Deputy Commissioner of Vs. Harjivandas J. Zaveri. - Court Judgment

Excerpt:
"the learned cit(a) has erred in law and on facts in deleting the addition made by the ao while rejecting the assessees method of valuation of stock".2. the assessee-firm deals in gold and silver ornaments. the sales are on retail basis. the assessee-firm started the business from asst. yr.1983-84; the first accounting period was closed on 30th june, 1983; while filing the return for the asst. yr. 1983-84, a detailed inventory of closing stock as audited/certified by the chartered accountant was attached; the assessment was completed for that year accepting the book results. in subsequent years also, upto asst. yr. 1987-88 the assessments had been completed on the basis of books of accounts maintained and in none of these years the closing stock shown had been disturbed. during the accounting period relevant to the asst. yr.1987-88, a search under s. 132(1) was conducted and subsequent to that, assessment for that year was finalised; even for that assessment year the book results were not disturbed although on account of certain unaccounted purchase/sales, the assessee agreed to be assessed on a sum of rs. 22 lakhs in addition to the income that worked out as per the books of accounts. it is pertinent to note that even for the asst. yr.1987-88 the method of valuation of closing stock the cost or market value, whichever is less, and last in first out (lifo) was accepted by the ao.3. during the assessment year under appeal i.e., asst. yr. 1988-89, the ao rejected the method of accounting which was being followed by the assessee ever since its inception. he held that the method of valuing closing stock in respect of different items of gold ornaments and silver ornaments was not correct. he rejected the assessees claim that it was following lifo system for showing the value of closing stock and further held that the assessee had not been following any system of accounting but showing the closing stock on convenience. relying upon the judgment of the honble supreme court in the case of cit vs. british paints india ltd. (1991) 188 itr 144 (sc) he rejected the book results and valued the closing stock at an average rate of purchases made during the accounting year. he also valued the opening stock at an average rate of purchase during the immediately preceding accounting year. thus, he worked out the undervaluation of closing stock of gold ornaments amounting to rs. 11,17,245 and silver ornaments amounting to rs. 54,706. the assessment order also mentions that in view of the change in the valuation of closing stock made by the ito, consequent action would be necessary for the immediate preceding assessment i.e., asst. yr. 1987-88.4. the assessee appealed to the cit(a). the cit(a) noted that the assessee had been following the regular system of accounting since last so many years and this method was based on accepted principles of accounting i.e., the cost or market price whichever is less and last in first out (lifo). he accordingly held that there was no justification for rejecting the book results by resorting to s. 145(1). he accordingly deleted the impugned additions of rs. 11,17,245 and rs. 54,706.5. shri b. p. chavda, the learned departmental representative, strongly supported the order of the ao and submitted that the ao had given detailed reasons for rejecting the book version of the assessee. he submitted that the assessee had been following a system of accounting which was defective; did not reflect the correct position of profits and accordingly, the ao was justified in rejecting the same by relying upon the judgment of the supreme court in the case of british paints india ltd. (supra).6. shri k. c. patel, the learned counsel for the assessee, strongly supported the order of the cit(a). he submitted that the assessee had been consistently following, the recognised method of accounting in valuing the closing stock year after year since its inception in 1981.he submitted that the assessee deals in a number of items (may be in more than 1000). it has maintained gold register regularly duly supported by the bills and vouchers; thus, there is no chance of any discrepancy with regard to the weight of the goods purchased in a particular year that remained in stock; however, due to innumerable items of ornaments it was not possible/practicable to identify each and every item otherwise there were complete details with regard to the weight of the items purchased in a particular year and which remained in the stock after accounting for the sales. he referred to the lifo method which has been defined as under : the last-in, first-out method, which is frequently known as the replacement cost method receives its support from the theory that goods sold are those more recently purchased and that goods are issued from the stock in accordance with last-in, first-out principle. thus, cost of the latest materials purchased will be the cost assigned to the first materials issued, until they are exhausted, then the price of the preceding lot is used and so on".he further relied upon the following paragraphs on valuation of stocks from different commentaries on advanced accountancy : (a) the stock at the end should be valued at cost price. however, if the market price is less than the cost price then (to incorporate the prospective loss on sale of such stock) it is advisable to value it at market price. if market price is more than the cost price then such market price (in order to adhere to the convention of conservatism) is left out.stock should be valued at cost or net realisable value (for replacement price), whichever is lower at the date of the balance sheet.spicers and peglers practical auditing, w.w. bigg indian edn. by s. v.ghatalia iv edn., p. 185 (iii) last in first out (lifo) method : in this method, pricing of issues is done in the reverse order of purchase, i.e., by adopting the price of the latest, available consignment. as the method applies the current cost of materials to the cost of units except when the purchases were made long ago, it is also sometimes known as the replacement cost method.this is comparatively recent method introduced first in the usa during the last war.principles and practice of cost