Duration: 60

mins
Slides: 17

LMT SCHOOL OF MANAGEMENT, THAPAR

UNIVERSITY
Masters of Business Administration

Course: Financial Reporting and Analysis

Faculty: Dr. Sonia Garg (Email:
sonia.garg@thapar.edu)

Session 15: Valuation of Inventories

AS-2 weblink
AS-2 applies to all inventory except the following
work in progress arising under construction contracts, including
directly related service contracts (see AS-7, Construction Contracts)
work in progress arising in the ordinary course of business of
service providers (service rendered but fees not received)
shares, debentures and other financial instruments held as stock-intrade (investments)
producers inventories of livestock, agricultural and forest products,
and mineral oils, ores and gases to the extent that they are
measured at net realisable value in accordance with well
established practices in those industries.

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Valuation of Inventories

Inventory
Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in
the production process or in the rendering of services.
Inventories include materials, maintenance supplies,
consumables and loose tools required for use in
production of goods or rendering of services
Inventories do not include machinery spares required
infrequently
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Valuation Policy
Finished Goods and Work-in-Progress are
valued at cost or net realisable value
whichever is lower
Raw material is valued at cost, except in a
situation when write down to net realisable
value is required
Cost of inventories
Cost of purchase
Cost of conversion
Other costs
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Cost of Purchase
Purchase price
Duty and taxes other than those
subsequently recoverable
Freight inwards
Other expenditure directly
attributable to the acquisition of
materials e.g. octroi
Trade discounts, rebates and duty
drawbacks are deducted
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Cost of Conversion
Direct Material
Direct Labour
Systematic Allocation of indirect costs
(production overheads)
Fixed Production Overhead: depreciation,
maintenance
Variable Production Overhead: power, lubricants

Allocation of fixed production overhead is done

on the basis of normal capacity (if production
much is less than the normal capacity)
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Example on Fixed Production

Overhead Allocation

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Other Considerations
Joint and by-products: if the cost of conversion of each
product is not separately identifiable, they are allocated on
a rational and consistent basis
Other costs: all costs which are incurred in bringing the
inventory to its present location and condition are included
in the cost of inventory e.g. cost of designing customized
products; interest and other borrowing costs are not
included
Exclusion of certain costs: abnormal wastage of material,
labour or capacity; storage costs unless required in stages
of production; administrative overheads; selling and
distribution costs
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10

Cost Formulas
Specific Identification: for customized production
Cost flow assumption: for mass production
FIFO (first in first out)
WAC (weighted average cost)
LIFO (last in last out)

AS-2 does not recognise the LIFO method

AS-2 is silent on whether the firm can use more
than one formula for different inventories
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When the inventory costs are increasing over time

Gross Profit and Net profit: FIFO > WAC >LIFO

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Net Realisable Value

Circumstances justifying write-down to NRV
When selling prices have declined
When inventory is damaged
When inventory is wholly or partially obsolete
When conversion cost or cost to sell have increased
Basis of write-down
Item-by-item basis i.e. write-down all inventory of one type
Factors to be considered while writing-down
Market price fluctuations
Inventory held more than that required by sales contract
Decline in prices more than purchase contract have to be taken
care by contingent losses
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Disclosure in F/S
Accounting policies adopted in
measuring and valuing inventories
Cost formula used in valuation
Total carrying amount of inventory
and its classification (FG, WIP and
RM)

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IFRS Converged IND AS 2 vs

AS-2
The converged IND AS 2 requires new assessment
of NRV in each subsequent period and allows
reversal of the write-down. Existing standard does
not deal with such reversal
Existing AS-2 specifically requires the cost of
inventory to include all cost incurred in bringing
the inventory to its present location and condition.
The converged IND AS 2 requires only the use of
consistent cost formulas for all inventories having
a similar nature and use to the entity
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17