995 issue]. and is as per legal position as of 1-4-2000, including Cenvat credit. This note replaces the earlier guidance note.
Accounting Treatment of Inputs received - When inputs are purchased, Purchase price (net of Excise) should be debited to Purchase Account and excise on inputs should be debited to ‘Cenvat Credit Receivable (Inputs) account’. Total Invoice amount (i.e. net purchase price plus excise) will be credited to Supplier’s Account (as the supplier has paid Excise and his Invoice is inclusive of excise paid by him on the material supplied). When duty is debited in Input Cenvat Credit Account (earlier RG23A Part II) while despatching the goods, ‘Excise Duty Paid on Final Products’ account should be debited and ‘Cenvat Credit Receivable (Input) account’ should be credited. [Author’s suggestion : This entry could be made once at the end of the month]. Balance in ‘Cenvat Credit Receivable (Input) account’ in General Ledger and credit in 'Input Cenvat Credit Account' as per excise records (that time ‘RG23 A Part II’) should tally, or reconciled.
If there is debit balance at the end of year in ‘Cenvat’ account, it means that credit is not fully utilised and should be shown under Current Assets under ‘Loans and Advances’. Closing stock of inputs should be valued ‘Net of Excise Duty’. However, since Cenvat on stock which has not been used is also utilised for payment of duty, purchases are understated to that extent. If balance in credit of Cenvat cannot be utilised for any reason, the same must be written off.
Change from method II to method I - The earlier guidance note of August 1995 had prescribed two methods. However, in view of accounting standard AS-2, method II - called 'inclusive method' was withdrawn by ICAI for inputs. (Chartered Accountant - November, 1999).
The method as specified in September 2000 guidelines is similar to earlier method I. If an enterprise was earlier following method II, it will have to shift to new method (which is similar to earlier method I). The change in accounting policy will have to be explained in accounts and necessary journal entries will have to be passed.
Write off of non-utilisable balance in Cenvat credit receivable account - Some times, Cenvat Credit Receivable Account may have balance, but it may not be possible to utilise the balance. This may happen in cases where credit on inputs is higher than duty payable on final products. Thus, though credit is available, it may be lying idle, as there is no scope for utilising the same.
As per guidance note of ICAI, the balances in Cenvat credit receivable account should be reviewed at end of the year. If it is found that balances in Cenvat credit are not likely to be used in normal course of business with a reasonable time, the non-usable excess credit should be adjusted in financial accounts i.e. purchase price of raw materials should be increased to that extent. If it is not possible to identify the excess credit to a particular lot or lots of materials purchased, the excess credit may be apportioned over entire purchases of raw materials, components etc. entitled to Cenvat credit during the year, on pro-rata basis. Valuation of closing stock will also increase to that extent.
Adjustment of excess credit related to capital goods should be made to concerned capital goods account. Excess Cenvat credit which relates to fixed assets acquired, should be added to cost of relevant fixed asset. If value of capital goods is enhanced, depreciation on revised un-amortised depreciable amount should be provided over residual useful life of the asset.
[Of course, depreciation for Income Tax purposes will be permitted if balance in Cenvat Credit Account in excise records is also reversed.]
If the asset does not exist, the relevant amount should be written off in the P&L account. In case of capital goods acquired on lease, excess Cenvat credit should be written off on a pro-rata basis along with lease rentals.
In relation to capital goods other than fixed assets (i.e. those which are 'capital goods' as per excise definition, but are not capitalised in books of account of the company), the accounting treatment is same as per accounting treatment of inputs. It is advisable the Cenvat Credit Receivable (Capital Goods) account is maintained separately for fixed assets (which are capitalised) and other capital goods.
If entry in Cenvat Credit available account is reversed, credit available in 'Cenvat Credit Account' as per excise records and balances in ‘Cenvat Credit Receivable’ in financial accounts will not tally. Hence, reconciliation statement will have to be prepared as this difference will continue in subsequent years also.
Reversal of Cenvat credit - In some cases, Cenvat credit on inputs is not available, e.g. when final product is fully exempt, or when inputs are rejected even before they are issued to production. In such cases, Cenvat credit will have to be reversed. In such case, appropriate adjustments in cost of inputs and value for purposes of stock will have to be made.
Accounting of Duty paid on Capital Goods purchased - It has to be remembered that if Cenvat credit on capital goods is availed, depreciation under section 32 of Income Tax is not available. Moreover, Cenvat credit on capital goods is available in two stages i.e. 50% in current year and balance 50% in subsequent year.
‘Capital Goods’ for Cenvat purposes include tools, spare parts etc., which are treated as consumables and normally not capitalised in financial accounts. Hence, question of claiming depreciation on these does not arise. When credit is availed of duty paid on machinery or equipment which is capitalised, it will be necessary to reduce cost of asset by the amount of duty claimed as credit.
