AS-2

Valuationof
Inventories

ACCOUNTING STANDARDS-2

VALUATION OF INVENTORIES
Key Points
Definitions
Inventories not covered by the Standard
Determination of cost of inventories
Exclusions from cost of inventories
Cost formulas
Method for valuation of inventories
Principles for valuation of inventories
Disclosure requirements
Objective

To formulate the method of computation

of cost of inventories and determine the
value of inventory at which it will be
shown in the Balance Sheet till it is not
sold and recognised as revenue.
 Inventories - Defined
Inventories are assets……

Held for sale in the

ordinary course of Held in the process
business. of such sale.

Held in the form of materials or supplies

that will be consumed in the production
process, or in rendering services.
To be brief, inventory includes…

Raw Material
Work-in Progress
Finished Goods
Spares
Consumables
Packaging Material
Consumables - not Spares – replaced and doesn’t
replaced and finished vanish from the machine
during the process during the process e.g. duct
e.g. Oil, coolant tapes, screw drivers
 Applicability
AS – 2 not applicable

Shares, debentures
and other financial
WIP under construction instruments held as
contracts, stock in trade

Livestock, agricultural and forest

WIP of service products, mineral oils, ores and
gases etc.
providers
Measurement of Valuation of
Inventories

Valuation of
inventories

Estimated Net
Cost
Realisable Value
Purchase
Selling price, less costs
Conversion
Of completion and
Other costs
Cost of sale
What costs to
be included
in inventory?
Cost includes….
The cost of inventories should comprise
all costs of purchase, costs of conversion
and other costs incurred in bringing the
inventories to their present location and
condition.
COSTS OF PURCHASE…
It includes…
Purchase Price
Duties and taxes (other than those
subsequently recoverable by the
enterprise from the taxing authorities)
Inward freight and Insurance for goods-
in-transit
Other expenditure directly attributable to
the acquisition.
COSTS OF PURCHASE…

What it does not include…

Trade Discounts and rebates.

Duty Drawbacks, Duties and taxes

subsequently recoverable by a firm from

the taxing authorities.

COSTS OF CONVERSION …
It includes all those expenses that are
incurred to convert raw material into
work-in-progress and finally, into finished
goods. Such a cost is generally called
CONVERSION COST.
Conversion Cost includes…
Direct Labour Cost
Fixed and variable production overheads
Joint Costs
 Carpenter in furniture unit Weaver in weaving unit

Tailor in readymade garment unit

Direct
Labour
Cost
(Examples)
COSTS OF CONVERSION …
Fixed production overheads…..
are indirect costs of production that remain fixed
irrespective of volume of production such as
depreciation. They should be charged to units of
production on the basis of normal capacity
Variable production overheads…..
they vary directly with the volume of production such
as indirect materials and indirect labour

Indirect Material – lubricating oil Indirect Labour – e.g. janitors

used in the production deptt
OTHER COSTS …

(A) Other costs are included in the cost

of inventories only to the extent that

they are incurred in bringing the

inventories to their present location and

condition.
e.g. expenditure incurred in designing products for specific
customers
OTHER COSTS …

(B) Interests and other borrowing

costs are excluded unless
specifically covered by AS 16 to be
included in the cost of the
qualifying product
Exclusion from cost of inventories
Storage Costs, unless those costs Administrative Overheads that
are necessary in the production do not contribute to bringing the
process prior to a further inventories to their present
production stage. location and condition.

Abnormal amounts of wasted

Selling and Distribution materials, labour and other
Costs. production costs
 Methods of
Inventory
Valuation
(on Actual Cost Basis)

Inventory, not Inventory,

ordinarily ordinarily
interchangeable interchangeable

Specific Weighted
Identification FIFO Average
Method Method
 Specific
Identification
Method
Specific Identification…
This method requires no assumption about the flow
of inventory units.
This method is used when items:
…are unique.
…can be directly identified with a specific purchase
and its invoice.
…are relatively small in number.
…are easily distinguishable.
Where Specific Identification
Method can be used?
Examples: Automobiles, custom furniture,
some types of jewelry, art.
Methodology

It is necessary for the business to

Keep records of the purchase price of
each specific unit
Keep records of each specific unit sold
and
Determine the ending inventory by
totalling the original cost of all the
specific units on hand
 Weighted
FIFO
Average
Where
specific
identification
method not
followed
 FIFO
( First In
First Out)
FIFO… First In, First Out.
The assumption about the flow of inventory
made under FIFO is …

The items are sold/issued in the

order they are acquired. It means
that an item received FIRST will
be sold/issued FIRST.
FIFO…..
FIFO… First In, First Out.
When a Sale/an issue occurs:

The earliest units purchased are

charged to Cost of Goods Sold.

The cost of the most recent purchases

remain in inventory.
Weighted
Average
Cost
Weighted Average Cost
Method…
❑ Under this method, no specific assumption is
made about the flow of inventory made.
❑ Cost of Goods Sold/Issued is computed by
multiplying the number of units sold/issued by
the average cost per unit.
❑ Average Cost is computed for all inventory
available for sale during the period.

