Inventory Valuation Semester 1

Download as pdf or txt
Download as pdf or txt
You are on page 1of 36

Inventory Valuation

Accounting Standard -2

Dr. Rama Nag (De)


Associate Professor

mail-id: rama00tdc@gmail.com
Our focus will be on the following topics

⮚ Meaning of Inventory
⮚ Features of Inventory
⮚ Different methods of pricing the issue of
materials
⮚ Valuation of Inventory as per AS-2 and its
Significance
⮚ Inventory Reconciliation
1.Meaning of Inventory
Some of the goods purchased or manufactured during a
particular accounting year, may not be sold during that year
only. On the other hand, some of the goods, for which
manufacturing process has been started during a particular
accounting year, may not be finished or saleable in the market
during that year, and consequently those semi-finished or
incomplete goods cannot be sold during that year. As a result,
there might be some unsold stock of raw materials or work-in-
progress (i.e. semi finished goods) or finished goods at the end
of every accounting year which becomes opening stock of next
accounting year.
As per Accounting Standard-2, Inventory means asset
held for sale in normal course of business.

The Inventory of different types of entities usually


include the following:

Types of entity Inventories


Manufacturing entity Raw materials, stores, spares, supplies, WIP,
finished goods

Trading / merchandising Supplies, finished goods


entity

Service-rendering entity Stores, spares


2. Features of Inventories
Inventories possesses the following features given below:-

● It can be of different patterns like raw materials, spares,


stores, work-in-progress, finished goods.
● It is a part of current asset of every concern.
● It is kept by all types of trading and manufacturing concerns.
● Value and quantity of inventory are continuously changing
with passage of time.
● It is a major component of working capital of every concern.
● Inventory is a generally valued at the end of every
accounting year
3. Valuation of Inventories
Accounting Standard 2 deals with the Valuation of Inventory.

Inventories is a generally valued at the end of every accounting


year.

As per AS - 2, INVENTORIES ARE TO BE VALUED AT LOWER OF


COST OF INVENTORY OR NET REALIZABLE VALUE(NRV) OF
THE INVENTORY.

Such selection of lower value is considered on item by item basis


(not on global basis).
Illustration-1:

Determine the value of closing stock for the given case- The company
deals in three products A, B & C which are neither similar not
interchangeable. At the time of closing its accounts of the year 2014-15,
historical cost and the net realisable value of the items of the closing stock
are determined as follows:

Items Cost (in lakhs) NRV (in lakhs)

A 40 28

B 32 32

C 16 24
Solution

As per AS-2, Valuation of Inventory, whenever Finished goods or WIP are to be


valued, then lower of Cost & NRV should be taken on Item by Item basis. In the
given case, stock to be valued as follows-

Items Cost (in lakhs) NRV (in lakhs) Lower


A 40 28 28

B 32 32 32

C 16 24 16

The Closing Stock is Rs. (28+32+16) lakhs = Rs. 76 lakhs


Calculation of Net Realizable Value (NRV)
For FINISHED GOODS-

Estimated Selling Price (market price) XXXX


Less: Estimated Selling Expenses (XXX)
Net Realizable Value XXXX
For WIP-

Estimated Selling Price (market price)


XXXX
Less: Estimated Selling Expenses
(XXX)
Less: Expenses incurred to complete production
(XXX)
Net Realizable Value
XXXX
Examples of Selling Expenses:- Commission on sale, Delivery Expenses,
etc.
Illustration-2

A Ltd. is a producer of chemicals. It provides the following information-


Chemical 1- 10,000 units- Cost Price Rs. 5/unit
Chemical 2- 15,000 units- Cost Price Rs. 6/unit
Semi- Finished Chemical 1- 6,000 units- Cost Price Rs. 3/unit

Estimated selling price:


Chemical 1- Rs. 5.20 ; Chemical 2- Rs. 6.30.
Commission to sale is 5% of selling price. Cost incurred for completion of
Chemical-1 is Rs. 1.30/unit. Calculate the value of inventory
Solution Calculation of Vauation of Inventory: Lower of Cost or NRV
Items Cost Particulars NRV Quantity Closing stock

