Accounting
Standard (AS) 2
Valuation
of Inventories
Contents
|
OBJECTIVE
|
|
|
SCOPE
|
Paragraphs 1-2
|
|
DEFINITIONS
|
3-4
|
|
MEASUREMENT
OF INVENTORIES
|
5-25
|
|
Cost
of Inventories
|
6-13
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|
Costs of Purchase
|
7
|
|
Costs of
Conversion
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8-10
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Other Costs
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11-12
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Exclusions from
the Cost of Inventories
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13
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|
Cost
Formulas
|
14-17
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|
Techniques
for the Measurement of Cost
|
18-19
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|
Net
Realisable Value
|
20-25
|
|
DISCLOSURE
|
26-27
|
Valuation of
Inventories 43
Accounting
Standard (AS) 2
Valuation
of Inventories
(This Accounting Standard
includes paragraphs set in bold italic type and plain type, which
have equal authority. Paragraphs in bold italic type indicate the main
principles. This Accounting Standard should be read in the context of its
objective and the General Instructions contained in part A of the Annexure to
the Notification.)
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 Standard deals with
the determination of such value, including the ascertainment of cost of
inventories and any write-down thereof to net realisable value.
Scope
1. This Standard should be applied in accounting for inventories
other than:
(a) work in progress arising under construction contracts, including
directly related service contracts (see Accounting Standard (AS) 7,
Construction Contracts);
(b) work in progress arising in the ordinary course of business of
service providers;
(c) shares, debentures and other financial instruments held as
stock-in-trade; and
(d) producers’ inventories of livestock, agricultural and forest
products, and mineral oils, ores and gases to the extent that they are measured
at net realisable value in accordance with well established practices in those
industries.
2.
The inventories referred
to in paragraph 1 (d) are measured at net realisable value at certain stages of
production. This occurs, for example, when agricultural crops have been
harvested or mineral oils, ores and gases
10 AS 2
have been extracted and sale is assured under a forward contract
or a government guarantee, or when a homogenous market exists and there is a
negligible risk of failure to sell. These inventories are excluded from the
scope of this Standard.
Definitions
3. The following terms are used in this Standard with the meanings
specified:
3.1
Inventories
are assets:
(a)
held for sale in the
ordinary course of business;
(b)
in the process of
production for such sale; or
(c)
in the
form of materials or supplies to be consumed in the production process or in
the rendering of services.
3.2 Net realisable 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.
4.
Inventories encompass
goods purchased and held for resale, for example, merchandise purchased by a
retailer and held for resale, computer software held for resale, or land and
other property held for resale. Inventories also encompass finished goods
produced, or work in progress being produced, by the enterprise and include
materials, maintenance supplies, consumables and loose tools awaiting use in
the production process. Inventories do not include machinery spares which can
be used only in connection with an item of fixed asset and whose use is
expected to be irregular; such machinery spares are accounted for in accordance
with Accounting Standard (AS) 10, Accounting for Fixed Assets.
Measurement
of Inventories
5. Inventories should be
valued at the lower of cost and net realisable value.
Cost
of Inventories
6. The cost of inventories should comprise all costs of
purchase, costs of conversion and other costs incurred in bringing the
inventories to
Valuation of
Inventories 11
their
present location and condition.
Costs
of Purchase
7. The costs of purchase consist of the purchase price including
duties and taxes (other than those subsequently recoverable by the enterprise
from the taxing authorities), freight inwards and other expenditure directly
attributable to the acquisition. Trade discounts, rebates, duty drawbacks and
other similar items are deducted in determining the costs of purchase.
Costs
of Conversion
8.
The costs of conversion of
inventories include costs directly related to the units of production, such as
direct labour. They also include a systematic allocation of fixed and variable
production overheads that are incurred in converting materials into finished
goods. Fixed production overheads are those indirect costs of production that
remain relatively constant regardless of the volume of production, such as
depreciation and maintenance of factory buildings and the cost of factory
management and administration. Variable production overheads are those indirect
costs of production that vary directly, or nearly directly, with the volume of
production, such as indirect materials
9.
The allocation of fixed
production overheads for the purpose of their inclusion in the costs of
conversion is based on the normal capacity of the
production facilities. Normal capacity is the production
expected to be achieved on an average over a number of periods or seasons under
normal circumstances, taking into account the loss of capacity resulting from
planned maintenance. The actual level of production may be used if it
approximates normal capacity. The amount of fixed production overheads
allocated to each unit of production is not increased as a consequence of low
production or idle plant. Unallocated overheads are recognised as an expense in
the period in which they are incurred. In periods of abnormally high
production, the amount of fixed production overheads allocated to each unit of
production is decreased so that inventories are not measured above cost.
Variable production overheads are assigned to each unit of production on the
basis of the actual use of the production facilities.
10. A production process may result in more than one product
being produced simultaneously. This is the case, for example, when joint
products are produced or when there is a 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
12 AS 2
the stage in the production process when the products become
separately identifiable, or at the completion of production. Most by-products
as well as scrap or waste materials, by their nature, 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.
Other
Costs
11. 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. For example, it may be appropriate to include overheads
other than production overheads or the costs of designing products for specific
customers in the cost of inventories.
12. Interest and other
borrowing costs are usually considered as not relating to bringing the
inventories to their present location and condition and are, therefore, usually
not included in the cost of inventories.
Exclusions
from the Cost of Inventories
13. In determining the cost of inventories in accordance with
paragraph 6, it is appropriate to exclude certain costs and recognise them as
expenses in the period in which they are incurred. Examples of such costs are:
(a) abnormal amounts of wasted materials, labour, or other
production costs;
(b) storage costs, unless those costs are necessary in the
production process prior to a further production stage;
(c) administrative overheads that do not contribute to bringing the
inventories to their present location and condition; and
(d)
selling and distribution costs.
Cost
Formulas
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.
Valuation of
Inventories 13
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
16. The cost of
inventories, other than those dealt with i n 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.
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. The FIFO formula assumes that the items of inventory which were
purchased or produced first are consumed or 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 enterprise.
Techniques
for the Measurement of Cost
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.
19.
The retail method is often
used in the retail trade for measuring inventories of large numbers of rapidly
changing items that have similar
14 AS 2
margins an d for which it is impracticable to use other costing
methods. The cost of the inventory is determined by reducing from the sales
value of the inventory the appropriate percentage gross margin. The percentage
used takes into consideration inventory which has been marked down to below its
original selling price. An average percentage for each retail department is
often used.
Net
Realisable Value
20. 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 necessary to make the sale have
increased. The practice of writing down inventories below cost
to
net realisable value is consistent with the view that assets should not be
21.
Inventories are usually
written down to net realisable value on an item-by-item basis. 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 and 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 down inventories based on a classification of inventory, for example,
finished goods, or all the inventories in a particular business segment.
22.
Estimates of net
realisable value are based on the most reliable evidence available at the time
the estimates are made as to 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 balance sheet date to the
extent that such events confirm the conditions existing at the balance sheet
date.
23.
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 inventory is based on
general selling prices. Contingent losses on firm sales contracts in excess of
inventory quantities held and contingent losses on firm purchase contracts are
dealt with in accordance with the principles enunciated in Accounting
Valuation of
Inventories 15
Standard (AS) 4, Contingencies and Events Occurring After the
Balance Sheet Date.
24. 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 there has been a decline in the price of materials and it is
estimated that the cost of the finished products will exceed 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.
25. An assessment is made of net realisable value as at each
balance sheet date.
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.
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.
