Accounting Standard – 2

Inventories Valuation

1.       Applicability and Nature : This AS is applicable from 01-04-1999 onwards and Mandatory for SMC, NON-SMC and Level-I,II & III (It means mandatory for all)

2.       Objective:-The main objective of this AS is to prescribe rule for valuation of inventories

3.       Para-1  

AS -2 is not applicable on

(i)                  Service provider

(ii)                Shares, Debentures and other financial instruments

(iii)               WIP of construction contracts.

(iv)              Producers inventory of Livestock, agricultural and forest product.

4.       Para-3 & 4          

Inventory means assets:

(i)                  Held for sale in normal course of business (Finished Goods)

(ii)                Held in the process of production (WIP)

(iii)               Held for consumption for production of goods or rendering of services. (Raw Material)

NOTE- As per the provision of AS-2, any specific loose tools should be considered as a part of cost of assets and should be depreciated over the remaining useful life of assets but common loose tools should be valued as Raw Material is valued.(ASI-2)

Note:- Stand-by equipment is not of the nature of spare. It should be treated as separate Fixed Asset and should be depreciated like other Fixed Assets.

5.       Para-5  

Valuation of Inventory:

Inventory is valued at COST or NRV whichever is less

Note : Lower will be selected on item by item basis or category basis but should not be on global basis.

Note:- Producers inventories of Livestock, agriculture and forest products can be valued at NRV as per established practice if (a) Sale is assured by a forward contract or by government guarantee, (b) Market is homogeneous and there is negligible risk of sale failure.

6.       Para-6

COST: Cost means all cost of purchase, all cost of conversion all other costs incurred in bringing the inventories to their present condition and location.

Para-7

Purchase cost includes the following:

(i)                  Purchase Price

(ii)                Duties and Taxes

(iii)               Freight Inwards

(iv)              Other expenditure directly attributable

(Ex.- Cost of containers, transit insurance and buying commission etc.)

Following items are either not included or deducted from cost of purchase:

(i)                  Trade Discount

(ii)                Rebate

(iii)               Duties and taxes that are subsequently recovered by the enterprise from the taxing authorities and

(iv)              Other similar items.

Para-8 & 9

Conversion cost includes the following:

(i)                  Direct material, direct labour and direct expenses (all direct costs)

(ii)                Allocated variable production overheads i.e. indirect material and indirect labour etc. normally these are allocated on the basis of actual production.

(iii)               Allocated fixed overhead i.e. depreciation of machinery and factory building, insurance of factory building and machinery etc. Normally these are allocated on the basis of normal capacity of production.

Fixed production recovery rate is calculated as follow:

= (Fixed Production Overhead)/ Normal Production Unit or Actual Production unit (whichever is higher)

Para-10-Cost allocation for Joint Products:

Production of Joint Products only:

Calculate Joint Cost and apportion it on various products  on a rational and consistent basis. Like sale value at split off point , physical quantity method etc.

Production of Main Products and By Products:

i)                    Compute joint cost

ii)                  Calculate NRV of By Products

iii)                Calculate Net Joint cost  by reducing NRV out of Joint Cost

iv)                Apportion the Net Joint cost on main products on a rational and consistent basis.

NOTE- In case of joint products, when the cost of conversion of each product are not separately identifiable, they are to be allocated between the products on a rational and consistent basis. For example on the basis of sales value at split off point.                

               

                Para-11 & 12

                Other costs means:

Cost incurred in bringing the inventories to their present condition and location is included in other cost. For example cost of designing the product for certain customers.

                Note- Interest and cost of borrowing is not included in other cost.

               

                Para-13

                Following costs are not included in the cost of inventories:

(i)                  Abnormal amount of wasted material, labour, and production cost.

(ii)                Storage cost, unless these are necessary in the production process prior to a further production stage.

(iii)               Administrative overhead and selling and distribution overheads etc.

Formulas to be used to determine cost of inventories:

(i)                  Specific Identification Method:- this method is used when items of inventory are not ordinarily interchangeable  and goods and services produced and segregated for a specific project.

(ii)               FIFO and Weighted average method

(iii)             Standard cost method:-  This is the cost which is determined taking into account normal levels of consumption of Materials and supplies, Labour, efficiency and capacity utilization. It should be regularly reviewed. Standard cost may be used if the results approximates the actual cost and FIFO or WAM are not applicable.

(iv)              Retail Price Method:- Cost of Inventory = Sales value of Inventory LESS Gross Margin. This method may be used if FIFO or WAM are not applicable.

7.       Net Realizable Value (NRV)

Net Realizable Value means the estimated selling price in ordinary course of business, less estimated cost of completion and estimated cost necessary to make the sale.

               

                Para-20                 Conditions under which inventories are valued at NRV

(i)                 Damaged items of inventories.

(ii)               Partial or Complete Obsolescence.

(iii)             Decline in selling prices

(iv)              Increase in the estimated costs of completion or costs necessary to make the sale.

NOTE-  Material and other supplies held for the use in the production of inventories are not written down below the cost if the finished goods in which they will be used are expected to be sold at or above cost.

8.       In accordance with Guidance Note on “Accounting Treatment of Excise Duty” and AS-2, Excise Duty should be considered as Manufacturing expense and be considered as an element of cost for Inventory valuation. It is mandatory for an entity to provide for liability for excise duty on finished goods lying in stock as at the end of the year and add the same to the value of closing stock.

9.       Para-26                 Disclosure Requirements:

(i)                  The accounting policies adopted in measuring inventories including the cost formulas

(ii)                Carrying amount of inventories and its classification into Finished Goods, Traded Goods, WIP and RM etc.

(iii)               Any change in the accounting policies adopted and its impact on the items of Financial Statements.