AS 2 – Valuation of Inventory

The valuation of inventory is crucial because of its direct impact in measuring profit/loss for an accounting period. The Objective of AS 2 Valuation of Inventory is to prescribe the manner in which value of inventory is to be determined by an enterprise. The standard also deals with the manner of ascertainment of cost of inventories and any write-down of inventories to net realisable value.

Inventories are assets held

  • for sales in the ordinary course of business
  • in the process of production for such sale or
  • in the form of materials or supplies to be consumed in the production process or in the rendering of services.

AS 2 deals with all Inventories except following

  • Work in progress arising under construction contracts, including directly related service contracts, being covered under AS 7.
  • Work in progress arising in the ordinary course of business of service providers.
  • Shares, debentures and other financial instruments held as stock-in-trade, and
  • Producers’ inventories  of livestock, agricultural and forest products and material oils, ores and gases to the extent that they are measured at NRV in accordance with well-established practices in those industries.

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Costs of Inventory

Costs of inventories comprise of the following:

  • All costs of purchase.
  • Costs of convention.
  • Other costs incurred in bringing the inventories to their present location and condition.

The costs of purchase consist of the purchase price including duties and taxes, freight inwards and other expenditure directly attributable to the acquisition.

The costs of the invention include costs directly related to production, which includes overheads, both fixed and variable.

Inventory Valuation

Inventory valuation is a three step process:

Step 1        Determine the cost of inventories

Step 2        Determine the NRV of inventories

Step 3        Compare the values of calculated in steps 1 and 2 above.

                  Lower of the two values is the value of inventories.

Net Realisable Value (NRV) is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

Cost Formula 

AS 2 allows cost of inventories to be determined on the basis of following cost formulas:

  • Specific identification method.
  • FIFO.
  • Weighted Average.
  • Standard Cost.
  • Retail Method.

Disclosure Requirements under AS 2 

  • the accounting policies adopted in measuring inventories, including the cost formula used.
  • the total carrying amount of inventories and its classification appropriate to the enterprise.


AS 1:Disclosure of Accounting Policies

AS 1: Disclosure of Accounting Policies

The Accounting Policies are vary from enterprise to enterprise. The purpose of Accounting Standard 1:Disclosure of Accounting Policies, is to promote a better understanding of financial statements by requiring disclosure of significant accounting policies in an orderly manner. Such disclosure facilitates a more meaningful comparison between financial statements of different enterprises.

Fundamental Accounting Assumptions

Accounting Policies

Going Concern 

The financial statements are normally prepared on the assumption that an enterprise will continue its operations in the foreseeable future and neither there is an intention, nor there is need to materially curtail the scale of operations.


The practice of using same accounting policies for similar transactions in all accounting periods. The consistency improves comparability of financial statements through time. An accounting policy can be changed if the change is required

  • by a statute.
  • by an accounting standard.
  • for a more appropriate presentation of financial statements.


Transactions are recognized as soon as they occur, whether or not cash or cash equivalent is actually received or paid and recorded in the financial statements of the periods to which they relate.

Accounting Policies

Accounting policies are the specific accounting principles and the methods of applying those principles adopted by the enterprise in the preparation and presentation of financial statements.

Examples :-

  • Methods of depreciation.
  • Valuation of inventories.
  • Valuation of Investment.
  • Translation of foreign currency items.
  • Valuation of fixed assets.
  • Treatment of retirement benefits.
  • Treatment of goodwill.
  • Treatment of expenditure during construction.
  • Treatment of contingent liabilities.
  • Recognition of profit on long term contracts.

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Points to be considered for the selection of  accounting policies

  • Prudence: According to this concepts all anticipated losses should be recognized immediately, but not anticipated profits.
  • Substance over form : The accounting treatment and presentation of transactions and events in financial statements should be governed by their substance and not merely by the legal form.
  • Materiality : Financial statements should disclose all material items which influence the decision of users of the financial statements.

Disclosure Requirements under AS 1

  • All significant accounting policies adopted in the preparation and presentation of financial statements should be disclosed.
  • Any change in the accounting policies which has a material effect in the current period or which is reasonably expected to have a material effect in a later period should be disclosed.
  • If the fundamental accounting assumptions, viz. going concern, consistency and accrual are followed in financial statements, a specific disclosure is not required. If a fundamental accounting assumption is not followed, the fact should be disclosed.

Indian Accounting Standards

What are Accounting Standards?

Accounting standards are written policy documents issued by government or expert institutes or other regulatory body covering various aspects of recognition, measurement, treatment, presentation and disclosure of accounting transactions in the financial statements.

Indian Accounting Standards 

The Institute of Chartered Accountants of India (ICAI), being a premier accounting body in India, took upon itself the leadership role by constituting the Accounting Standards Board (ASB) in 1977. The ‘Accounting Standards’ issued by the ASB establish standards which have to be compiled by the business entities so that the financial statements are prepared in accordance with generally accepted accounting principles.

