Indian Accounting Standard – 2

Valuation of Inventories-:

The objective of this standard is to formulate the method of computation of cost of inventories/stock, to determine the value of closing stock/ inventory at which, the inventory is to be shown in balance sheet till its’ sale and recognition as revenue.

Meaning-:

Inventories are assets- held for sale in the ordinary course of business, in the process of production for such sale; or in the form of materials or supplies to be consumed in the production process or in the rendering of services.

 Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (See Ind AS 113, Fair Value Measurement.)

Applicability-:

1) Work-in-progress arising under construction contract including directly related to service contract (AS-7 Construction contracts).

2) Work-in-progress arising in ordinary course of business for service providers (Incomplete consultancy services, incomplete merchant bank activities, Medical services in progress)

3) Financial Instrument held as stock-in-trade (Shares, Debentures, and Bonds etc.)Producer's inventories like livestock, agricultural and forest products, mineral oils, ores and gases. Such inventories are valued at net realizable value.

Non applicability:

1) Work in progress arising under construction contracts, including directly related service contracts. Work in progress arising in the ordinary course of business of service providers.

2) Shares, debentures and other financial instruments held as stock-in-trade and

3) Producer’s inventories of livestock, agricultural and forest products, agricultural produce after harvest, mines and other wasting Assets.

Measurement of inventories

9 Inventories shall be measured at the lower of cost and net realizable value.

Cost of inventories-:

10 The cost of inventories shall comprise all costs of purchase, costs of

Conversion and other costs incurred in bringing the inventories to their

Present location and condition.

Cost of purchase-:

Purchase price, Duties and Taxes, Freight inward, other expenditures directly

Attributable to  the acquisition.

Less -Duties and taxes recoverable by enterprises from taxing authorities, Trade discount, Rebate, Duty drawback, other  items.

Costs of conversion-:

Includes Direct Costs, Fixed Production Overheads, and Variable Production overheads.

Other Direct Cost-:

Costs directly related to the units of production, such as direct labour.

Cost Formulas-:

23. The cost of inventories of items that are not ordinarily interchangeable

and goods or services produced and segregated for specific projects shall be

assigned by using specific identification of their individual costs.

24. Specific identification of cost means that specific costs are attributed to

Identified items of inventory. This is the appropriate treatment for items that are

Segregated for a specific project, regardless of whether they have been bought or

Produced. However, specific identification of costs is inappropriate when there are

Large numbers of items of inventory that is ordinarily interchangeable. In such

Circumstances, the method of selecting those items that remain in inventories could be

Used to obtain predetermined effects on profit or loss.

25. The cost of inventories, other than those dealt with in paragraph 23, shall

Be assigned by using the first-in, first-out (FIFO) or weighted average cost

Formula. An entity shall use the same cost formula for all inventories having a

Similar nature and use to the entity. For inventories with a different nature or

Use, different cost formulas may be justified.

2

 Indian Accounting Standard (Ind AS) 41, Agriculture, is under formulation. Accordingly, this

Paragraph would be effective from the date Ind AS 41, Agriculture, comes into effect.

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26. For example, inventories used in one operating segment may have a use to the

Entity different from the same type of inventories used in another operating segment.

However, a difference in geographical location of inventories (or in the respective tax

Rules), by itself, is not sufficient to justify the use of different cost formulas.

27. The FIFO formula assumes that the items of inventory that were purchased or

Produced first are sold first, and consequently the items remaining in inventory at the

End of the period are those most recently purchased or produced. Under the weighted

Average cost formula, the cost of each item is determined from the weighted average

of the cost of similar items at the beginning of a period and the cost of similar items

purchased or produced during the period. The average may be calculated on a

periodic basis, or as each additional shipment is received, depending upon the

circumstances of the entity.

Net realizable value-:

28. The cost of inventories may not be recoverable if those inventories are

damaged, if they have become wholly or partially obsolete, or if their selling prices

have declined. The cost of inventories may also not be recoverable if the estimated

costs of completion or the estimated costs to be incurred to make the sale have

increased. The practice of writing inventories down below cost to net realisable value

is consistent with the view that assets should not be carried in excess of amounts

expected to be realised from their sale or use.

29. Inventories are usually written down to net realisable value item by item. In

some circumstances, however, it may be appropriate to group similar or related items.

This may be the case with items of inventory relating to the same product line that

have similar purposes or end uses, are produced and marketed in the same

geographical area, and cannot be practicably evaluated separately from other items in

that product line. It is not appropriate to write inventories down on the basis of a

classification of inventory, for example, finished goods, or all the inventories in a

particular operating segment. Service providers generally accumulate costs in respect

of each service for which a separate selling price is charged. Therefore, each such

service is treated as a separate item.

30. Estimates of net realisable value are based on the most reliable evidence

available at the time the estimates are made, of the amount the inventories are

expected to realise. These estimates take into consideration fluctuations of price or

cost directly relating to events occurring after the end of the period to the extent that

such events confirm conditions existing at the end of the period.

31. Estimates of net realisable value also take into consideration the purpose for

which the inventory is held. For example, the net realisable value of the quantity of

inventory held to satisfy firm sales or service contracts is based on the contract price.

If the sales contracts are for less than the inventory quantities held, the net realisable

value of the excess is based on general selling prices. Provisions may arise from firm

sales contracts in excess of inventory quantities held or from firm purchase contracts.

Such provisions are dealt with under Ind AS 37 , Provisions, Contingent Liabilities

and Contingent Assets.

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32. 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 at or above cost. However, when a decline in

the price of materials indicates that the cost of the finished products exceeds net

realisable value, the materials are written down to net realisable value. In such

circumstances, the replacement cost of the materials may be the best available

measure of their net realisable value.

33. A new assessment is made of net realisable value in each subsequent period.

When the circumstances that previously caused inventories to be written down below

cost no longer exist or when there is clear evidence of an increase in net realisable

value because of changed economic circumstances, the amount of the write-down is

reversed (ie the reversal is limited to the amount of the original write-down) so that

the new carrying amount is the lower of the cost and the revised net realisable value.

This occurs, for example, when an item of inventory that is carried at net realisable

value, because its selling price has declined, is still on hand in a subsequent period

and its selling price has increased.

Recognition as an expense

34. When inventories are sold, the carrying amount of those inventories shall

be recognised as an expense in the period in which the related revenue is

recognised. The amount of any write-down of inventories to net realisable value

and all losses of inventories shall be recognised as an expense in the period the

write-down or loss occurs. The amount of any reversal of any write-down of

inventories, arising from an increase in net realisable value, shall be recognised

as a reduction in the amount of inventories recognised as an expense in the

period in which the reversal occurs.

Disclosure

36. The financial statements shall disclose:-

(a) the accounting policies adopted in measuring inventories,

including the cost formula used;

(b) the total carrying amount of inventories and the carrying

amount in classifications appropriate to the entity;

(c) the carrying amount of inventories carried at fair value less costs to

sell;