Definition of Inventory AS 2 Inventories are Assets: ‘© Held for sale in the ordinary course of business (Finished Goods) ‘In the process of Production for Such Sole (i01P) or ‘© In the form of materials or supplies to be consumed in the production process or in the rendering of services (Raw Material). ‘As per the definition of inventory or closing stock it includes following things; ‘* Items which are held for sale in the normal course of business that is finished stock of goods. ‘© Work-in-progress (\0IP) for such sale. Goods which are not yet Finished or ready to sale. ‘* Raw material which is not even issued for production while valuation of closing stock or inventory. It also includes consumable stores item, Non - Applicability AS 2 AS-2 is not applicable to following cases. ‘© Work in process in the construction controct business including, directly related to service contract. ‘© Any financial instruments held as stock in trade which includes shares, debentures, bonds etc. ‘© Other inventories like livestock, agricultural product and forest product, natural gases and mineral oils ete. ‘© Work in progress in the business of banking, consulting and service business. That means it includes incomplete consulting service, merchant banking service and medical service in process. All of above are not cover under the definition of inventory/ closing stock that’s why this accounting standard if not become applicable to above cases or in the course of business. AS 2- VALUATION OF INVENTORIES 31MEASUREMENT OF INVENTORY AT BS DATE Cost of Inventory Valuation of inventory is made at cost or market/ net realisable value whichever is lower. So that for the purpose of valuation cost of inventory is required to obtain, There can be three types of cost are included in the inventory which are as follow. (@)__Purchase cost: ‘© Invoice price at which goods are purchased © Duties and taxes paid © Freight inward * Any other expenditure directly relating to acquiring goods Above cost should be reduced by following ‘© Duties and taxes received or receivable back from the tax authority ‘© Trade discount © Rebote © Duty drawback (b) Cost of Conversion It includes direct labour, material and other direct expense plus allocation of fixed and variable production overhead incurred for conversion or raw material in to finished goods. Following things should be considered for conversion cost of the inventory. |. Fixed production overhead — it includes indirect cost for production shich remains constant without relating to numbers of units produced. For example — depreciation and maintenance of Factory building. 2. Variable overhead — indirect cost of production which depends on the number of units are produced such as packing materiel and other supporting material to finished product. 3, Allocation of fixed expense should be made on the bases of normal capacity and ellocation of variable cost will be done on the basis of actual numbers of units are produced. Example on allocation of Overheads: Pluto Itd, has a plant with the normal capacity to produce 5,00,000 unit of a product per annum and the expected fixed overhead is € 15,00,000. Fixed overhead on the basis of normal capacity is & 3 per unit (15,00,000/5,00,000). Case I: ‘Actual production is $,00,000 units. Fixed overhead on the basis of nonmal AS 2- VALUATION OF INVENTORIES 32capacity and actual overhead will lead to same figure of € 15,00,000, Therefore, it is advisable to include this on normal capacity. Case 2: Actual production is 3,75,000 units, Fixed overhead is not going to change with the change in output and will remain constant at® 15,00,000, therefore, overheads on actual basis is € 4 p/u (1$,00,000/3,75,000). Hence by valuing inventory at & 4 each for fixed overhead purpose, it will be overvalued and the losses of & 3,75,000 will also be included in closing inventory leading to a higher gross profit then actually eamed. Therefore, it is advisable to include fixed overhead per unit on normal capacity to actual production (3,75,000 x 3) € I1,25,000 and balance € 3,75,000 shall be transferred to Profit & Loss Account. Case 3: ‘Actual production is 7,50,000 units, Fixed overhead is not going to change with the change in output and will remain constant