Accounting Standard 2--Valuation of Inventories

Introduction:

This AS is talking about how to value the inventories lying as closing stock in the balance sheet date. Value of this closing stock is directly related to the profit, any unnecessary increase in value of closing stock leads to an increase in false profit. So the care should be taken in determining the cost of inventories. According to the principal of prudence the stock should be value at lower of cost or net realizable value. This AS tells about how to determine the *cost and **Net Realizable value of stock.

Inventories: Inventories are the assets(economic benefits are expected to flow)held by an enterprise: a)for sale in the ordinary course of business (finished goods)b)which are in process of production(wip) and c) which are to be consumed in the production process.(raw-material)

*Cost of closing stock:

This include cost of purchase(of raw material), 2)cost of conversion(of raw-material into finished good)and 3)other cost.

Cost of purchase:

This cost include purchase price +duties and taxes +freight inward +other cost attributable directly to purchase, from this derived amount, deduction will be made for taxes and duties that are received by the enterprises from taxing authority, trade discount and reabate.

Cost of conversion:

This include cost directly related to production like direct labor and overhead cost(both fixed and variable).variable cost are easily allocatable to the closing inventories but for fixed cost we need to consider normal capacity of production:

If the actual production is more than normal capacity production, overhead costs are allocated on the basis of actual production.

If the actual production is less than normal capacity production, overhead costs are allocated on the basis of normal capacity production.

Other costs:

These are some rare costs that are incurred in bringing the material in its present condition. A) like cost of design in custom made unit may be taken as cost of inventories.

b) borrowing cost and interest costs are normally not included in cost of inventories but in case where inventories get longer period to get ready for sale the interests and borrowing costs will include in cost of inventories, like making of wine.

c) Amortization of intangibles(like patent ,trademarks,etc) are also taken as part on inventories cost.

**Net realizable value..NRV=selling price of the product-further costs require to bring the product in selling condition. thus if a material present cost=1000 and it require further cost of 500 to make it in selling condition and the selling price of the product in the market is 2500..Net realizable value will be 2000(I,e 2500-500)..NRV of each item should be determined separately not at whole finshed products. Only sometimes when the products are very similar then are recognized in group while determining NRV.

Measurement basis..this AS says that inventories are measured either by FIFO or weighted average method

Important points for AS 2 valuation of inventories:

1)      The by-product will be valued at net realizable value and it will be deducted from the cost.

2)      Borrowing cost and interest cost will only be include in the cost of inventory when production require substantial period of time to bring the material into the saleable condition like in wine and spirites that require time to mature..otherwise no interest and borrowing cost will be included in cost of inventories. For example sugar produce seasonally and being sold throughout the year here bringing the sugar in saleable condition doesn’t require time only its seasonal that’s why stocks are kept and sold throughout the year so in this case the interest will not add in closing stock.

3)      An enterprise should follow only one cost formula at a time for its inventory ..either FIFO or weighted average formula method, one branch in FIFO and other branch in weighted average is not permissible.

4)      Storage and advertisement cost are not to be included in cost of inventories.

5)      Exchange fluctuation will not be added in the cost of inventories.

6)      For service provider only WIP will not be included in determining cost of inventory.

7)      AS 2 does not apply for the inventory of livestock, mineral oils, forest products,shares debentures and other financial instruments held as stock-in-trade, wor-in-progress under construction contract.

8)      Inventories do not include spares of machineries used only in connection with the item of fixed assets.

9)      Abnormal gains/losses should be recognized (written) as separate line items in the profit and loss account.

10)  Enterprise should disclose a) Accounting policies adopted in measuring inventories including cost formula used b) carrying amount of inventories and its classification appropriate to the enterprise.

This was all about this Accounting Standards; hope you all will like it.