Chemical-1 5 Estimated SP 5.20 - -

- - (-) Commission @5% (0.26) - -

5 Net value 4.94 10,000 49,400

Chemical-2 6 Estimated SP 6.30 - -

- - (-) Commission @5% (0.315) - -

6 Net value 5.985 15,000 89,775

Chemical-1 (WIP) 3 Estimated SP 5.20 - -

- - (-) Commission @5% (0.26) - -

- - (-) Cost to complete (1.30) - -

3 Net value 3.64 6,000 18,000

- - - - - 1,57,175
Valuation of Defective Finished Goods
As per Accounting Standard-2, goods are valued at Cost
or NRV, whichever is LOWER.
Generally, due to this defective nature in the goods,
NRV is having a lower estimation.
These defective goods are generally valued at NRV only.
Meaning of Cost
Cost is defined as the value of money that has been used
to produce something or deliver a service. Cost can be
calculated using various cost techniques.

These techniques are elaborated as follows:-

● Standard Cost Technique-


Standard Cost Technique means the cost which is
considered from cost accounts’ department in the
entity. This standard cost is generally not available in
small entities.
● Retail Price Technique-
Here profit (GP) is reduced from selling price to calculate the
cost price. This technique can be applied where the GP ratio
is constant and the selling price of the stock can be
identified.
● Actual Cost Technique-
Actual Cost Technique is the most detailed method of
calculating cost of stock.
Calculation of Actual Cost
Cost of raw material- No. of units × Cost per unit XXXX

Where, {Cost of unit= Landing Cost / (Purchased quantity - Normal Loss)}

{Abnormal Loss is calculated as= (units lost abnormally × cost per unit),

Labour cost- No. of hours × cost per hour


XXXX
Production overhead- No. of units × production overhead per unit XXXX
Less: Sale Proceed of By-product (XXX)

Total Cost XXXX

## Cost of Finished Goods = Total Production Cost / [Input Quantity - Normal Loss]

Abnormal cost is to be written of in Profit & Loss A/c


Note:
1. Landing Cost of Raw Materials 2. Following costs are
not included in the Cost
Particulars Rs. of Production
Purchase price XXXX
A. Selling expenses
Add: Unloading charges XXXX B. General administration
overhead
Add: Freight inward XXXX C. Finance cost /
borrowing cost
Add: Taxes (if GST credit not XXXX
available) D. Storage cost
E. Abnormal loss
Landing cost XXXXX
Illustration-3:

X Ltd. Purchased goods at the cost of Rs. 40 lacs in October, 2005. Till March,
2006, 75% of the stocks were sold. The company wants to disclose closing stock
at Rs. 10 lacs. The expected sale value is Rs. 11 lacs and a commission of 10% on
sale is payable to the agent. Advise, what is the correct closing stock to be
disclosed as at 31.3.2006.

Solution:

It is a finished stock, hence it will be taken at Cost or NRV whichever is LOWER.

Cost 40,00,000 × 25% 10,00,0000

NRV Estimated Selling Price 11,00,000


(-) commission (@10%) (1,10,000) 9,90,000

Hence, Value of the Closing Stock is Rs. 9,90,000


SIGNIFICANCE OF VALUATION OF
INVENTORY

As per Accounting Standard - 2, inventory should be valued by a


concern on the principle of its Cost or NRV whichever is LOWER.

