IV Semester M.Com

1. INVENTORIES
Ind AS - 2
Mr. Sathish V
Assistant Professor
PES Institute of Advanced Management Studies
NH-206, Sagar Road Shivamogga

3. IAS / IND AS 2 - INVENTORIES
Sources
1. IAS – 2: Inventories
2. Ind AS – 2: Inventories
MEANING OF INVENTORIES
As known, Inventories represent an assets. ( Resource controlled by the
entity due to its past action which generates future economic benefit and it
either tangible or intangible)
1. Held for sale in the ordinary course of business such as finished goods,
2. Inventories in the process of production for sale which are normally in
the form of raw materials and work-in-progress,
3. Inventories in the form of materials or supplies to be consumed in the
production process or in the rendering of services, etc
4. Inventories encompass goods purchased and held for resale including
merchandise purchased by a retailer and held for resale, or land and
other property held for resale.
E.g. : Stock in trade, stock of finished goods, stock of WIP, stock of RM,
maintenance supply spares.

4. OBJECTIVES OF THE STANDARD
ACCOUNTING TREATMENT OF
INVENTORIES
Determination of cost at which
inventory is recognised ( when initially buy
the inventory)
Value at which it should be carried
forward till revenue is recognised (before
bal sheet if its not consumed/sold – subsequent
measurement)
Treatment when related revenue is
recognised (When you acquire you recognize
it, when you sold/dispose you need to
derecognize and related expenditure)
Cost formulas used to assign costs to
inventory (On bal sheet date if you have
unsold inventory- Cost/NRV – which cost
mtd needs to use)
Write down to its NRV and reversals
(When NRV is less than carrying value)

5. SCOPE OF THE STANDARD
This Standard applies to all inventories, Except:
 Financial instruments (Ind AS 32, Financial Instruments)
 Biological assets (i.e. living animals or plants) related to agricultural activity and
agricultural produce at the point of harvest (Ind AS 41, Agriculture)
 Producers of agricultural and forest products, agricultural produce after harvest, and
minerals and mineral products, to the extent that they are measured at net realizable
value in accordance with well-established practices in those industries.
 Commodity broker-traders who measure their inventories at fair value less costs to
sell. When such inventories are measured at fair value less costs to sell, changes in
fair value less costs to sell are recognised in profit or loss in the period of the
change.
 Produce from mining activity to the extent their produce is measured at NRV.

6. Cost, Net Realizable Value and Fair Value
1. Net realizable value is the estimated selling price in the ordinary
course of business less the estimated costs of completion and the
estimated costs necessary to make the sale.
2. Fair value is the amount for which the inventories could be
exchanged, or a liability settled, between knowledgeable and willing
buyers and sellers in an arm’s length transaction.
3. Cost of inventories comprises of all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to
their present location and condition.
4. Basic Measurement Principle is, inventories should be measured at
the lower of cost and net realizable value.

7. Cost of Inventories (contd)
However, the following items do not constitute parts of cost of
inventories.
1. Abnormal amount of wasted materials, labour or other
production costs,
2. Storage costs (unless those costs are necessary in the
production process before a further production stage),
3. Administrative overheads that do not contribute to
bringing inventories to their present location and condition,
and
4. Selling costs.

8. Cost of inventory
Cost of Purchase – Purchase price
Import duties if any
Transportation cost
Handling cost
Cost of Conversion - Direct Labor
Variable Production OVHs
Fixed production OVHs
Other costs if any

9. I. Cost of Purchase
1. Normally, cost of purchase of inventories is computed based on cost
formula – FIFO or Weighted Average Cost Formula.
2. The cost of inventories of items that are not ordinarily inter-
changeable and goods or services produced and segregated for
specific projects should be assigned by using specific identification
of their individual costs.
3. A manufacturing entity can also use Standard Cost Method
(Practice of substituting an expected cost for an actual cost and variance are
recorded to show difference)
4. Normally, in retail trade, a trader deals in numerous items. It
becomes cumbersome to use FIFO or WAC for the determination of
cost of each and every item. Under Retail Method (Para 22, IAS –
2), gross profit is deducted from the selling price to determine the
cost of inventories.

10. II. Costs of Conversion
1. This is applicable to only the manufacturing firms.
2. These costs include direct labour cost, other direct
expenses (like, production royalty) and the factory
overheads – both variable and fixed.
3. Variable production overheads such as indirect labour cost
and indirect material costs which vary with the levels of
activity are charged based on actual expense to production.
4. Fixed overheads such as depreciation and maintenance of
factory buildings and equipment are charged to production
based on normal capacity – unabsorbed fixed overhead is
expensed in the year the expense is incurred.

