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Management Notes

Throughput Accounting, Objectives, Performance Measurement, Practical Problems

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Throughput Accounting (TA) is a management accounting approach, rooted in the Theory of Constraints (TOC), that focuses on maximizing the rate at which an organization generates money through sales rather than minimizing costs or maximizing production. It treats throughput (sales revenue minus totally variable/direct material costs) as the primary performance measure, while treating almost all other costs—labour, overheads—as largely fixed in the short run. Unlike traditional costing, which emphasizes cost allocation and product-level profitability, TA emphasizes identifying and managing the bottleneck (constraint) that limits overall system output, since improving flow through the constraint directly increases the entire organization’s profitability.

Objectives of Throughput Accounting:

1. Maximizing Throughput (Money Generation Rate)

The primary objective of throughput accounting is to maximize throughput—defined as sales revenue minus totally variable costs (mainly direct materials)—at the fastest possible rate. Unlike traditional costing which may encourage producing inventory to absorb fixed overheads, TA insists that a product only generates value when it is actually sold, not merely manufactured. This shifts organizational focus from “keeping machines busy” to “generating cash through sales.” By making throughput the central metric, management decisions—pricing, product mix, capacity investment—are all evaluated based on their impact on this money-generation rate, ensuring efforts align directly with the organization’s fundamental goal of making money now and in the future.

2. Identifying and Managing Bottlenecks (Constraints)

A core objective is to identify the bottleneck resource—the constraint that limits the entire system’s throughput—and ensure organizational efforts concentrate on exploiting and elevating it. Since the whole production system can only move as fast as its slowest link, TA directs management attention away from optimizing every individual process (which can create false local efficiencies) toward optimizing the one resource that truly restricts output. This objective includes subordinating all non-bottleneck resources to the pace of the bottleneck, ensuring they don’t overproduce, and systematically working to elevate the bottleneck’s capacity (through investment, better scheduling, or process improvement) once fully exploited.

3. Minimizing Inventory and Work-in-Progress

TA aims to minimize inventory levels, viewing excess inventory not as an asset but as a liability that ties up cash, incurs holding costs, and often masks underlying production inefficiencies. Unlike traditional costing where absorption of fixed overhead can encourage overproduction to lower unit cost, TA discourages producing beyond what the bottleneck can process and what the market can sell. This objective promotes just-in-time-style flow, reduces obsolescence risk, and improves cash flow by preventing capital from being locked in unsold or unfinished goods, thereby increasing the organization’s overall financial flexibility and responsiveness to changing market demand.

4. Controlling and Reducing Operating Expenses

While TA treats most costs as largely fixed in the short term (labour, overheads, rent), a key objective is still to control and progressively reduce total operating expense—the money spent converting investment into throughput. This isn’t about aggressive cost-cutting that could damage capacity, but about ensuring operating expenses are justified by their contribution to increasing throughput. Objectives include eliminating wasteful spending unrelated to the bottleneck, and evaluating any cost increase (e.g., overtime, additional staff) strictly in terms of whether it sufficiently elevates system throughput. This ensures operating expense growth remains disciplined and tied to genuine capacity or output gains.

5. Improving Decision-Making on Product Mix and Pricing

TA aims to guide better short-term decisions on product mix, pricing, and order acceptance by evaluating products based on throughput per unit of the bottleneck resource, rather than traditional full-cost or contribution-margin analysis alone. This prevents the common error of prioritizing products with high absolute profit margins but low throughput efficiency at the constraint. By ranking products according to throughput generated per bottleneck-minute, management can maximize overall profitability given limited bottleneck capacity, ensuring resources are allocated to the most financially advantageous mix of orders, especially in constrained or make-to-order manufacturing environments.

6. Enhancing Overall Organizational Profitability and Continuous Improvement

Ultimately, TA’s objective is to align all operational decisions with the organization’s overarching financial goal—increasing net profit, return on investment, and cash flow—rather than isolated departmental efficiency metrics. It embeds a continuous improvement philosophy through the Theory of Constraints’ five-step process (identify, exploit, subordinate, elevate, and repeat), ensuring that as one bottleneck is resolved, the next constraint is identified and addressed. This creates an ongoing cycle of performance improvement, helping organizations remain competitive by consistently increasing throughput while keeping inventory and operating expenses under control across changing business conditions.

Throughput Accounting for Performance Measurement:

1. Measures Throughput

Throughput accounting measures the rate at which an organisation generates money through sales. Throughput is generally calculated as:

Throughput = Sales Revenue − Totally Variable Cost

In most applications, direct material cost is treated as the main totally variable cost. A higher throughput indicates that the organisation is generating more money from its sales activities. Management can compare throughput across products, departments or periods to evaluate performance. This measure helps shift attention from simply increasing production to generating sales and improving the flow of profitable products through the system.

2. Measures Bottleneck Performance

Throughput accounting gives significant importance to bottleneck resources, as they restrict the overall output of the organisation. Performance is measured by examining how effectively the bottleneck is utilised. Idle time, unnecessary setup time, breakdowns and poor scheduling at the bottleneck can reduce throughput. Management can monitor these factors and take corrective action. Improving bottleneck utilisation can increase the organisation’s ability to produce and sell products. Therefore, throughput accounting provides a focused measure of performance where production capacity is constrained.

3. Throughput per Bottleneck Hour

Throughput accounting measures product performance by calculating the throughput generated per unit of bottleneck time. This is particularly useful when several products compete for limited machine or labour capacity.

Throughput per Bottleneck Hour = Throughput per Unit ÷ Bottleneck Hours per Unit

Products generating higher throughput per bottleneck hour are generally considered more attractive. This measure helps management evaluate product mix and resource utilisation. It ensures that scarce capacity is allocated to products that make the greatest contribution to overall financial performance.

4. Measures Inventory Performance

Throughput accounting treats inventory as an investment rather than automatically considering increased inventory as a sign of better performance. Excess inventory ties up funds and may result in storage, handling, obsolescence and quality costs. Performance is therefore improved by maintaining the necessary level of inventory and ensuring smooth movement of materials through production. Management can monitor inventory levels and identify unnecessary accumulation. This supports the objective of reducing working capital requirements while maintaining sufficient materials to prevent disruption at the constraint.

5. Measures Operating Expense

Throughput accounting considers operating expense as the money spent to convert inventory into throughput. Examples include salaries, depreciation, utilities, rent and other operating expenses. Management monitors whether these expenses are supporting the generation of throughput. The objective is not simply to minimise every expense but to ensure that resources are used effectively to generate additional sales. Performance improves when throughput increases without a proportionate increase in operating expenses. Therefore, operating expense is an important performance measure under throughput accounting.

6. Measures Return on Investment

Throughput accounting can be used to assess performance through the relationship between throughput, investment and operating expense.

Return on Investment = (Throughput − Operating Expense) ÷ Investment

A higher return indicates that the organisation is generating more profit from the resources invested. Management can use this measure to compare performance over different periods or evaluate alternative decisions. It encourages managers to increase throughput, control operating expenses and avoid unnecessary investment in inventory or capacity. Thus, throughput accounting links operational performance with financial performance.

7. Identifies Performance of Products

Throughput accounting helps compare products based on the throughput they generate and the amount of constrained resource they consume. A product with a high selling price is not necessarily the most profitable if it requires substantial bottleneck time. Management can calculate throughput per bottleneck hour and rank products accordingly. This provides a more useful performance measure when capacity is restricted. It helps management identify products that make the best use of scarce resources and contribute most effectively to overall organisational performance.

8. Improves Resource Utilisation

Throughput accounting evaluates how effectively scarce resources are being used. Particular attention is given to bottleneck machines, skilled labour and other constrained resources. Idle time at a bottleneck represents lost production and potential sales. Management therefore monitors utilisation and seeks ways to reduce interruptions, setup time and unnecessary processing. Better utilisation increases throughput without necessarily requiring additional investment. This makes resource utilisation an important performance indicator and helps management focus improvement efforts on areas that have the greatest impact on overall performance.