The significance of valuation of inventories are as follows:-

➔ To value the inventory in accordance with its current


market price
➔ To ascertain current year's profit correctly
4. Different Methods of Pricing the Issue of Materials
Pricing the issue of materials refers to the price at which
materials are issued from stores to the production process.
Different methods which are used for pricing the issues of
materials from stores to production process are discussed below:
● Cost Price Methods:
○ Specific Price Method
○ First-in First-out (FIFO) Method
○ Last-in First-out (LIFO) Method
○ Base Stock Method
● Average Price Methods:
○ Simple Average Price Method
○ Weighted Average Price Method
○ Periodic Simple Average Price Method
○ Periodic Weighted Average Price Method
○ Moving Simple Average Price Method
○ Moving Weighted Average Price Method
● Market Price Methods:
○ Realizable Price Method
○ Replacement Price Method
● Notional Price Methods:
○ Standard Price Method
○ Inflated Price Method
● Reuse Price Method
Out of the above methods some important and frequently used methods of
pricing the issues of materials are discussed below:

● FIRST-IN FIRST-OUT (FIFO) METHOD-


In this method, materials received first in the store are to be issued
first to the production process. The price at which the materials, is
received second, second materials are to be issued from the store
at that price and so on.

● LAST-IN FIRST-OUT (LIFO) METHOD-


In this method, materials received last in the store are to be issued
first to the production process. The price at which the materials is
received prior to the last materials, second materials are to be
issued from store at that price and so on.
● BASE STOCK METHOD-
This method assume that a minimum quantity of stock must be
maintained by an entity at all times for its regular operations. This
minimum quantity of stock is known as Base Stock (or Safety Stock
or Buffer Stock). It is valued at its original purchase cost, while the
stocks over this level are valued under any other method such as
FIFO, LIFO, Average, etc.

● SIMPLE AVERAGE PRICE METHOD-


This method is applicable when goods are acquired at different
prices and they are not clearly identifiable. The stock that are
issued are valued at average price determined on the basis of the
price of lots existing on the date of issue.
● WEIGHTED AVERAGE PRICE METHOD-
This method of material pricing determines the value of inventory
considering both the prices of materials and the quantities of such
materials acquired. The weighted average price method is
determined using any one of the following two formulas :

➔ Under Perpetual System-


(Total Cost of Inventory Owned) / (Total Quantity of Inventories)

➔ Under Periodic System-


(Value of Op. Stock + purchase cost of Stock) / (Qty. of Op. Stock + Qty. of
Stock purchased)
5. INVENTORY RECONCILIATION
Sometimes, stock of goods may not be valued on the date of
preparation of financial statements of an entity; rather stocks
are valued after few days from the date of preparation of
financial statements. As a result, some transactions are
involving stock may take place in between the date of
preparation of financial statements and the date of actual stock
valuation. In such a situation, a reconciliation of inventory
between the date of preparation of financial statements and the
date of actual stock taking is needed. Accordingly, inventory
reconciliation statement is started from the value of physical
stock as on the date of actual stock taking and ended at the
value of physical and/or actual stock on the date of preparation
of financial statements.
Illustration-4:
Solution:

Statement showing computation of value of closing stock as on 31-3-2014

Particulars Details Amount


Stock on 01-04-2013 at cost 40,000

Add: Purchases for the year 2013-14 2,25,000


Add: Credit purchases not recorded 25,000 2,50,000

Less: Sales of the year 2013-14 at cost (Rs. 3,00,000 - 30% thereof) (2,10,000)

Value of Closing Stock as on 31-3-2014 80,000


Illustration-5:
Solution:
1. Here, net realizable value of the product (i.e. Rs. 420) is less than
its total cost (i.e. Rs. 450) and cost of raw material (i.e. Rs. 250)
is more than the replacement cost (i.e. Rs. 210). In the situation,
raw materials should be valued at replacement cost and the value
of stock of raw materials would be: (500 units × Rs. 210 =) Rs.
1,05,000.
2. Here, net realizable value of the product (i.e. Rs. 490) is more
than its total cost (i.e. Rs. 450). the situation, raw materials
should be valued at actual cost of materials and the value of stock
of raw materials would be: (500 units × Rs. 250 =) Rs. 1,25,000
Illustration-6:
Illustration-7:
THANK YOU
MAKING AN IMPACT THAT MATTERS !!

You might also like