The Institute of Cost and Works Accountants of India (ICWAI) has issued a discussion paper on conceptual issues faced in development of Cost Accounting Standards (CAS). ICWAI has already issued twelve CASs. The aim of CASs is to achieve uniformity and consistency in classification, measurement and assignment of cost to product (including services). Cost of product is measured for three purposes. Financial accounting uses it for inventory valuation; regulators use it for different purposes (e.g. for determining the excise duty on items produced for captive consumption and for regulating price of a product); and managers use it for decision-making. Product cost used for decision-making depends on the nature of the decision for which it is used. Clearly CASs neither covers product cost used for inventory valuation (which is governed by GAAP) nor product cost used for decision-making. Therefore, CASs cover product cost, which is used by regulators. However, it is expected that in the long run CASs will impact industry practices, and thus, might impact GAAP.
One of the issues highlighted by the discussion paper is the accounting for finance cost.
Conventionally, finance cost is excluded from the realm of cost accounting. Product cost does not include finance cost. From regulatory point of view, this is appropriate. Usually, regulators allow a price to ensure adequate return on invested capital. Invested capital is the total of borrowed capital and equity capital. Inclusion of finance cost in the product cost results in double counting.
It may be argued that if an amount paid to a third party for use of its resources is included in product cost, it is appropriate to include the amount paid to a third party for use of its money. This argument is not tenable. For example, an entity owns a building. Depreciation and rates and taxes are included in the product cost. Its investment in the building is considered in calculating invested capital, and thus, in calculating the amount of return on invested capital. On the other hand, when an entity takes a building on lease, rent is included in the product cost. Lease rent should be higher than the total of depreciation and rent and taxes as the lease rent includes a reasonable return on investment in building by the lessor. Therefore, if every thing is equal, the price of the product to be fixed by the regulator should be similar, if not the same.
The present Central Excise Rules, in order to levy excise duty, assesses the value of items produced for captive consumption at 115 per cent of the product cost. Perhaps, the revenue department has assumed average gross margin at 15 per cent. Gross margin covers return on investment and other costs not included in the product cost. Therefore, it is appropriate not to include finance cost in the product cost to avoid double counting.
Convergence of Indian Accounting Standards with IFRS will change the measurement of interest cost from the practice being followed in India. Under IFRS, in some situations, a transaction, which is not a borrowing (lending), is broken into two parts: borrowing (lending) and other transaction. For example, if material is purchased on deferred credit basis, the transaction is broken into borrowing and purchase transaction. The cost of material is the price paid less interest for the period of deferred credit calculated using the market interest rate. Similarly, if a seller allows credit for long period (say, for more than six months), revenue is the amount receivable less the amount of interest calculated at an imputed rate of interest.
IFRS requires an entity to use the effective interest rate method to calculate interest expense and interest income. Simply said, effective interest rate is the market rate prevailing at the time of borrowing (lending). Therefore, interest expense (interest income) to be recognized in financial statements might differ from the amount paid or payable (received or receivable) as interest to the lender (borrower).
At present implicit interest included in the cost of material is included in the product cost. With adoption of the new set of accounting standards, this anomaly will be corrected, as cost accounting will recognize material cost at the amount at which the purchase is recognized in financial statements.
