8

Accounting Standard (AS) 2

Valuation of Inventories
Contents
OBJECTIVE SCOPE $E%I&ITIO&S )EAS*+E)E&T O% I&VE&TO+IES Cost of Inventories Costs of Purchase Costs of Conversion Other Costs Exclusions from the Cost of Inventories Cost %or-ulas Tec!ni.ues for t!e )easure-ent of Cost &et +ealisa/le Value $ISC0OS*+E Paragra !s "#2 '# ( ,#2, 6-13 7 8-10 11-12 13 14-17 18-1 20-2! 21#22

Valuation of Inventories ('

Accounting Standard (AS) 2 Valuation of Inventories

(T!is Accounting Standard includes aragra !s set in /old italic t3 e and lain t3 e4 5!ic! !ave e.ual aut!orit36 Paragra !s in /old italic t3 e indicate t!e -ain rinci les6 T!is Accounting Standard s!ould /e read in t!e conte7t of its o/8ective and t!e 9eneral Instructions contained in art A of t!e Anne7ure to t!e &otification6)

O/8ective
" #rimar$ issue in accountin% for inventories is the &etermination of the value at 'hich inventories are carrie& in the financial statements until the relate& revenues are reco%nise&( )his *tan&ar& &eals 'ith the &etermination of such value+ inclu&in% the ascertainment of cost of inventories an& an$ 'rite-&o'n thereof to net realisa,le value(

Sco e
"6 T!is Standard s!ould /e a lied in accounting for inventories ot!er t!an: (a) 5or; in rogress arising under construction contracts 4 including directl3 related service contracts (see Accounting Standard (AS) 24 Construction Contracts)< (/) 5or; in rogress arising in t!e ordinar3 course of /usiness of service roviders< (c) s!ares4 de/entures and ot!er financial instru-ents !eld as stoc;#in#trade< and (d) roducers= inventories of livestoc;4 agricultural and forest roducts4 and -ineral oils4 ores and gases to t!e e7tent t!at t!e3 are -easured at net realisa/le value in accordance 5it! 5ell esta/lis!ed ractices in t!ose industries6 2( )he inventories referre& to in #ara%ra#h 1 -&. are measure& at net realisa,le value at certain sta%es of #ro&uction( )his occurs+ for exam#le+ 'hen a%ricultural cro#s have ,een harveste& or mineral oils+ ores an& %ases

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AS 2

have ,een extracte& an& sale is assure& un&er a for'ar& contract or a %overnment %uarantee+ or 'hen a homo%enous mar/et exists an& there is a ne%li%i,le ris/ of failure to sell( )hese inventories are exclu&e& from the sco#e of this *tan&ar&(

$efinitions
'6 T!e follo5ing ter-s are used in t!is Standard 5it! t!e -eanings s ecified: '6" Inventories are assets: (a) !eld for sale in t!e ordinar3 course of /usiness< (/) in t!e rocess of roduction for suc!

sale< or (c) in t!e for- of -aterials or su lies to /e consu-ed in t!e roduction rocess or in t!e rendering of services6 '62 &et realisa/le value is t!e esti-ated selling rice in t!e ordinar3 course of /usiness less t!e esti-ated costs of co- letion and t!e esti-ated costs necessar3 to -a;e t!e sale6 4( Inventories encom#ass %oo&s #urchase& an& hel& for resale+ for exam#le+ merchan&ise #urchase& ,$ a retailer an& hel& for resale+ com#uter soft'are hel& for resale+ or lan& an& other #ro#ert$ hel& for resale( Inventories also encom#ass finishe& %oo&s #ro&uce&+ or 'or/ in #ro%ress ,ein% #ro&uce&+ ,$ the enter#rise an& inclu&e materials+ maintenance su##lies+ consuma,les an& loose tools a'aitin% use in the #ro&uction #rocess( Inventories &o not inclu&e machiner$ s#ares 'hich can ,e use& onl$ in connection 'ith an item of fixe& asset an& 'hose use is ex#ecte& to ,e irre%ular0 such machiner$ s#ares are accounte& for in accor&ance 'ith "ccountin% *tan&ar& -"*. 10+ "ccountin% for 1ixe& "ssets(