9. Supports Continuous Improvement

Throughput accounting supports continuous improvement by encouraging management to identify and remove constraints. Once one bottleneck is improved or removed, another constraint may become the limiting factor. Management can then focus on the new constraint and continue improving the production system. Performance is measured by observing improvements in throughput, reduced operating expenses and efficient use of investment. This approach encourages managers to focus on the overall system rather than optimising individual departments at the expense of organisational performance.

10. Focuses on Overall Organisational Performance

Throughput accounting focuses on improving the performance of the entire organisation rather than individual departments alone. A department may appear efficient because it produces large quantities, but excessive production can create unnecessary inventory if sales cannot absorb the output. Throughput accounting instead focuses on increasing sales, managing constraints and controlling operating expenses. Performance is therefore assessed through the combined effect of throughput, investment and operating expenses. This system encourages decisions that improve overall profitability rather than merely improving the performance of individual activities.

Practical Problems on Throughput Accounting:

Problem 1: Calculation of Throughput

A company manufactures Product A, which is sold for ₹500 per unit. The totally variable cost, mainly direct material, is ₹200 per unit. During the month, the company sells 1,000 units. Calculate the throughput per unit and total throughput. This problem tests the basic concept of throughput accounting. Students should first calculate throughput per unit by deducting totally variable cost from selling price. Then, total throughput is calculated by multiplying throughput per unit by the number of units sold. The result shows the amount available to cover operating expenses and generate profit.

Answer: Throughput per unit = ₹500 − ₹200 = ₹300

Total Throughput = ₹300 × 1,000 = ₹3,00,000

Problem 2: Throughput per Bottleneck Hour

A company produces Product A and Product B. Product A generates throughput of ₹300 per unit and requires 2 hours of bottleneck time. Product B generates throughput of ₹400 per unit and requires 4 hours of bottleneck time. Calculate throughput per bottleneck hour for each product and determine which product should receive priority when bottleneck capacity is limited. This problem demonstrates how throughput accounting helps management allocate scarce resources. Students should divide throughput per unit by bottleneck hours required per unit and compare the resulting figures.

Answer:

Product A = ₹300 ÷ 2 = ₹150 per bottleneck hour

Product B = ₹400 ÷ 4 = ₹100 per bottleneck hour

Product A should receive priority.

Problem 3: Product Mix Decision

A company produces Products A and B using a machine that is the bottleneck. Product A provides throughput of ₹200 per unit and requires 1 hour of bottleneck time. Product B provides throughput of ₹300 per unit and requires 3 hours. The machine is available for 600 hours. Calculate throughput per bottleneck hour and determine the product that should be prioritised. This problem shows that the product generating the highest throughput per unit is not necessarily the best choice. Throughput accounting focuses on the return generated from each unit of scarce bottleneck capacity.

Answer:

A = ₹200 ÷ 1 = ₹200 per hour

B = ₹300 ÷ 3 = ₹100 per hour

Product A should be prioritised.

Problem 4: Calculation of Return on Investment

A company earns throughput of ₹10,00,000 during a year. Its operating expenses are ₹6,00,000, while total investment is ₹20,00,000. Calculate the return on investment using the throughput accounting approach. This problem demonstrates how throughput accounting connects operational performance with financial performance. Students should first determine the profit by deducting operating expenses from throughput. The resulting profit is then divided by total investment and multiplied by 100. The calculated percentage indicates how effectively the organisation is generating profit from the resources invested in the business.

Answer:

Profit = ₹10,00,000 − ₹6,00,000 = ₹4,00,000

ROI = ₹4,00,000 ÷ ₹20,00,000 × 100

ROI = 20%

Problem 5: Special Order Decision

A company receives a special order for 500 units at ₹450 per unit. The totally variable cost is ₹250 per unit. The order requires 1,000 hours of bottleneck capacity. The company can alternatively use these hours to produce another product generating ₹120 throughput per bottleneck hour. Determine whether the special order should be accepted. Students should calculate the throughput from the special order and compare it with the throughput sacrificed from the alternative use of the bottleneck. The order should be accepted only if it provides a better financial benefit from the scarce resource.

Answer:

Special order throughput = (₹450 − ₹250) × 500 = ₹1,00,000

Alternative throughput = 1,000 × ₹120 = ₹1,20,000

Special order should be rejected.

Problem 6: Make or Buy Decision

A company manufactures a component internally at a totally variable cost of ₹150 per unit. An outside supplier offers the component for ₹180 per unit. Each component requires 1 hour of bottleneck capacity. The released bottleneck hour can produce another product generating throughput of ₹50. Determine whether the component should be made or purchased. This problem demonstrates that throughput accounting considers the opportunity created by releasing bottleneck capacity. Although internal production appears cheaper than purchasing, management must also consider the additional throughput that can be earned by using the scarce resource elsewhere.

Answer:

Making cost = ₹150

Buying cost = ₹180

Additional throughput from released bottleneck = ₹50

Effective cost of making = ₹150 + ₹50 = ₹200

Buy the component for ₹180.

Management Notes

Life Cycle Costing, Objectives, Planning, Estimation, Cost Reduction and Profitability, Practical Problems

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Life Cycle Costing (LCC) is a costing technique that tracks and accumulates all costs a product incurs across its entire life cycle from initial research and development, through design, production, marketing, and distribution, to final customer service and eventual disposal/decommissioning. LCC recognizes that a large portion of a product’s total cost is committed early (during R&D and design) even though it’s incurred later. This holistic view helps management make better pricing, investment, and product-mix decisions by revealing true total profitability over a product’s life, rather than a distorted snapshot from a single accounting period. LCC is especially vital for products with high upfront development costs and long market life, such as pharmaceuticals, automobiles, and electronics.

Planning of Life Cycle Costs:

1. Identification of Product Life Cycle

The first step in planning life cycle costs is to identify the complete life cycle of the product. It generally includes research and development, product design, production, marketing, distribution, sales, customer service and product withdrawal. Management estimates the duration and activities involved in each stage. Understanding the complete life cycle helps identify all costs that may arise throughout the product’s existence. This prevents management from focusing only on manufacturing costs and supports better long term cost planning and profitability analysis.

2. Estimation of Research and Development Costs

Research and development costs are estimated at the initial stage of product planning. These may include market research, product research, testing, product design, development of prototypes and technical studies. Although these costs are incurred before production begins, they can significantly affect the total life cycle cost of the product. Proper estimation helps management determine the amount of investment required and evaluate whether the proposed product is commercially viable. It also supports decisions regarding product features, technology and development alternatives.

3. Planning Product Design Costs

Product design has a major influence on the total life cycle cost because many future production and service costs are determined during the design stage. Management evaluates materials, components, product features, manufacturing methods and technical specifications. Designers aim to achieve the required quality and functionality at the lowest possible life cycle cost. Value engineering may be used to eliminate unnecessary features and reduce future costs. Effective design planning can reduce manufacturing, maintenance, warranty and after sales service costs throughout the product’s life.

4. Estimation of Production Costs

Production costs include direct materials, direct labour, manufacturing overheads, machinery, energy and other costs incurred during manufacturing. Management estimates these costs based on expected production volume, technology, material prices, labour requirements and production methods. The estimated production cost is compared with the target cost to identify possible cost gaps. Cost reduction opportunities are then examined before production begins. Proper production cost planning helps maintain profitability while ensuring that the product meets required quality and customer expectations.

5. Planning Marketing and Distribution Costs

Marketing and distribution costs are important elements of total life cycle cost. They may include advertising, sales promotion, sales staff salaries, transportation, warehousing, packaging and distribution expenses. Management estimates these costs based on the expected market size, distribution network, promotional strategy and sales volume. Effective planning helps determine the total cost of bringing the product to customers. It also enables management to evaluate alternative distribution channels and promotional methods that can provide the required market coverage at an acceptable cost.