11. III. Other Costs
1. Other Costs included in the cost of inventories are those
costs which are incurred in bringing the inventories to their
present location and condition.
2. However, Interest and other borrowing costs are usually
considered as not relating to bringing the inventories to
their present location and condition and are, therefore,
usually not included in the cost of inventories.

12. Costing Main and By-products
1. A production process may result in more than one product
being produced simultaneously. This is the case, for
example, when joint products are produced or when there
is a main product and a by-product.
2. Value of by-product is normally trivial or immaterial and
may be deducted from the total cost. The net cost is then
allocated among the main products using sales value ratio
at the point of separation or completion of production.
3. If there is no market for the products derived at the point
of separation, back flush approach is adopted to
determine their respective fair value.( Delays the recording of
cost until the event have taken place , than standard costs are used to work
backward to flush out the manufacturing costs)

13. Net Realizable Value
1. Net realizable value is the estimated selling price in the ordinary
course of business less the estimated costs of completion and the
estimated costs necessary to make the sale.
2. Estimates of realizable value are based on the most reliable
evidence available at the time the estimates are made.
3. While computing net realizable value, an entity has to consider the
purpose for which the inventory is held - Often an entity holds
inventory with firm sales contract. In such a case, net realizable
value of inventories should be the contract price.
NRV = ESP - ECC – ECMS
ECC – only for semi finished goods
What we are going to get the amount when we sell the inventory in
ordinary course of business by deducting cost incur for sale. That net
amount called as NRV.

14. Circumstances when Inventories are written down to
Net Realizable Value
In the following circumstances, net realizable value of
inventories is lower than their costs.
1. Damaged inventories
2. Inventories which are wholly or partially obsolete
or
3. When selling price of inventories is declined below
cost
In this types of circumstances, inventories are valued
at net realizable value.

15. Reversal of Write Down and Recognition of Expense
1. When inventories are sold, the carrying amount of those
inventories shall be recognized as an expense in the period
in which the related revenue is recognized.
2. If an inventory, which was written down to net realizable
value, remained unsold on the subsequent reporting date
and it is evidenced that its net realizable value has
increased above the cost, the previous write down is
reversed and the inventory is carried at cost. Reversal is
restricted to original write down. The inventories are
valued at lower of the cost and revised net realizable value.

16. Disclosures
The following disclosures should be made (Para 36, IAS – 2).
a. The accounting policies adopted in measuring inventories including
the cost formula used,
b. The total carrying amount of inventories by appropriate classes(RM,
FG, wip, Production supply )
c. The amount of inventories recognized as expense during the period
(when inventories are sold).
d. The amount of reversal of write downs recognized as deduction from
inventories recognized as an expense during the period,
e. Circumstances that required write downs or reversals of write downs,
and
f. Inventories pledged as security.

17. Illustration – 1 (Rebates): An auto dealer gets ` 3,000
rebate per car across the models on purchase of more
than 10,000 cars in a year. The car dealer had achieved
the eligible quantity limit. During 2011, he purchased
15,000 cars and sold 14,600 cars. 400 cars were in its
showroom at the end of the year. Average cost per car
before considering rebate was ` 4,50,000. He wants to
include the rebate amount of ` 4.5 crores in the
revenue.
Was it the appropriate accounting policy?

18. Solution (Rebates):
The dealer should not recognize rebates as a part of revenue.
Rather, it should be deducted from cost of purchases.
Cost per unit (670,50,00,000 ÷ 15,000 cars) = ` 4,47,000
Particulars
Amount
(` crores)
Cost of 15,000 cars (at ` 4,50,000 per car) 675.00
Less: Rebate (15,000 cars × ` 3,000) 4.50
Cost of purchase 670.50
Less: Cost of Closing stock (400 cars × ` 4,47,000) 17.88
 Cost of goods sold 652.62

19. Illustration – 2 (Cost of Materials): ABC
company purchases 1,100 units of raw materials
at ` 5,000 per unit, refundable excise duty ` 240
per unit, transport and handling charges is
20,000, and transport insurance ` 800. The
supplier granted 2% trade discounts.
Find out the purchase price of the raw materials
which should be included in the cost
determination process. VAT which is at 2% is
non-refundable.

