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AS 2 – Valuation of Inventories Paper 1: Financial Reporting Chapter 1 Unit 3

CA B. Hari Gopal B.com, PGDBA, FCA, FCMA, DISA(ICAI), PMP (PMI, USA), EPBM (IIMC), MCT

Learning Objectives

1. Gain insight in to Accounting Standard 2

2. Disclosure requirements

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Introduction to Accounting Standard 2 • Background • Exceptions • Scope

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AS 2 – Background

Accounting Standard 2 – Valuation of inventories

Provide guidance for determining the value of inventories

Provide guidance on cost formulas

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AS 2 – Exceptions AS 2 does not apply in accounting

for following inventories

WIP arising under Construction contracts including directly related service contracts

WIP arising in the ordinary course of business of service providers

Shares, Debentures and other financial instruments held as stock in trade

Producer’s Inventories to the extent that they are measured at net realizable value as per practices of

industry – Ex : Livestock, mineral oils, etc

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AS 2 – Scope

Accounting Standard 2 – defines inventories as assets

Finished goods

Work In Progress

Raw Materials

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Measurement of inventories

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Measurement of inventories

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Inventories

Raw Materials WIP

At Cost

Replacement cost

Finished Goods

Lower of the following

Cost

Cost of Purchase

Cost of conversion

Other costs

Net Realizable value

Realizable value less

Selling Expenses

Measurement of inventories Inventories SHOULD BE valued at the lower of cost

and net realizable value Cost of goods is the summation of

Cost of purchase

Cost of conversion

Other costs

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Cost of Purchase

From the above, items like duty drawback, CENVAT, VAT, trade discount are deducted

Includes the purchase price plus all other necessary expenses directly attributable to purchase of stock

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Cost of Conversion

Direct Materials are included in Cost of purchase, whereas other items are known as Cost of conversion

Factory cost = Direct Materials + Direct Labour + Factory Variable Overhead + Factory Fixed Overhead

In case of Manufacturing organizations, cost of inventory includes cost of conversion

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Cost of Conversion – Direct Labour & Variable overheads

It is advisable to include Direct Labour and Variable overhead in cost of conversion on the basis of normal

capacity

Variable overhead are indirect expenses which is directly related to the production level – it changes with change in

production level

Direct labour is the cost of labour directly attributed to the units of production

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Cost of Conversion – Fixed overheads

However, if the actual production is considerably more than the normal capacity, then fixed overhead is to be

included on the basis of actual capacity

When the actual production is equal to or less than the normal capacity, then fixed overheads are considered on

the basis of normal capacity

Fixed overhead are indirect expenses which generally remains constant. It varies only when there is a major shift

in production

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Cost of Conversion – Joint Products and By-products

Sometimes a single production process may result in more than one product

Joint Product – if the additional product is intended and has good market value

By-product – if the additional product don’t have good market value

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Costs – to be excluded from cost of inventories

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Exclusions from cost of inventories

Abnormal wastage of Materials, Labour and other production costs

Storage costs unless necessary in the production process

Administrative overheads that do not contribute to bringing the inventories to their present location / condition

Selling and distribution costs

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Borrowing costs

Interest and other borrowing costs are not usually considered as part of cost of inventories. However there

are exceptions given below

As per AS 16, for inventories that are qualifying assets, any directly attributable borrowing costs (for

acquisition, construction or production) should be capitalized as part of their cost

Qualifying assets – are inventories that take substantial time to bring them to a salable condition

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Cost Formulas

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Cost Formulas

Following are various cost formulas suggested by the statement

Specific Identification Method

FIFO / Weighted Average Price

Standard Cost Method / Adjusted Selling Price Method or Retail Method

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Net Realisable Value

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Net Realisable Value (NRV) NRV = Estimated selling price – Estimated cost of completion – Estimated costs to make the sale

Two conditions wherein cost exceeds the NRV

While estimating NRV, the purpose of holding the stock also be taken in to consideration.

The provision of cost or NRV, whichever is less, is applicable to Finished goods, which are ready for sale.

Raw materials and WIP are not for sale and hence the NRV cannot be estimated. They needs to be valued at cost, However, if NRV of the finished goods is less than the cost, than the relevant Raw material and WIP are to valued at Replacement cost

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Disclosure

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Disclosure

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Information about the carrying cost held in different classifications of inventories and extent of the changes in these assets is useful to financial statement users. Common classification of inventories are – (a). Raw materials and components (b). Work in Progress (c). Finished Goods, Stores and Spares (d). Loose tools

The Financial Statements should disclose: (a). The accounting policies adopted in measuring inventories, including the cost formula used (b). The total carrying amount of inventories together with a classification appropriate to the enterprise

Lesson Summary

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4. Finally we had discussed the Disclosure requirements as per AS - 2

3. We had also learnt the meaning and usage of Net Realisable Value

2. We had also discussed the various cost formulas used in inventory valuation

1. We have learnt the background of AS – 2, exceptions and Scope

Testing time

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AS – 2 : Valuation of Inventories

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True or False – 1

Accounting Standard 2 apply to shares, debentures and other financial instruments held as stock in trade

Answer: B. False

A. True B. False

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True or False – 2

Accounting Standard 2 does not apply to work in progress arising in the ordinary course of business of service providers

Answer: A. True

A. True B. False

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MCQ – 1

As per AS 2 inventories includes –

A. Finished Goods

C. Raw materials

B. Work in progress

D. All of the above

Answer : D. All of the above

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MCQ – 2

According to AS 2 cost of goods is the summation of –

A. Cost of purchase

C. Other cost necessary to bring the inventory in present location and condition

B. Cost of conversion

D. All of the above

Answer : D. All of the above

What Next ……

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Please follow session on – AS – 2 : Valuation of Inventories – Practical Paper 1: Financial Reporting Chapter 1 Unit 3

Thank You

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