Value Addition
Value addition is the measure of the wealth created by an organization and also how that wealth is distributed among various stakeholders. Accounting from the days of the past, has been an approach to measure the profits of the entity available to the shareholders. But an entity has several other shareholders to whom the profit earned by the shareholders may not be a correct indicator. Employees, Financial Institutions, Government and Society are other key stakeholders of an entity who do not find useful information in the figure of profit generated by the entity to the shareholders.
Value Added Statement (VAS) is aimed at supplementing a new dimension to the existing system of corporate financial accounting and reporting. Since VAS represents how the value or wealth created or generated by an entity is shared among different stakeholders, it is thus, also significant from the national point of view. The main objective of this statement lies in deriving a measure of wealth (i.e. value), the entity has contributed to the society through the collective efforts of the various stakeholders. This statement is prepared and published voluntarily with the annual financial reports. Thus, the presentation of a statement of value-added aids in disclosure of value added by an entity.
Computation of Value Addition
So, the question is how is value addition computed? Let’s take an example of an Income Statement and convert the statement into Value Added Statement.
SN | Income Statement | Amount |
1 | Sales | 1,248,000 |
2 | Consumption of raw materials | (642,000) |
3 | Consumables | (8,000) |
4 | Local taxation | (1,600) |
5 | Other manufacturing expenses | (88,400) |
6 | Excise duty | (36,000) |
7 | Depreciation | (3,200) |
| Operating Profit | 468,800 |
8 | Other income | 11,000 |
9 | Salaries to administrative staffs | (124,000) |
10 | Directors’ remuneration | (1,000) |
11 | Other administrative expenses | (35,000) |
12 | Interest on short term overdraft loan | (21,800) |
13 | Interest on working capital loan | (4,000) |
14 | Interest from term loan | (10,200) |
15 | Other finance charges | (52,800) |
16 | Provision for tax | (11,000) |
| Net Profit | 220,000 |
19 | Opening Profit/Loss Balance | 12,000 |
17 | Fixed asset replacement reserve | (80,000) |
18 | Dividend | (32,000) |
20 | Closing Profit/Loss Balance | 120,000 |
SN | Value Added Statement | Amount |
1 | Sales | 1,248,000 |
2 | Consumption of raw materials | (642,000) |
3 | Consumables | (8,000) |
5 | Other manufacturing expenses | (88,400) |
6 | Excise duty | (36,000) |
8 | Other income | 11,000 |
11 | Other administrative expenses | (35,000) |
12 | Interest on short term overdraft loan | (21,800) |
13 | Interest on working capital loan from bank | (4,000) |
15 | Other finance charges | (52,800) |
Total Value Added | 371,000 | |
19 | Opening Profit/Loss Balance | 12,000 |
20 | Closing Profit/Loss Balance | (120,000) |
17 | Fixed asset replacement reserve | (80,000) |
7 | Depreciation | (3,200) |
Value Added to Company | 191,200 | |
18 | Dividend | (32,000) |
| Value Added to Shareholders | 32,000 |
10 | Directors’ remuneration | (1,000) |
| Value Added to Directors | 1,000 |
9 | Salaries to administrative staffs | (124,000) |
| Value Added to Staffs | 124,000 |
14 | Interest on term loan from bank | (10,200) |
| Value Added to Financial Institutions | 10,200 |
4 | Local taxation | (1,600) |
16 | Provision for tax | (11,000) |
| Value Added to Government | 12,600 |
Total Application of Value Added | 371,000 |
The rate of value addition in the above entity is computed as follows based on turnover: NPR 371,000 / NPR 1,248,000; equals to 29.72%. This is the generally accepted way of computing rate of value addition obtained by an entity.
The rate of value addition is a very important number in the context of finance and economy. This figure is associated also in deciding whether an entity is eligible to receive the business concessions and facilities, normally related to taxes and export concessions.
In an interesting decision from the Supreme Court in the case of Ganapati Plastic Industries v/s Department of Industries, the method of computing the value addition came into disagreement between the Ganapati Plastic Industries and the Department of Industry. The two parties came to disagreement relating to the recognition of the costs relating to the fees paid to clearing agent, pre-operation expenses and the cost of the raw materials for computing the value-added rate. The court did not go into discussing the treatment of these expenses but ordered the Department of Industry to recompute the value addition rate providing sufficient reasoning for the same. Well with this, when there is disagreement in computing the value addition rate we could always go back to the basics of the principle of value addition, as discussed above.
Contract Manufacturing
Contract manufacturing is a concept somehow related to the principle of value addition. Contract manufacturing is when a contract manufacturer enters an agreement with another company to make certain components or products over a specified period of time. Recognized as a form of outsourcing, a contract manufacturer may enter a business agreement with a company to produce parts, components, or whole products for the company to their specifications. The manufactured products are then used by the company in its own manufacturing process or to complete their own products. Contract manufacturers are often third-party organizations that work exclusively in subcontracting or sell their products to other firms or agencies.
Section 50 of Industrial Enterprise Act, 2076 restricts industries (both domestic industry and industry with foreign investment) to enter into contract manufacturing arrangement with other industries in consideration to produce main product but permits contract manufacturing for any parts of manufacturing process or ancillary goods or services required by the industry. Similar restrictions are imposed under Section 45 of the Foreign Investment and Technology Transfer Act, 2075 as well. Some entities are involved in the manufacturing activity but that constitutes only a small portion of their entire manufacturing process and outsource the rest. Such industry could potentially not be viewed as manufacturing industry. On the other hand, some industries are simply involved in packaging activity and thus are not qualified to be categorized as manufacturing unit, although packaging is a process of manufacturing, as it clearly constitutes only a small portion of the entire manufacturing process. Furthermore, Industrial Enterprise Act, 2076 does not consider packaging as manufacturing activity as it includes industrial activity of packaging under list of activities carried out by service industry under Schedule 8 of the Act.
What constitutes a significant manufacturing process is an important question. It could be analyzed on the basis of the cost incurred, man hours involved, involvement of the major technology or formula of the company and so on. It is more of an engineer’s assessment than an accountant’s. The assessment would depend on the factors like: Plants, equipment and machineries required for manufacturing process, Use of Manpower, Core Manufacturing Activities: Conversion/Change in form, Design and Specification and so on.
A decision on the similar note was made in the case of Inland Revenue Office, Simara v/s Eastern Textile Industries Limited by Supreme Court. Eastern Textile Industries Limited was not qualified to be a textile manufacturing industry to be able to obtain the drawback facility for indirect taxes, as the industry was only involved dyeing the textiles on behalf of the others, which is essentially a form of service, rather than being a textile manufacturing industry.