6. Estimation of Customer Service Costs

Customer service costs may continue throughout the product’s market life. These include installation, technical support, maintenance, repairs, warranty services, replacement of parts and customer assistance. Management should estimate these costs while designing the product because design decisions can significantly affect future service requirements. A product that is inexpensive to manufacture may become costly if it requires frequent repairs or maintenance. Therefore, planning customer service costs helps management evaluate the complete economic impact of product decisions and improve long term profitability.

7. Estimation of Product Withdrawal Costs

Product withdrawal costs arise when a product reaches the end of its useful or commercial life. These may include product discontinuation, disposal, removal of equipment, inventory clearance, recycling, environmental compliance and customer support obligations. Management should estimate these costs in advance to understand the complete financial impact of the product. Proper planning prevents unexpected expenses at the end of the product life cycle. It also helps organisations develop suitable strategies for product replacement, inventory management and environmentally responsible disposal.

8. Determination of Total Life Cycle Cost

After estimating costs at different stages, management calculates the total life cycle cost of the product.

Total Life Cycle Cost = R&D Cost + Design Cost + Production Cost + Marketing Cost + Distribution Cost + Customer Service Cost + Withdrawal Cost

This calculation provides a complete picture of the financial resources required throughout the product’s life. Management can compare the total life cycle cost with expected revenue to determine the product’s overall profitability. It also helps identify stages where significant cost reduction opportunities exist.

9. Comparison with Expected Revenue

The estimated total life cycle cost is compared with the expected revenue from the product. This comparison helps determine whether the product is likely to achieve the desired profit over its entire life. Management considers expected selling price, sales volume, market demand and product life. If expected profitability is insufficient, changes may be made to product design, pricing, production methods or marketing strategy. This ensures that product decisions are based on long term financial performance rather than short term manufacturing cost alone.

10. Continuous Monitoring and Cost Reduction

Life cycle cost planning continues even after the product enters the market. Actual costs are compared with estimated costs at regular intervals to identify significant variations. Management can then introduce corrective measures such as reducing material usage, improving production efficiency, controlling service costs or changing distribution methods. Kaizen costing and value improvement techniques may also be used for continuous cost reduction. Regular monitoring helps ensure that the product remains profitable throughout its life cycle and that unexpected costs do not significantly reduce the expected return.

Estimation of Life Cycle Costs:

1. Research and Development (R&D) Cost Estimation

R&D costs are estimated at the very start of a product’s life and include expenses for basic research, feasibility studies, concept development, and prototype testing. These costs are often significant and largely irrecoverable if the product fails to reach market. Estimation involves forecasting scientist/engineer time, laboratory equipment, testing trials, and patent/licensing fees. Since R&D outcomes are uncertain, estimates rely on historical data from similar past projects, expert judgment, and phased budgeting (approving funds stage-by-stage as feasibility is proven). Accurate R&D cost estimation is critical because decisions made here—regarding technology, materials, and design—lock in the majority of costs for all subsequent life cycle stages.

2. Design and Development Cost Estimation

Design costs cover converting the R&D concept into a manufacturable product—engineering drawings, tooling design, prototype refinement, and test-run production. Estimation here uses techniques like parametric cost estimation (using cost drivers such as size, weight, or complexity) and analogous estimation (comparing with similar historical products). Since roughly 80-90% of a product’s total life cycle cost is committed during design (even though not yet spent), rigorous estimation at this stage is essential. Target costing principles are often applied here to work backward from market price to allowable design cost, ensuring the estimated design outcome aligns with profitability goals before production begins.

3. Manufacturing/Production Cost Estimation

Production cost estimation covers direct materials, direct labour, and manufacturing overheads incurred once the product goes into full-scale production. This is typically the most familiar costing stage, using standard costing, activity-based costing, or job/process costing techniques depending on production type. Estimation considers expected production volumes, learning-curve effects (costs falling as cumulative output rises), economies of scale, and supplier price trends. Unlike R&D and design costs which are largely fixed/sunk once committed, production costs are more controllable in real-time through operational efficiency measures. Accurate estimation here supports pricing decisions, budgeting, and comparison against the target cost established during the design phase.

4. Marketing and Distribution Cost Estimation

These costs include advertising, sales promotion, channel/distributor margins, packaging, warehousing, and transportation costs incurred to bring the product to customers throughout its market life. Estimation requires forecasting sales volume over the product’s expected life, marketing intensity needed at each life cycle stage (heavy launch spend, sustaining spend during growth/maturity, reduced spend during decline), and logistics costs based on distribution network complexity. These costs vary significantly by product category and market reach (local versus global). Because marketing spend directly influences sales volume, which in turn affects unit cost recovery, this estimation must be closely integrated with sales forecasting and pricing strategy.

5. Customer Service and Warranty Cost Estimation

Post-sale costs include installation support, warranty repairs/replacements, call center support, spare parts inventory, and field service visits. Estimation relies on historical failure/defect rates, warranty claim patterns from similar products, and expected product usage intensity. These costs can be substantial for durable goods (automobiles, appliances, machinery) where failures may occur years after sale. Estimation techniques include setting warranty cost as a percentage of sales revenue based on past claims experience, or using reliability engineering data (mean time between failures) to project service costs across the product’s operational life. Underestimating this stage is a common cause of life cycle cost overruns.

6. Disposal/Decommissioning Cost Estimation

End-of-life costs include dismantling, recycling, environmental remediation, and disposal of the product or its components once it reaches obsolescence. Increasingly important due to environmental regulations (e.g., e-waste rules, extended producer responsibility laws), these costs are estimated based on the product’s material composition, regulatory disposal requirements, and expected volumes reaching end-of-life. For industrial equipment, decommissioning may also include site restoration costs. Though often small relative to other life cycle stages, disposal costs are growing in significance for electronics, batteries, and chemical products, and are increasingly factored into upfront pricing and design decisions (design-for-disassembly) to minimize future environmental liability.

7. Overall Estimation Approach — Cost Accumulation Across Stages

Total life cycle cost estimation requires accumulating all the above category estimates across the product’s entire expected life span, then relating this total to expected total revenue (or units sold) to determine life cycle profitability. Techniques used include discounted cash flow analysis (to account for time value of money across a multi-year life), sensitivity analysis (testing how changes in volume/price assumptions affect total cost), and scenario planning for different market conditions. This comprehensive estimate becomes the baseline for target costing decisions, investment approval (go/no-go), and pricing strategy, ensuring management commits to a product only if lifetime profitability, not just current-period costs, is favorable.

Life Cycle Costing for Cost Reduction and Profitability:

1. Cost Reduction at Design Stage

Life cycle costing helps reduce costs by identifying major cost elements during the product design stage. A large portion of a product’s total cost is committed before production begins. Management can examine materials, components, technology and product features and select economical alternatives. Value engineering can eliminate unnecessary features without reducing essential quality. By controlling costs at the design stage, the organisation can avoid expensive modifications later. This approach helps achieve lower total life cycle cost and improves the profitability of the product throughout its market life.

2. Reduction of Production Costs

Life cycle costing helps management analyse production costs throughout the product’s manufacturing period. Costs such as materials, labour, energy, machinery and overheads are monitored and compared with planned levels. Variations can be investigated and corrective action can be taken to reduce waste, improve labour productivity and increase resource utilisation. Continuous improvement techniques can also be applied to reduce manufacturing costs. Lower production costs increase the contribution earned from each unit and help the organisation maintain its desired profit margin despite competitive market conditions.

3. Control of Marketing and Distribution Costs

Marketing and distribution expenses can represent a significant part of total product life cycle cost. Life cycle costing helps management evaluate advertising, sales promotion, packaging, transportation, warehousing and distribution expenses. Alternative marketing channels and distribution methods can be compared based on their cost and expected benefits. Unnecessary promotional or distribution expenditure can then be reduced. Effective control of these costs ensures that the product reaches customers efficiently while maintaining an acceptable cost structure. This directly contributes to improved overall profitability.