)easure-ent of Inventories
,6 Inventories s!ould /e valued at t!e lo5er of cost and net realisa/le value6

Cost of Inventories
16 T!e cost of inventories s!ould co- rise all costs of urc!ase4 costs of conversion and ot!er costs incurred in /ringing t!e inventories to

Valuation of Inventories ""

t!eir resent location and condition6 Costs of Purc!ase 7( )he costs of #urchase consist of the #urchase #rice inclu&in% &uties an& taxes -other than those su,se2uentl$ recovera,le ,$ the enter#rise from the taxin% authorities.+ frei%ht in'ar&s an& other ex#en&iture &irectl$ attri,uta,le to the ac2uisition( )ra&e &iscounts+ re,ates+ &ut$ &ra',ac/s an& other similar items are &e&ucte& in &eterminin% the costs of #urchase( Costs of Conversion 8( )he costs of conversion of inventories inclu&e costs &irectl$ relate& to the units of #ro&uction+ such as &irect la,our( )he$ also inclu&e a s$stematic allocation of fixe& an& varia,le #ro&uction overhea&s that are incurre& in convertin% materials into finishe& %oo&s( 1ixe& #ro&uction overhea&s are those in&irect costs of #ro&uction that remain relativel$ constant re%ar&less of the volume of #ro&uction+ such as &e#reciation an& maintenance of factor$ ,uil&in%s an& the cost of factor$ mana%ement an& a&ministration( 3aria,le #ro&uction overhea&s are those in&irect costs of #ro&uction that var$ &irectl$+ or nearl$ &irectl$+ 'ith the volume of #ro&uction+ such as in&irect materials ( )he allocation of fixe& #ro&uction overhea&s for the #ur#ose of their inclusion in the costs of conversion is ,ase& on the normal ca#acit$ of the #ro&uction facilities( 4ormal ca#acit$ is the #ro&uction ex#ecte& to ,e achieve& on an avera%e over a num,er of #erio&s or seasons un&er normal circumstances+ ta/in% into account the loss of ca#acit$ resultin% from #lanne& maintenance( )he actual level of #ro&uction ma$ ,e use& if it a##roximates normal ca#acit$( )he amount of fixe& #ro&uction overhea&s allocate& to each unit of #ro&uction is not increase& as a conse2uence of lo' #ro&uction or i&le #lant( 5nallocate& overhea&s are reco%nise& as an ex#ense in the #erio& in 'hich the$ are incurre&( In #erio&s of a,normall$ hi%h #ro&uction+ the amount of fixe& #ro&uction overhea&s allocate& to each unit of #ro&uction is &ecrease& so that inventories are not measure& a,ove cost( 3aria,le #ro&uction overhea&s are assi%ne& to each unit of #ro&uction on the ,asis of the actual use of the #ro&uction facilities( 10( " #ro&uction #rocess ma$ result in more than one #ro&uct ,ein% #ro&uce& simultaneousl$( )his is the case+ for exam#le+ 'hen 6oint #ro&ucts are #ro&uce& or 'hen there is a main #ro&uct an& a ,$-#ro&uct( 7hen the costs of conversion of each #ro&uct are not se#aratel$ i&entifia,le+ the$ are allocate& ,et'een the #ro&ucts on a rational an& consistent ,asis( )he allocation ma$ ,e ,ase&+ for exam#le+ on the relative sales value of each #ro&uct either at

