As 2- Indian Accounting Standard -Valuation of Inventory

GAJVEER SINGH MAHUR (GSM) AS-2
mahurgajveer@gmail.com
AS-2- VALUATION OF INVENTORIES
CONTENTS OF AS-2
Asked in
CA.Exam
(1) Applicability & Non-applicability of AS-2
(2) Meaning of inventory
(3) Valuation of inventory
(4) Cost of inventory
(5) Valuation of stock of raw material
(6) Valuation of stock of finished goods
(7) Disclosure requirements
(8) Summary (Exam day revision)

[1] Applicability & Non-applicability of AS-2
Applicability This Standard should be applied in accounting for
inventories:
 Finished goods stock;
 Work-in-progress stock;
 Raw material stock
Non-
applicability
As-2 is not applicable in following types of inventories:
1) work in progress arising under construction
contracts, including directly related service
contracts; ( being covered under AS);
Note: building under construction is a WIP, but AS-2 is
not applicable on this WIP.
Note: But Inventory held for use in construction, (e.g.
cement lying at the site) is covered by AS 2.
2) work in progress arising in the ordinary course of
business of service providers(audit in progress,
medical services in progress)
3) shares, debentures and other financial
instruments held as stock-in-trade; and
4) producers’ inventories of

Note: where sale is assured under a forward contract or
a government guarantee or where a homogenous
market exists and there is negligible risk of failure to
sell.

[2] Meaning of Inventory
Meaning of
Inventory
Inventories are assets:
1) held for sale in the ordinary course of
business(finished goods)
2) in the process of production for such sale(work-in-
progress)
3) in the form of materials or supplies to be
consumed in the production process or in the
rendering of services(raw material, stores, spares,
consumables)
Containers
and Empties
1) Containers and empties are neither goods for sale
in the ordinary course of business, nor are they
goods in the production process nor they are
materials or supplies for consumption in the
production process or in rendering of services.
2) The Expert Advisory Committee of ICAI has
however expressed an opinion that containers and
empties are items of inventory.
3) It seems nevertheless that containers and empties
having useful life more than one year should be
regarded as depreciable assets, in accordance with
AS 6.
Machinery
spares
(A) Machinery spares treated as Inventory:
1) Machinery spares, which are not specific to a
particular item of fixed asset but can be used
generally for various item of fixed assets, should be
treated as inventories for the purposeofAS-2.
2) Such machinery spares should be charged to the
statement of profit and loss and when issued for
consumption in the ordinary course of operations.

(B) Machinery spares treated as capital spares :
The machinery spares of the following types should be
capitalized being of the nature of capital
spares/insurance spares-
i) Machinery spares which are specific to a
particular item of fixed assets ,i.e., they can be used
only in connection with a particular item of the
fixed asset, and
ii) Their use is expected to be irregular.
Note:(1) Machinery of the nature of capital
spares/insurance spares should be capitalized
separately at the item of their purchase whether
procured at the time of purchase of the fixed asset
concerned or subsequently.
Note:(2) insurance spares should be allocated on a
systematic basis over period not exceeding the useful
life of the principal item, i.e., the fixed asset to which
they relate.
Note:(3) When the related fixed asset is either
discarded or sold, the written down the value less
disposal value, if any, of the capital spares/insurance
spares should be written off.
Note:(4) The stand–by equipment is a separate fixed
asset in its own right and should be depreciated like the
any other fixed asset.

Explanation of meaning of inventory
Note: containers & empties are treated as inventories
(opinion of EAC)

Explanation of machinery spares parts

[3] Valuation of Inventories
Valuation of
Inventory
Inventories should be valued at:
 cost
or
 Net realisable value
Whichever is lower.
Note:(1) Cost is to be calculated separately for stock of:
 Raw material
 Work-in-progress
 Finished goods
Note:(2) Cost may be calculated as follows:
1) Actual cost
2) Estimated cost
Note:(3) Actual cost of inventory may be calculated by using
following cost formula:
a) Specific identification method
b) Other method
 FIFO method
 Weighted average method
Note:(4) Estimated cost may be calculated as follows:
a) Standard cost
b) Retail method
Meaning of
NRV Estimated selling price
Less: estimated cost of completion
Less: estimated costs necessary to
make the sale(selling expenses)
XXXX
(XXXX)
(XXXX)
Net realisable value XXXX

Note:(1) How to estimate NRV:
i) Estimates of net realisable value are to be based
on the most reliable evidence available at the
time the estimates are made as to the amount
the inventories are expected to realise.
ii) These estimates take into consideration:
 fluctuations of price or
 Cost directly relating to events occurring
after the balance sheet date to the extent
that such events confirm the conditions
existing at the balance sheet date.
iii) Net realisable value of the quantity of
inventory held to satisfy firm sales or service
contracts is based on the contract price.
iv)If the sales contracts are for less than the
inventory quantities held, the net realisable
value of the excess inventory is based on general
selling prices.
v) An assessment is made of net realisable value as
at each balance sheet date.
vi)The AS 2 is silent whether an item of inventory
carried at net realisable value, can be written up
on subsequent increase of net realisable value.
The IAS 2, Inventory permits such write-ups.
When to apply
specific
identification
method
Specific identification method should be applied in
following conditions:
1) items are not ordinarily interchangeable and
2) Goods are specifically segregated for specific
projects.