4. Reduction of After Sales Costs

Life cycle costing considers costs incurred after the product is sold, including warranty, repairs, maintenance, installation and customer support. Management can identify products or components that create excessive service costs and improve their design or quality. Investing in better materials or components at the design stage may increase initial cost but reduce future warranty and maintenance expenses. Therefore, life cycle costing helps management consider the total economic impact of product decisions. Lower after sales costs can significantly improve the product’s overall profitability.

5. Improved Resource Utilisation

Life cycle costing helps organisations use resources efficiently throughout the product’s life. Materials, labour, machinery, energy and financial resources are analysed at different stages to identify inefficient utilisation. Management can compare alternative processes and technologies to select options that provide the required output at lower total cost. Efficient resource utilisation reduces waste and unnecessary expenditure. It also improves productivity and helps the organisation achieve greater output from available resources. Consequently, better resource utilisation contributes to both cost reduction and improved long term profitability.

6. Better Pricing Decisions

Life cycle costing provides information about the total cost of a product throughout its entire life. This information helps management determine whether the expected selling price is sufficient to cover all product related costs and provide the desired profit. Instead of considering only manufacturing cost, management also considers research, development, marketing, distribution, warranty and withdrawal costs. This provides a more realistic basis for pricing decisions. Appropriate pricing helps the organisation recover total life cycle costs and achieve the expected profit over the product’s market life.

7. Improved Product Profitability

Life cycle costing helps measure the total profitability of a product by comparing its total life cycle revenue with total life cycle costs. A product may generate high profits during production but involve significant research, marketing or after sales costs. Life cycle analysis identifies these costs and provides a complete picture of profitability. Management can compare different products and allocate resources towards those offering better long term returns. This supports product portfolio decisions and helps improve overall organisational profitability.

8. Supports Continuous Improvement

Life cycle costing encourages continuous improvement throughout the product’s life. Actual costs are regularly compared with planned costs to identify areas of inefficiency. Management can introduce improvements in product design, production methods, materials, distribution and customer service. Small improvements made continuously can result in significant cost savings over the entire product life cycle. Techniques such as Kaizen costing and value engineering support this process. Continuous improvement helps maintain competitiveness, control costs and protect profit margins as market conditions and customer expectations change.

9. Helps in Product Mix Decisions

Life cycle costing helps management compare the profitability of different products by considering their complete life cycle costs and revenues. Some products may have high initial development costs but generate substantial profits over a long market life, while others may require lower initial investment but provide limited returns. By analysing total life cycle profitability, management can identify products that provide better long term value. This information helps in decisions relating to product introduction, continuation, modification or withdrawal and supports efficient allocation of organisational resources.

10. Supports Long Term Profit Planning

Life cycle costing provides a long term view of costs and revenues, making it useful for strategic profit planning. Management can estimate the expected financial performance of a product from its introduction to its withdrawal. This helps identify future cost pressures, investment requirements and profitability risks. Cost reduction opportunities can be planned at each stage of the product life cycle. By considering the complete economic life of the product, management can make better decisions regarding pricing, design, production, marketing and customer service, thereby supporting sustainable profitability.

Practical Problems on Life Cycle Costing:

Problem 1: Calculation of Life Cycle Cost and Profit

A company plans to launch a new product. The estimated costs are: Research and Development ₹2,00,000, Design ₹1,00,000, Production ₹8,00,000, Marketing ₹1,50,000, Distribution ₹1,00,000 and After Sales Service ₹50,000. The product is expected to generate total revenue of ₹16,00,000 during its entire life cycle. Calculate the total life cycle cost and life cycle profit. The problem tests the basic application of life cycle costing by considering all major costs incurred from product development to customer service. Students should add all life cycle costs and deduct the resulting total from total expected revenue to determine the overall profitability of the product.

Problem 2: Life Cycle Cost Per Unit

A company expects to sell 20,000 units of a product during its life cycle. Estimated total costs are: Development ₹4,00,000, Production ₹12,00,000, Marketing ₹3,00,000, Distribution ₹1,00,000 and Customer Service ₹2,00,000. Calculate the total life cycle cost and life cycle cost per unit. The problem helps students understand how total product costs are spread over the expected lifetime sales volume. First, all costs should be added to determine total life cycle cost. The total cost should then be divided by expected units sold to calculate the average life cycle cost per unit.

Problem 3: Life Cycle Profit Per Unit

A company estimates that a product will sell 25,000 units at ₹200 per unit during its entire life cycle. Estimated costs are: Research and Development ₹5,00,000, Production ₹20,00,000, Marketing ₹4,00,000, Distribution ₹2,00,000 and After Sales Service ₹1,00,000. Calculate total revenue, total life cycle cost, total profit and profit per unit. This problem helps students understand how life cycle costing can be used to determine overall profitability. Students should first calculate total revenue by multiplying selling price by expected units. Total life cycle costs are then deducted from revenue to determine total profit.

Problem 4: Cost Reduction Through Life Cycle Costing

A company estimates the life cycle cost of a product at ₹50,00,000. Management wants to reduce the cost by 10% through better design, cheaper materials and improved production methods. Calculate the required cost reduction and revised target life cycle cost. The problem demonstrates how life cycle costing can support cost reduction throughout the product’s life. Students should calculate the required saving by applying 10% to the existing life cycle cost. The saving should then be deducted from the original cost to determine the revised target cost. This approach highlights the importance of controlling costs before and during production.

Problem 5: Comparison of Two Products

A company is considering two products, A and B. Product A has expected life cycle revenue of ₹60,00,000 and total life cycle cost of ₹45,00,000. Product B has expected revenue of ₹55,00,000 and total life cycle cost of ₹38,00,000. Calculate the life cycle profit and profit margin for both products and identify the more profitable product. This problem demonstrates the usefulness of life cycle costing in product selection. Students should calculate profit by deducting total life cycle cost from revenue. Profit margin can then be calculated as profit divided by revenue multiplied by 100.

Problem 6: Effect of After Sales Cost

A company expects to earn total revenue of ₹40,00,000 from a product. Production and other costs excluding after sales service amount to ₹27,00,000. Estimated warranty and after sales service costs are ₹3,00,000. Calculate total life cycle cost and life cycle profit. Also determine the profit if after sales costs were ignored. This problem shows why after sales costs must be included in life cycle costing. Ignoring such costs can result in an overstatement of product profitability. Students should compare profitability with and without after sales costs to understand their effect on the total economic performance of the product.

Problem 7: Target Life Cycle Cost

A company expects to sell 30,000 units of a product at ₹500 each. Management requires a total life cycle profit of ₹45,00,000. Calculate the target total life cycle cost and target cost per unit. This problem applies the basic target costing principle to life cycle costing. First, total expected revenue is calculated by multiplying selling price by expected units. The desired profit is then deducted from total revenue to determine the maximum allowable life cycle cost. Finally, the target total life cycle cost is divided by expected units to determine the target life cycle cost per unit.

Problem 8: Life Cycle Costing and Cost Gap

A company estimates the total life cycle cost of a product at ₹72,00,000, while management has set a target life cycle cost of ₹65,00,000. Calculate the cost gap and percentage reduction required to achieve the target. The problem helps students understand how life cycle costing identifies the amount of cost reduction needed. The cost gap is calculated by subtracting the target cost from the estimated cost. The required percentage reduction is calculated by dividing the cost gap by estimated life cycle cost and multiplying by 100. Management can then use value engineering and other cost reduction techniques to close the gap.

Management Notes

Customs Act Meaning

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An Act to consolidate and amend the law relating to customs.

Be it enacted by Parliament in the Thirteenth Year of the Republic of India as follows. 

Short Title Extent and Commencement:

(1) This Act may be called the Customs Act, 1962.

(2) It extends to the whole of India.

(3) It shall come into force on such date 2 as the Central Government may by notification in the Official Gazette, appoint.

Definitions.