If the assessee follows the accounting system as suggested by Guidance Note of Institute of Chartered Accountants of India, the condition gets satisfied. According to Guidance Note published by Institute of Chartered Accountants of India in September, 2000 issue of ‘Chartered Accountant’, the accounting treatment is as follows :
If the enterprise does not avail Cenvat credit, no accounting treatment is necessary. Separate entries in respect of duty on capital goods are to be made only when (i) The manufacturer is entitled to Cenvat credit as per rule and (ii) There is a reasonable certainty that the Cenvat credit will be indeed utilised. If there are little or no chances of the Cenvat credit being utilised, entries need not be and in fact, should not be made.
When the enterprise avails Cenvat credit, Cenvat credit should be reduced from purchase cost. The entry would be : Debit Capital Goods account net price excluding excise duty, Debit excise duty element to Cenvat Credit Receivable (Capital Goods) Account with 50% duty and Cenvat Credit on capital goods deferred account balance 50%. Credit Supplier’s account with full amount (i.e. cost of capital goods inclusive of excise duty paid on such capital goods). The subsequent entries will be similar to Method I for Cenvat on inputs. Thus, when Cenvat credit is utilised, Excise Duty paid on final products is debited and ‘Cenvat Credit Receivable (Capital Goods) Account' is credited. Unadjusted balance standing in the Cenvat credit Receivable (Capital Goods) Account will be shown on assets side under the head ‘Advances’.
Naturally, depreciation will not be charged on the excise duty component of the value of machinery etc. which is capitalised.
In next year when balance Cenvat credit is availed, amount of Cenvat credit availed should be credited to 'Cenvat Credit on capital goods deferred account' with corresponding debit to 'Cenvat credit Receivable (Capital Goods) Account.
Inventory of spare parts, tools etc. will be valued Net of Specified Duty, i.e. duty paid of tools, spare parts, capital goods etc. will not form part of their cost.
Accounting treatment by lessee when capital goods acquired on lease - The lessee can avail Cenvat on duty paid on capital goods obtained on lease. If the financing arrangement includes financing of excise duty component, in the books of lessor, asset given on lease should be shown at purchase cost net of excise duty on capital goods. The excise duty on capital goods (which would be availed as Cenvat credit by lessee) should be recorded and disclosed separately as duty recoverable from lessee. This will not form part of ‘Minimum Lease Payments’. In the books of lessee, treatment of Cenvat credit on capital goods should be same as per other capital goods. However, leased capital asset and corresponding depreciation will not be accounted in books of lessee. It may be noted that as per excise rules, lessor cannot finance excise duty portion of capital goods, if lessee intends to avail Cenvat.
If excise duty on capital goods does not form part of financing arrangement and lessee pays the duty directly to supplier, no entry is necessary in books of lessor.
Accounting treatment by lessor when capital goods given on lease - In the books of lessor, where the financing arrangement also covers the specified duty on capital goods, the asset given on lease should be shown at purchase cost net of specified duty on the capital goods. The specified duty on capital goods, which would be availed as Cenvat credit by lessee, should be recorded and disclosed separately as the duty recoverable from lessee. This will not form 'Minimum Lease Payments'. This is because definition of 'minimum lease payment' as per Guidance Note on Accounting for Leases issued by ICAI, is as follows - 'The payments over the lease term that the lessee is or can be required to make (excluding costs for services and taxes to be paid by and be reimbursable to lessor) together with the residual value'.
If the specified duty does not from part of financing arrangement and the lessee pays the duty directly to supplier, the same need not be recorded in books of the lessor.
In the books of lesssee, Cenvat credit on the capital goods acquired on lease should be same as per other capital goods i.e. 50% in Cenvat credit receivable (Capital Goods) account and 50% in Cenvat Credit (Capital Goods) deferred account'.
Accounting treatment when capital goods obtained on hire purchase - Capital goods acquired on hire purchase should be recorded and disclosed at net cash value, i.e. cash value net of Cenvat credit available in the books of hirer. The other accounting treatment in the books of hirer is same as if the asset has been acquired on outright purchase basis. These entries are to be made even if the excise duty on the capital goods does not form part of the financing arrangement.
In the books of vendor, if excise duty on capital goods forms part of financing arrangement, the vendor should book the sale at price inclusive of duty on the capital goods. If excise duty paid on capital goods does not form part of financing arrangement, the same need not be recorded in the books of vendor.
