Value Added Statements – A way to Show Value added by organisation apart from Financials

Value Added statement isn’t an Account in the traditional sense. It is mere a statement showing the economic output of the reporting entity. It is different from the traditional Profit and Loss Account. In traditional Profit and Loss account, reporting is for net income figures. This is very often different from the economic output generated by the enterprise. The Economic output or the value added (VA) is the total output generated by the enterprise. Such VA is on account of the collective effort of capital, management and employees.

In economic terms, VA is the market price of the output less the price of goods and services bought-in. Gross Value Added (GVA) or Net Value Added (NVA) are two variants of Value Added Statement. Reporting enterprises use it to disclose their economic output for the reporting period.

Gross Value Added (GVA)

It is arrived at by deducting the cost of all materials and services brought in from the sales revenue. The Gross Value Added (GVA) statement can be shown in form of a statement as given below –

Gross Value Added of a Manufacturing Company

Applied as follows –

A reconciliation statement is also prepared. It reconciles GVA with Profit as reported on traditional Profit and Loss statement. Such reconciliation statement can be prepared in format as given below –

Reconciliation between Gross Value Added and Profit Before Taxation

Benefits of reporting GVA over NVA

The reasons for reporting GVA over NVA can be summarised as below –

• GVA can be derived more objectively than NVA. It is because depreciation is prone to subjective judgement. Unlike a bought-in cost, its calculation involves subjective estimations.
• GVA format involves reporting depreciation along with the retained profit for the year. The resultant sub-total shows the Value Addition including the portion available for re-investment.
• The practice of reporting GVA reflects closer correspondence between VA and national income figures. It is because economists prefer gross measures of national income over net figures.

Net Value Added (NVA)

In simple term, NVA can be defined as GVA less depreciation. In the form of a statement, it can be presented as –

Net Value Added of a Manufacturing Company

Applied as follows –

A reconciliation statement is also prepared. It reconciles NVA with Profit as reported on traditional Profit and Loss statement. Such reconciliation statement can be prepared in format as given below –

Reconciliation between Net Value Added and Profit Before Taxation

Benefits of reporting NVA over GVA

Although, many prefer to report GVA, reporting NVA also as valid reasons. Few of those reasons are –

• Value addition or wealth creation is also due to using of fixed assets. There is a loss in value or wearing out of fixed assets as new assets are created by use of it. It is necessary to provide for allowance to account wearing out or loss of value of these fixed assets. If this is not done, the wealth creation or Value Addition will be overstated.
• NVA is more firm base for calculating productivity bonus than GVA. Productivity is depended on new investments in fixed assets and modernisation of equipment. So, the value-added component improves from it. And it is natural for the company to claim a share of this extra VA. As depreciation is recognised in calculating NVA, it is in company’s interest. Thus, NVA is more firm base for calculating productivity bonuses.
• The concept of matching demands that depreciation is deducted along with bought-in costs. If GVA is used, then it would be inconsistent. This is because all bought-in costs would be charged only for the items that have a life of less than 1 year. For the assets having a life of more than 1 year, their costs would be ignored. Instead, it would be treated as a depreciable fixed asset. These Costs would never appear as a charge while arriving at GVA. On contrary, while calculating NVA, depreciation is charged along with all bought-in costs. Hence, NVA solves this issue by recognising depreciation as an element of cost.

Limitation of VA

VA Statement shows the application of VA to several interest groups. But, the risk associated with the company is borne only by the shareholders. Employees, government and outside financiers are interested only in their share in VA. But, at the time of trouble, the whole risk is of shareholders. So, academicians question the concept of showing VA applied to several interested groups. They advocate showing the net VA as accruing to shareholders. This Net VA is residual profit after meeting obligations of outside interest groups. However, academics also admit that VA statement can be shown as a supplementary statement. But, in no case VA statement can substitute the traditional income statement. It should only supplement the traditional statement of financial information.

Another contemporary criticism of VA Statement is that such statements are non-standardised. One such non-standardisation is due to inclusion/exclusion of depreciation in calculating VA. Another major area of non-standardisation in current VA practice is taxation. Some Companies report only tax on profits under the heading of “VA applied to governments”. Others report an extensive range of taxes and duties under the same heading. One such different treatment is for GST (earlier Excise/VAT). Some deduct it as bought-in cost. And Some academics argue it should be shown as an application of VA. However, this criticism is a temporary phenomenon. With proper framework and reporting from more companies, standardisation can be achieved.

Interpretation of VA

Absolute Value of net VA and its proportion to gross output are very important. But, factor components of VA reveal more information. It is generally found that VA is highest for service Companies. Likewise, it is lowest for trading business. This phenomenon can be explained with an example. Let’s consider a hypothetical situation. There are three companies X, Y and Z. Each sells the finished product for ₹500. Company X buys raw material for ₹100. It performs three operations – grinding, processing and packaging. Thereafter it sells the finished product for ₹500. Company Y buys a semi-finished product from the market for ₹300. It performs minor operations and sells the finished product for ₹500. Company Z buys the finished product from another company for ₹450 and sells it for ₹500.

Thus, even though turnover of all three companies is equal, their VA is different. As a percentage of gross output, Company X’s VA is 80%. Likewise, for Y & Z, it is 40% and 10%. At this point, it looks as if company X has the highest Value addition. Now suppose Company X uses 90% of its VA for meeting out wage bill, the position will be entirely different. So, considering the ratio of net value added to gross output does not yield a complete picture. If company’s VA comes from the unproductive labour force, there will be little for future investments. Hence, one should not focus merely on net VA to gross output. One should also consider the contribution of various factor costs to the net VA.