at& 15,00,000, therefore, overheads on actual basis is % 2 (15,00,000/ 7,50,000). Hence by valuing inventory at & 3 each for fixed overhead purpose, we will be adding the element of cost to inventory which actually has not been incurred. At € 3 per unit, total fixed overhead comes to % 22,50,000 whereas, actual fixed overhead expense is only © 15,00,000. Therefore, it is advisable to include fixed overhead on actual basis (7,50,000 x 2) € 15,00,000. ©) Other cost It includes any other expenditure incurred to bring inventory or stock in the present locatio) condition. Cost should wot include abnormal wastage relating to material and labour, storage cost, administrative expenses & selling and distribution expenses. AS 16 — BORROWING COST The extent to which borrowing cost is included in the cost of inventories is determined on the basis of the requirement of AS 16 Borrowing Costs. Methods of valuation of inventory as per AS 2 AS 2- VALUATION OF INVENTORIES 33There ore numbers of method for valuation of the inventory in the normal course of business which includes FIFO, LIFO, weighted average cost, standard cost and retail method. But practically following tivo methods only used as per AS 2. ji. supply. FIFO (first in first out) Weighted average Net realisable value ‘As per AS 2 Net realisable value means normal selling price of the goods less estimated expenditure to sale such goods, It is estimated value on the basis of reliable evidence at time of valuation. Estimation of net realisable value can be done on the following basis. Hf the finished goods in which rai material and supply is used is sold at cost or above the cost, then the estimated realisable value of raw material and supplies is considered more than cost. It the finished goods in which ras material and supply are used is sold at belos cost then the estimated reolisable value of rai material or supply is equal to replacement price of raw material or Inventories T [Raw Materials Finished Goods and Work in progress At cost (if finished . goods are sold Lower of the following at or above cost), | Ee otherwise at 8 m Cost Net Realisable Value Ch ——) Costs] | Realisable value Cost of Purchase) | ,Costot | [Other Less Selling Expenses less estimated cost of completion Allocation of cost to joint products and by-products © A production process may result in more than one product being produced simultaneously. This is the case, for exomple, when joint products are produced or ‘hen there is @ main product and a by-product. When the costs of conversion of each product are not separately identifiable, they are allocated between the products on a rational and consistent basis. The allocation may be based, for example, on the relative sales value of each product either at the stage in the production process when the products become separately AS 2- VALUATION OF INVENTORIES 34identifiable, or at the completion of production. © Most by-products, by their noture, are immaterial, When this is the case, they are often measured at net realisable value and this value is deducted from the cost of the main product. As a result, the carrying amount of the main product is not materially different from its cost. TECHNIQUES FOR THE MEASUREMENT OF COST Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate to actual cost. Standard Cost Method: Cost is based on normal levels of materials and supplies, labour efficiency and capacity utilization. They are regularly reviewed and revised where necessary. Retail Method: Cost is determined by reducing the sales value of the inventory by the appropriate percentage gross margin. The percentage used takes into consideration inventory that has been marked dorn to below its original selling price. This method is often used in the retail industry for measuring inventories of rapidly changing items that have similar margins. What are Cost Formulas? AS 2 Inventories prescribes that when the inventories are: ‘© Not ordinarily interchangeable; and © Goods or services are produced and segregated for specific projects, their cost shall be assigned using specific Identification. This is rather unusual in practice, but it happens, for example when products are exclusive and unique, like jewelry, antiques or some types of