Cost of Utilities is Variable Cost and needs to be Absorbed on the basis of Actual Capacity Utilization

[Rakesh Singh]

2015 (10) TMI 1990 - CESTAT NEW DELHI

M/s India Glycols Ltd. Versus CCE, Allahabad

It has been explained in the Guidance Notes on CAS-4 that fixed overheads comprise of expenses which do not vary with the change in volume of production such as fixed portion of salaries and wages, rent, insurance, technical assistance/know-how fees, amortized cost of moulds, patterns, patents, hire charges for tools and equipments, charges for a particular design, various items of works overheads listed in para 5.4, quality control and R & D, etc. and Variable Overheads comprise of expenses which vary in proportion to the change in the volume of production e.g. variable portion of salaries and wages, cost of utilities, royalty, job charges, etc.

The question of using Normal or Actual capacity utilization as a denominator came up in the instant case where it was held that utilities are part of variable cost and is to be absorbed on the basis of actual capacity utilization and not on the basis of normal capacity utilization.

The Issues:

1. The company had a manufacturing unit in Gorakhpur for manufacture of denatured rectified spirit, an excisable goods from molasses and another unit in Kashipur which manufactured Ethylene glycol. The dispute is in respect of the clearances of de-natured rectified spirit by the Gorakhpur unit of the appellant to their Kashipur Unit during the period from December, 2012 to March, 2012. In respect of these clearances which are to be treated as clearance for captive consumption, the appellant Gorakhpur Unit was discharging duty liability on the value determined under Rule 8 of the Central Excise Valuation Rules, 2000, that is, on the basis of 110% of the cost of production.

2. There is no dispute that the cost of production in terms of the CBEC's Circular is to be determined on basis of CAS-IV format developed by ICWAI. The dispute is only about the calculation of the cost of production on the basis of CAS-IV format. The appellant during the period of dispute had divided the expenses on account of salary and wages, utilities, direct expenses, depreciation, works over head and administrative over heads by normal capacity utilization and only raw material consumption expenses and process chemical consumption expenses had been divided by the actual capacity utilization (actual production) and the per-unit cost of the de-natured rectified spirit had been determined on this basis. However, according to the department all the expenses, i.e., raw material (molasses consumption expenses), process chemical expenses, salary and wages, utility, direct expenses, depreciation, works over head and administrative over heads must be divided by the actual capacity utilization which was much less than the production on normal capacity utilization and the per unit cost of production has to be determined on this basis.

That based on these costing guidelines, the expenses on account of salaries and wages, direct expenses, depreciation, works over heads and administrative over heads have to be absorbed in cost on the basis of the normal capacity utilization as during the period of dispute, the actual capacity utilization was much less than the normal capacity utilization.

3. That in this regard, the utilities, that is, the expenses on account of power, water, etc are also to be treated as fixed over heads; that the appellant have treated the expenses on account of principal raw material consumption and process chemicals as variable expenses and have absorbed the same in the costing on the basis of the actual capacity utilization and that the Commissioner's order treating even the fixed over heads like salaries and wages, direct expenses, depreciation works over heads and utilities as variable cost and absorbing the same for determining the cost of production by dividing these expenses also by actual capacity utilization is not correct. He therefore, pleaded that the impugned order is not correct, as the same is contrary to the principles of costing. Besides this, he also pleaded that whatever duty was payable by the Gorakhpur unit its CENVAT Credit was available to the Kashipur Unit and as such it is a Revenue's neutral situation and for this reason also, there is no justification for this huge duty demand.

4. Shri Ranjan Khanna, ld. DR, opposed the stay application by reiterating the findings of the Commissioner. He pleaded that even as per the principles regarding determining of cost of production of the goods manufactured for captive consumption, utilities expenses are variable over heads and the same are to be absorbed in the production cost based on the actual capacity utilization; that the expenses on account of utilities during 2008-2009 were about 15.19 crore; that the appellant have, therefore, wrongly absorbed the expenses on account of utilities on the basis of normal capacity utilization which was four times higher than the actual capacity utilization during the period of dispute. He also pleaded that during 2011-2012 when their cost accountant changed and a new accountant joined, the expenses on account of utilities, salaries and wages utilities direct expenses depreciation works over heads and administrative over heads were treated as variable over heads and were absorbed by dividing the same by actual capacity utilization.

5.The Honorable Court considered the period of dispute in this case is from 1st December, 2007 to 1st March, 2012 and the dispute is in respect of the assessable value of the de-natured rectified spirit manufactured and cleared by Gorakhpur Unit to the Kashipur Unit of the same appellant company for its captive consumption, i.e., for its use in the manufacture of ethylene glycol. There is no dispute that the assessable value of the de-natured rectified spirit manufactured and cleared by the Gorakhpur unit, who is appellant in this case, was to be determined on the basis of 110% of the cost of production under Rule 8 of the Central Excise Valuation Rules, 2000. There is also no dispute that in terms of the Board's Circular No. 692/8/2003CX dated 13/2/2003, the cost of production was to be determined strictly in accordance with the CAS-IV Format Standard developed by the Institute of Cost Works Accountant of India (ICWAI). The dispute is only about application of the CAS Format and its guidelines for calculation of the cost. The various expenses for manufacture of de-natured rectified spirit are:

(a) principal raw material consumption (molasses consumption)

(b) Consumption of other processed chemicals

(c) salaries and wages

(d) utilities like electricity, water, etc.