When to apply
FIFO/Weighted
average
method
When there are large numbers of items of inventory
which are ordinarily interchangeable.
When to use
standard cost
When it is impracticable to calculate the actual cost
and standard cost may be used for convenience if the
results approximate actual cost.
When to use
retail method
The retail method is generally used
i) In the retail trade
ii) Inventories of large numbers of rapidly
changing items
iii) goods have similar margins and
iv)For which it is impracticable to use other
costing methods.
Note :(1) The cost of the inventory is determined by
reducing from the sales value of the inventory the
appropriate percentage gross margin.
 Cost of inventory =(sales value-gross margin)
Note :(2) The percentage used takes into
consideration inventory which has been marked
down to below its original selling price.
Note :(3) An average percentage for each retail
department is often used.

Explanation of valuation of inventory

[4] Calculation of the cost of inventories
How to
calculate
cost of raw
material
Cost of raw material includes:
Purchase price
Less: trade discount
Add: excise duty on raw material (if non
refundable)
Add: vat/sales tax/CST (if non
refundable)
Add: cost of containers
Add: freight/ insurance
Add: loading /unloading charges
Add: other cost directly attributable to
acquisition
Less: rebate
Less: duty drawback
XXXX
(XXXX)
XXXX
XXXX
XXXX
XXXX
XXXX
XXXX
(XXXX)
(XXXX)
Cost of raw material XXXX
Note:(1) following costs are excluded from the cost of
raw material:
1) Abnormal loss of material
2) Storage cost
3) Interest and borrowing cost
Note:(2) storage cost: Storage costs are normally not
included in cost of raw material but in following cases
storage cost may be included in the cost of raw
material:
i) Storage cost are necessary in the production
process prior to a further production stage

How to
calculate
cost of
finished
goods & WIP
Costs of finished goods comprise:
Cost of raw material
+
costs of conversion
+
Add: other costs incurred in bringing
the inventories to their present
location and condition
XXXX
XXXX
XXXX
Cost of finished goods XXXX
Note: (1) present location means at factory stage.
Note: (2) present condition means at finished stage.
Note: (3) Cost of conversion: cost of conversion means
cost of converting raw material into finished
goods(excluding cost of raw material)
Direct labour
+
Direct expenses
+
Systematic allocation of Fixed and
variable production overheads
XXXX
XXXX
XXXX
Cost of conversion XXXX
Note: (4) Variable production overheads are assigned
to each unit of production on the basis of the actual
capacity.
Note: (5) fixed production overheads are recovered on
the basis of:
 Normal capacity or
 Actual capacity

Whichever is higher.
Note: (6) Excise duty on output is product cost rather
than period cost. Hence taken in production cost and
consequently in cost of inventory.
Note: (7) Other Costs may be included in cost of
inventory provided they are incurred to bring the
inventory to their present location and condition. Eg.
Cost of design
Note: (8) Treatment of amortisation of intangibles
for ascertaining inventory costs.
It appears that amortisation of intangibles related to
production, e.g. patents right of production or copyright
for a publisher should be taken as part of inventory
costs.
Note: (9) Exchange differences are not taken in
inventory costs under Indian GAAP.
Note: (10)Exclusions from the cost of inventories
Following costs are not included in cost of inventories
i) Abnormal amounts of wasted materials, labour,
or other production costs;
ii) Storage costs, unless the production process
requires such storage;
iii) Administrative overheads that do not
contribute to bringing the inventories to their
present location and condition;
iv)Selling and distribution costs.
Note: (11) Interest and other borrowing costs are
usually considered as not relating to bringing the
inventories to their present location and condition.
These costs are therefore not usually included in cost of

inventory. Interests and other borrowing costs however
are taken as part of inventory costs, where the
inventory necessarily takes substantial period of time
for getting ready for intended sale. Example of such
inventory
is wine.
Allocation of
joint costs to
joint or By-
product
1) The value of by products, scrap and wastes are
usually not material. Therefore these by-products
are valued at net realisable value
2) Costs incurred up to the stage of split point (joint
costs) should be allocated different joint products
on a rational and consistent basis.
3) The basis of allocation may be:
 Sale value at split off point
 Net realisable value
4) The cost of main product is allocated joint cost
minus net realisable value of by-products, scraps
or wastes.
[5] Valuation of raw material stock
If finished
goods are
expected to
be sold at or
above cost
Stock of raw material should be valued always at cost of
raw material if the finished products in which they will
be incorporated are expected to be sold at or above cost
If finished
goods are
expected to
be sold at
below cost
Stock of raw material should be valued at NRV
(replacement cost of raw material) when:
i) There has been a decline in the price of materials
and
ii) It is estimated that the cost of the finished

products will exceed net realisable value
Explanation of valuation of inventory of raw material

[6] Valuation of finished goods stock/ WIP stock
Valuation of
stock of
finished
stock
Finished goods stock should be valued at:
 cost of finished goods
or
 Net realisable value
Whichever is lower.
Valuation on
item by item
basis
1) Inventories are usually written down to net
realisable value on an item- by-item basis.
2) In following cases, similar or related items may be
grouped together
i) Items of inventory are relating to the same
product line that have similar purposes or
end uses and
ii) These product are produced and marketed
in the same geographical area and
iii) These product cannot be practicably
evaluated separately from other items in
that product line.
[7] Disclosure requirements
Disclosures
in notes to
accounts
The financial statements should disclose:
1) The accounting policies adopted in measuring
inventories, including the cost formula used; and
2) The total carrying amount of inventories and its
classification appropriate to the enterprise.
Note: Common classifications of inventories are
 raw materials and components,
 work in progress,
 finished goods,
 stores and spares, and loose tools.

As 2- Indian Accounting Standard -Valuation of Inventory

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