automobiles. When the goods are ordinarily interchangeable (e.g. large volumes of merchandise), then IndAS 2 permits using either © FIFO, ie, first-in-first-out method; or ‘* Weighted average method. The standard AS 2 Inventories does not permit using LIFO (last-in-first-out). TRADE DISCOUNT & CASH DISCOUNT Trade discount shall alioays be deducted from cost of inventory while cash discount shall not be deducted, directly transfer to profit and loss account. EEDA con spatec) Sen Pharma Linited, a renowned company in the held of pharmaceuticals has the fellowsing four items Un imentoty: The Cost and Net realizable value is given as fallosss: item Cost Wet Realisable Value AS 2- VALUATION OF INVENTORIES 35.4 2000 7400 2 5000 5l00 é 4.900 4550 2 3200 2990 Total 15600 14,540 Determine the volue of Inventories: 2. On an item by stem basis 4.0n a group basis Solution ‘inventories shall be measured at the lower of cost and net realisable value, ‘item by item basis: a 1400 zs 5,000 c 4400 > 2940 14,290 “Group basis 14,540 za CAL Module) The company deals 1 three products, A, B and’ 6, which are neither similar nor interchangeable. At the time of closing of its account far the year 2016-17, the Historical Cost and Net Realisable Value of the items of closing stock are determined as Follows: ttems | Historical Cost (Rs in lakhs) Wet Realisable Value (Rs in lakhs) a 4 2 2 32 32 e 6 26 What will be the value of closing stock? Solution As per AS 2 (Revised) on ‘Valuation of inventories’, inventories should be valued at the lower of cost and net reolisable valuestnvehtories should be written doin to net realisable value on an item-by-item basis in the given case. tems Historical Cost Net Realisable Value Valuation of closing (Rs in lakhs) (Rs in lakhs) stock (Rs in lakhs) a ry] 2 Fr 3 32 32 32 ¢ 16 24 6 ae 4 76 AS 2- VALUATION OF INVENTORIES 36Hence, closing stock will be valued at Rs 76 lakhs. Ez CAI Module) X Co, Limited purchased goods at the cost of Rs 40 lakhs in October, 2018. TH March, 20/7, 75% of the stocks were sold. The company wants to disclase clesing stock at Rs 10 lakhs. The expected sale value is ‘Rs I lakhs and a commission at 10% on sale is payable to the agent. Advice, what is the conect closing stock to be disclosed as at 313.2077, Solution AS per AS 2 (Revised) “Valuation of Inventories”, the inventories are to be valued at lower of cost or net realisable value. In this case, the cost of inventory is Rs 10 lakhs. The net realisable value 7s 11,00,000 x 90% = 4,90,000 50, the stock should be valued ot Rs 9,90,000; BEA, 0 seat In a production process, normal waste Is 5% of input. 5,000 MT of input were put in process resulting in wastage of 300 MT. Cost per MI of input ls € 1,000. The entire guantity of waste is on stock at the year end. State with reference to Accounting Standard, how sill you value the Imentories in this case? Solution ‘As per AS 2 (Revised), @lonormal amounts of wasted taterials, labour and other production costs are excluded from cost of inventoriés.and such costs are recognised as expenses in the period in which they ‘are incurred, {In this case, normal waste is 250 MT and abnormal waste is 50 MT. The cost of 250 MT will be included in determining the cost of inventories (finished goods) at the year end. The cost of abnormal waste (50 MT x 1,052.6315 = Rs $2,632) will be charged to the profit and loss statement. Cost per MT (Normal Quantity of 4,750 MT) = 50,00,000 / 4,750 = Rs |,052.6315 Total value of inventory =\4,700 MT x Rs 1,052.6315 = Rs 49,47,368. Ea CAL Module) You are required to value the inventory per kg of tinished goods consisting of Rs per ky. ‘Material cost 200 bivect labour 4 Direct variable overhead 2 Fixed production charges far the year on normal working capacity of 2 lakh kgs is Rs 20 lakhs, 4,000 kes of Pnished goods are in stock at the year end. AS 2- VALUATION OF INVENTORIES 37Solution 1n accordance with AS 2 (Revised), the cost of conversion include a systematic allocation of fixed and variable overheads that. are incurred in converting materials into finished goods. The allocation of fixed overheads For the purpose of their inclusion in the cost of conversion is bosed on normal capacity of the production facilities. Cost per kg, of finished goods: Rs