In this Act, unless the context otherwise requires, (1) “adjudicating authority” means any authority competent to pass any order or decision under this Act, but does not include the Board Commissioner (Appeals) or Appellate Tribunal;

(1A) “aircraft” has the same meaning as in the Aircraft Act, 1934 (22 of 1934);

(1B) “Appellate Tribunal” means the Customs, Excise and Gold (Control) Appellate Tribunal constituted under section 129;

(2) “assessment” includes provisional assessment, reassessment and any order of assessment in which the duty assessed is nil;

(3) “baggage” includes unaccompanied baggage but does not include motor vehicles;

(4) “bill of entry” means a bill of entry referred to in section 46;

(5) “bill of export” means a bill of export referred to in section 50;

(6) “Board” means the Central Board of Excise and Customs constituted under the Central Boards of Revenue Act, 1963 (54 of 1963);

(7) “coastal goods” means goods, other than imported goods, transported in a vessel from one port in India to another;

(7A) “Commissioner (Appeals)” means a person appointed to be a Commissioner of Customs (Appeals) under sub-section (1) of section 4;

(8) “Commissioner of Customs”, except for the purposes of Chapter XV, includes an Additional Commissioner of Customs;

(9) “conveyance” includes a vessel, an aircraft and a vehicle;

(10) “customs airport” means any airport appointed under clause (a) of section 7 to be a customs airport;

(11) “customs area” means the area of a customs station and includes any area in which imported goods or export goods are ordinarily kept before clearance by Customs Authorities;

(12) “customs port” means any port appointed under clause (a) of section 7 to be a customs port and includes a place appointed under clause (aa ) of that section to be an inland container depot;

(13) “customs station” means any customs port, customs airport or land customs station;

(14) “dutiable goods” means any goods which are chargeable to duty and on which duty has not been paid;

(15) “duty” means a duty of customs leviable under this Act;

(16) “entry” in relation to goods means an entry made in a bill of entry shipping bill or bill of export and includes in the case of goods imported or to be exported by post, the entry referred to in section 82 or the entry made under the regulations made under section 84;

(17) “examination”, in relation to any goods, includes measurement and weighment thereof;

(18) “export”, with its grammatical variations and cognate expressions means taking out of India to a place outside India;

(19) “export goods” means any goods which are to be taken out of India to a place outside India;

(20) “exporter”, in relation to any goods at any time between their entry for export and the time when they are exported, includes any owner or any person holding himself out to be the exporter;

(21) “foreign-going vessel or aircraft” means any vessel or aircraft for the time being engaged in the carriage of goods or passengers between any port or airport in India and any port or airport outside India, whether touching any intermediate port or airport in India or not, and includes –

( i ) any naval vessel of a foreign Government taking part in any naval exercises;

(ii) any vessel engaged in fishing or any other operations outside the territorial waters of India;

(iii) any vessel or aircraft proceeding to a place outside India for any purpose whatsoever;

(21A) “Fund” means the Consumer Welfare Fund established under section 12C of the Central Excises and Salt Act, 1944 (1 of 1944);

(22) “goods” includes:

(a) vessels, aircrafts and vehicles;

(b) stores;

(c) baggage;

(d) currency and negotiable instruments; and

(e) any other kind of movable property;

(23) “import”, with its grammatical variations and cognate expressions, means bringing into India from a place outside India;

(24) “import manifest” or “import report” means the manifest or report required to be delivered under section 30;

(25) “imported goods” means any goods brought into India from a place outside India but does not include goods which have been cleared for home consumption;

(26) “importer”, in relation to any goods at any time between their importation and the time when they are cleared for home consumption, includes any owner or any person holding himself out to be the importer;

(27) “India” includes the territorial waters of India;

(28) “Indian customs waters” means the waters extending into the sea up to the limit of contiguous zone of India under section 5 of the Territorial Waters, Continental Shelf, Exclusive Economic Zone and Maritime Zones Act, 1976 (80 of 1976) and includes any bay, gulf, harbour, creek or tidal river;

(29) “land customs station” means any place appointed under clause(b) of section 7 to be a land customs station;

(30) “market price”, in relation to any goods, means the wholesale price of the goods in the ordinary course of trade in India;

(31) “person-in-charge” means, –

(a) in relation to a vessel, the master of the vessel;

(b) in relation to an aircraft, the commander or pilot-in-charge of the aircraft;

(c) in relation to a railway train, the conductor, guard or other person having the chief direction of the train;

(d) in relation to any other conveyance, the driver or other person-in-charge of the conveyance;

(32) “prescribed” means prescribed by regulations made under this Act;

(33) “prohibited goods” means any goods the import or export of which is subject to any prohibition under this Act or any other law for the time being in force but does not include any such goods in respect of which the conditions subject to which the goods are permitted to be imported or exported have been complied with;

(34) “proper officer”, in relation to any functions to be performed under this Act, means the officer of customs who is assigned those functions by the Board or the Commissioner of Customs;

(35) “regulations” means the regulations made by the Board under any provision of this Act;

(36) “rules” means the rules made by the Central Government under any provision of this Act;

(37) “shipping bill” means a shipping bill referred to in section 50;

(38) “stores” means goods for use in a vessel or aircraft and includes fuel and spare parts and other articles of equipment, whether or not for immediate fitting;

(39) “smuggling”, in relation to any goods, means any act or omission which will render such goods liable to confiscation under section 111 or section 113.

(40) “tariff value”, in relation to any goods, means the tariff value fixed in respect thereof under sub-section (2) of section 14;

(41) “value”, in relation to any goods, means the value thereof determined in accordance with the provisions of sub-section (1) of section 14;

(42) “vehicle” means conveyance of any kind used on land and includes a railway vehicle;

(43) “warehouse” means a public warehouse appointed under section 57 or a private warehouse licensed under section 58;

(44) “warehoused goods” means goods deposited in a warehouse;

(45) “warehousing station” means a place declared as a warehousing station under section 9.

Management Notes

Customs Value, Methods of Valuation for Customs

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Methods of Valuation:

According to the Customs Valuation Rules, 1988, the Customs Value should normally be the “Transaction Value”, i.e., the price actually paid or payable after adjustment by Valuation Factors (see below) and subject to (a) Compliance with the Valuation Conditions (see below) and (b) Customs authorities being satisfied with the truth and accuracy of the Declared Value.

Transaction Value:

Rule 3(i) of the Customs Valuation Rules, 1988 states that the value of imported goods shall be the transaction value. Rule 4(i) thereof states that the transaction value of imported goods shall be the price actually paid or payable for the goods when sold for export to India, adjusted in accordance with the provisions of Rule 9.

The price actually paid or payable is the total payment made or to be made by the buyer to the seller or for the benefit of the seller for the imported goods. It includes all payments made as a condition of sale of the imported goods by the buyer to the seller or by the buyer to a third party to satisfy an obligation of the seller.

If objective and quantifiable data do not exist with regard to the Valuation Factors, if the Valuation Conditions are not fulfilled, or if Customs authorities have doubts concerning the truth or accuracy of the declared value in terms of Rule 10A of the Customs Valuation Rules, valuation has to be carried out by another method in the following hierarchical order:

Comparative Value Method – Comparison with Transaction Value of Identical goods (Rule 5);

Comparative Value Method – Comparison with Transaction Value of Similar goods (Rule 6);

Deductive Value Method – Based on sale price in the importing country (Rule 7); Computed Value Method – Based on cost of materials, fabrication and profit in the country of production (Rule 7A);

Fallback Method – Based on previous methods with greater flexibility (Rule 8).

Valuation Factors:

Valuation Factors are the various elements which must be taken into account by addition (Dutiable factors) to the extent these are shown to be not already included in the price actually paid or payable or deduction (Non-dutiable factors) from the total price incurred in determining the Customs Value, for assessment purposes.

