AS 2 – Valuation of Inventories

Paper 1: Financial Reporting Chapter 1 Unit 3

CA B. Hari Gopal B.com, PGDBA, FCA, FCMA, DISA(ICAI), PMP (PMI, USA),
EPBM (IIMC), MCT
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Learning Objectives

1. Gain insight in to Accounting

Standard 2

2. Disclosure requirements
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Introduction to Accounting Standard 2

• Background
• Exceptions
• Scope
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AS 2 – Background

Accounting Standard 2 – Valuation of inventories

Provide guidance for determining the

value of inventories

Provide guidance on cost formulas

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AS 2 – Exceptions
AS 2 does not apply in accounting
for following inventories
WIP arising under Construction contracts
including directly related service contracts

WIP arising in the ordinary course of business

of service providers

Shares, Debentures and other financial

instruments held as stock in trade
Producer’s Inventories to the extent that they are
measured at net realizable value as per practices of
industry – Ex : Livestock, mineral oils, etc
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AS 2 – Scope
Accounting Standard 2 – defines inventories as
assets

Finished goods

Work In Progress

Raw Materials
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Measurement of inventories
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Measurement of inventories
Inventories

Raw Finished
WIP
Materials Goods

Lower of the
At Cost
following

Replacement Net Realizable

Cost
cost value

Realizable value
Cost of Cost of Other
less
Purchase conversion costs
Selling Expenses
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Measurement of inventories
Inventories SHOULD BE valued at the lower of cost
and net realizable value
Cost of goods is the summation of

Cost of purchase

Cost of conversion

Other costs
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Cost of Purchase

Includes the purchase price plus all other necessary

expenses directly attributable to purchase of stock

From the above, items like duty drawback, CENVAT, VAT,

trade discount are deducted
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Cost of Conversion

In case of Manufacturing organizations, cost of inventory

includes cost of conversion

Factory cost = Direct Materials + Direct Labour + Factory

Variable Overhead + Factory Fixed Overhead

Direct Materials are included in Cost of purchase,

whereas other items are known as Cost of conversion
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Cost of Conversion – Direct Labour &

Variable overheads

Direct labour is the cost of labour directly attributed to the

units of production

Variable overhead are indirect expenses which is directly

related to the production level – it changes with change in
production level

It is advisable to include Direct Labour and Variable

overhead in cost of conversion on the basis of normal
capacity
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Cost of Conversion – Fixed overheads

Fixed overhead are indirect expenses which generally

remains constant. It varies only when there is a major shift
in production

When the actual production is equal to or less than the

normal capacity, then fixed overheads are considered on
the basis of normal capacity

However, if the actual production is considerably more

than the normal capacity, then fixed overhead is to be
included on the basis of actual capacity
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Cost of Conversion – Joint Products

and By-products

Sometimes a single production process may result in more

than one product

Joint Product – if the additional product is

intended and has good market value

By-product – if the additional product don’t

have good market value
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Costs – to be excluded from cost of

inventories
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Exclusions from cost of inventories

Abnormal wastage of Materials, Labour and other
production costs

Storage costs unless necessary in the production

process

Administrative overheads that do not contribute to

bringing the inventories to their present location /
condition

Selling and distribution costs

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Borrowing costs

Interest and other borrowing costs are not usually

considered as part of cost of inventories. However there
are exceptions given below

As per AS 16, for inventories that are qualifying

assets, any directly attributable borrowing costs (for
acquisition, construction or production) should be
capitalized as part of their cost

Qualifying assets – are inventories that take

substantial time to bring them to a salable condition
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Cost Formulas
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Cost Formulas
Following are various cost formulas suggested by the
statement

Specific Identification Method

FIFO / Weighted Average Price

Standard Cost Method / Adjusted Selling Price

Method or Retail Method
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Net Realisable Value

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Net Realisable Value (NRV)

NRV = Estimated selling price – Estimated cost of
completion – Estimated costs to make the sale

Two conditions wherein cost exceeds the NRV

While estimating NRV, the purpose of holding the

stock also be taken in to consideration.

The provision of cost or NRV, whichever is less, is

applicable to Finished goods, which are ready for sale.
Raw materials and WIP are not for sale and hence the NRV cannot
be estimated. They needs to be valued at cost, However, if NRV of
the finished goods is less than the cost, than the relevant Raw
material and WIP are to valued at Replacement cost
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Disclosure
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Disclosure
The Financial Statements should disclose:
(a). The accounting policies adopted in measuring inventories, including
the cost formula used
(b). The total carrying amount of inventories together with a
classification appropriate to the enterprise

Information about the carrying cost held in different classifications of

inventories and extent of the changes in these assets is useful to
financial statement users. Common classification of inventories are –
(a). Raw materials and components (b). Work in Progress
(c). Finished Goods, Stores and Spares (d). Loose tools
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Lesson Summary
1. We have learnt the background of AS – 2,
exceptions and Scope

2. We had also discussed the various cost

formulas used in inventory valuation

3. We had also learnt the meaning and usage of

Net Realisable Value

4. Finally we had discussed the Disclosure

requirements as per AS - 2
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Testing time
AS – 2 : Valuation of Inventories
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True or False – 1

Accounting Standard 2 apply to shares, debentures

and other financial instruments held as stock in trade

A. True B. False

Answer: B. False
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True or False – 2
Accounting Standard 2 does not apply to work in
progress arising in the ordinary course of business of
service providers

A. True B. False

Answer: A. True
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MCQ – 1

As per AS 2 inventories includes –

A. Finished Goods B. Work in progress

C. Raw materials D. All of the above

Answer : D. All of the above

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MCQ – 2

According to AS 2 cost of goods is the summation of –

A. Cost of purchase B. Cost of conversion

C. Other cost necessary to

bring the inventory in D. All of the above
present location and
condition
Answer : D. All of the above
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What Next ……
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Please follow session on –

AS – 2 : Valuation of Inventories – Practical
Paper 1: Financial Reporting Chapter 1 Unit 3
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Thank You