Illustrative example of Entries for Cenvat - The Guidance Note gives an illustration of entries. The illustration is on the assumption that there is opening stock of 10 units purchased at Rs. 10 per unit plus Rs. 2/- excise duty, aggregating to Rs. 12/-. 100 units of raw materials are purchased at Rs. 10 per unit, plus Rs. 2 for excise duty, aggregating to Rs. 12/-. Out of these, 70 units are consumed in process involving manufacture of 70 items of final product. These 70 units of final product are sold @ Rs. 15/- per unit, inclusive of excise duty of Rs. 3/- per unit. The Cenvat credit has been utilised fully for payment of duty on final products. The entries will be as follows :
Cenvat on inputs - Entries in respect of Cenvat on inputs are as follows - (This was termed as Method I as per 1995 guidelines).
Purchase of raw materials Dr. Rs. 1,000
Cenvat Credit Receivable Dr. Rs. 200
To Sundry Creditors Cr. Rs. 1,200
(Being purchase of 100 units)

Excise Duty Paid on final products Dr. Rs. 210
Cenvat Credit Receivable Account Cr. Rs. 210
The P&L account will look as follows :
To Opening stock of Raw Materials (10 units) Rs. 100
To Purchase of Raw Materials (100 units) Rs. 1000
Less : Stock of Raw Materials (40 units) Rs. 400
Net Consumption of RM (70 units) Rs. 700
Excise Duty paid Rs. 210
In the Balance Sheet, the stock of materials will be shown at Rs. 400/-.
In the Cenvat Credit Receivable Account, opening debit balance will be Rs. 20 (in case of 10 pieces pf opening stock). During the period, there will be debit of Rs. 200 in respect of inputs purchased during the year. This account will be credited by Rs. 210 as the duty was paid on 70 pieces from Cenvat credit account. Thus closing debit balance will be Rs. 10/- in the Cenvat Credit Receivable account will be shown as asset under 'Loans and Advances'. Thus, total ‘assets’ will be Rs. 410.
Accounting of Capital Goods - In case of capital goods, the entries will be different. Cenvat credit on capital goods can be taken in two stages - 50% in current year and 50% in subsequent year.
Definition of capital goods as per Income Tax (which is also followed for Company Law purposes) is different from definition of Capital Goods under rule 57AA(a) [earlier 57Q] of Central Excise for purposes of Cenvat. e.g. items like consumable, spare parts, tools are defined as 'capital goods' for Cenvat on capital goods but not considered as 'capital goods' in regular accounts. Thus, the entries will depend on whether the definition is same or different.
(A) If capital goods as defined in regular accounts are same as capital goods as per Cenvat -

Purchase of capital goods Dr. Rs. 1,000
Cenvat Credit Receivable Dr. Rs. 100
(Capital goods) account
Cenvat Credit on capital Dr. Rs. 100
goods deferred account
To Sundry Creditors Cr. Rs. 1200
(Being purchase of capital goods)

Excise Duty Paid on final products Dr. Rs. 80
Cenvat Credit Receivable Cr. Rs. 80
(capital goods) account
In the balance sheet, capital goods will be valued net of excise duty and depreciation will automatically be provided on net value only. Unadjusted balance of Rs. 20/- standing in the Cenvat credit receivable (Capital Goods) Account will be shown on assets side under the head 'Loans and Advances'. Similarly, debit balance of Rs. 100 in Cenvat Credit on capital goods deferred account will be shown as current asset under Loans and Advances'.
In next year when balance Cenvat credit is availed, amount of Cenvat credit availed should be credited to 'Cenvat Credit on capital goods deferred account' with corresponding debit to 'Cenvat credit Receivable (Capital Goods) Account.
(B) If capital goods as defined in regular accounts are different from capital goods as per Cenvat - In such cases, the item will not be capitalised in books of account and will be written off in accounts.
If 100 units of 'tools' are purchased which are treated as 'consumables' in accounts, but 'capital goods' for purpose of excise law, and if stock is 40 units at the year end, the entries in books of account will be as follows -
Purchase of tools Dr. Rs. 1,000
Cenvat Credit Receivable (capital goods) account Dr. Rs. 100
Cenvat Credit on capital goods deferred account Dr. Rs. 100
To Sundry Creditors Cr. Rs. 1200
(Being purchase of 100 units)

Excise Duty Paid on final products Dr. Rs. 80
Cenvat Credit Receivable Account Cr. Rs. 80
The P&L account will look as follows :
To Purchase of tools Rs. 1,000
Less : Stock of tools Rs. 400
Net Consumption of tools Rs. 600
Excise Duty paid Rs. 80
In the Balance Sheet, the stock of tools will be shown at Rs. 400/- Unadjusted balance of Rs. 20/- standing in the Cenvat credit receivable (Capital Goods) Account will be shown on assets side under the head 'Loans and Advances'.