Dutiable Factors:

Commissions and brokerage, except buying commissions;

The cost of containers which are treated as being one for Customs purposes with the goods in question;

The cost of packing whether for labour or materials;

The value, apportioned as appropriate, of the following goods and services where supplied directly or indirectly by the buyer free of charge or at reduced cost for use in connection with the production and sale for export of the imported goods, to the extent that such value has not been included in the price actually paid or payable:

  • Material, components, parts and similar items incorporated in the imported goods;
  • Tools, dies, moulds and similar items used in the production of the imported goods;
  • Materials consumed in the imported goods;
  • Engineering, developing, artwork, design work, and plans and sketches undertaken elsewhere than in the importing country and necessary for the production of imported goods;
  • Royalties and license fees related to goods being valued that the buyer must pay either directly or indirectly, as a condition of sale of the goods being valued, to the extent that such royalties and fees are not included in the price actually paid or payable;
  • The value of any part of the proceeds of any subsequent resale, disposal or use of the goods that accrues directly or indirectly to the seller;
  • Advance payments;
  • Freight charges up to the place of importation;
  • Loading, unloading and handling charges associated with transporting the goods;
  • Insurance.

Non-dutiable Factors:

  • The following charges provided they are separately declared in the commercial invoice:
  • Interest charges for deferred payment;
  • Post-importation charges (e.g. inland transportation charges, installation or erection charges, etc.);
  • Duties and taxes payable in the importing country.

Cases where transaction value may be rejected:

The transaction value may not be accepted for customs valuation in the following categories of cases as provided in Rule 4(2):

If there are restrictions on use or disposition of the goods by the buyer. However, the transaction value not to be rejected on this ground if restrictions:

  • Are imposed by law or public authorities in India;
  • Limit geographical area of resale;
  • Do not affect the value of the goods substantially.

If the sale or price is subject to a Condition or consideration for which a Value cannot be determined. However, conditions or considerations relating to production or marketing of the goods shall not result in rejection.

If part of the proceeds of the subsequent resale, disposal or use of the goods accrues to the seller, unless an adjustment can be made as per valuation factors.

Buyer and seller are related; unless it is established by the importer that:

  • The relationship has not influenced the price;
  • The importer demonstrates that the price closely approximates one of the test values.

The transaction price declared can also be rejected in terms of Rule 10A, when the proper customs officer has reasons to doubt the truth or accuracy of the value declared & if even after furnishing of further information/documents or other evidence produced, proper officer is not satisfied & has reasonable doubts about the value declared.

Management Notes

Types of Custom Duties

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Basic Customs Duty

Basic custom duty is the duty imposed on the value of the goods at a specific rate. The duty is fixed at a specified rate of ad-valorem basis. This duty has been imposed from 1962 and was amended from time to time and today is regulated by the Customs Tariff Act of 1975. The Central Government has the right to exempt any goods from the tax.

Countervailing Duty (CVD)

This duty is imposed by the Central Government when a country is paying the subsidy to the exporters who are exporting goods to India. This amount of duty is equivalent to the subsidy paid by them. This duty is applicable under Sec 9 of the Customs Tariff Act.

Additional Customs Duty or Special CVD

To equalize imports with locals’ taxes like service tax, VAT and other domestic taxes which are imposed from time to time, a special countervailing duty is imposed on imported goods. Hence, is imposed to bring imports on an equal track with the goods produced or manufactured in India. This is to promote fair trade & competition practices in our country.

Safeguard Duty

To make sure that no harm is caused to the domestic industries of India, a safeguard duty is imposed to safeguard the interest of our local domestic industries. It is calculated on the basis of loss suffered by our local industries.

Anti-Dumping Duty

Often, large manufacturer from abroad may export goods at very low prices compared to prices in the domestic market. Such dumping may be with intention to cripple domestic industry or to dispose of their excess stock. This is called ‘dumping’. To avoid such dumping, Central Government can impose, under section 9A of Customs Tariff Act, anti-dumping duty up to margin of dumping on such articles, if the goods are being sold at less than its normal value. Levy of such anti-dumping duty is permissible as per WTO agreement. Anti-dumping action can be taken only when there is an Indian industry producing ‘like articles.

National Calamity Contingent Duty

This duty is imposed by Sec 129 of the Finance Act. The duty is levied on goods like tobacco, pan masala or any items that are harmful for health. The rate of the tax varies from 10% to 45% and different rates are applied for different reasons.

Education Cess on Customs Duty

At the prescribed rate is levied as a percentage of aggregate duties of customs. If goods are fully exempted from duty or are chargeable to nil duty or are cleared without payment of duty under prescribed procedure such as clearance under bond, no cess would be levied.

Protective Duties

Tariff Commission has been established under Tariff Commission Act, 1951. If the Tariff Commission recommends and Central Government is satisfied that immediate action is necessary to protect interests of Indian industry, protective customs duty at the rate recommended may be imposed under section 6 of Customs Tariff Act. The protective duty will be valid till the date prescribed in the notification.

Calculating Custom Duty

Custom duty can be calculated on either a specific or an ad valorem basis. The value of goods, for the latter, is determined by Rule 3(i) of the Customs Valuation Rules, 2007. If there is no quantifiable data w.r.t. valuation factors, then the valuation of the items is done using other means based on a system of hierarchy, as follows:

  • Comparative Value Method: This method compares transaction values of items similar in nature (Rule 4)
  • Comparative Value Method: This method compares transaction values of items similar in nature (Rule 5)
  • Deductive Value Method: This method uses the sale price of items in the importing country (Rule 7)
  • Comparative Value Method: This method uses costs related the fabrication, materials as well as profit in the production country (Rule 8)
  • Fallback Method: This method is based on the earlier methods that offer higher flexibility (Rule 9)

Custom Duty Rates

These rates can either be specific or ad valorem. The duty, in general, varies from the range 0-150%. The average rate, however, is 11.90%. There is a list to refer to for goods that are exempted from this duty.

There are other types of fee that are applicable to custom duty. Thy include:

  • LC: Landing charge – 1% CIF
  • CVD: Countervailing Duty – 0%, 6% or 12% (CIFD + LC)
  • CEX: Education and Higher Education Cess – 3% CVD
  • CESS: Education + Higher Education – 3% (Duty + CEX (Education and Higher Education Cess) + CVD)
  • Additional CVD: 4% (CIFD + LC + CVD + CESS + CEX)
Management Notes

Valuation for Customs Duty, Tariff Value

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Customs valuation is the process where customs authorities assign a monetary value to a good or service for the purposes of import or export. Generally, authorities engage in this process as a means of protecting tariff concessions, collecting revenue for the governing authority, implementing trade policy, and protecting public health and safety. Customs duties, and the need for customs valuation, have existed for thousands of years among different cultures, with evidence of their use in the Roman Empire, the Han Dynasty, and the Indian sub-continent. The first recorded customs tariff was from 136 in Palmyra, an oasis city in the Syrian desert. Beginning near the end of the 20th century, the procedures used throughout most of the world for customs valuation were codified in the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade (GATT) 1994.

Transaction value

The primary basis for customs valuation under the Agreement is “transaction value” as defined in Article 1. Article 1 defines transaction value as “the price actually paid or payable for the goods when sold for export to the country of importation.” Article 1 must be read together with Article 8, which lets Customs authorities make adjustments to the transaction value in cases where certain specific parts of the good – considered to be a part of the value for customs purposes – are incurred by the buyer but are not actually included in the price paid or payable for the imported goods. Article 8 also allows for the inclusion in transaction value of exchanges (“considerations”) between the buyer and seller in forms other than money. Articles 2 through 7 provide methods of determining the customs value whenever it cannot be determined under the provisions of Article 1.

The methods of customs valuation, in descending order of precedence, are:

  • Transaction Value of Merchandise in Question – price actually paid or payable for the goods sold. (Art. 1)
  • Transaction Value of Identical Merchandise (Art. 2)
  • Transaction Value of Similar Merchandise (Art. 3)
  • Deductive Value (Art. 5)
  • Computed Value (Art. 6)
  • Derivative Method (Art. 7)

This hierarchy is codified in domestic legislation.

