AID15896: ABC Ltd. An Indian Company, acts as a limited risk distributor

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Q: ABC Ltd. An Indian Company, acts as a limited risk distributor in respect of the goods manufactured by its parent company.

Dr. Profit and loss account of ABC Ltd India for the year ended March 31, 2010 Cr.

Particulars

Amount

(Rs.)

Amount

(Rs.)

Particulars

Amount (Rs.)

Amount

(Rs.)

To Purchases

1,500

By Sales

2,500

To Gross profit

1,000

Total

2,500

Total

2,500

To Employee Cost

250

By Gross Profit

1,000

To Rent

200

To Legal Charges

100

To Depreciation

200

Total Operating Expenses

750

Total

1,000

Total

1,000

To Interest Cost

150

To Loss on sale of assets

20

To Net Profit before tax

80

Total

1,000

Total

1,000

In this case, ABC Ltd. purchases the goods from its AE only on receipt of orders received from third party domestic customer. Accordingly, it does not bear the risk of inventory.  

In such a scenario, Berry Ratio would be an appropriate PLI as it represents a return on a company’s value added functions and assumes that those functions are captured in its operating expenses. Thus, a Berry Ratio > 1 implies that the distributor earns enough to be able to recover its operating costs.

ABC Ltd.’s Berry Ratio (Gross Profit/Operating Expenses) works out to be 1.33 (100/75).

Similarly, the mean of Berry Ratio of comparable companies is 1.17, which is illustrated as under:

Name of the Company

Gross Profit

(Rs.)

Operating Expenses (Rs.)

Berry Ratio

(GP/Op. Exp)

Purchase price in comparable transactions at same quantity by domestic companies from their AEs

A Ltd.

50

40

1.25

1,380

B Ltd.

75

80

0.94

1,390

C Ltd.

120

80

1.50

1,410

D Ltd.

90

90

1.00

1,370

Mean

1.17

1,387.5

Since, the Berry Ratio of ABC Ltd. is higher than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are at arm’s length.  

Alternate Proposition I:

If Berry Ratio of ABC Ltd. Is 1.03 as compared to that of mean of comparable companies 1.17, is there any need to order for re-assessment of arm’s length price?

Since, the Berry Ratio of ABC Ltd. is lower than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are not at arm’s length.

Impact on assessment of Arm’s Length Price:

Particulars

Amount (Rs.)

Net Profit as per Profit & Loss Account before tax

80

Add : Adjustment for over-statement in Purchase Price on goods purchased from AE [= Purchase cost debited in Profit & Loss A/c (-) Average Purchase Price of Comparable Companies

= Rs.1,500 – 1,387.50]

112.50

Revised Net Profit after adjustment of over-statement in Purchase price but before tax

192.50

Alternate Proposition II:

Interest expense indicates only the extent to which the firm’s assets are secured by debt and the amount of depreciation recorded on a firm’s accounts is more likely to reflect the timing of that firm’s acquisition of assets than the actual depletion of capital assets. What would be the impact on assessment if these both are excluded from Operating expenses for calculation of Berry Ratio?

Impact on assessment of Arm’s Length Price:

Particulars

Amount (Rs.)

Net Profit as per Profit & Loss Account before tax

80

Add : Interest expense already excluded in computing operating expense, hence not considered further

Add: Depreciation on assets added back

Nil

200

Revised Net Profit after adjustment of over-statement in Purchase price but before tax

380

Revised Operating Expenses = 750-200 =550

Revised Berry Ratio = (Gross Profit/Operating Expenses) works out to be 1.82 (1000/550).

Since, the Berry Ratio of ABC Limited. is higher than that of the mean of comparable companies, the international transactions of ABC Ltd. regarding purchase of goods are at arm’s length.

Capacity Utilisation Adjustment

XYZ Ltd. An Indian Company, acts as a limited risk distributor in respect of the goods manufactured by its parent company.

Dr. Profit and loss account of ABC Ltd India for the year ended March 31, 2010 Cr.

Particulars

Amount

(Rs.)

Amount

(Rs.)

Particulars

Amount (Rs.)

Amount

(Rs.)

To Purchases

1,500

By Sales

2,500

To Gross profit

1,000

Total

2,500

Total

2,500

To Employee Cost

250

By Gross Profit

1,000

To Rent

200

To Legal Charges

100

To Depreciation

200

Total Operating Expenses

750

Total

1,000

Total

1,000

To Interest Cost

150

To Loss on sale of assets

20

To Net Profit before tax

80

Total

1,000

Total

1,000

Installed capacity: 10,000 hours. Capacity Utilisation: 75%. Cost of Fixed Assets Rs.10,000, Depreciation provided till date Rs.8,000, rate of depreciation @ 10%. Also given that there are 40 labourers, 260 working days and 8 hours per day. Industry capacity utilization rate is 90%

What would be the adjustments required?

Answer Blurr Actual Answer after purchase