20. Solution to Illustration – 2 (Cost of Materials)
Purchase Price of Raw Materials
Particulars
Amount (`)
Purchase Price (1,100 units × ` 5,000) 55,00,000
Less: Trade Discount (at 2%) 1,10,000
Net Price 53,90,000
Add: Excise Duty (though refundable, it is considered for VAT
calculation) (1,100 units × ` 240) 2,64,000
Price inclusive of Excise Duty 56,54,000
Add : VAT at 2% of ` 56,54,000 1,13,080
57,67,080
Less: Refundable Excise Duty 2,64,000
55,03,080
Add: Transport and handling charges 20,000
transport Insurance 800 20,800
Total Purchase Price 55,23,880

21. Illustration – 3 (Pricing on FIFO, WAC and Standard
Cost methods): Prepare the Stores Ledger Account using (a)
FIFO basis, (b) Weighted Average Cost basis and (c) Standard Cost
(at ` 103) method. Also ascertain the cost of material issued to
production and the cost of closing stock at the end of December
2011.
1. October 1, 2011: Opening stock: 3,000 kgs at ` 95 per kg
2. Purchases:
October 15, 2011: 2,000 kgs at ` 100 per kg
November 2, 2011: 5,000 kgs at ` 105 per kg
December 3, 2011: 4,000 kgs at ` 110 per kg
3. Issues:
October 22, 2011: 2,000 kgs
November 15, 2011: 1,600 kgs
December 21, 2011: 5,000 kgs

22. Solution to Illustration – 3
Stores Ledger Account (FIFO)
Date
Receipts Issues Balance
Quantity
(kgs)
Rate
(`)
Amount
(`)
Quantity
(kgs)
Rate
(`)
Amount
(`)
Quantity
(kgs)
Rate
(`)
Amount
(`)
1-10-11 - - - - - - 3,000 95 2,85,000
15-10-11 2,000 100 2,00,000 - - - 3,000
2,000
95
100
2,85,000
2,00,000
22-10-11 - - - 2,000 95 2,85,000 1,000
2,000
95
100
95,000
2,00,000
2-11-11 5,000 105 5,25,000 - - - 1,000
2,000
5,000
95
100
105
95,000
2,00,000
5,25,000
15-11-11 - - - 1,000
600
95
100
95,000
60,000
1,400
5,000
100
105
1,40,000
5,25,000
3-12-11 4,000 110 4,40,000 - - - 1,400
5,000
4,000
100
105
110
1,40,000
5,25,000
4,40,000
21-12-11 - - - 1,400
3,600
100
105
1,40,000
3,78,000
1,400
4,000
105
110
1,47,000
4,40,000

23. Solution to Illustration – 3
Stores Ledger Account (WAC Method)
Date
Receipts Issues Balance
Quantity
(kgs)
Rate
(`)
Amount
(`)
Quantity
(kgs)
Rate
(`)
Amount
(`)
Quantity
(kgs)
Rate
(`)
Amount (`)
1-10-11 - - - - - - 3,000 2,85,000
15-10-11 2,000 100 2,00,000 - - - 5,000 4,85,000
22-10-11 - - - 2,000 97 1,94,000 3,000 2,91,000
2-11-11 5,000 105 5,25,000 - - - 8,000 8,16,000
15-11-11 - - - 1,600 102 1,63,200 6,400 6,52,800
3-12-11 4,000 110 4,40,000 - - - 10,400 10,92,800
21-12-11 - - - 5,000 105 5,25,000 5,400 5,67,800

24. Solution to Illustration – 3
Stores Ledger Account (SC Method)
Date
Receipts Issues Balance
Quantity
(kgs)
Rate
(`)
Amount
(`)
Quantity
(kgs)
Rate
(`)
Amount
(`)
Quantity
(kgs)
Rate
(`)
Amount (`)
1-10-11 - - - - - - 3,000 2,85,000
15-10-11 2,000 100 2,00,000 - - - 5,000 4,85,000
22-10-11 - - - 2,000 103 2.06,000 3,000 2,79,000
2-11-11 5,000 105 5,25,000 - - - 8,000 8,04,000
15-11-11 - - - 1,600 103 1,64,800 6,400 6,39,200
3-12-11 4,000 110 4,40,000 - - - 10,400 10,79,200
21-12-11 - - - 5,000 103 5,15,000 5,400 5,64,200

25. Illustration – 4 (Retail Method): MNP Ltd is a
departmental stores dealing in 5,000 items. It finds it
difficult to determine the cost of each and every
inventory item separately and therefore, wants to
apply retail method. At the year end, it has classified
the goods into four categories in accordance with
gross profit rate as follows.
What should be the cost of inventory under retail method?
Category Sales Amount (`
million)
Gross Profit to
Cost (%)
I 380 15
II 1,120 10
III 2,000 5
IV 3,000 2

