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.
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 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.
AS 2 allows cost of inventories to be determined on the basis of following cost formulas:
- Specific identification method.
- 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.