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AS 2

the sta%e in the #ro&uction #rocess 'hen the #ro&ucts ,ecome se#aratel$ i&entifia,le+ or at the com#letion of #ro&uction( 8ost ,$-#ro&ucts as 'ell as scra# or 'aste materials+ ,$ their nature+ are immaterial( 7hen this is the case+ the$ are often measure& at net realisa,le value an& this value is &e&ucte& from the cost of the main #ro&uct( "s a result+ the carr$in% amount of the main #ro&uct is not materiall$ &ifferent from its cost( Ot!er Costs 11( Other costs are inclu&e& in the cost of inventories onl$ to the extent that the$ are incurre& in ,rin%in% the inventories to their #resent location an& con&ition( 1or exam#le+ it ma$ ,e a##ro#riate to inclu&e overhea&s other than #ro&uction overhea&s or the costs of &esi%nin% #ro&ucts for s#ecific customers in the cost of inventories( 12( Interest an& other ,orro'in% costs are usuall$ consi&ere& as not relatin% to ,rin%in% the inventories to their #resent location an& con&ition an& are+ therefore+ usuall$ not inclu&e& in the cost of inventories( E7clusions fro- t!e Cost of Inventories 13( In &eterminin% the cost of inventories in accor&ance 'ith #ara%ra#h 6+ it is a##ro#riate to exclu&e certain costs an& reco%nise them as ex#enses in the #erio& in 'hich the$ are incurre&( Exam#les of such costs are9 -a. a,normal amounts of 'aste& materials+ la,our+ or other #ro&uction costs0 -,. stora%e costs+ unless those costs are necessar$ in the #ro&uction #rocess #rior to a further #ro&uction sta%e0 -c. a&ministrative overhea&s that &o not contri,ute to ,rin%in% the inventories to their #resent location an& con&ition0 an& -&. sellin% an& &istri,ution costs(

Cost %or-ulas
"(6 T!e cost of inventories of ite-s t!at are not ordinaril3 interc!angea/le and goods or services roduced and segregated for s ecific ro8ects s!ould /e assigned /3 s ecific identification of t!eir individual costs6

Valuation of Inventories "'

1!( *#ecific i&entification of cost means that s#ecific costs are attri,ute& to i&entifie& items of inventor$( )his is an a##ro#riate treatment for items that are se%re%ate& for a s#ecific #ro6ect+ re%ar&less of 'hether the$ have ,een #urchase& or #ro&uce&( :o'ever+ 'hen there are lar%e num,ers of items of inventor$ 'hich are or&inaril$ interchan%ea,le+ s#ecific i&entification of costs is ina##ro#riate since+ in such circumstances+ an enter#rise coul& o,tain #re&etermine& effects on the net #rofit or loss for the #erio& ,$ selectin% "16 T!e cost of inventories4 ot!er t!an t!ose dealt 5it! in aragra ! "(4 s!ould /e assigned /3 using t!e first#in4 first#out (%I%O)4 or 5eig!ted average cost for-ula6 T!e for-ula used s!ould reflect t!e fairest ossi/le a ro7i-ation to t!e cost incurred in /ringing t!e ite-s of inventor3 to t!eir resent location and condition6 17( " variet$ of cost formulas is use& to &etermine the cost of inventories other than those for 'hich s#ecific i&entification of in&ivi&ual costs is a##ro#riate( )he formula use& in &eterminin% the cost of an item of inventor$ nee&s to ,e selecte& 'ith a vie' to #rovi&in% the fairest #ossi,le a##roximation to the cost incurre& in ,rin%in% the item to its #resent location an& con&ition( )he 1I1O formula assumes that the items of inventor$ 'hich 'ere #urchase& or #ro&uce& first are consume& or sol& first+ an& conse2uentl$ the items remainin% in inventor$ at the en& of the #erio& are those most recentl$ #urchase& or #ro&uce&( 5n&er the 'ei%hte& avera%e cost formula+ the cost of each item is &etermine& from the 'ei%hte& avera%e of the cost of similar items at the ,e%innin% of a #erio& an& the cost of similar items #urchase& or #ro&uce& &urin% the #erio&( )he avera%e ma$ ,e calculate& on a #erio&ic ,asis+ or as each a&&itional shi#ment is receive&+ &e#en&in% u#on the circumstances of the enter#rise(

Tec!ni.ues for t!e )easure-ent of Cost

18( )echni2ues for the measurement of the cost of inventories+ such as the stan&ar& cost metho& or the retail metho&+ ma$ ,e use& for convenience if the results a##roximate the actual cost( *tan&ar& costs ta/e into account normal levels of consum#tion of materials an& su##lies+ la,our+ efficienc$ an& ca#acit$ utilisation( )he$ are re%ularl$ revie'e& an&+ if necessar$+ revise& in the li%ht of current con&itions( 1 ( )he retail metho& is often use& in the retail tra&e for measurin% inventories of lar%e num,ers of ra#i&l$ chan%in% items that have similar