The rates of customs duties leviable on imported goods (& export items in certain cases) are either specific or on ad valorem basis or at times specific cum ad valorem. When customs duties are levied at ad valorem rates, i.e., depending upon its value, it becomes essential to lay down in the law itself the broad guidelines for such valuation to avoid arbitrariness and to ensure that there is uniformity in approach at different Customs formations. Section 14 of the Customs Act, 1962 lays down the basis for valuation of import & export goods in the country. It has been subject to certain changes basic last change being in July-August, 1988 when present version came into operation. Briefly the provisions are explained in the following paragraphs.

Tariff Value:

The Central Government has been empowered to fix values, under sub-section (2) of Section 14 of the Customs Act, 1962 for any product which are called Tariff Values. If tariff values are fixed for any goods, ad valorem duties are to be calculated with reference to such tariff values. The tariff values may be fixed for any class of imported or export goods having regard to the trend of value of such or like goods and the same has to be notified in the official gazette. Recently tariff values have been fixed in respect of import of Crude Palm Oil, RBD Palm Oil, RBD Palmolein under Notification No.36/2001-CUS (N.T.), dated 3.8.2001 and for RBD Crude Palmolein under Notification No. 40/2001-CUS (N.T.) dated 28.08.2001.

Valuation of Imported/Export Goods where no Tariff Values fixed:

Section 2(41) of the Customs Act, 1962 defines ‘Value’ in relation to any goods to mean the value thereof determined in accordance with the provisions of sub-section (1) of Section 14 thereof.

Sub-section (1) of Section 14 in turn states that when a duty of customs is chargeable on any goods by reference to their value, the value of such goods shall be deemed to be: “the price at which such or like goods are ordinarily sold, or offered for sale, for delivery at the time and place of importation or exportation, as the case may be, in the course of international trade, where the seller and the buyer have no interest in the business of each other and the price is the sole consideration for the sale or offer for sale”.

As far as export goods are concerned, provisions of sub-section (1) of Section 14 provide a complete code of valuation by itself. On the other hand, for imported goods, as per sub-section (1A) of Section 14, the value is required to be determined in accordance with rules made in this behalf. Accordingly, the Customs Valuation (Determination of Price of Imported Goods) Rules, 1988 have been framed and notified under Notification No.51/88-CUS (N.T.) dated 18.7.1988.

The provisions of sub-section (1) of Section 14 follow the provisions contained in Article VII of GATT. The Customs Valuation Rules closely follow the WTO Customs Valuation Agreement to implement Article VII of GATT. The methods of valuation prescribed therein are of a hierarchical order. The importer is required to truthfully declare the value in the B/E and provide a copy of the invoice and file a valuation declaration in the prescribed form to facilitate correct and expeditious determination of value for assessment purposes.

Management Notes

Levy and Collection of duties not covered under GST

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There are certain activities which are items not covered under GST. They are beyond the scope of GST, i.e., GST will not apply on them. These are classified under Schedule III of the GST Act as “Neither goods nor services”.

1.Services by an employee to the employer in relation to his employment

Related parties include employer-employee which raised many concerns whether employment now attracted GST.  This clarification has been brought in to clarify whether GST is not applicable on employment. An employee will still pay income tax on salary earned .

  1. Court/Tribunal Services including District Court, High Court and Supreme Court

Courts will not charge GST to pass judgement.

  1. Duties performed by:

  • The Members of Parliament, State Legislature, Panchayats, Municipalities and other local authorities
  • Any person who holds a post under the provisions of the Constitution
  • Chairperson/Member/Director in a body established by the government or a local body and who is not an employee of the same

  1. Services of a funeral, burial, crematorium or mortuary including transportation of the deceased

There are no taxes on funeral services for any religion.

  1. Sale of land and sale of building

Construction of a new building is subject to GST (being works contract).

  1. Actionable claims (other than lottery, betting and gambling)

Actionable Claims’ means claims which can be enforced only by a legal action or a suit, example a book debt, bill of exchange, promissory note. A book debt (debtor) is not goods because it can be transferred as per Transfer of Property Act but cannot be sold. Bill of exchange, promissory note can be transferred under Negotiable Instruments Act by delivery or endorsement but cannot be sold. 

Actionable claims are neither products nor services. They can be considered as something in lieu of money. So GST will not apply on these.

Lottery, betting, and gambling attract 28% GST.

  1. Supply of goods from a place in the non-taxable territory to another place in the non-taxable territory without such goods entering into India*.
  2. Supply in Customs port before Home consumption*:
    (a) Supply of warehoused goods to any person before clearance for home consumption;
    (b) Supply of goods by the consignee to any other person, by an endorsement of documents of title to the goods, after the goods have been dispatched from the port of origin located outside India but before clearance for home consumption.

  3. Petroleum Product, Alcohol

One of the biggest burdens for home buyers is that they will have to bear both GST and Stamp Duty. This is because Stamp Duty was not subsumed under the GST. As a result, they are paying both the taxes which is a burden.

Since GST does not cover road tax, Vehicle Tax was not subsumed under GST. So, vehicle buyers still need to pay road tax as per the Motor Vehicle Act.

In order to bring alcohol under the purview of GST, a constitutional amendment is needed. Hence, Excise on Liquor was not covered under GST.

The Tax on sale and consumption of Electricity is not covered by GST. So, states still charge VAT and centre charges Central Excise on electricity bills.

Toll Tax, environment tax and all other taxes that are directly paid by the users are still levied by the states as they do not come under GST.

Entertainment tax collected by the Local Bodies is not covered under GST. As a result, users will have to pay extra tax in addition to GST which leads to an increase in the price of things like movie tickets.

All the above taxes are a burden on the users or consumers, hence they want the government to levy a single tax to avoid double taxation.

Management Notes

Sales Tax / Central Sales Tax Meaning and Definition, Features

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A sales tax is a tax paid to a governing body for the sales of certain goods and services. Usually laws allow the seller to collect funds for the tax from the consumer at the point of purchase. When a tax on goods or services is paid to a governing body directly by a consumer, it is usually called a use tax. Often laws provide for the exemption of certain goods or services from sales and use tax. A value-added tax (VAT) collected on goods and services is like a sales tax.

The indirect tax imposed on selling and purchasing of goods within India is referred to as Sales Tax. It is an additional amount paid over and above the base value of the product being purchased. This tax, usually imposed on the seller by the government, enables the seller to recover the tax from the purchaser. It is usually charged from buyers at the point of purchase or the exchange of some specific goods and is chargeable at a certain percentage of the product value.

Sales Tax is levied by the Central Government as well as State Governments. It is decided by the Central Government basis its tax policies. State Sales Tax laws vary between states.

Central Sales Tax

The following are some of the key features of the Central Sales Tax Act.

  • Lays down principles regarding the time of sale and purchase of goods
  • Enlists goods that have special importance for trade and commerce
  • Lays down regulations regarding charging, collection and distribution of taxes generated from interstate trade
  • Holds the final authority for settling interstate trade disputes

State Government Taxes

State Governments in India have the power to decide on Sales Tax policies as per their unique financial requirements. This explains the reason as to why sales taxes vary from state to state. States classify businesses dealing in the sale of goods under three heads – manufacturers, dealers and sellers. Each of them require certificates to operate legally.

Exemptions from Sales Tax

The following categories are exempted from State Sales Tax and are offered to overcome double taxation, or on humanitarian grounds.

  • Certain specific goods as per the list of goods that have been exempted by the state government
  • Products from sellers with valid state resale certificates
  • Products sold for the purpose of charities or educational institutions like schools

Sales Tax Calculation

Sales Tax rate applicable on a particular product can be calculated through a simple formula:

Total Sales Tax = Cost of item x Sales tax rate

While the formula is a simple one, sellers and manufactures need to consider the following while calculating Sales Tax on their goods:

  • It is calculated as a percentage
  • Be updated on the Sales Tax rate of the state and city that the manufacturer or seller belongs to, as it varies from state to state

Types of Sales Tax

Though countries across geographies have their unique Sales Tax policies, there are certain standard types of sales taxes that are applicable to most countries. They are:

Wholesale Sales Tax: Tax levied on individuals dealing with wholesale distribution of goods is referred to as Wholesale Sales Tax.