accounting by n. k. prasad, revised and enlarged 5th edn. p. 320 (2) last in first out (lifo) (see fig. 6.2) : this is the price paid for the material last taken into stock from which the material to be priced could have been drawn.this method also ensures materials being issued at actual cost. its use is based on the principle that costs should be as closely as possible related to current price levels. under this method production cost is calculated on a basis which approximates to replacement cost. it will be seen from the figure that the stock in hand arrived at by applying this method is like lifo at cost.5.12 the basis on which inventories are valued is determined by the management. the normal basis is cost or net realisable value whichever is lower.statement of auditing practices published by institute of chartered accountants of india 1977 edn. p. 32.relying upon the above authorities, the learned counsel for the assessee repeatedly claimed that the assessee in fact had strictly followed at cost method of accountancy and lifo system which is recognised principle in valuation of closing stock. he, therefore, pleaded that the additions made on account of undervaluation of closing stock were uncalled for and the learned cit(a) was justified in deleting the same.7. we have considered the rival submissions and perused the facts on record. the point for consideration before us is whether can it be said that correct profits could not be deduced and whether the ao by having his own estimate of valuing the opening and closing stock for making the additions has adopted a better system for arriving at the profits.we find that the assessee-firm has been consistently valuing the closing stock at cost and following the system of last-in first-out (lifo) year after year since its inception in 1981. both at cost method of accountancy and lifo system are recognised principles in accountancy for valuation of closing stock. it is now well-settled that the assessee is entitled to value closing stock at cost or market price, whichever is lower, and further the value of closing stock must be the value of opening stock in the succeeding year. the supreme court in chainrup sampatram vs. cit (1953) 24 itr 481 (sc) has explained the stock valuation theory. the theory underlines the accepted principles, that the closing stock could be valued at the option of the assessee at cost or market value, whichever is lower. their lordships quoted with approval an extract from the report of the committee constituted in england : "as the entry for stock which appears in a trading account is merely intended to cancel the charge for the goods purchased which have not been sold it should necessarily represent the cost of the goods. if it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure ...from this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom viz., the adoption of market value at the date of making value at the date of making up accounts, if that value is less than the cost. it is of course an anticipation of the loss that may be made on those goods in the following year, and may even have the effect, if prices rise again, of attributing to the following years results a greater amount of profits than the difference between the actual sale price and the actual cost price of the goods in question"."while anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock in not brought into account, as no prudent trader would care to show increased profit before its actual realisation. this is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy. as profits for income tax purposes are to be computed in conformity with the ordinary principles of commercial accounting, unless of course, such principles have been superseded or modified by legislative enactments, unrealised profits in the shape of appreciated value of goods remaining unsold at the end of an accounting year and carried over to the following years account in a business that is continuing are not brought into the charge as a matter of practice, though as already stated, loss due to a fall in the price below cost is allowed even if such loss has not been actually realised".in view of the above, we are of the considered opinion that the method of valuation followed by the assessee is an accepted method of accounting adopted under the it act. the assessee has maintained regular books of accounts : stock register showing detailed particulars such as opening stock, purchases, sales and closing stock and detailed inventories of closing stock were being furnished with the return of income from the beginning of the first assessment year and the ao had been accepting the method of accounting being followed by the assessee.in the assessment order also the ao has nowhere mentioned that the closing stock being shown at cost does not include the other expenses such as freight, transport, octroi, etc. therefore, there is nothing on record to suggest that the books of accounts maintained by the assessee during the normal course of business did not reflect the correct position of profits or that the assessee had suppressed any item of expenditure directly or indirectly to this stock in hand. the only point which weighed with the ao appears to be that over the years the value of goods held in stock by the assessee had gone up very high and that the closing stock being shown at the cost did not commensurate with the prevailing rates in a particular year. this appears to be a reason for disturbing the book results and application of provisions of s. 145, otherwise, the ao, as stated above, has not pointed out any defect in the maintenance of books of accounts including the stock register. accordingly the ratio laid down by the honble supreme court in the case of british paints india ltd. (supra) will not apply to the facts of the present case because in that case the system of accounting adopted was such which excluded, for the valuation of stock-in-trade, all costs other than the cost of raw materials for the goods-in-process and finished products and such system resulted in a distorted picture of the true state of the business for the purpose of computing the chargeable income. we accordingly decline to interfere and concur with the findings of the learned cit(a).

