CA Saugat Gautam

NAS 2
Inventories
Production Process

Before During After

• Raw • WIP • Finished

materials goods
Inventory

• Inventories are assets:

• held for sale in the ordinary course of business; [Finished Goods]
• in the process of production for such sale; or [Work-in-process]
• in the form of materials or supplies to be consumed in the production process or in
the rendering of services. [Raw materials]
 Journal Entries for Inventory
Particulars Debit (Rs.) Credit (Rs.)
Purchase of inventory
Inventory A/c --------------Dr. xxx
To Cash/Bank/Payable A/c xxx

Sale of inventory
Cash/Bank/Receivable A/c ---- ----Dr. xxx

Matching
To Revenue [NFRS 15] xxx

Cost of Goods Sold (COGS) A/c ------------ Dr. xxx

To Inventory A/c xxx
Scope

• NAS 2 applies to all inventories

except:
• Financial Instruments (NAS 32 and NFRS
9)
• Biological assets related to agricultural
activity and agricultural produce at the
point of harvest (NAS 41)
 Biological Assets
(living plants or animals)

Related to agriculture Not related to agriculture

activity activity

Bearer plants – NAS 16 Agricultural Produce NAS 16

At the point of harvest –

NAS 41

After harvest – NAS 2

Agriculture Produce – NAS 41

Bearer Plant – NAS 16

Inventory – NAS 2
Measurement
Lower of:

Cost Net Realisable Value

Cost of Purchase

Cost of Conversion

Other costs
 Cost [para 11-15]
Cost of Purchase Cost of Conversion Other Costs
Purchase price xxx Direct Labour xxx Other costs in bringing the
Duties & Taxes xxx Variable Prodn OH xxx inventory to present location and
(non-refundable) Fixed Prodn OH xxx condition
Transport, Handling xxx Cost of Conversion xxx
Other directly attributable costs xxx
Less: Trade discounts/rebates xxx
Cost of Purchase xxx
 Allocation of Fixed Production Overheads

The allocation of fixed production overheads to the costs of

conversion is based on the normal capacity of the production
facilities.

Normal capacity is the production expected to be achieved on

average over a number of periods or seasons under normal
circumstances, taking into account the loss of capacity resulting
from planned maintenance.

Unallocated overheads are recognised as an expense in the

period in which they are incurred
Example
Fixed Production Overheads Amount (Rs.)
Depreciation of Factory Machine, Building xxx
Rent of Factory Building xxx
Salary of Production Manager xxx
Total (for April) Rs. 10,00,000
÷Normal Production 20,000 units
Fixed OH/unit Rs.50/unit
 Fixed Production OH – Dr. 10,00,000
To Cash/Bank/Payable 10,00,000
Actual Production for April

18,000 units 20,000 units 25,000 units

Allocated to inventory Allocated to inventory Allocated to inventory
= 18000 x Rs. 50 = 20,000 x Rs. 50 = 25000 x 50 = Rs. 12,50,000
(Actual exp > Allocated exp
= Rs. 9,00,000 = Rs. 10,00,000
This cannot be the case)

Unallocated = Rs. Unallocated = 0 Revised F.OH rate

1,00,000 = Rs. 10,00,000/25000 units = Rs.
40/unit

Allocated to inventory
= 25000 x 40 = Rs. 10,00,000
Unallocated = 0
 Fixed Production OH – Dr. 10,00,000
To Cash/Bank/Payable 10,00,000
Actual Production for April
18,000 units 20,000 units 25,000 units
Inventory A/c – Dr. 9L Inventory A/c – Dr. 10L Inventory A/c – Dr. 10L
SoPL A/c – Dr. 1L To F. OH 10L To F. OH 10L
To F. OH 10L (Recovery rate = Rs. (Recovery rate = Rs. 40/unit)
50/unit)
 Actual Fixed Overhead incurred
during the period
Fixed Overhead
=
Recovery Rate
Higher of (Normal or Actual
Production units)
 A = Abnormal amounts of wasted materials,
labour, or other production costs

S
Excluded from = Storage costs unless those costs are
necessary in the production process before a
the cost of further production stage;

inventories A = Administrative Overhead that do not

contribute to bringing inventories to their
present location and condition; and

S = Selling Costs
Deferred Payment

• An entity may purchase inventories on deferred

settlement terms. When the arrangement
effectively contains a financing element, that
element, for example a difference between the
purchase price for normal credit terms and the
amount paid, is recognised as interest expense
over the period of the financing.