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AS 2

mar%ins an& for 'hich it is im#ractica,le to use other costin% metho&s( )he cost of the inventor$ is &etermine& ,$ re&ucin% from the sales value of the inventor$ the a##ro#riate #ercenta%e %ross mar%in( )he #ercenta%e use& ta/es into consi&eration inventor$ 'hich has ,een mar/e& &o'n to ,elo' its ori%inal sellin% #rice( "n avera%e #ercenta%e for each retail &e#artment is often use&(

&et +ealisa/le Value

20( )he cost of inventories ma$ not ,e recovera,le if those inventories are &ama%e&+ if the$ have ,ecome 'holl$ or #artiall$ o,solete+ or if their sellin% #rices have &ecline&( )he cost of inventories ma$ also not ,e recovera,le if the estimate& costs of com#letion or the estimate& costs necessar$ to ma/e the sale have increase&( )he #ractice of 'ritin% &o'n inventories ,elo' cost to net realisa,le value is consistent 'ith the vie' that assets shoul& not ,e 21( Inventories are usuall$ 'ritten &o'n to net realisa,le value on an item,$-item ,asis( In some circumstances+ ho'ever+ it ma$ ,e a##ro#riate to %rou# similar or relate& items( )his ma$ ,e the case 'ith items of inventor$ relatin% to the same #ro&uct line that have similar #ur#oses or en& uses an& are #ro&uce& an& mar/ete& in the same %eo%ra#hical area an& cannot ,e #ractica,l$ evaluate& se#aratel$ from other items in that #ro&uct line( It is not a##ro#riate to 'rite &o'n inventories ,ase& on a classification of inventor$+ for exam#le+ finishe& %oo&s+ or all the inventories in a #articular ,usiness se%ment( 22( Estimates of net realisa,le value are ,ase& on the most relia,le evi&ence availa,le at the time the estimates are ma&e as to the amount the inventories are ex#ecte& to realise( )hese estimates ta/e into consi&eration fluctuations of #rice or cost &irectl$ relatin% to events occurrin% after the ,alance sheet &ate to the extent that such events confirm the con&itions existin% at the ,alance sheet &ate( 23( Estimates of net realisa,le value also ta/e into consi&eration the #ur#ose for 'hich the inventor$ is hel&( 1or exam#le+ the net realisa,le value of the 2uantit$ of inventor$ hel& to satisf$ firm sales or service contracts is ,ase& on the contract #rice( If the sales contracts are for less than the inventor$ 2uantities hel&+ the net realisa,le value of the excess inventor$ is ,ase& on %eneral sellin% #rices( Contin%ent losses on firm sales contracts in excess of inventor$ 2uantities hel& an& contin%ent losses on firm #urchase contracts are &ealt 'ith in accor&ance 'ith the #rinci#les enunciate& in "ccountin%

Valuation of Inventories ",

*tan&ar& -"*. 4+ Contin%encies an& Events Occurrin% "fter the ;alance *heet <ate( 24( 8aterials an& other su##lies hel& for use in the #ro&uction of inventories are not 'ritten &o'n ,elo' cost if the finishe& #ro&ucts in 'hich the$ 'ill ,e incor#orate& are ex#ecte& to ,e sol& at or a,ove cost( :o'ever+ 'hen there has ,een a &ecline in the #rice of materials an& it is estimate& that the cost of the finishe& #ro&ucts 'ill excee& net realisa,le value+ the materials are 'ritten &o'n to net realisa,le value( In such circumstances+ the re#lacement cost of the materials ma$ ,e the ,est availa,le measure of their net realisa,le value( 2!( "n assessment is ma&e of net realisa,le value as at each ,alance sheet &ate(

$isclosure
216 T!e financial state-ents s!ould disclose: (a) t!e accounting olicies ado ted in -easuring inventories4 including t!e cost for-ula used< and (/) t!e total carr3ing a-ount of inventories and its classification a ro riate to t!e enter rise6 27( Information a,out the carr$in% amounts hel& in &ifferent classifications of inventories an& the extent of the chan%es in these assets is useful to financial statement users( Common classifications of inventories are ra' materials an& com#onents+ 'or/ in #ro%ress+ finishe& %oo&s+ stores an& s#ares+ an& loose tools(