Material Cost 200 Direct Labour 40 Direct Variable Production Overhead 20 Fixed Production Overhead (2000000/200000) 0 Hence the value of 4,000 kgs. of finished goods = 4,000 kgs x Rs 27 PA roe) n 5st March 2012, a business ttm finds that cost of a partly finished unit on that date is Rs 530. The init can be finished in 2017-18 by an additional expenditure of Rs 310. The finished unit can be sold far ks 750 subject to payment of 99% brokerage on selling price. The firm seeks your advice regarding the amount at which the unfinished unit should be valued as at 3tst March, 2017 far preparation of Final accounts, assume that the party finished unit cannot be sold in semi Finished form and its NRV is 2670 without processing it farther, RsiN0,80,000 Solution VALUATION OF UNFINISHED UNIT Rs ‘Net selling price 750 Less: Estimated cost of completion G0) 440 Less: Brokerage (4% of 750) Go) Net realizable Volue 410 Cost oF inventory 330 Volue of inventory CLower of cost and net realizable value) 410 za RTP Wov.t3) A Limited is engaged in manutacturing of Chemical ¥ for which Rass Material X is reguired. The company provides you following information for the year ended 31st March, 2017, Particulars Rs. Raw Material ¥ ast price 380 nloading Charges 20 AS 2- VALUATION OF INVENTORIES 38Freight imvard @ ‘Replacement cost 300 Chemical ¥ ‘Material consumed 440 Direct Labour 120 Variable overheads Zz Additional information: ‘© Total fixed overhead for the year was 4,00,000/- on normal capacity of 20,000 units, © Chasing balance of Rav Material X was 1,000 units and Chemical ¥ was 2,400 units, You are regutred to calculate the total value of closing stock of Raw» Material X and Chemical ¥ according to AS 2, when Q Net realizable value of Chemical ¥ is 800/- per unit GD Wet realizable value of Chemical ¥ is 600/- per unit Solution G@) When Net Realizable Value of the Chemical ¥ is 300/- per unit RV is greater than the cost of Finished Goods ie. 660/- (Refer iN.) Hence, Rave Material and Finished Goods ate to be Valued ot cost. Value of Closing Stock: ety. Rate Amount Raw Material X 7000 4 440,000 Finished Goods ¥ 2,400 680 15,845000 Total Value of Closing Stock 20,24,000 Gi) When Net Realizable Value of the Chemical ¥ is 600/- per unit RV is less than the costlof Finished. Goods Y ie. % 660. Hence, Raw Material is to be valued at replacement cost and Finished Goods are to be valued at NRV since NRV is less than the cost. Value of Closing Stock: ey. Rote | Amount ‘Raw Material X 1,000 300 3,00,000 Finished Goods ¥ 2400 600 14,40,000 Total Value of Closing Stock 17,40,000 Working Note: Raw Material X Amount Cost Price 350 ‘Adal Freight innard @ Unloading charges 20 Cost “a Chemical ¥ Armount Materials consumed 440 AS 2- VALUATION OF INVENTORIES 39Direct Labour 120 Variable overheads 30 Fixed overheads (%4,00,000/20,000 units) | 20 Cost 660 EEE, 1 siete WA td. purchased raw material @ F 400 per kg. Company dees not sell raw material but uses in prodtction of finished goods, The finished goods in which rass material 's used are expected to be sold at below cost. At the end of the accounting yeor, company is having 18,000 kg of ras material in inventory. As the company never sells the rasy material, it does not knows the selling price of rasy material and Aence cannot calculate the realizable value of the raw material far valuation of imentories at the end of the year, However, replacement cost of rass material is ® 300 per lg, Hosa soil you value the imentory of raw material? Answer: As per Ind AS 2 “inventories”, materials and other supplies held for use in the production of inventories ‘are not written down below cost if the Finished products in which they will be incorporated are expected to be sold ot or above cost. However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realizable value, the materials are written down to net realizable value. in such circumstances, the replacement cost of the materials may be the best avoilable measure of their net realizable value. Therefore, in this case, UA Ltd. will Value thelinventory of raw material at % 30,00,000 (10,000 ko. @ 300 per kg.). AS 2- VALUATION OF INVENTORIESStudent Notes:- AS 2- VALUATION OF INVENTORIES BalStudent Notes:- AS 2- VALUATION OF INVENTORIES 3.12