ICDS – 2

Valuation of Inventories

By- CA Premlata Daga

B.Com, CA, LCS, DISA (ICAI)
ICDS 2 shall be applied for valuation of inventories EXCEPT:

• WIP arising out of Construction Contract

• Shares, Debentures and other Securities which are held as stock in trade.
• Producers, Inventories of Livestock, Agriculture and Forest Products,
Mineral Oils, Ores and Gases to the extent valued at Net Realisable Value
• Machinery spares which can be dealt with only in connection with a
Tangible Fixed Asset and their use is expected to be irregular
 SOME DEFINITIONS AS PER ICDS:

Inventory:
• Held for sale in the ordinary course of business
• In the process of production for such sale
• In the form of materials or supplies to be consumed in the process of
production process or rendering of services

Net Realisable Value:

Is the estimated selling price in the ordinary course of the business less the
estimated cost of completion and the estimated cost necessary to make the sale.
Cost of Inventory:

• All cost of Purchase

• Cost of Services
• Cost of Conversion
• Other cost incurred in bringing the inventories in their present location and condition
Cost of Purchase:

• Purchase Price (Including duties and taxes)

• Freight Expenses
• Other expenses directly attributable to the acquisition
• Trade Discounts, Rebates and other similar items to be deducted
Conversion Cost:

• Cost directly related to the units of production

• Systematic allocation of Fixed and Variable production overheads that are incurred in
converting materials into finished goods
 SOME DEFINITIONS AS PER ICDS:

Cost of Purchase:

• Purchase Price (Including duties and taxes)

• Freight Expenses
• Other expenses directly attributable to the acquisition
• Trade Discounts, Rebates and other similar items to be deducted
 Exclusions from the cost of Inventory

• Abnormal amounts of wasted material, labour or other production overhead.

• Storage cost unless those costs are necessary in the production process prior to further
production process.
• Administrative overheads that do not contribute to the bringing the inventories to their
present location and condition
• Selling Cost
Illustration:

Direct Material: Rs.100/- per Kg

Direct Labour: Rs.20/- per Kg
Direct Variable Production overhead: Rs.10/- per kg

Fixed production charges for the year on normal capacity of 1 lac kgs is 10
lacs. 2000 Kgs of finished goods are on stock at the end of the year.

What will be the cost of inventory ?

SOLUTION:

Sr. No. Particulars Amount

1. Material Cost 100/-

2. Direct Labour Cost 20/-

3. Direct Variable Production Overhead 10/-

4. Direct Fixed Production Overhead 10/-

(Rs.10 lacs/ 1 Lac Units)

5. Total Cost per Kg of Finished Product 140/-

6. Value of 2000 kgs of Finished Goods Rs.2,80,000/-

Case Study:

G Ltd a wire netting company while valuing its finished goods at the end of the
year includes interest on banks overdraft as an element of cost, for the reason
that overdraft has been taken specifically for the purpose of financing current
assets like inventory and for meeting day to day working expenses.

Is the treatment correct ?

Case Study:

Trousers Ltd have 1 Lac of trousers in his inventory. The selling price of all the
trousers taken together is 20 Lacs. It was not possible for the company to
maintain costing of individual items. The average gross profit margin is 20% on
sales.
The Company valued the inventory at Rs.16 Lacs ( 20 Lacs – 20 %)

Is the treatment correct ?

Answer:

The treatment is correct and this method is known as Retail Method of Inventory Valuation.

Retail Method of Valuation :

Where it is impracticable to use the costing methods for valuation of inventory, the retail
method can be used in the retail trade for measuring inventories of large number of rapidly
changing items that have similar margins. 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.
Case Study:

X Ltd has to pay delayed cotton clearing charges over and above the negotiated
price for taking a delayed delivery charges from the suppliers ware house.
Upto 2017-2018 the company regularly included such charges in the valuation
of closing stock. This being in the nature of interest the company decided to
exclude it from the closing stock valuation from 2018-2019 onwards.
This will result into decrease in profit for the year by 10 lacs.

Is the treatment correct ?

Case Study

The company deals in three products X,Y, and Z which are neither similar nor inter-changeable. At the
time of closing of accounts at 31st March 2018 the historical cost and the net realisable value of the
items of closing stock were as follows:

Sr. No. Historical Cost Net Realisable Value

(Rs. In Lacs) (Rs. In Lacs)
1. 40 28
2. 32 32
3. 16 24
Total 88 84

Calculate the value of closing stock as on 31st March 2018.

 Solution:

Inventories shall be written down to net realizable value on an item‐by‐item basis.

Where ‘items of inventory' relating to the same product line having 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, such inventories shall be grouped together and written down to net realizable value on an aggregate basis.

Sr. No. Historical Cost Net Realisable Value Closing Cost

(Rs. In Lacs) (Rs. In Lacs) (Rs. In Lacs)
1. 40 28 28
2. 32 32 32
3. 16 24 16
Total 88 84 76
 Valuation of Inventory in Case of Certain Dissolutions

In case of dissolution of a partnership firm or association of person or body of

individuals, notwithstanding whether business is discontinued or not, the
inventory on the date of dissolution shall be valued at the net realizable value.
Case Study:

X Ltd is having 10,000 Kg of product X which is an important element of the finished

goods XY manufactured by the company. The historic cost of product X is Rs.700 per Kg
and the Net Realisable Value is Rs.650/-per Kg.

The finished product will be sold @ 1200/- per Kg which gives around 15% profit on the
cost price.
At the end of the year the company valued the Product X at Rs. 65,00,000/- following the
rule Cost or NRV which ever is lower.

Is the Valuation Correct ?

Solution:

No, the inventory of Product X should be valued at cost because:

Materials and other supplies held for use in the production of inventories shall not be
written down below the cost, where the finished products in which they shall be
incorporated are expected to be sold at or above the cost.