ACCOUNTING &

VALUATION OF
INVENTORY
By: Dr. Chhavi Mehta
International Management Institute
Inventory
 IndAS 2 `Valuation of Inventories’

 What is inventory?
 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.
 Inventories often constitute (except in case of a services company) a
significant portion of the total assets of a company
Importance

 Gross Profit = Sales – Cost of goods sold (COGS)

 COGS = Opening stock + Purchases – Closing stock

 COGS + Closing stock = Opening stock + Purchases

 Opening stock + Purchases = Goods available for sale

 Problem: How to apportion goods available for sale between ending inventory and
cost of good sold?
 Closing stock (inventories) – In Balance Sheet as current assets and in P&L as a
reduction in expenses
Inventory flow – Trading Organisation
Inventory flow – Manufacturing Organisation
Methods of Inventory Accounting

 Periodic inventory system

 Perpetual inventory system
Periodic Inventory System
 Keep record of receipts of goods
 At the end physical count of goods is undertaken to ascertain the value

of ending inventory
 Cost of goods sold

 Goods available for sale – Ending inventory

 Beginning inventory + Purchases – Ending inventory
Perpetual Inventory System
 Keep record of receipt as well as delivery
 At the end physical count of goods is undertaken to compare the
balance value of ending inventory
 Ending inventory
 Goods available for sale – Cost of goods sold
 Beginning inventory + Purchases – Cost of goods sold
Steps for Inventory Valuation
 Ascertain the quantity of ending inventory
 Ascertain the stage of completion and cost to be included in inventory
cost
 Allocate the cost to be allocated between ending inventory and cost of
goods sold
 Compare the cost of ending inventory with its net realizable value
Cost of Inventories

 Comprises of:
 Cost of purchase
 Costs of conversion
 Other cost incurred to bring inventories to their present location and
condition
Cost of Purchase
 Includes purchase price, import duties and other taxes, transport,
handling and other costs directly attributable to the acquisition
 Exclude taxes and duties which are subsequently recoverable from tax
authorities, trade discount, quantity discount and rebates etc.
Cost of Conversion
 Cost directly related to the production
 Systematic allocation of fixed and variable production overheads
 Costs not to be considered for valuation:
 Storage costs (unless necessary in the production process before further
production)
 Administrative overheads
 Selling and distribution overheads
Cost of Conversion

 Borrowing Cost
 Ifinventory takes substantial period to be ready for sale, borrowing cost
directly attributable are included
Costing Methods
 For identifying the cost:
 Specific identification
 First In First Out (FIFO)
 Last In First Out (LIFO)
 Weighted Average Method

 IndAS 2 permits use of specific identification, FIFO and Weighted

Average Cost Method
Specific Identification Methods
 Cost of inventories, that are not ordinarily interchangeable and can be
identified or for specific project
 Not practical when a large number of inventory items which are
interchangeable
 Some form of approximation is used  Formula used should reflect the
fairest possible approximation to the cost incurred
First in First Out (FIFO)
 Assumes that the items of inventory purchased or produced first are
consumed or sold first
 Items remaining in the inventory are those that were purchased or
produced recently
 In inflationary situations – Will result in higher closing stock and lower
cost of goods sold
FIFO
Last in First Out (LIFO)
 Assumes that the items of inventory purchased or produced recently are
consumed or sold first
 Items remaining in the inventory are those that were purchased or
produced first
 In inflationary situations – Results in lower closing stock and higher cost
of goods sold
Weighted Average Method
 Weighted average of the cost of similar items at the beginning of a
period and cost of similar item produced or purchased during the period
 Either on a periodic basis or for each shipment
Valuation of Inventory
 Inventories should be valued at the Lower of Cost and Net Realizable
Value (NRV)
 Reason:
 Assets should not be carried in balance sheet in excess of the amounts that the
entity expects to realise from their sale or use
 Don’t overstate Profit and Assets
Net Realizable Value (NRV)
 NRV = (Estimated selling price in the ordinary course of business) –
(Estimated cost of completion + Estimated cost to make the sale)
 Estimate based upon the most reliable evidence that may be available at the time
estimates are being made
 NRV is ascertained on an item-to-item basis rather than as a group
Net Realizable Value (NRV)

 Material are not written down below cost if the finished products in
which they will be used are expected to be sold above cost
 Replacement cost of the material may be the best measure of their net
realizable value
Steps in Inventory Valuation Process
 Ascertain the quantity of ending inventory
 Ascertain the stage of completion
 Ascertain cost
 Ascertain net realizable value
 Value the inventory at lower of cost and net realizable value
Disclosure
 Accounting policies adopted in measuring inventories, including the cost formula used
 Total carrying amount of inventories and its classifications appropriate to the entity –
Raw material, components, work-in-progress, finished goods, stores and spares, loose
tools
 Carrying amount of inventories carried at fair value less costs to sell
 Amount of inventories recognized as an expense during the period
 Amount of any write-down of inventories recognized as an expense in the period
 Amount of any reversal of any write-down that is recognized as a reduction in the
amount of inventories recognized as expense in the period
 Circumstances or events that led to the reversal of a write-down of inventories
 Carrying amount of inventories pledged as security for liabilities
Bajaj Auto Ltd – AR 2018-19
Thank You!