Average cost per unit

Cost of goods available for sale
= Number of units available for sale
Other Methods of Inventory Valuation
(Other than actual cost basis)

Retail Method

Standard Cost Method

Retail Method
This method is not on actual cost but aims at ensuring that the
value of inventories being a close approximation to cost

Used by retail businesses, particularly department stores, that have

numerous items with low unit costs usually.

Needed information includes:

Beginning inventory at cost and retail.

Net purchases at cost and retail.

Net sales.
Value of CS at retail prices OS + Purchases – Sales
₹ 160000 + ₹ 280000 - ₹ 400000
₹ 40000

Average % of cost to retail prices ₹ 𝟏𝟐𝟎𝟎𝟎𝟎 + ₹ 𝟐𝟒𝟎𝟎𝟎𝟎

𝑿 𝟏𝟎𝟎
₹ 𝟏𝟔𝟎𝟎𝟎𝟎 + ₹ 𝟐𝟖𝟎𝟎𝟎𝟎

= 81.82%

Value of CS at cost price ₹ 40000 X 81.82%

= ₹ 32728
Standard Cost Method…….

This method is based upon standard cost

which is the predetermined price based
on the attainable efficiency standard for
the given volume of output
Standard cost is determined by careful
consideration of various factors which are
likely to affect cost such as quantity of
purchase, quantity discount,
transportation costs…..
Standard Cost Method
Standard costs take into account normal levels
of consumption of materials and supplies,
labour, efficiency and capacity utilisation. They
are regularly reviewed and, if necessary,
revised in the light of current conditions.

Under this method, the cost of goods

sold/issued and the closing inventory is
calculated at the standard cost.
Net Realisable Value

Net realisable value

means the estimated
selling price in ordinary
course of business,
less estimated cost of
completion and
estimated cost
necessary to make the
sale.
Comparison between Cost and Net
Realisable Value
The LCM principle may be applied on
either :
1. Aggregate basis
2. Group basis
3. Item wise basis As per AS 2, the
Comparison between
Cost and NRV
Should be made
Item by item or by
Group of items
 X Ltd gives you the following details of the inventory for the year 2021-22. Find out the value of
closing inventory by (a) Group method; (b) Item by item method:
Article Group No. of units Cost per unit (₹) Realizable value per unit (₹) Realization Expenses
1. A 200 100 120 25/3%
2. B 400 200 200 10%
3. A 600 150 160 25/3%
4. B 800 250 300 10%
 X Ltd gives you the following details of the inventory for the year 2021-22. Find out the value of
closing inventory by (a) Group method; (b) Item by item method:
Article Group No. of units Cost per unit (₹) Realizable value per unit (₹) Realization Expenses
1. A 200 100 120 25/3%
2. B 400 200 200 10%
3. A 600 150 160 25/3%
4. B 800 250 300 10%
RM should be measured at lower of
cost or replacement cost
Disclosures

Accounting policies adopted in valuing

inventories, including the cost formula used
Total carrying amount of inventories and its
classification appropriate to the enterprise

Examples of common classification are (i) raw

materials (ii) WIP (iii) finished goods
(iv) stores and spares
(v) Loose Tools
Raw Material
Particulars Kg ₹

Purchase Price(10000 kg x ₹ 100) 10000 10,00,000

GST credit(10000 kg x ₹ 10) -100000
Freight, loading & unloading charges 40800
Total material cost 940800
Normal Loss(10000 x 2%) 200
Total Cost of normal units 9800 940800
Cost of normal units per kg 96
Cost of materials consumed@₹ 96 9500 912000
Cost of closing inventory@₹96(9760 - 9500) 260 24960
Cost of abnormal loss@₹96(9800 - 9760) 40 3840
Finished Goods
Particulars Kg ₹

Materials consumed 912000

Direct labor cost 228000
Direct overheads cost 57000
Fixed overheads(₹ 600000/20000 units) X 1900 57000
Cost of production of finished goods 1900 1254000
Cost of production of finished goods per unit 660
Cost of closing inventory of finished goods(900 x ₹
660) 594000
Valuation of Stock
Case 1 Cost NRV Case 2 Cost NRV
Raw material 96 90 Raw material 96 90
Finished goods 660 720 Finished goods 660 630
 What are
inventory
systems?
The issue of Inventory System
is …

… should we record transactions related

to inventory INSTANTANEOUSLY or
PERIODICALLY?
If we record transactions related
to inventory INSTANTANEOUSLY,
then we are using a System of
Inventory which is known as …
PERPETUAL INVENTORY
SYSTEM
And, if we are recording
transactions related to
inventory periodically then, it is
called … PERIODIC
INVENTORY SYSTEM.
Overview of Perpetual and
Periodic Systems
Perpetual system
Inventory records are updated whenever a
purchase or a sale is made.
Advances in information technology have
made the cost of using this system practical.
Periodic system
Inventory records are not updated when a
sale is made.
Perpetual Inventory System
It is a method of recording changes in
inventories on a continuous basis in the
Inventory Account.
It provides a continuous record of the balances
in both Inventory Account and Cost of Goods
Sold Account.
The affordability of the computerized
accounting software have made the perpetual
system of inventory cost effective for many
kind of businesses.
Periodic Inventory System

