Accounting Standard (AS) 2*
Valuation of Inventories
Objective of Accounting Standard 2 - Valuation of Inventories - AS 2
A primary issue in accounting for inventories is the determination of the value at which inventories are carried in the financial statements until the related revenues are recognised.This Statement dealswith the determination of such value, including the ascertainment of cost of inventories and any
write-down thereof to net realisable value.
Scope of Accounting Standard 2 - Valuation of Inventories - AS 2
1. This Statement should be applied in accounting for inventories other than:
(a) work in progress arising under construction contracts, including directly related service contracts (see Accounting Standard (AS) 7, Accounting for Construction Contracts3);
(b) work in progress arising in the ordinary course of business of service providers;
(c) shares, debentures and other financial instruments held as stock-in-trade; and
(d) producersí 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.
2. The inventories referred to in paragraph 1 (d) aremeasured at net realisable value at certain stages of production. This occurs, for example, when agricultural crops have been harvested or mineral oils, ores and gases have been extracted and sale is assured under a forward contract or a government guarantee, orwhen ahomogenousmarket exists and there is a negligible risk of failure to sell.These inventories are excluded fromthe scope of this Statement.
Definitions of Accounting Standard 2 - Valuation of Inventories - AS 2
3. The following terms are used in this Statement with the meanings specified:
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. Net realisable value 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.
4. Inventories encompass goods purchased and held for resale, for example, merchandise purchased by a retailer and held for resale, computer software held for resale, or land and other property held for resale. Inventories also encompass finished goods produced, or work in progress being produced,
by the enterprise and include materials, maintenance supplies, consumables and loose tools awaiting use in the production process. Inventories do not include machinery spares which can be used only in connection with an itemof fixed asset and whose use is expected to be irregular; suchmachinery
spares are accounted for in accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets.
Measurement of Inventories of Accounting Standard 2 - Valuation of Inventories - AS 2
5. Inventories should be valued at the lower of cost and net realisable value.
Cost of Inventories of Accounting Standard 2 - Valuation of Inventories - AS 2
6. The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.
Costs of Purchase of Accounting Standard 2 - Valuation of Inventories - AS 2
7. The costs of purchase consist of the purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities), freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates, duty drawbacks and
other similar items are deducted in determining the costs of purchase.
Costs of Conversion of Accounting Standard 2 - Valuation of Inventories - AS 2
8. The costs of conversion of inventories include costs directly related to the units of production, such as direct labour. They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.
9. The allocation of fixed production overheads for the purpose of their inclusion in the costs of conversion is based on the normal capacity of the production facilities. Normal capacity is the production expected to be achieved on an average over a number of periods or seasons under normal
circumstances, taking into account the loss of capacity resulting from planned maintenance. The actual level of production may be used if it approximates normal capacity. The amount of fixed production overheads allocated to each unit of production is not increased as a consequence of low production or idle plant. Unallocated overheads are recognised as an expense in the period in which they are incurred. In periods of abnormally high production, the amount of fixed production overheads allocated to each unit of production is decreased so that inventories are not measured above cost. Variable production overheads are assigned to each unit of production on the basis of
the actual use of the production facilities.
10. A production process may result in more than one product being produced simultaneously. This is the case, for example, when joint products are produced or when there is a main product and a by-product. When the costs of conversion of each product are not separately identifiable, they are
allocated between the products on a rational and consistent basis. The allocation may be based, for example, on the relative sales value of each product either at the stage in the production process when the products become separately identifiable, or at the completion of production. Most
by-products as well as scrap or waste materials, by their nature, are immaterial. When this is the case, they are often measured at net realisable value and this value is deducted from the cost of the main product. As a result, the carrying amount of the main product is not materially different
from its cost.
Other Costs of Accounting Standard 2 - Valuation of Inventories - AS 2
11. Other costs are included in the cost of inventories only to the extentthat they are incurred in bringing the inventories to their present location and condition. For example, it may be appropriate to include overheads other than production overheads or the costs of designing products for
specific customers in the cost of inventories.
12. Interest and other borrowing costs are usually considered as not relating to bringing the inventories to their present location and condition and are, therefore, usually not included in the cost of inventories.
Exclusions from the Cost of Inventories of Accounting Standard 2 - Valuation of Inventories - AS 2
13. In determining the cost of inventories in accordance with paragraph 6, it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred. Examples of such costs are:
(a) abnormal amounts ofwastedmaterials, labour, or other production costs;
(b) storage costs, unless those costs are necessary in the production process prior to a further production stage;
(c) administrative overheads that do not contribute to bringing the inventories to their present location and condition; and
(d) selling and distribution costs.