Following are the Accounting Standards issued by Accounting Standards Board.

AS 1       Disclosure of Accounting Policies.

AS 2       Valuation of Inventories.

AS 3       Cash Flow Statements.

AS 4       Contingencies and Events Occurring after the Balance Sheet Date.

AS 5       Net Profit or Loss for the period, Prior Period Items and Changes in Accounting Policies.

AS 6       Depreciation Accounting.

AS 7       Construction Contracts.

AS 8       Research & Development (Now included in AS 26)

AS 9       Revenue Recognition.

AS 10     Accounting for Fixed Assets.

AS 11     The Effects of Changes in Foreign Exchange Rates.

AS 12     Accounting for Government Grants.

AS 13     Accounting for Investments.

AS 14     Accounting for Amalgamations.

AS 15     Employee Benefits.

AS 16     Borrowing Costs.

AS 17     Segment Reporting.

AS 18     Related Party Disclosures.

AS 19     Leases.

AS 20     Earning per Share.

AS 21     Consolidated Financial Statements.

AS 22     Accounting for Taxes on Income.

AS 23     Accounting for Investments in Associates in Consolidated Financial Statements.

AS 24     Discontinuing Operations.

AS 25     Interim Financial Reporting.

AS 26     Intangible Assets.

AS 27     Financial Reporting of Interests in Joint Ventures.

AS 28     Impairment of Assets.

AS 29     Provisions, Contingent Liabilities & Contingent Assets.

AS 30     Financial Instruments: Recognition and Measurement.

AS 31     Financial Instruments: Presentation

AS 32     Financial Instruments: Disclosure

AS 3 – Cash Flow Statements

Cash Flow Statements are the summary of inflows (receipts) and outflows (payments) of cash and cash equivalents during an accounting period.

  • Cash comprises cash on hand and demand deposits with banks.
  • Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and which are subject to an insignificant risk or changes in value. A short–term investment is one, which is due for maturity within three months from the date of acquisition. Investments in shares are not normally taken as a cash equivalent, because of uncertainties associated with them as to realisable value.

Cash flow is determined by looking at three components by which cash enters and leaves a company:

  1. Cash flow from Operating Activities
  2. Cash flow from Investing Activities
  3. Cash flow from Financing Activities

Cash Flow from Operating Activities

Operating activities are primarily derived from the principal revenue-producing activities of the enterprise. Therefore, they generally result from the transactions and other events that enter into the determination of net profit or loss.

Examples of cash flows from operating activities are:

  • cash receipts from the sales of goods and the rendering of services
  • cash receipts from royalties, fees, commissions and other revenue
  • cash payments to suppliers for the goods and services
  • cash payments to and on behalf of employees
  • cash receipts and cash payments of an insurance enterprise for premiums and claims, annuities and other policy benefits
  • cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities
  • cash flows arising from the purchase and sale of dealing or trading securities and
  • cash advances and loans made by financial enterprises.

Cash flow from Investing Activities

Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents.

Examples of cash flow from investing activities are:

  • Cash payments to acquire fixed assets (including intangibles)
  • Cash receipts from disposal of fixed assets (including intangibles)
  • cash payments/receipts to acquire/from the disposal of shares, warrants or debt instruments of other enterprises  and  interests  in  joint  ventures  (other  than payments for those instruments considered to be cash equivalents and those held for dealing or trading purposes)
  • cash advances and loans made to third parties (other  than advances and loans made by a financial enterprise)
  • cash receipts from the repayment of advances and loans made to third parties  (other  than  advances  and  loans  of  a  financial enterprise)
  • cash payments/receipts for/from futures contracts, forward contracts, option contracts and swap contracts except when the contracts are held for dealing or trading purposes, or the payments/receipts  are classified as financing activities.

Cash flow from Financing Activities

Financing activities are activities that result in changes in the size and composition of the owners’ capital and borrowing of the enterprises.

Examples of cash flows arising from financing activities are:

  • cash proceeds from issuing shares or other similar instruments
  • cash proceeds from issuing debentures, loans, notes, bonds, and other short or long-term borrowings and
  • cash repayments of amounts borrowed.

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Reporting Cash Flows from Operating Activities

An enterprise should report cash flows from operating activities using either:

  • the direct method, whereby major classes of gross cash receipts and gross  cash  payments  are  disclosed  or
  • the indirect method, whereby net profit or loss is adjusted for the effects of transactions of a non-cash nature, any deferrals or accruals  of  past  or  future  operating  cash  receipts  or payments,  and  items  of  income  or  expense  associated  with investing or financing cash flows.

Format for direct and indirect methods are given belowCash Flow

Cash Flow