Under this method, changes in

inventories are recorded on periodic basis
and thus, inventory balances and the cost
of goods sold can be determined only on
periodic basis.
Taking a Physical Count of
Inventory
The actual quantity on hand is determined by
taking a physical count in case of periodic
inventory system and a cost is attached to the
quantity counted.
With a perpetual system, closing balance of
inventory can be taken from the Inventory
Account and a physical count can reveal
inventory shrinkage or clerical error.
Periodic vs Perpetual System
Periodic Perpetual
Based on physical Based on book records
verification
This exercise is It is continuous process
undertaken periodically and provides running
usually once in a to record of inventories in
ascertain value of stock hand
Directly determines Directly determines
Stock and takes cost of cost of sales and takes
goods sold as residual stock as balancing figure
figure
Simple & less expensive Costlier
Periodic vs Perpetual System
Periodic Perpetual
Cost of sales includes Closing stock includes
loss of goods as goods loss of goods as all
not in stock are assumed unsold goods are
to be sold assumed to be in stock
Inventory control not Easier to exercise control
possible because as physical stock can be
shortages/discrepancies verified from book record
cannot be located and shortages can be
immediately. investigated immediately/
Requires closure of Stock can be determined
business for counting of without affecting the
stock. It is suitable for operation of business.
small organisations Good for large concerns.
How to find
the Value of
Inventory?
The issue of Inventory Valuation
requires…

…an assumption about

the flow of inventory so
that we can judge the
flow of cost of inventory!!!
Remember…
Flow of physical inventory is
difficult to know and hence,
there is a need of making an
assumption about the physical
movement of inventory.
And, according to the physical
movement assumption, cost flow
is presumed.
Evaluation of FIFO
Merits Demerits
Conforms to the physical flow Cost of goods sold does not
of goods reflect the current cost and the
cost of job may be understated
Simple
Minimises losses from
Spoilage and deterioration
bcoz goods purchased first are
issued first
In periods of falling prices, In periods of rising prices,
lower income is reported, thus Higher income reported
income tax liability is reduced
LIFO… Last In, First Out.
The assumption about the flow of inventory
made under LIFO is …

•The items are sold/issued in the

reverse order they are acquired. It
means that an item received LAST
will be sold/issued FIRST.

It means that the newest units are sold

and the oldest units remain in inventory.
LIFO… Last In, First Out.
When a Sale/an issue occurs:

The LATEST units purchased are

charged to Cost of Goods Sold.

The cost of the OLDEST units remain

in inventory.
Evaluation of LIFO
Merits Demerits

Matching current Does not conform to

costs with current the physical flow of
revenues goods

In periods of rising In periods of falling

prices, lower income, prices, higher income,
thus income tax thus income tax
liability is reduced liability is increased
Weighted
Average
Cost
 Average Cost Method…
❑ Under this method, no specific assumption is made
about the flow of inventory made.
❑ Cost of Goods Sold/Issued is computed by
multiplying the number of units sold/issued by the
average cost per unit.
❑ Average Cost is computed for all inventory
available for sale during the period.

Average cost per unit

Cost of goods available for sale

= Number of units available for sale
Evaluation of Weighted Average
Cost
Merits Demerits
Averages out the effect of Puts heavy burden on
price fluctuations clerical staff because a
new weighted average
price is required to be
calculated on the receipt
of the new lot
Objective, consistent and Does not match recent
does not permit profit costs with current
manipulation revenue as LIFO does
 Inventory CostI Flow Methods

FIFO LIFO Average Cost

• The oldest units • The newest • An average cost is
are sold and the units are sold computed for all
newest units and the oldest inventory available
remain in units remain in for sale during the
inventory. period.
inventory.
• The cost of the •COGS is computed
• The cost of the most recent by multiplying the
oldest units units number of units sold
purchased is purchased is by the average cost
transferred to transferred to per unit.
COGS. COGS.
 Compare Inventory Methods:
General
✓ LIFO gives a
better reflection
 FIFO gives a
of COGS in the better measure
income of inventory on
statement. the balance
✓ Therefore, sheet.
LIFO is a better  Therefore,
measure of
FIFO is a better
income.
measure of
inventory
value.
Compare Inventory Methods –
During Increasing Prices

LIFO provides a
proper value of  It
COGS in the undervalues
income statement COGS and
and Profits are provides
less. MORE profit.
 FIFO provides
But, it provides proper value
undervaluation of of inventory
inventory on
Balance Sheet. in the balance
sheet.
Compare Inventory Methods –
During Decreasing Prices
LIFO provides
lower value of  It provides
COGS in the higher COGS
income statement and provides
and Profits are
more. less profit.
 FIFO provides
But, it provides lower value of
higher value of inventory in
inventory on
Balance Sheet. the balance
sheet.