Judgment:
"The learned CIT(A) has erred in law and on facts in deleting the addition made by the AO while rejecting the assessees method of valuation of stock".

2. The assessee-firm deals in gold and silver ornaments. The sales are on retail basis. The assessee-firm started the business from asst. yr.

1983-84; the first accounting period was closed on 30th June, 1983; while filing the return for the asst. yr. 1983-84, a detailed inventory of closing stock as audited/certified by the chartered accountant was attached; the assessment was completed for that year accepting the book results. In subsequent years also, upto asst. yr. 1987-88 the assessments had been completed on the basis of books of accounts maintained and in none of these years the closing stock shown had been disturbed. During the accounting period relevant to the asst. yr.

1987-88, a search under s. 132(1) was conducted and subsequent to that, assessment for that year was finalised; even for that assessment year the book results were not disturbed although on account of certain unaccounted purchase/sales, the assessee agreed to be assessed on a sum of Rs. 22 lakhs in addition to the income that worked out as per the books of accounts. It is pertinent to note that even for the asst. yr.

1987-88 the method of valuation of closing stock the cost or market value, whichever is less, and Last In First Out (LIFO) was accepted by the AO.3. During the assessment year under appeal i.e., asst. yr. 1988-89, the AO rejected the method of accounting which was being followed by the assessee ever since its inception. He held that the method of valuing closing stock in respect of different items of gold ornaments and silver ornaments was not correct. He rejected the assessees claim that it was following LIFO system for showing the value of closing stock and further held that the assessee had not been following any system of accounting but showing the closing stock on convenience. Relying upon the judgment of the Honble Supreme Court in the case of CIT vs. British Paints India Ltd. (1991) 188 ITR 144 (SC) he rejected the book results and valued the closing stock at an average rate of purchases made during the accounting year. He also valued the opening stock at an average rate of purchase during the immediately preceding accounting year. Thus, he worked out the undervaluation of closing stock of gold ornaments amounting to Rs. 11,17,245 and silver ornaments amounting to Rs. 54,706. The assessment order also mentions that in view of the change in the valuation of closing stock made by the ITO, consequent action would be necessary for the immediate preceding assessment i.e., asst. yr. 1987-88.

4. The assessee appealed to the CIT(A). The CIT(A) noted that the assessee had been following the regular system of accounting since last so many years and this method was based on accepted principles of accounting i.e., the cost or market price whichever is less and Last in First Out (LIFO). He accordingly held that there was no justification for rejecting the book results by resorting to s. 145(1). He accordingly deleted the impugned additions of Rs. 11,17,245 and Rs. 54,706.

5. Shri B. P. Chavda, the learned Departmental Representative, strongly supported the order of the AO and submitted that the AO had given detailed reasons for rejecting the book version of the assessee. He submitted that the assessee had been following a system of accounting which was defective; did not reflect the correct position of profits and accordingly, the AO was justified in rejecting the same by relying upon the judgment of the Supreme Court in the case of British Paints India Ltd. (supra).

6. Shri K. C. Patel, the learned counsel for the assessee, strongly supported the order of the CIT(A). He submitted that the assessee had been consistently following, the recognised method of accounting in valuing the closing stock year after year since its inception in 1981.

He submitted that the assessee deals in a number of items (may be in more than 1000). It has maintained gold register regularly duly supported by the bills and vouchers; thus, there is no chance of any discrepancy with regard to the weight of the goods purchased in a particular year that remained in stock; however, due to innumerable items of ornaments it was not possible/practicable to identify each and every item otherwise there were complete details with regard to the weight of the items purchased in a particular year and which remained in the stock after accounting for the sales. He referred to the LIFO method which has been defined as under : The last-in, first-out method, which is frequently known as the replacement cost method receives its support from the theory that goods sold are those more recently purchased and that goods are issued from the stock in accordance with last-in, first-out principle. Thus, cost of the latest materials purchased will be the cost assigned to the first materials issued, until they are exhausted, then the price of the preceding lot is used and so on".

He further relied upon the following paragraphs on valuation of stocks from different commentaries on advanced accountancy : (a) The stock at the end should be valued at cost price. However, if the market price is less than the cost price then (to incorporate the prospective loss on sale of such stock) it is advisable to value it at market price. If market price is more than the cost price then such market price (in order to adhere to the convention of conservatism) is left out.

Stock should be valued at cost or net realisable value (for replacement price), whichever is lower at the date of the balance sheet.

Spicers and Peglers Practical Auditing, W.W. Bigg Indian Edn. by S. V.Ghatalia IV Edn., p. 185 (iii) Last in First out (LIFO) Method : In this method, pricing of issues is done in the reverse order of purchase, i.e., by adopting the price of the latest, available consignment. As the method applies the current cost of materials to the cost of units except when the purchases were made long ago, it is also sometimes known as the replacement cost method.

This is comparatively recent method introduced first in the USA during the last war.

Principles and Practice of Cost Accounting By N. K. Prasad, Revised and Enlarged 5th Edn. p. 320 (2) Last in first out (LIFO) (see Fig. 6.2) : This is the price paid for the material last taken into stock from which the material to be priced could have been drawn.

