RACY CASES – 4
V Pattabhi Ram
Wafers was tired to the bones. For the seventh time that day she wondered whether she had done the smart thing in taking up CA. China, her engineering friend at IIT, had no factories to attend. Muscles, her medico pal, had no hospitals to visit. Why CA alone had articleship that demanded her to do her chartered accountant’s bidding, she couldn’t fathom. Here she was arguing the whole day with her client. The stupid Principal Accountant had some profit figure in his mind. Obviously dictated by his boss, the invisible CFO (was it Chief Fraud Officer, she wondered) whom she had never met. Even a greenhorn like Wafers, who had grown up reading only mushy Mills and Boon, could sense that the company was sinking like the Titanic. Yet the company wanted to report fat profits. Phew.
The blessed traffic wasn’t moving. “Oh God, why the hell were they honking when the signal was still red. Was this a civilized city”, asked China? She was hardly listening. “Stocks are to be valued at the lower of cost price or net realizable value,” she remembered from her PE 2 days. She had then asked her Senior Manager, “Sir, does that apply for finished goods only or to raw material as well” and the good gent had said, “to both, madam.” Now here at Titanic (that’s how she called her sinking client company) some foolish purchase manager had used the outdated EOQ model to pile inventory at a time when the world had moved into JIT. Titanic was sitting on eight months inventory and material prices had dropped like ninepins. The raw material bought at Rs 70 per kg could now be bought or sold only at Rs 50 a kg. At the audit, she wanted the raw materials to be valued at the lower realizable price (Rs 50) but the Accountant would have none of it.
Oh, when was that Accounting Standards workshop to which her firm had sponsored her? Last month? Well the date didn’t matter. What mattered was what the professor from IIM who had handled the session had said about valuations. She had jotted, “if the realizable price of the raw material is less than the cost of the raw material, the raw material need not be valued at the lower realizable price if the finished goods in which the raw material was to be used could be sold at a price which was higher than the cost of production of the finished goods.” Oh God, what a mouthful she had then cursed. But the smart professor pacing up and down in his trademark “trapeze walk” had chalked in some numbers on the green board. Raw material realizable price Rs 50, raw material cost price Rs 70; Raw material could still be valued at Rs 70 if the finished goods that cost Rs 110 in which the raw material was used could be sold at Rs 111. In his inimitable style he had explained the logic saying, “the raw material is bought for conversion to finished goods; it isn’t purchased for trading. The loss of Rs 20 (50-70) is notional since on conversion the finished goods would be sold at a profit fully covering the Rs 70”. Even she understood.
That guy in the middle row had shot his hand up with a counter. “Sir, this would mean that if the realizable price of the raw material is less than its cost, the raw material would have to be valued at the lower realizable price if the finished goods in which the raw material is used was being sold at a price less than the cost of production of the finished goods.” And like the professor he had supplied the numbers. “Raw material realizable price Rs 50, raw material cost price Rs 70; Raw material would have to be valued at Rs 50 if the finished goods that cost Rs 110 in which the raw material was used was sold at Rs 85”. Wow. Must be from a big firm she had murmured. Even the professor had looked impressed and offered an explanation for nitwits like her. “While the raw material wasn’t bought for trading, it would make sense to sell the raw material as it is (Rs 50) and lose Rs 20 (50-70) than to convert it into finished goods (110), sell at Rs 85 and lose Rs 25 (85-110). So you should value the raw material at Rs 50.” She had seriously told herself, “So AS does take into account business sense”. Why the hell could the Principal Accountant not understand she asked addressing no one in particular? May be he hadn’t attended any classes.
The signal at the traffic turned green. And then it struck her. What if the numbers read differently? What if the finished goods could be sold at Rs 105 when the cost of production was Rs 110? The plain reading of the standard would suggest that the raw material would have to be valued at the lower realizable price of Rs 50 since the finished good was being sold at less than cost. But what if she extrapolated the professor’s explanation? If she were running the business would she sell the raw material at Rs 50 and lose Rs 20 or would she convert it into finished goods to cost Rs 110, sell it at Rs 105 and thereby lose Rs 5. Of course she would do the latter. If that was right she should record only a loss of Rs 5 in valuing her raw material. Meaning she could value it at Rs 65 (cost price 70 less projected loss 5) instead of at Rs 50. Titanic was sitting on 10 lakh kgs of that raw material. By her argument the company could report profits higher by Rs 150 lakhs. That would be close to the target profit that the silly accountant had in mind. “Eureka”, she screamed. “Yes, you can deduct the loss on finished goods (105-110) from the cost of raw material (Rs 70) to arrive at the value of the raw material …… But the value of the raw material would be restricted to the selling price of the raw material,” said China. “How did you know” asked a stunned Wafers. “IIT mind” said China.
She didn’t sleep that night. She raced to her office at 8 am. Her boss agreed with her analysis. The letter of the Standards doesn’t matter, the spirit does, he said, patting her on her back. But for Titanic would she have ever got a hang of this? Would any textbook have explained it to her the way it struck her? Bravo articleship she told herself.
FIRST published in the Hindu Business Line