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AS -2 VALUATION OF INVENTORY
Objective
Determination of the carrying amount of inventories in financial statements. This includes
determination of cost of inventory and any amount to be written off to bring it to NRV.

Scope
This standard is NOT applicable for the following inventories:

a. Work -in- progress (WIP) arising under construction contracts; (AS 7);
b. WIP of service providers;
c. If the entity holds shares, debentures, and other financial instruments as stock-in-
trade;
d. Inventories of livestock, agricultural and forest products, mineral oils, ores and gases
to the extent that they are measured at NRV in accordance with well-established
practices in those industries (as per Industry rules and regulations).

The point (d) is an option to the entity and if it chooses to carry inventory at cost, the standard
measurement rules apply i.e. measuring at lower of cost or NRV.

Definition
Inventories are assets which are:

a. Held for sale in the Ordinary course of business i.e. Finished Goods
b. Used in the process of production for such sale i.e. raw material, WIP etc.
c. To be consumed in the process of production or in rendering the services e.g.
consumable and loose tools, etc.

Measurement of inventories

Inventory is valued at Cost or NRV whichever is lower

Cost of Inventory
Includes

Cost of purchase Cost of Conversion Other costs incurred to bring

the inventory to present
location and condition.

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Cost of Purchase
Cost of purchase includes all costs incurred to purchase the material. The following items are
directly related to the purchase of material.

Rupees

Purchase price i.e. Basic price of material xxx

Add xxx

NON- refundable taxes & duties

Carrying Costs e.g. inward freight cost xxx

Inward insurance cost xxx

All other costs incurred directly related to acquisition and bringing it xxx
to warehouse.

Less (xxx)

Trade discounts

Quantity discounts (xxx)

Duty drawbacks and other similar items (xxx)

Cost of purchase XXXX

Cost of Conversion
This included the costs incurred to convert the raw materials into finished goods. For
example, major costs like Labour, Factory rent, fuel costs, power expenses (factory
overheads) and other items.

OVERHEADS

Variable OHs Fixed OHs

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Actual Capacity > Actual Capacity <

Normal Capacity Normal Capacity

Absorb based on Actual Absorb based on

capacity Normal capacity

What is Normal capacity?

Normal capacity is the number of units of production on an average over a period under
normal circumstances after considering loss of capacity under normal circumstances. (Normal
capacity= Total capacity Less planned maintenance).

What is Actual capacity?

Actual capacity is actual production of goods.

The following costs should be excluded from “COST”

1. Abnormal waste of Raw materials, labour or other production costs;

2. Storage costs;
3. General administration OHs;

4. Selling and Distribution Costs:

5. Interest & Financial charges in general;

Allocation of costs in special situations:

Joint Products
Two or more outputs generated simultaneously, by a single manufacturing process using
common input, and being substantially equal in value.

E.g. Butter cheese and cream from milk

By product
It is a secondary or incidental product in a process of manufacture and generally it has
insignificant value.

E.g. In manufacture of sugar- sugar is main product and molasses

Allocation of cost in case of Joint products

In this case, the joint cost (common costs) is allocated between the products on a rational
and consistent basis.

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Basis of allocation: May be

a. On the sales value of each products become separately identifiable;

b. On the sales value after completion of production;

Allocation of cost in case of by- products

As per AS-2, No need to find out the cost of by product. It is required to find out the cost of
Main product only. The following points help us to find out the cost of Main product.

❖ Find out the joint costs of main product & by products.

❖ Compute Net realisable value of by product at the time of separation.
❖ Cost of main product= total joint costs of main product& by product Less NRV of by
product.

Cost Formulas
Costs of inventory should be ascertained in the following manner:

Whether inventory items

are interchangeable?

NO YES

Specific identification cost method Use FIFO or Weighted Avg Method

Net Realisable Value (NRV)

Estimated Selling Price in the ordinary course of business xxx

Less: Cost of completion (applies if you are computing NRV of WIP) (xx)

Less: Cost to make the sale (Applies to both WIP & FG) (xx)

Net Realisable Value xxx

NRV of work in progress

WIP is the one which is not completed or partially completed. Finding out expected selling
price for WIP is not possible as nobody purchase the WIP product. It is meant to be converted
into FG and to sell as FG. Hence we start computing the NRV of WIP with Excepted selling
price of FG and deduct the costs to be incurred to complete it as FG & Costs incurred to sell.

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Raw material valuation

Strictly speaking, raw material valuation is NOT based on Cost (or) NRV whichever is less. Its
valuation is fully based on the valuation of finished goods as the entity is purchasing raw
material not to sell in the ordinary course of business as raw material BUT to use it for
producing the finished goods. Intention is to sell FG and not RM.

Raw material valuation

FG is sold at cost or above cost FG is sold below cost

Value at COST only; No need to write down Value at Replacement cost

to NRV

Replacement cost
It is the amount that an entity would have to pay to replace an asset at the present time,
according to its current worth.

Disclosures
The financial statement 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.

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Questions
Q1.

The company deals in three products, A, B and C, which are neither similar nor
interchangeable. At the time of closing of its account for the year 2016-17, the
Historical Cost and Net Realisable Value of the items of closing stock are determined
as follows:

Items Historical Cost (Rs in lakhs) Net Realisable Value (Rs in lakhs)
A 40 28
B 32 32
C 16 24
What will be the value of closing stock?

Q2.

X Co. Limited purchased goods at the cost of Rs 40 lakhs in October, 2016. Till March,
2017, 75% of the stocks were sold. The company wants to disclose closing stock at Rs
10 lakhs. The expected sale value is Rs 11 lakhs and a commission at 10% on sale is
payable to the agent. Advise, what is the correct closing stock to be disclosed as at
31.3.2017.

Q3.

In a production process, normal waste is 5% of input. 5,000 MT of input were put in

process resulting in wastage of 300 MT. Cost per MT of input is Rs 1,000. The entire
quantity of waste is on stock at the year end. State with reference to Accounting
Standard, how will you value the inventories in this case?

Q4.

On 31st March 2017, a business firm finds that cost of a partly finished unit on that date
is Rs 530. The unit can be finished in 2017-18 by an additional expenditure of Rs 310.
The finished unit can be sold for Rs 750 subject to payment of 4% brokerage on selling
price. The firm seeks your advice regarding the amount at which the unfinished unit
should be valued as at 31st March, 2017 for preparation of final accounts. Assume that
the partly finished unit cannot be sold in semi finished form and its NRV is zero without
processing it further.

Q5.

During the production of main product Bomex, a by-product Brucil is also produced.
Total cost of conversion is Rs 3,88,500 and 1,25,000 units of Bomex and 7000 units of
Brucil arise from the process. Brucil cannot be sold at the time of split off. It can be sold

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after further process. Further process costs Rs 0.50 per unit. After further process, by-
product can be sold for Rs 6 per unit. Calculate the cost of conversion of Bomex (Main
product)?

Q6.

Calculate the value of raw materials and closing stock based on the following information:

Raw Material X
Closing balance 500 Units
Per unit (Rs)
Cost price including excise duty 200
Excise duty (Cenvat credit is receivable on the excise duty paid) 10
Freight inward 20
Unloading charges 10
Replacement cost 150
Finished Goods Y
Closing balance 1200 Units
Per unit (Rs)
Material consumed 220
Direct Labour 60
Direct overhead 40

Total Fixed overhead for the year was Rs 2,00,000 on normal capacity of 20,000 units.
Calculate the value of the closing stock, when

i.Net Realisable Value of the Finished Goods Y is Rs 400.

ii.Net Realisable Value of the Finished Goods Y is Rs 300.

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