TMI Blog1992 (8) TMI 121X X X X Extracts X X X X X X X X Extracts X X X X ..... acts in this regard are brought out below in brief. The assessee had been valuing its closing stock of finished goods and work-in-progress on ' lower of cost or realisable value ' and its opening stock is brought forward on that basis. The term cost as was adopted by the company was ' total cost '. The appellant company retained its method of valuation on ' cost or realisable value ', but, modified the term cost to mean ' direct cost '. In direct cost, the appellant company had considered the element of cost of raw materials, stores and such other materials, that go into production of the various articles manufactured by it and included the element of variable cost of manufacture. The element of fixed cost such as on administration etc., were not considered as part of the cost, on the reasoning that, they are incurred in the normal course of running of the business and as such in no way contribute to the production of the articles. In support of its method of determination of the cost of the products, it had obtained the opinion of a Cost Accountant Shri R.J. Goel (copy of opinion placed at pages 523-535 of Volume 2 of paper book). The opinion has considered the standard Accountin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... month (by taking any one month as giving standard or normal production) would be in variance with the absorption cost of another month, because, of the fluctuation in the production. He felt that, the allocation of the expenses, which involves certain amount of assumptions, the end result of cost would include assumed portions as well and since no two persons would agree to the basis of assumptions and its quantum, it would never project the cost of the product to its near accurate value. He considered the proposition of direct cost method. He felt that, this method limited itself to the point of stages of actual production, which are identifiable and did not involve any arbitrariness. He felt that, the fixed expenses which do not vary with production or with the factors which influence the production, both internal and external, should be charged off to the profit and loss account. He accordingly concluded that, the appellant company should adopt direct cost method for valuing the finished and the semi-finished goods. He felt that, the element of direct cost should include (a) cost of raw-materials ; (b) power fuel ; (c) cost of direct contract labour ; (d) grinding media : and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts India Ltd., the ratio laid down would be inapplicable to it. On the above-mentioned facts, submissions and after considering the materials that have been placed on our record, at pages 352-522, we are giving our conclusions. We would to begin with bring out the definition of the terms ' direct costing ', ' absorption costing ', ' variable costs ' and the Standard prescribed by the Institute of Chartered Accountants of India (AS 2), in regard to the valuation of inventories of finished and work-in progress. The term ' direct costing ' has been defined as ' the method whereby the cost of inventories is determined so as to include the appropriate share of variable costs only, all fixed costs being charged against revenue in the period in which they are incurred '. The term ' variable costs ' has been defined as ' those costs of production which vary directly, or nearly directly, with the volume of production '. The term ' absorption costing ' has been defined to mean ' the method whereby cost of inventories is determined so as to include appropriate share of both variable and fixed costs, the latter being allocated on the basis of normal level of production ', In para 24 of this ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h result in the production of goods, i.e., without which, the goods would not have reached its finished state. Eric Kohler in his Dictionary for Accountants has defined ' direct cost ' as the cost of any good or service that contributes to and is readily ascribable to product or service output, any other cost incurred being regarded as fixed costs. This definition indicates that, ' direct cost ' is the same thing as ' factory cost ' or ' prime cost ' or ' cost of produced goods '. Direct Cost therefore, should include all those costs, which are directly related to the making of the product. Such costs are, direct raw-materials, direct incidental raw-materials, direct power fuel, direct labour and direct overheads. The meaning of the above terms as stated in Eric Kohler's Dictionary for Accountants are reproduced hereunder. ' Direct Material ' means material entering into and becoming a constituent element of a product. ' Direct Labour ' means labour applied directly to a product. ' Direct Overhead ' means factory, selling or other expense attributed to solely to a certain product, and thus constituting a direct cost. Under normal parlance, direct raw-material and direct labour ar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the method adopted by the assessee, the gross profit is higher, but, the net profit is lower, because, the element of direct labour (own employees) is charged off as revenue, though, it had contributed directly in the making of the finished product, viz., Cement. The assessee conveniently omits the definition of the term ' variable costs ', as defined above, which includes those costs of production, which vary directly or nearly directly with the volume of production. Direct labour, whether, of own employees or of contract labour are fundamentally treated as variable with the volume of production, which is why, in the definition of variable costs too, reference is made to the term ' nearly directly '. Therefore, we are of the opinion that, in the method of direct costing adopted by the assessee, the exclusion of the cost of its own employees does not reflect the element of direct cost of the goods produced and under process and requires to be modified with the element of own labour cost as well. The choice of direct costing method or absorption costing method rests with the assessee, so long as the cost of inventory reflects to near approximation, its true value. The direct cost m ..... X X X X Extracts X X X X X X X X Extracts X X X X
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