Valuation of Inventories - AS-2

1. Accounting Standard: 2
Valuation of Inventories

2. Accounting Standard-2 deals with:
• Determination of value at which inventories
are carried in Financial Statements,
• Ascertainment of cost,
• Situation in which carrying cost of inventories
is written below cost.

3. Scope Other than
• WIP arising under construction contracts (AS –
7)
• WIP arising in ordinary course of business of
service provider (AS – 9)
• Shares debentures and other financial
instruments held as stock in trade (AS – 13 / 30)
• Inventories of livestock, agricultural forest
product, mineral oil ores and gases valued at
NRV as per estabilished practices in those
industries

4. Inventories are assets:
• held for sale in ordinary course of business,
• in the process of production for such sale,or
• in the form of material or supplies to be
consumed in the production process or in the
rendering of services.

5. Measurement: Inventories should be valued at
lower of Cost and Net realizable value.
Net Realizable Value =
Estimated selling price – Estimated cost
necessary to make sale.

6. Cost of Inventories: These include all cost of
purchase, cost of conversion and other cost
incurred in bringing the inventories to their present
location and condition.
But does not include:
i) abnormal amount,
ii) storage cost unless necessary in the
production,
iii) administrative overhead,
iv) selling and distribution cost.

7. • Cost of Purchase: Purchase price net of Trade
discount, Rebate, + duties & Taxes (non-
cenvatable) + freight, any other cost attributable
to acquisition.
• Cost of conversion: include cost directly related
to unit of production i.e. variable overhead,
allocable fixed overhead.
• Variable Overheads are to be allocated on the
basis of actual production.
• Fixed Overheads are to be allocated on the
basis of normal production.

8. Joint Product and By Product
• Joint Product: If cost is separately identifiable
then on actual basis or else on rational basis i.e.
sales value at the time when product becomes
separately identifiable or at completion of
product.
• By Product / scrap / waste: It is normally
measure at NRV and this value is deducted from
the cost of main product.

9. Cost Formula: Valuation of inventories
depend on cost formula used by entity:
a) Specific identification method,
b) FIFO,
c) Weighted Average,
d) Standard Cost,
e) Retail Method (for retail trader).

10. • Application of formula: Cost formula is
applied item by item.
• Inventories are not written down below
cost if finished product of such inventory
are expected to be sold at above cost.

11. Disclosure:
• Accounting policy adopted in measuring
including cost formula used,
• Total carrying cost of inventories and its
classification.

12. Expert Opinion on determination of
Normal Capacity and Fixed Over heads
• Case referred to is of PSU controlled by Ministry of
Steel.
• Before 31.12.2005 company was producing 7.5 MT of
concentrate per year and 3 MT of pelletisation per year
from their mines and plants.
• After SC judgement the company had to shutdown it
mines and its activities were restricted only to producing
pellets by procuring ores from outside source.
• Company allocated the FOH based on actual production
for the financial year adjusted to the average production
of last five years.

13. Expert Opinion on determination of Normal
Capacity and Fixed Over heads
• Company considered following expenses in Fixed
overhead in Valuation of Inventories:
– General Expenses : Expenditure on township maintenance and
healthcare, Printing & Stationery, Books & periodicals,
conveyance, training, legal, consultancy, courier, freight and
other office expenses.
– Tender notice & advertisement: for hiring various services &
procurement of material
– Other Income: Interest on Loans & advances given to the
employees.
In 2010-11 CAG expressed its opinion that company should
reassess its normal capacity for valuation of Inventory further it
should also exclude the above expense.

14. Opinion Given by Expert Committee
• The normal capacity may be determined at the average of
production of last 5 years provided it approximates the production
expected to be achieved in the future periods also. However, if there
are significant changes in circumstances,then such an estimation
would not be appropriate. In such a situation, budgeted production
should also be considered for determining normal capacity.
• The staff welfare expenditure to the extent these are used by the
employees of factory/production unit who render their services in
relation to production activities, should be considered for inclusion in
the cost of inventories
• Tender notice advertisement expenses cannot be included in the
cost of inventories as these expenses relates to cost prior to
procurement of inventories.
• Regards interest income recovered from the employees, the
Committee is of the view that these are part of ‘other income’ and,
therefore, should not be adjusted in the cost of inventories.

15. THANKS.