A write up on Accounting Standard – 2, Valuation of Inventories

1. Assumption for this write up:

a. The Company understands and accepts that their raw material, WIP and finished
goods qualify under the definition of AS 2.
b. The Company follows standard costing method of accounting.
c. The Company has followed the AS 2 requirements for measuring the Cost of
Inventories, Costs of Purchase, Costs of Conversion and other defined costs
2. Purpose of write up
a. To throw light on whether standard costing is an accepted method of costing
b. To identify method of Valuation disclosure in case of adoption of standard costing
method of valuation.
3. Important extracts from AS 2, Valuation of Inventories:
a. As per paragraph 14 - “The cost of inventories of items that are not ordinarily
interchangeable and goods or services produced and segregated for specific projects
should be assigned by specific identification of their individual costs.”
b. As per paragraph 15 –“Specific identification of cost means that specific costs are
attributed to identified items of inventory. This is an appropriate treatment for
items that are segregated for a specific project, regardless of whether they have
been purchased or produced. However, when there are large numbers of items of
inventory which are ordinarily interchangeable, specific identification of costs is
inappropriate since, in such circumstances, an enterprise could obtain
predetermined effects on the net profit or loss for the period by selecting a
particular method of ascertaining the items that remain in inventories.”
c. As per paragraph 16 – “The cost of inventories, other than those dealt with in
paragraph 14, should be assigned by using the first-in, first-out (FIFO), or weighted
average cost formula. The formula used should reflect the fairest possible
approximation to the cost incurred in bringing the items of inventory to their
present location and condition.”
d. As per paragraph 17 – “A variety of cost formulas is used to determine the cost of
inventories other than those for which specific identification of individual costs is
appropriate. The formula used in determining the cost of an item of inventory needs
to be selected with a view to providing the fairest possible approximation to the cost
incurred in bringing the item to its present location and condition.
e. As per paragraph 18 – “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 the actual cost. 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.”
f. As per Paragraph 26 – “The financial statements should disclose:
i. (a) the accounting policies adopted in measuring inventories, including the
cost formula used; and
ii. (b) the total carrying amount of inventories and its classification appropriate
to the enterprise.”
 g. As per Paragraph 27 – “Information about the carrying amounts held in different
classifications of inventories and the extent of the changes in these assets is useful
to financial statement users. Common classifications of inventories are raw
materials and components, work in progress, finished goods, stores and spares, and
loose tools.”
4. Interpretation of the above mentioned extracts of AS – 2 in context with the standard
costing method of costing:
a. As per Paragraph 17, the underlying principle for using a particular cost formula for
valuing inventory is to provide the fairest possible approximation to the cost
incurred in bringing the item to its present location and condition and as per
paragraph 18, standard costing method can be used for convenience if the results
approximate the actual cost. Hence, standard costing is an accepted form of
inventory valuation under AS -2.
b. As per Paragraph 16, the inventory costing has to be done using FIFO or weighted
average cost formula only in those cases where specific identification of costs is
inappropriate or not possible. Specific identification of costs is inappropriate of cost
is defined in paragraph 14 & 15. Since, the products of the Company are a result of
differentiated input & conversion process, the valuation of the output will be
specific. Management has to establish that the standard costing results in specific
identification of the costs for each of the product, if management does so, then,
their method of costing is acceptable under paragraph 16.
5. Conclusion:
a. As per AS 2, FIFO and weighted average cost are not the only two methods of
inventory valuation; they are only two popular methods.
b. AS 2 permits Company to use standard costing or retail costing or any other specific
identification of individual costs method, as a method of inventory valuation,
provided they can establish that their method of costing results in specific
identification of the costs for each of the product, i.e., more appropriate than FIFO
or WAC.
c. The Company has to ensure the disclosure of the accounting policy in measuring
inventory (inventory measurement at cost or net realisable value – lower of the
two), cost formula (usage of Standard Costing method of Inventory Valuation), the
total carrying amount of inventories and its classification appropriate to the
enterprise.
d. Consistent accounting policy should be used, i.e., there should be same valuation
policy for entire range of Raw material or WIP or Finished Goods.

By: CA. Aparna RamMohan

caaparnasridhar@gmail.com