26. Solution to Illustration – 4 (Retail Method):
Cost of Inventory under Retail Method
Cate-
gory
Sales
Amount
(` million)
Gross
Profit
to
Cost
(%)
Cost of Inventory
(` million)
I 380 15 [380 × (100 ÷ 115)] 330.43
II 1,120 10 [1,120 × (100 ÷ 110)] 1,018.18
III 2,000 5 [2,000 × (100 ÷ 105)] 1,904.76
IV 3,000 2 [3,000 × (100 ÷ 102)] 2,941.18

27. Illustration – 5 (Conversion Costs): The following
production and overhead details pertain to a company.
Direct labour cost for 2011: ` 5,70,00,000. There was
low production in 2011 due to market recession.
a. Can the firm include actual fixed overhead for the
determination of cost of conversion?
b. Find out the conversion cost in accordance with IAS – 2.
Year
Production
(units)
Fixed
Overhead (`)
Variable
Overhead (`)
2009 12,00,000 1,10,00,000 50,00,000
2010 15,00,000 1,30,00,000 61,70,000
2011 10,00,000 1,45,00,000 44,00,000

28. Solution to Illustration – 5:
a. No – output is much lower due to market recession – if
charged actual, unit cost will be substantially higher
making the product less profitable
b. Average annual production capacity = [(12,00,000 +
15,00,000 + 10,00,000 units) ÷ 3] = 12,33,333 units
c. Balance of fixed overhead of ` 27,43,241 is to be
expensed. This clause intends to ensure that in
depressed production situation, inventory is not valued
above cost.
Particulars Amount (`)
Direct labour cost 5,70,00,000
Variable overheads 44,00,000
Fixed overheads [` 1,45,00,000 × (10,00,000 ÷ 12,33,333 units)] 1,17,56,759
Total conversion costs 7,31,56,759

29. Illustration – 6 (Other Costs of Inventories): An entity belonging
to the processing industry incurs the following storage costs.
In addition, it has incurred cost for supplying goods from factory to sales
depot amounting to ` 2 crores from where goods are despatched to the
dealers, and transport expenses to dealers depot ` 2.4 crores.
It has incurred ` 40 lakhs interest on working capital loan which has been
used for financing raw material and finished goods inventories. The
company wishes to charge interest cost proportionately to inventories.
The production cycle of the company is just 7 days. Administrative
expenses: ` 3 crores and other selling expenses: ` 2 crores.
Find out which of the above items should be included proportionately in
the cost of inventories.
Expenses for raw material warehouse ` 1.0 crores
Expenses for intermediate process stores ` 1.2 crores
Expenses for finished goods stores ` 1.8 crores
Total ` 4.0 crores

30. Solution Illustration – 6 (other costs of
inventories):
Only the following items of costs shall be
included in the cost of inventories
proportionately.
Particulars
Amount
(` crores)
Expenses for raw material warehouse 1.0
Expenses for intermediate process stores 1.2
Transportation from factory to sales depot 2.0
Total of other costs to be included proportionately in
the cost of inventories 4.2

31. Case – 1 (Main and By-products): Gurgaon Chemical Ltd
produces two main products M1 and M2, and a by-product, B. During 2011, the
following expenses are identified in relation to production: Material cost as per
weighted average cost method ` 44 crores, Direct labour cost ` 5.2 crores,
General factory administration ` 3.3 crores, Depreciation ` 2 crores, Repairs and
maintenance ` 1 crore and Indirect labour and material ` 1.2 crores.
At the point of separation, the following units were received during 2011: M1
2,02,000 kgs; M2 4,50,000 kgs and B 20,000 kgs which are sold at ` 50 per kg.
M1 and M2 do not have ready market. They are further processed incurring
separate processing cost of ` 7.5 crores and ` 11.5 crores respectively.
Completed units sold: M1 1,90,000 kgs at ` 4,500 per kg and M2 4,45,000 kgs
at ` 1,500 per kg. Closing stock: M1 20,000 kgs and M2 45,000 kgs. Abnormal
loss in separate processes: M1 2,000 kgs and M2 8,000 kgs. Opening stock: M1
10,000 kgs at ` 1,800 per kg and M2 48,000 kgs at ` 650 per kg.
Administrative, selling and distribution costs, and borrowing costs: ` 38.55
crores. Since the products are not normally separately processed, the company
has established normal profit on the completed products as the profit on
separate processing as well.
How should the company determine the cost of finished goods inventory? Help
the company in selection of accounting policy. It wishes to adopt FIFO method
for finished goods inventory.

