Accounting Standards

Accounting Standard 2
(Valuation of Inventories)
Objective
A primary issue in accounting for inventories is the determination of the value at which inventories are carried
in the financial statements until the related revenues are recognised. This Statement deals with the
determination of such value, including the ascertainment of cost of inventories and any write-down thereof to
net realisale value.
Scope/Applicability
This Statement should e applied in accounting for inventories other than!
(a) "or# in progress arising under construction contracts, including directly related service contracts$
() "or# in progress arising in the ordinary course of usiness of service providers (incomplete consultancy
services, incomplete merchant an# activities, medical services in progress)$
(c) Shares, deentures and other financial instruments held as stoc#-in-trade$ and
(d) %roducers& inventories of livestoc#, agricultural and forest products, and mineral oils, ores and gases. Such
inventories are valued at 'et realisale value
Net realisable value is the estimated selling price in the ordinary course of usiness less the estimated costs of
completion and the estimated costs necessary to ma#e the sale.
Definitions
The following terms are used in this Statement with the meanings specified!
Inventories are assets!
(a)(eld for sale in the ordinary course of usiness ()inished goods)$
() In the process of production for such sale (raw materials and wor#-in-progress)$ or
(c) In the form of materials or supplies to e consumed in the production process or in the rendering of
services (stores, spares, raw materials, consumales). Inventories do not include machinery.
(d) Spares which can e used only in connection with an item of fi*ed assets and whose use is irregular, such
machinery spares are accounted for in accordance with AS+, accounting for fi*ed assets.

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Accounting Standards
Measurement of Inventories
Inventories should e valued at the lower of cost and net realisale value.
Major points in valuation of inventories:
+) -etermination of cost of inventories
.) -etermination of net realisale value of inventories
/) 0omparison etween the cost 1 net realisale value.
! "ost of Inventories
0ost of Inventory includes!
a) 0ost of purchase
) 0ost of conversion
c) 2ther cost (incurred in ringing the inventories to their present location 1 condition)
The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in
ringing the inventories to their present location and condition.
a! "osts of #urc$ase
The costs of purchase consist of the purchase price including duties and ta*es (other than those suse3uently
recoverale y the enterprise from the ta*ing authorities), freight inwards and other e*penditure directly
attriutale to the ac3uisition. Trade discounts, reates, duty drawac#s and other similar items are deducted in
determining the costs of purchase.
b! "osts of "onversion
It consists of cost directly related to the units (i.e. direct laour, direct material, direct e*penses)
%i&ed production over$ead: Indirect cost of production that remains relatively constant regardless of
volume of production (i.e. -epreciation and 4aintenance of factory uilding, cost of factory management)
'ariable production Over$ead: Indirect cost of production that varies directly or nearly directly
with the volume of production (i.e. indirect material, Indirect laour)
Allocation fi&ed production over$ead: 2n normal capacity. In periods of anormally high
production the amount of fi*ed production overheads allocated to each unit of production is decreased so that
inventories are not measured aove cost.
Allocation 'ariable production over$ead: 2n Actual %roduction
In case of (oint products: "hen the cost of conversion of each product is not separately identifiale,
total cost of conversion is allocated etween the products on the rational and consistent asis .
In case of by) products: If y-products, scrap or waste materials are not of material value ,they are
measured at net realisale value, then net realisale value is deducted from cost of conversion.
c! Ot$er "osts
2ther costs are included in the cost of inventories only to the e*tent that they are incurred in ringing the
inventories to their present location and condition. )or e*ample, it may e appropriate to include overheads
other than production overheads or the costs of designing products for specific customers in the cost of
inventories.
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Accounting Standards
Interest and other orrowing costs are usually considered as not relating to ringing the inventories to their
present location and condition and are, therefore, usually not included in the cost of inventories.
*&clusions from t$e "ost of Inventories
In determining the cost of inventories, it is appropriate to e*clude certain costs and recognise them as e*penses
in the period in which they are incurred. 5*amples of such costs are!
(a) Anormal amounts of wasted materials, laour, or other production costs$
() Storage costs, unless those costs are necessary in the production process prior to a further production stage$
(c) Administrative overheads that do not contriute to ringing the inventories to their present location and
condition$ and
(d) Selling and distriution costs.
"ost %ormulas
+ The cost of inventories of items that are not ordinarily interchangeale and goods or services produced
and segregated for specific pro6ects should e assigned y specific identification of their individual costs.
. The cost of inventories should e assigned y using the first-in, first-out ()I)2), or weighted average
cost formula. The formula used should reflect the fairest possile appro*imation to the cost incurred in ringing
the items of inventory to their present location and condition.
2!Determination of net realisable value of inventories
The net realisable value means the estimated selling price in ordinary course of usiness, less estimated cost
of completion and estimated cost necessary to ma#e the sale. 5stimation of net realisale value also ta#es into
account the purpose for which the inventory is held. The cost of inventories may not e recoverale if those
inventories are damaged, if they have ecome wholly or partially osolete, or if their selling prices have
declined. The cost of inventories may also not e recoverale if the estimated costs of completion or the
estimated costs necessary to ma#e the sale have increased. The practice of writing down inventories elow cost
to net realisale value is consistent with the view that assets should not e carried in e*cess of amounts
e*pected to e realised from their sale or use.
An assessment is made of net realisale value as at each alance sheet date.
*stimation of Net +ealisable 'alue
The net realisale value of the materials and other supplies held for use in production of finished goods is
held as under!-
If finished product in which raw material and supplies used is sold at cost or aove cost, then the
estimated realisale value of raw material and supplies is considered more than its cost.
If finished product in which raw material and supplies used is elow cost, then the estimated net
realisale value of raw material or supplies is e3ual to replacement price of raw material or supplies.
,!"omparison bet-een cost and net realisable value
Should e made y item y item or y group of items
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Accounting Standards
Disclosure
26. The financial statements should disclose:
(a) the accounting policies adopted in measuring inventories, including the cost formula used; and
(b) the total carrying amount of inventories and its classification appropriate to the enterprise.
Information aout the carrying amounts held in different classifications of inventories and the e*tent of the
changes in these assets is useful to financial statement users. 0ommon classifications of inventories are raw
materials and components, wor# in progress, finished goods, stores and spares, and loose tools.
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