[Note - The illustrations in respect of capital goods are designed by author. These are not given in the guidance note of the ICAI. Hence, these cannot be taken as authentic guidelines of ICAI].
CONFLICT BETWEEN INCOME TAX PROVISIONS & ACCOUNTING STANDARDS - As per section 145A of Income Tax Act, stock should be valued including excise duty. However, as per Accounting Standard of ICAI (AS-2), inventory of inputs should be valued exclusive of excise duty, if Cenvat credit of input is availed. - . - In case of capital goods, depreciation cannot be claimed on excise portion of value of capital goods. In view of this, for capital goods, entries are required to be made as per guidance note of ICAI.
Inventory Valuation and Cenvat - Valuation of inventory is affected by Cenvat considerations.
Inventory 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, inventories 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. Item-wise 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 refundable. Thus, duty paid on inputs will have to be added while valuing stock, even if Cenvat credit is 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 purchase consists of purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to such acquisition. trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase. - . - 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].
If Cenvat credit of duty paid on inputs is not available for any reason, the closing stock should be valued inclusive of duty paid on inputs. [Guidance Note of ICAI on Accounting Treatment of Modvat / Cenvat - September 2000 issue of Chartered Accountant].
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. 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].
CENVAT CREDIT SHOULD BE ADDED BOTH IN OPENING AND CLOSING STOCK - If Cenvat credit on inputs is added for valuation of closing stock, it should be added for valuation of opening stock also. - Tribunal view confirmed in CIT v. Indo Nippon Chemical Co. Ltd. (2000) 112 Taxman 555 (Bom HC DB). In this case, reliance was placed on Chainrup Sampatram v. CIT (1953) 24 ITR 481 (SC), where it was held that profits do not arise out of valuation of closing stock. The source of profit is business.
ACCOUNTING TREATMENT OF UNPAID EXCISE DUTY ON FINAL PRODUCTS - Duty liability of excise is fastened as soon as goods are manufactured, though duty is payable at the time of removal. ICAI has published revised guidance note on 'Accounting Treatment for Excise Duty' effective from 1-4-1999 (published in July 2000 issue of Chartered Accountant, superceding earlier guidance note of 1988). As per these guidelines, estimated duty liability on finished goods in stock should be provided in books of account on the basis of rates and valuation on date of balance sheet. While estimating the duty liability, factors like exemptions availed, pattern of sales e.g. export sales, SSI exemptions etc. should be considered. If no duty is payable on intermediate products, it is not necessary to make provision of duty liability in respect of intermediate products.
Excise duty provided on stock should be included in valuation of stock of finished goods. If excise duty was, in fact, paid on finished stock (this may happen if duty paid stock is lying at depots / branch offices), it will have to be included while valuing closing stock.
Valuation of inventory of WIP and final products - AS PER GUIDANCE NOTE OF ICAI, while valuing inventories of WIP and final products, the value of inputs should be net of duty on inputs, i.e. the purchase cost as reduced by Cenvat credit, if Cenvat credit is available. If Cenvat credit is not available, the material cost should be inclusive of excise duty. [Guidance Note of ICAI on Accounting Treatment for Excise Duty - Chartered Accountant July 2000 - view reiterated in Guidance Note of ICAI on Accounting Treatment of Modvat / Cenvat - Chartered Accountant - September, 2000].
GUIDANCE NOTE OF ICWA - ICWA of India has issued 'Guidance Note on Valuation Audit under Central Excise Law' in July, 1997. This guidance note also states that cost of inputs should be exclusive of Cenvat credit.
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 = JT 1999(7) SC 544 = 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.
Payment of excise duty demands from Cenvat credit - If a demand for excise duty is received, assessee may pay it through Cenvat credit account. If demand is paid out of credit balance in Cenvat Credit account, it should be debited to appropriate account, depending upon nature of demand. e.g. (a) If demand is in respect of final product, it should be debited to excise duty account. (b) If demand pertains to disallowance of Cenvat credit in respect of purchases of inputs during the current year, it should be added to cost of inputs and inventory valuation will have to be suitably adjusted. (c) If demand is in respect of purchases in previous years, the disallowance should be debited to excise duty account and treated as expense of the current year. However, if the raw materials are still in stock, duty demand should be added to cost of stock of inputs.
Excise duty is manufacturing expense - Excise duty should be considered as a manufacturing expense and should be considered as an element of cost for inventory valuation, like other manufacturing expenses. Excise duty cannot be treated as a period cost. If duty paid on inputs is not recoverable as credit, it becomes part of manufacturing cost and must be included in valuation of WIP / finished goods. - Guidance Note of ICAI on Accounting Treatment for Excise Duty - Chartered Accountant - July 2000.

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