32. Case – 1 (Main and By-products): Gurgaon Chemical
Ltd produces two main products M1 and M2, and a
by-product, B. During 2011, the following expenses
are identified in relation to production: Material cost
as per weighted average cost method ` 44 crores,
Direct labour cost ` 5.2 crores, General factory
administration ` 3.3 crores, Depreciation ` 2 crores,
Repairs and maintenance ` 1 crore and Indirect
labour and material ` 1.2 crores.
At the point of separation, the following units were
received during 2011: M1 2,02,000 kgs; M2
4,50,000 kgs and B 20,000 kgs which are sold at ` 50
per kg.

33. M1 and M2 do not have ready market. They are further
processed incurring separate processing cost of ` 7.5 crores
and ` 11.5 crores respectively. Completed units sold: M1
1,90,000 kgs at ` 4,500 per kg and M2 4,45,000 kgs at ` 1,500
per kg. Closing stock: M1 20,000 kgs and M2 45,000 kgs.
Abnormal loss in separate processes: M1 2,000 kgs and M2
8,000 kgs. Opening stock: M1 10,000 kgs at ` 1,800 per kg
and M2 48,000 kgs at ` 650 per kg.
Administrative, selling and distribution costs, and borrowing
costs: ` 38.55 crores. Since the products are not normally
separately processed, the company has established normal
profit on the completed products as the profit on separate
processing as well.
How should the company determine the cost of finished goods
inventory? Help the company in selection of accounting
policy. It wishes to adopt FIFO method for finished goods
inventory.

34. Illustration – 7 (Inventory Valuation):
A dealer has purchased 1,000 cars on defer
payment basis at ` 25,000 per month per
car. The cash price of each car is `
2,80,000. Amount to be paid in 12 monthly
equal instalments. At the end of 2011, 20
cars were in stock. The company found cost
of inventory at ` 60 lakhs.
Was the company correct in its inventory
valuation approach?

35. Solution to Illustration – 7 (Inventory Valuation):
1. IAS – 2 allows the purchase of inventories on deferred
settlement basis (Para 18).
2. When the arrangement contains a financing element, it
(i.e., difference between the purchase price for normal
credit terms and the amount paid) shall be recognized as
interest expense over the period of financing.
3. The company costed inventory at ` 3,00,000 but it should
have excluded the interest element.
4. So the cost of inventory should be ` 56 lakhs.
Deferred payment price (` 25,000 × 12) ` 3,00,000
Less: Cash price 2,80,000
Interest expense 20,000

36. Illustration – 8 (Net Realizable Value):
A dealer of sanitary fittings holds 1,000
pieces of wash basins for delivering to a
contractor under firm contract. The contract
quantity is 900 pieces at ` 3,400 whereas
retail price of the same is ` 4,200.
What should be the net realizable value of
the inventories?

37. Solution to Illustration – 8 (Net Realizable Value):
1. As per IAS – 2 (Para 31), the net realizable value of the
quantity of inventory held to satisfy firm sales or service
contracts is based on the contract price.
2. If the sales contracts are for less than the inventory
quantities held, the net realizable value of the excess is
based on general selling prices.
3. Accordingly, net realizable value of 1,000 pieces of wash
basin should be ` 34,80,000 as shown below.
900 units × ` 3,400 30,60,000
100 units × ` 4,200 4,20,000
Net realizable value (or cost of inventories) 34,80,000

38. Case – 2 (Lower of Net Realizable Value and Cost): ABC Company holds materials
and supplies held for production. They are held for utilizing in the production and
accordingly, they will be sub-merged in the finished goods. Whereas net realizable
value of raw materials and supplies might have fallen but the price of related finished
goods remained unchanged and above the cost. This indicates that cost of materials and
supplies would be realized. In such a case, inventories are not written to net realizable
value.
Cost of materials of 100 units is ` 10,000 plus ` 1,000 are the related expenses of
bringing them to their present location and conditions.
Latest purchase price is ` 8,000 plus ` 1,100 are the related expenses of bringing them to
their present location and conditions.
They are not readily saleable. However, ABC Company can either send it back to the
supplier for which it has to incur transportation and other related expenses of ` 1,100.
The dealer will deduct 5% from the current market price.
The entity has checked that 100 units would result in 100% finished goods. Cost of
production of finished goods is estimated at ` 30,000 including cost of materials at `
11,000. Market price of the finished goods at the year end had fallen from the average
price of ` 40,000 to ` 32,000; but it was anticipated that there will be more price fall
because of low international demand and cheaper imports. The price was anticipated to
fall by another ` 3,000 shortly.
Should the company written down its inventory to the following net realizable value?
Net realizable value: Value to be realized by return to the supplier: ` 7.60
Less: Transportation and related expenses: 1.10
6.50
It was observed that price of finished goods fell to ` 28,200 in the first week of the new year.