Manufacturers’ Sales Tax: Tax charged on manufacturers of some specific goods is known as Manufacturers’ Sales Tax.

Retail Sales Tax: Tax levied on sale of retail goods and directly payable by the final consumer is called Retail Sales Tax.

Use Tax: This is a tax levied on the consumer for goods bought without paying sales tax. This usually holds true when goods are bought from vendors who are not a part of the tax jurisdiction.

Value Added Tax: An additional tax levied by some central governments on all purchases is called the Value Added Tax.

Management Notes

Tax Administration

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Composition of Central Board of Direct Taxes

The Central Board of Direct Taxes is the administrative authority for levying and collection of sale taxes in India. It is a part of the Department of Revenue that is integral to the Ministry of Finance, and functions as per the Central Board Revenue Act, 1963.

The Central Board of Direct Taxes is composed of members who are assigned responsibilities across different departments like Income Tax, Revenue, Investigation, Legislation and Computerisation, Personnel and Vigilance, and Audit. The governing body is headed by the Chairman.

The Central Board of Direct Taxes is responsible for the following:

  • Formulate policies related to direct taxes.
  • Oversee administration of direct tax laws along with the Income Tax Department.
  • Investigates complaints and disputes related to evasion of taxes.

According to the federal structure of Goods and Services Tax in India, the taxation system has been divided into two parts Central GST (CGST) and State GST (SGST). In this case Centre and States will simultaneously levy Goods and Services Tax across the value chain. The Goods and Services Tax will be levied on every supply of goods and services. Centre would levy and collect Central Goods and Services Tax (CGST), and States would levy and collect the State Goods and Services Tax (SGST) on all transactions within a State.

This topic concentrates on defining the concepts of GSTN. GSTN Act Commencement, Powers of Officer, Tax exemption and Levy, Time value of money and Input tax credit. Let us now start defining the concept of GSTN.

GSTN abbreviated as Goods and Services Tax Network, is a not-for-profit, non-Government Company to provide shared IT infrastructure and services to Central and State Governments, tax payers and other stakeholders. The key objectives of GSTN are to provide a standard and uniform interface to the taxpayers, and shared infrastructure and services to Central and State/UT governments. Goods and Services Tax Network (GSTN) is a Section 8 (under new companies Act, not for profit companies are governed under section 8), non-Government, private limited company. It was incorporated on March 28, 2013.

GST Act Commencement

The Goods and Services Tax Act Commencement covers Section 1 – Short title, extent and commencement

  • This Act may be called the Central / State Goods and Services Tax Act, 2016.
  • It extends to the whole of India / State’s name.
  • It shall come into force on such date as the Central or a State Government may, by notification in the Official Gazette, appoint in this behalf:

Only if different dates may be appointed for different provisions of this Act and any reference in any such provision to the commencement of this Act shall be construed as a reference to the coming into force of that provision.

Management Notes

Taxable value of Goods and Services not covered under GST

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GST exemptions for goods

There is a list of goods which do not attract GST as recommended by the GST Council. The reasons for granting exemption on goods might include any of the following:

  • In the interest of the public
  • The exemption is as per the GST Council’s recommendation
  • The exemption is granted by the Government through a special order
  • The exemption is allowed on specific goods through an official notification

Moreover, there are two types of GST exemptions on goods. These are as follows:

  • Absolute exemption: Under this type of exemption, the supply of specific types of goods would be exempted from GST without considering the details of the supplier or receiver and whether the good is supplied within or outside the State.
  • Conditional exemption: Under this type of exemption, supply of specific types of goods would be GST exempt subject to certain terms and conditions which have been specified under the GST Act or any amendment or notification.

Here is a list of some of the most common goods which are GST exempt:

Types of goods Examples
Live animals Asses, cows, sheep, goat, poultry, etc.
Meat  Fresh and frozen meat of sheep, cows, goats, pigs, horses, etc.
Fish  Fresh or frozen fish
Natural products Honey, fresh and pasteurized milk, cheese, eggs, etc.
Live trees and plants Bulbs, roots, flowers, foliage, etc.
Vegetables  Tomatoes, potatoes, onions, etc.
Fruits Bananas, grapes, apples, etc.
Dry fruits Cashew nuts, walnuts, etc.
Tea, coffee and spices Coffee beans, tea leaves, turmeric, ginger, etc.
Grains  Wheat, rice, oats, barley, etc.
Products of the milling industry  Flours of different types
Seeds  Flower seeds, oil seeds, cereal husks, etc.
Sugar  Sugar, jaggery, etc.
Water  Mineral water, tender coconut water, etc.
Baked goods Bread, pizza base, puffed rice, etc.
Fossil fuels Electrical energy
Drugs and pharmaceuticals Human blood, contraceptives, etc.
Fertilizers  Goods and organic manure
Beauty products Bindi, kajal, kumkum, etc.
Waste  Sewage sludge, municipal waste, etc.
Ornaments Plastic and glass bangles bangles, etc.
Newsprint  Judicial stamp paper, envelopes, rupee notes, etc.
Printed items Printed books, newspapers, maps, etc.
Fabrics  Raw silk, silkworm cocoon, khadi, etc.
Hand tools Spade, hammer, etc.
Pottery  Earthen pots, clay lamps, etc.

GST Exemption on services

Just like specific goods, specific services are also GST exempt. There are three types of supply of services which would qualify for GST exemption. These include the following:

  • Supplies which have a 0% tax rate
  • Supplies which do not attract CGST or IGST due to the provisions stated in a notification which amends either Section 11 of CGST Act or Section 6 of IGST Act
  • Supplies which are defined under Section 2(78) of the GST Act which are not taxable.

Since these types of supplies are GST exempt, any Input Tax Credit which is applicable on these supplies would not be available to utilise or set off the GST liability.

Moreover, even under supply of services, there can be two types of GST exemptions which are as follows –

  • Absolute exemption wherein the service would be exempted from GST without any conditions
  • Conditional exemption or partial exemption wherein exemption is granted based on a condition. This condition states that if the service is supplied intra-State or if the service is supplied by a registered person to an unregistered one, GST would be exempted if the total value of such supplies received by a registered person is not more than INR 5000/day.

Here is a list of some of the services which enjoy GST exemption:

Types of services  Examples 
Agricultural services Cultivation, supplying farm labour, harvesting, warehouse related activities, renting or leading agricultural machinery, services provided by a commission agent or the Agricultural Produce Marketing Committee or Board for buying or selling agriculture produce, etc.
Government services Postal service, transportation of people or goods, services by a foreign diplomat in India, services offered by the Reserve Bank of India, services offered to diplomats, etc.
Transportation services  Transportation of goods by road, rail, water, etc., payment of toll, transportation of passengers by air, transportation of goods where the cost of transport is less than INR 1500, etc.
Judicial services Services offered by arbitral tribunal, partnership firm of advocates, senior advocates to an individual or business entity whose aggregate turnover is up to INR 40 lakhs
Educational services Transportation of faculty or students, mid-day meal scheme, examination services, services offered by IIMs, etc.
Medical services  Services offered by ambulance, charities, veterinary doctors, medical professionals, etc. 
Organizational services  Services offered by exhibition organisers for international business exhibitions, tour operators for foreign tourists, etc.
Other services  Services offered by GSTN to the Central or State Government or Union Territories, admission fee payable to theatres, circuses, sports events, etc. which charge a fee up to INR 250

Though GST is applicable for all businesses and on the supply of goods and services, the above-mentioned exemptions are available. These exemptions reduce the GST burden and help in the socio-economic development of the country.

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