• Interest recognized as per Effective Interest

Rate (EIR) method.
Example

A Ltd. purchased goods with payment Rs. 1,21,000

being made at the end of 2nd year. The cash price
of the goods as on today is Rs. 1,00,000. How shall
A Ltd. record these transactions ?
Solution
Calculation of Effective Interest Rate (EIR)
Present Value (PV) = Rs. 1,00,000
Future Value (FV) = Rs. 1,21,000
Rate of interest (r) = ?
We have,
FV = PV(1+r)n
121,000 = 100,000 (1+r)2
r = 10% (EIR)
 Amortisation Table
Opening Interest @ EIR 10% Payment Closing
Year
(a) (b) (c) (a+b-c)
1 1,00,000 10,000 - 1,10,000
2 1,10,000 11,000 1,21,000 -
 Journal Entries (A Ltd.)
Date Particulars L.F Debit (Rs.) Credit (Rs.)
.
Y-1 (begin) Inventory A/c ----------------------- Dr. 1,00,000

To Supplier A/c 1,00,000

Y-1 (end) Interest expense A/c (SoPL) ------------Dr. 10,000

To Supplier A/c 10,000

Y-2 (end) Interest expense A/c (SoPL) ------------Dr. 11,000

To Supplier A/c 11,000

Supplier A/c ----------------------------Dr. 1,21,000

To Bank A/c 1,21,000
Net Realisable Value (NRV)
Particulars Amount (Rs.)
Estimated Selling Price in the ordinary course of xxx
business
Less: Estimated cost of completion xxx
Less: Estimated cost to sell (e.g., agents' xxx
commission)
Net Realisable Value* xxx

*NRV shall be calculated on item-by-item basis.

Example
Items Cost (Rs.) NRV (Rs.) Measure At Impairment Loss

A 80 84 80 (Cost) 0
B 75 70 70 (NRV) 5
C 90 88 88 (NRV) 2
Total 245 242 238 7
Measurement of Raw materials

• 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 realizable value. In such circumstances, the
replacement cost of the materials may be the best available measure of their net
realisable value.
 When there is decline in price
of materials

Can the finished goods to be

produced from the materials be
sold at or above cost ?

Yes No

Raw material will be

Raw material will valued at lower of:
be valued at cost. - Cost
- Replacement Cost
Question (Dec 2018)
Answer
Exception of Measurement
This Standard does not apply to the measurement of inventories held by:
- producers of agricultural and forest products, agricultural produce after harvest,
and
- minerals and mineral products,
to the extent that they are measured at net realisable value (not at lower of cost
or NRV) in accordance with well-established practices in those industries.
When such inventories are measured at net realisable value, changes in that
value are recognised in profit or loss in the period of the change.
- agricultural crops have been harvested, or
- minerals have been extracted

Sale is assured under

Forward Contract

Government Guarantee

Active market exists and there is

negligible risk of failure to sell
Question

Give your comments on the following:

Rum Pum Noodles, manufacturing noodles, has valued at the
year end its closing stock of packed finished goods for which firm
sales contracts have been received, at realizable value inclusive
of profit and cash incentive. As at the year end, the ownership of
the goods has not been transferred to the buyer.
Reversal of Loss
• 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.
 Example
Year 1 Year 2 Year 3
Cost =Rs. 100 Carrying amount = Rs. 90 Carrying amount = Rs. 94
NRV = Rs. 90 NRV = Rs. 94 NRV = Rs. 102
Measure at Rs. 90 Cost = Rs. 100 Cost = Rs. 100
Measure at Rs. 94 Measure at Rs. 100
(Increase by Rs. 4) (Increase by Rs. 6)

Impairment (SoPL) – Dr. 10 Inventory A/c – Dr. 4 Inventory A/c – Dr. 6

To Inventory 10 To Reversal of impairment(SoPL) 4 To Reversal of impairment 6
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.

Are the items of inventory

ordinarily interchangeable ?

Yes No

FIFO or Weighted Specific Identification

Average Cost Method

LIFO is not allowed