(e) Direct Expenses

(f) Depreciation

(g) Works over heads

(h) Administrative over heads.

6. The appellant in the present case have absorbed the raw material consumption expenses and process chemical consumption expenses on the basis of the actual production, which during the period of dispute, was one-fourth of the production on normal capacity utilization. The other expenses, i.e., expenses on account of salary and wages, utilities, direct expenses, depreciation, works over heads and administrative over heads have been treated as fixed expenses and the same have been absorbed in the costing by dividing the same by the production on normal capacity utilization and not actual production which was much lower. However, according to the department, all the expenses are to be absorbed in costing by dividing the same by actual production which was one-fourth of the production under normal capacity utilization. We find that in terms of para 5.9 of the Cost Accounting Standard of Cost on determining the cost of production on captive consumption (CAS-IV format), the over heads shall be divided into variable over heads and fixed over heads; that while variable over heads are the items of expense with the change with the volume of production such as the cost of utilities, raw material, etc., the fixed over heads are those whose value does not change with the volume of production, such as salaries, rent, etc and according to this para 5.9 while variable production over heads shall be absorbed in production cost based on actual capacity utilization, i.e., on the basis of actual production, the fixed production over heads and similar items of fixed cost such as salaries & wages, administrative over heads, depreciation, etc relating to manufacturing, which do not change with the volume of production shall be absorbed in the production cost on the basis of normal capacity or actual capacity utilization, whichever is higher. Applying this guideline, prima facie, the expenses on account of salaries and wages, direct expenses, depreciation, works over heads and administrative over heads are to be absorbed in cost on the basis of the normal capacity utilization, as in the present case the actual production was much lower than the production based on the normal capacity utilization and prima facie, this is what the appellant had done. However, we find that there are considerable expenses each year on utilities which in terms of the para 5.9 of the CS Format guidelines are to be treated as variable over heads and the cost of variable over heads is to be absorbed in costing based on the actual captive utilization while this is the cost of utilities have been absorbed by the appellant on the basis of normal capacity utilization which prima facie is not correct and on this point, the department has a case.

Held:

The total duty demand confirmed by the Commissioner in our prima facie view, at least, the duty demand based on the absorption of cost of utilities in the costing may be upheld. As regards, the plea of the Appellant regarding Revenue, the neutrality, prima facie we are not convinced with this plea. In view of the above discussion we are of the view that this is not the case for total waiver. The appellant, therefore, are directed to deposit an amount of ₹ 50 lakh within a period of six weeks for compliance with the Provision of Section 35F. On pre-deposit of this amount within a stipulated period, the requirement of pre-deposit, balance amount of duty demand, interest and penalty would stand waived and recovery thereof stated.

Discussions to this article

[Debtosh Dey]

Many judgments on captive consumption, related party transactions/ arm's length price and even legitimacy of business expenses, are based on normal costs. These all presuppose existence of cost accounting and cost audit. Recently, the Prime Minister also has called for scientific audits, though in the context of scientific research institutions, but rousing a hope for ending unscientific audits, including the one conducted by CAG (Ref TOI news dated 4-Jan-16). Cost orientation can fulfill this hope, if right initiatives are taken up for mandatory use of appropriate standards for input-output, time-work and capacity measurement in cost accounts for reporting normal costs and normal profits in cost audits. This will not only infuse science in cost accounting & cost audit, but also improve financial management and by far outweigh traditional accounting & auditing in terms of quality of information besides adding values for tax authorities.

Debtosh Dey, M.Sc (Engg), FIE, C. Engg (I), FCMA, FCS, LL.B.

[K T Rao]

Sir,

Observation: Absorption of cost of utilities based on normal capacity is not in order in terms of Para 5.9 of CAS-4 and therefore it is prima facie not correct.

Our views:

In absence of complete information it is assumed that the appellant has facility for production/generation of utilities for captive consumption in the production activities. Based on the above assumption attention is drawn to para 5.3.1 and para 5.9 of CAS-8 “Cost of utilities”.

Quote:

Para 5.3.1 Cost of self generated utilities for own consumption shall comprise direct material cost, direct employee cost and direct expenses and factory overheads.

Para 5.9: The cost of production and distribution of utilities shall be determined based on the normal capacity or actual capacity utilization whichever is higher and unabsorbed cost, if any shall be treated as abnormal cost. Cost of a stand-by utility shall include the committed cost of maintaining such a utility.

The decision of the commissioner is in order if the cost of utilities appearing in the main cost sheet “De-Natured Rectified Spirit” has been determined based on the principle stated in CAS-8. In other words cost of production of per unit of utilities has been determined based on “normal capacity” (in the instant case as actual capacity utilization is very less). In case cost of utilities appearing in the De-Natured Rectified Spirit cost sheet is the actual expenses than the appellant has a case to defend.

K T RAO