AS 2 Valuation of Inventory-Revised Notes and Applicability. In the previous article, we have given complete details of A.S 6 (Depreciation) and A.S 10 (Fixed Assets). Today we are providing the full details of Accounting Standard – 2 valuation of inventory. In this article, you can get the definition of A.S – 2 valuations of inventories, applicability, and non-applicability, valuation of inventory. This notes is useful for IPCC students.
Accounting Standard – 2 Valuation of Inventory
What are Inventories?
Inventories are assets:
(a) held for sale in ordinary course of business;
(b) in the process of production fro such sale (WIP);
(c) in the form of materials or supplies to be consumed in the production process or rendering of services.
This Accounting Standard applies to Level I, Level II and Level III Entities.
However, this standard does not apply to the valuation of following inventories:
(a) WIP arising under construction contract (Refer AS – 7);
(b) WIP arising in the ordinary course of business of service providers;
(c) Shares, debentures and other financial instruments held as stock in trade; and
(d) Producers’ inventories of livestock, agricultural and forest products, and mineral oils ores and gasses to the extent that they are measured at net realizable value in accordance with well-established practices in those industries.
Inventories should be valued at the lower of cost and net realizable value
The cost of inventories should comprise –
(a) all costs of purchase
(b) costs of conversion
(c) other costs incurred in bringing the inventories to their present location and condition.
The costs of purchase consist of –
(a) the purchase price
(b) duties and taxes ( other than those subsequently recoverable by the enterprise from the taxing authorities like CENVAT credit)
(c) freight inwards and other expenditure directly attributable to the acquisition.
Trade discounts (but not cash discounts), rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase.
The costs of conversion include direct costs and systematic allocation of fixed and variable production overhead.
Joint or by-products:
In case of joint or by-products, the costs incurred up to the stage of split off should be allocated on a rational and consistent basis. The basis of allocation may be sale value at split off point or sale value at the completion of production. In case of the by products of negligible value or wastes, valuation may be taken at net realizable value. The cost of main product is then joint cost minus net realizable value of by product or waste.
The other costs are also included in the cost of inventory to the extent they contribute in bringing the inventory to its present location and condition.
Interest and other borrowing costs are usually not included in cost of inventory. However, AS-16 recommends the areas where borrowing costs are taken as cost of inventory.
Certain costs are strictly not taken as cost of inventory.
(a) Abnormal amounts of wasted materials, labour, or other production costs;
(b) Storage costs, unless those costs are necessary in the production process prior a further production stage;
(c) Administrative overheads that do not contribute to bringing the inventories to their present location and condition;
(d) Selling and Distribution costs.
Following are to be deducted from cost of purchase:
- Duties & Taxes recoverable from taxing authorities
- Trade Discounts
- Duty Drawbacks
- Other similar items
Cost of inventories in certain conditions:
The following methods may be used for convenience if the results approximate actual cost.
Standard Cost: It takes into account normal level of consumption of material and supplies, labour, efficiency and capacity utilization. It must be regularly reviewed taking into consideration the current condition.
Retail Method: Normally applicable for retail trade Cost of inventory is determined by reducing the gross margin from the sale value of inventory.
Net Realisable Value means the estimated selling price in ordinary course of business, at the time of valuation, less estimated cost of completion and estimated cost necessary to make the sale.
Comparison between net realizable value and cost of inventory
The comparison between cost and net realizable value should be made on item-by-item basis. (In some cases, group of items-by-group of item basis)
The financial statements shall disclose:
(a) the accounting policies adopted in measuring inventories, including cost formula used;
(b) the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity;
(c) the carrying amount of inventories carried at fair value less cost to sell; (d) the amount of inventories recognised as an expense during the period; (e) the amount of any write-down of inventories recognised as a expense; (f) the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense;
(g) the circumstances or events that led to the reversal of a write- down of inventories; and (h) the carrying amount of inventories pledged as security for liabilities.
Differences between Ind AS 2, Inventories, and AS 2, Valuation of Inventories :
1. Ind A.S 2 deals with the subsequent recognition of cost/carrying amount of inventories as an expense, whereas the AS 2 does not provide the same (refer paragraphs 1 and 34 of Ind AS 2).
2. Ind A.S 2 provides explanation with regard to inventories of service providers whereas the AS 2 does not contain such an explanation (refer paragraphs 8, 19 and 29 of Ind AS 2).
3. A.S 2 explains that inventories do not include machinery spares which can be used only in connection with an item of fixed asset and whose use is expected to be irregular; such machinery spares are accounted for in accordance with Accounting Standard (A.S) 10, Accounting for Fixed Assets. Ind AS 2 does not contain specific explanation in respect of such spares as this aspect is covered under Ind AS 16.
4. Ind AS 2 does not apply to measurement of inventories held by commodity broker-traders, who measure their inventories at fair value less costs to sell. However, this aspect is not there in the existing AS 2. Accordingly, Ind AS 2 defines fair value and provides an explanation in respect of distinction between ‘net realizable value’ and ‘fair value’. The A.S 2 does not contain the definition of fair value and such explanation.
5. Ind AS 2 provides detailed guidance in case of subsequent assessment of net realisable value (refer paragraph 33 of Ind AS 2). It also deals with the reversal of the write-down of inventories to net realisable value to the extent of the amount of original write-down, and the recognition and disclosure thereof in the financial statements. A.S 2 does not deal with such reversal.
6. Ind AS 2 excludes from its scope only the measurement of inventories held by producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products though it provides guidance on measurement of such inventories (refer paragraphs 4 and 20 of Ind AS 2). However, A.S 2 excludes from its scope such types of inventories.
7. AS 2 specifically provides that the formula used in determining the cost of an item of inventory should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition whereas Ind AS 2 does not specifically state so and requires the use of consistent cost formulae for all inventories having a similar nature and use to the entity. Ind AS 2 also explains this aspect (refer paragraphs 25 and 26)
8. Ind AS 2 requires more disclosures as compared to the A.S 2
Click Here to download AS – 2 Valuation of inventories notes by ICAI.
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