BhARAT HEAVY ELECTRICALS LIMITED.

By: Dheeraj Agarwal, Sanchit Agarwal, Kriti Singhal, Sonali Sharma, Pankaj Juneja, Nishant Pruthi

INFORMATION GIVEN
Bharat Heavy Electricals Limited (BHEL) is the largest manufacturer of

power plant equipment in India. Selected portions of the companys accounting policy on inventory valuation (Accounting Policy Note 7) taken from the report for the year ended March 31, 2006 are given. Also the items in BHELs revenue 2005-2006 are as follows: Turnover Other operational income Other income Jobs done for internal use Interest income on investment Other interest income Exchange Variation Provision written back Accretion/Decretion to work in progress, finished goods and scrap

REQUIRED
1.

Does BHELs inventory valuation policy conform to generally accepted accounting principles applicable to inventories? Explain the significance of the item Accretion/decretion to work in progress, finished goods appearing as a revenue. Do you agree with the manner of presentation of the item? The amount for the years 2005-2006 and 2004-2005 were Rs. 3860 million and Rs. 5398 million respectively. How would you interpret these numbers?

2. Explain

1. Inventory valuation & GAAP

i.

Inventory is valued at actual/estimated cost or net realizable value, whichever is lower.

This conforms to GAAP as according to the cost principle all values listed and reported are the costs to obtain or acquire the asset, and not the fair market value. This follows the principle of conservatism according to which we take that value of inventory i.e. actual or realizable whichever is minimum.

ii.

Finished goods in plant and work-in-progress involving Hydro and Thermal sets including gas-based power plants, boilers, boiler auxiliaries, compressors and industrial turbo sets are valued at actual/estimated factory cost or at 97.5% of realizable value, whichever is lower.
According to US GAAP, Revenue is recognized on percentage-of-completion method for Construction Contracts. Percentage of completion; or the intrinsic value, reckoned at 97.5% of contract value, the remaining 2.5% is recognized as income when the contract is completed. Hence the items in production cycle are valued at actual/estimated factory cost or 97.5% of the realizable value, whichever is lower.

iii. In respect of valuation of finished goods in plant

and work in progress, cost means factory cost; actual/estimated factory cost includes excise duty payable on manufactured goods. It conforms to GAAP because according to Accounting Standard 2 the cost of inventories comprise costs of conversion, costs of purchase and other costs incurred in bringing the inventories to their present location and condition. Hence it will include the excise duty payable on manufactured goods.

iv. In respect of raw materials, components, loose

tools, stores and spares, cost means weighted average cost. According to Accounting Standard 2 the cost of items that are ordinarily interchangeable (like raw material) is assigned by using the first-in, first-out (FIFO), or weighted average cost formula.

v.
a)

For construction contracts entered into on or after 01.04.2003 Where current estimates of cost and selling price of a contract indicates loss, the anticipated loss in respect of such contract is recognized immediately irrespective of whether or not work has commenced.
According to Accounting Standard 7 When it is probable that total contract costs will exceed total contract revenue, the expected loss should be recognized as an expense immediately. The amount of such a loss is determined irrespective of: whether or not work has started on the contract. Hence the given condition is in accordance with GAAP.

v. b.

For all other contracts Where current estimates of cost and selling price of an individually identified project forming part of a contract indicates loss, the anticipated loss, in respect of such project on which the work had commenced, is recognized.
According to Full Disclosure principle of GAAP an enterprise need to disclose the aggregate amount of costs incurred and recognized profits (or recognized losses) up to the reporting date, hence given condition is in conformation with GAAP.

c.

In arriving at the anticipated loss, total income including incentives on exports/ deemed exports is taken into consideration.
According to Accounting Standard 7 incentive payments are additional amounts payable to the contractor these form a part of contract revenue and hence help in calculating the anticipated loss.

vi. The

components and other materials purchased/ manufactured against production orders but declared surplus are charged off to revenue retaining residual value based on technical estimates.
According to GAAP the contract cost may be reduced by incidental income like the sale of surplus materials at the end of the contract. Hence the declared surplus is charged off to revenue.

2. ACCRETION/ DECRETION
By accretion or decretion of work in progress, finished

goods and scrap we mean change(i.e increase or decrease) in the stock. IMPORTANCE: The inventory change is often presented as an adjustment to purchases in the calculation of the cost of goods sold. In the given example it is used as a revenue as it forms a part of inventory valuation.

 The change in inventories

YEAR 2005-2006 2004-2005

Accretion/Decretion (Rs.million) 3860 5398

The above figures tells us that in In 2004-2005 as compared to 2005-2006 revenue from inventories is more.

We can also say that in 2005-2006 there is more revenue from conversion of inventories to sales as compared to in 2004-2005.
Hence Accretion/(decretion) to work-in-progress, finished goods and scrap appearing as a revenue signifies the increase or decrease in sales. It implies that there is increase in sales if there is decretion as it means there is less stock

available compared to previous year and more stock has been sold in current

 We dont agree with the manner of presentation of the

item because Accretion/(decretion) to work-in-progress doesnt imply that there is increase or decrease in sales. But Accretion/(decretion) to finished goods implies that there is increase or decrease in sales. So the item should appear as Accretion/(decretion) to finished goods.