ACCOUNTING STANDARD – 2
“Valuation of inventories”
Introduction
AS -2 (Revised) ‘Valuation of Inventories; provides complete guidance for determining the value at which inventories, are carried in the financial statements until related revenues are recognized. It also provides guidance on the cost formulas that are used to assign costs to inventories and any write-down thereof to net realizable value.
Scope of AS 2
Applicability of AS 2 in accounting for inventories other than
Work in progress arising under construction contracts, including directly related services contracts;
Work in progress arising in the ordinary course of business of service providers;
Shares, debenture and other financial instruments held as stock-in- trade;
Producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realizable value in accordance with well-established practices in those industries.
Definition of Inventories
Inventories are assets
Held for sale in the ordinary course of business. It includes goods purchased and held for resale
In the process of production for such sale. It includes finished goods or work in progress, produced, or materials and supplies awaiting use in the Production process. Other than machinery spares, services, servicing equipment and stand-by equipment meeting the definition of PPE
In the form of materials* or supplies* to be consumed in
Rendering of services
production process
Determination of Cost of Inventories
Cost of purchase
Purchase price
Duties and other taxes (non- recoverable from the taxing authorities)
Other expenditure directly attributable to the acquisition
Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase
Cost of Conversion
It can be
Direct Labour
Overheads
Overheads further can be
Fixed production overheads (remains relatively constant regardless of the volume of production.
Variable production overheads (it vary directly, or nearly directly, with the volume of production.
Other costs
Costs incurred to bring the inventories to their present location and condition
Allocation of Cost to Joint Products and By – Products
When more than one product is produced in the process
Outcome-Joint products
When the cost of conversion of each product is separately identifiable, Cost of each product is calculated on the basis of separate cost incurred.
When the cost of conversion of each product is not separately identifiable, Allocation of cost is based on relative sales value of each product either at the state in the production process when the products become separately identifiable, or at the completion of production.
Outcome – Main product with a By – product
When the by- product is immaterial --- By-product is measured at NRV and this value is deducted from the cost of the main product.
When the by- product is material --- By-product is treated as joint product and accordingly, the accounting is done.
Joint Cost
If an enterprise incurs joint cost in a common process for different output then allocation of joint cost over each product can be made on the basis of following Ratios: -
Ratio
Sales value at separation -- Point is goods are not further processed
NRV Ratio if goods are further processed
HRV = {Sales after further processing – Further processing cost}
Conversion cost
Factory Overheads
Variable Factory Overheads
Fixed Factory Overheads
Factory overheads can be ascertained through the following steps
Step -1
Recovery rate P.U. =
Fixed Overhead
Nornal output or actual output whichever is higher
Step – 2
Recovered O/H as a part of cost of inventory = No. of units actual produced × Recovery Rate p.u.
Direct labour
The amount of direct wages should be taken as per factory records (that is (i.e. Pay Roll sheets, wages register etc.
Costs excluded from the cost of inventories and recognized as expenses
Abnormal amounts of wasted material, labour, or other production costs;
Storage costs, unless the production process requires such storage;
Administrative overheads that do not contribute to bringing the inventories to their preset location and condition;
Selling and distributing costs.
Costing Formulas
FIFO
Weighted Average method
Retail value method
Explanation on Retail Value Method: -
In case the enterprise deals with large quantity & variety of goods (i.e. Departmental stores etc.) then valuation of Closing stock at cost for these enterprises shall be made as follows: -
Weighted Average method = Total cost × Retail value of Closing Stock
Total Retail Value
OR
FIFO = Cost for Pruchased Goods × Retail value of Closing Stock
Retail Value for purchased goods
Measurement of Inventories
Raw Materials At cost (if finished goods are sold at or above cost), otherwise at replacement cost
Finished Goods and Work in progress
Lower of Cost OR Net Realisable Value
Net realisable value means the Realisable Value less Selling Expenses less estimated cost of completion
DISCLOSURE
Information about the carrying amounts held in different classification of inventories and the extent of changes in these assets must be disclosed in financial statements.
Stock-in-trade (in respect of goods acquired for trading),
Finished Goods,
Work in progress,
Raw materials and components,
Common Classification of inventories
Stores and Spares,
Lose tools,
Others
The financial statements should disclose
Accounting policies adopted in measuring inventories, including the cost formula used.
The total carrying amount of inventories together with its classification appropriate to the enterprise.