This method also ensures materials being issued at actual cost. Its use is based on the principle that costs should be as closely as possible related to current price levels. Under this method production cost is calculated on a basis which approximates to replacement cost. It will be seen from the figure that the stock in hand arrived at by applying this method is like LIFO at cost.

5.12 The basis on which inventories are valued is determined by the management. The normal basis is cost or net realisable value whichever is lower.

Statement of Auditing Practices Published by Institute of Chartered Accountants of India 1977 Edn. P. 32.

Relying upon the above authorities, the learned counsel for the assessee repeatedly claimed that the assessee in fact had strictly followed at cost method of accountancy and LIFO system which is recognised principle in valuation of closing stock. He, therefore, pleaded that the additions made on account of undervaluation of closing stock were uncalled for and the learned CIT(A) was justified in deleting the same.

7. We have considered the rival submissions and perused the facts on record. The point for consideration before us is whether can it be said that correct profits could not be deduced and whether the AO by having his own estimate of valuing the opening and closing stock for making the additions has adopted a better system for arriving at the profits.

We find that the assessee-firm has been consistently valuing the closing stock at cost and following the system of Last-in First-out (LIFO) year after year since its inception in 1981. Both at cost method of accountancy and LIFO system are recognised principles in accountancy for valuation of closing stock. It is now well-settled that the assessee is entitled to value closing stock at cost or market price, whichever is lower, and further the value of closing stock must be the value of opening stock in the succeeding year. The Supreme Court in Chainrup Sampatram vs. CIT (1953) 24 ITR 481 (SC) has explained the stock valuation theory. The theory underlines the accepted principles, that the closing stock could be valued at the option of the assessee at cost or market value, whichever is lower. Their Lordships quoted with approval an extract from the report of the committee constituted in England : "As the entry for stock which appears in a trading account is merely intended to cancel the charge for the goods purchased which have not been sold it should necessarily represent the cost of the goods. If it is more or less than the cost, then the effect is to state the profit on the goods which actually have been sold at the incorrect figure ...

From this rigid doctrine one exception is very generally recognised on prudential grounds and is now fully sanctioned by custom viz., the adoption of market value at the date of making value at the date of making up accounts, if that value is less than the cost. It is of course an anticipation of the loss that may be made on those goods in the following year, and may even have the effect, if prices rise again, of attributing to the following years results a greater amount of profits than the difference between the actual sale price and the actual cost price of the goods in question".

"While anticipated loss is thus taken into account, anticipated profit in the shape of appreciated value of the closing stock in not brought into account, as no prudent trader would care to show increased profit before its actual realisation. This is the theory underlying the rule that the closing stock is to be valued at cost or market price whichever is the lower, and it is now generally accepted as an established rule of commercial practice and accountancy. As profits for income tax purposes are to be computed in conformity with the ordinary principles of commercial accounting, unless of course, such principles have been superseded or modified by legislative enactments, unrealised profits in the shape of appreciated value of goods remaining unsold at the end of an accounting year and carried over to the following years account in a business that is continuing are not brought into the charge as a matter of practice, though as already stated, loss due to a fall in the price below cost is allowed even if such loss has not been actually realised".

In view of the above, we are of the considered opinion that the method of valuation followed by the assessee is an accepted method of accounting adopted under the IT Act. The assessee has maintained regular books of accounts : stock register showing detailed particulars such as opening stock, purchases, sales and closing stock and detailed inventories of closing stock were being furnished with the return of income from the beginning of the first assessment year and the AO had been accepting the method of accounting being followed by the assessee.

In the assessment order also the AO has nowhere mentioned that the closing stock being shown at cost does not include the other expenses such as freight, transport, octroi, etc. Therefore, there is nothing on record to suggest that the books of accounts maintained by the assessee during the normal course of business did not reflect the correct position of profits or that the assessee had suppressed any item of expenditure directly or indirectly to this stock in hand. The only point which weighed with the AO appears to be that over the years the value of goods held in stock by the assessee had gone up very high and that the closing stock being shown at the cost did not commensurate with the prevailing rates in a particular year. This appears to be a reason for disturbing the book results and application of provisions of s. 145, otherwise, the AO, as stated above, has not pointed out any defect in the maintenance of books of accounts including the stock register. Accordingly the ratio laid down by the Honble Supreme Court in the case of British Paints India Ltd. (supra) will not apply to the facts of the present case because in that case the system of accounting adopted was such which excluded, for the valuation of stock-in-trade, all costs other than the cost of raw materials for the goods-in-process and finished products and such system resulted in a distorted picture of the true state of the business for the purpose of computing the chargeable income. We accordingly decline to interfere and concur with the findings of the learned CIT(A).