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“Valuation of inventories”


AS -2 (Revised) ‘Valuation of Inventories; provides complete guidance for determining the value at which inventories, are carried in the financial statements until related revenues are recognized. It also provides guidance on the cost formulas that are used to assign costs to inventories and any write-down thereof to net realizable value.

Scope of AS 2

Applicability of AS 2 in accounting for inventories other than

  1. Work in progress arising under construction contracts, including directly related services contracts;

  2. Work in progress arising in the ordinary course of business of service providers;

  3. Shares, debenture and other financial instruments held as stock-in- trade;

  4. Producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realizable value in accordance with well-established practices in those industries.

Definition of Inventories

Inventories are assets

Held for sale in the ordinary course of business. It includes goods purchased and held for resale

In the process of production for such sale. It includes finished goods or work in progress, produced, or materials and supplies awaiting use in the Production process. Other than machinery spares, services, servicing equipment and stand-by equipment meeting the definition of PPE

In the form of materials* or supplies* to be consumed in

  1. Rendering of services

  2. production process

Determination of Cost of Inventories

Cost of purchase

Purchase price

  1. Duties and other taxes (non- recoverable from the taxing authorities)

  2. Other expenditure directly attributable to the acquisition

  3. Trade discounts, rebates, duty drawbacks and other similar items are deducted in determining the costs of purchase

Cost of Conversion

It can be

  1. Direct Labour

  2. Overheads

Overheads further can be

  1. Fixed production overheads (remains relatively constant regardless of the volume of production.

  2. Variable production overheads (it vary directly, or nearly directly, with the volume of production.

Other costs

Costs incurred to bring the inventories to their present location and condition

Allocation of Cost to Joint Products and By – Products

When more than one product is produced in the process

Outcome-Joint products

  1. When the cost of conversion of each product is separately identifiable, Cost of each product is calculated on the basis of separate cost incurred.

  2. When the cost of conversion of each product is not separately identifiable, Allocation of cost is based on relative sales value of each product either at the state in the production process when the products become separately identifiable, or at the completion of production.

Outcome – Main product with a By – product

When the by- product is immaterial --- By-product is measured at NRV and this value is deducted from the cost of the main product.

When the by- product is material --- By-product is treated as joint product and accordingly, the accounting is done.

Joint Cost

If an enterprise incurs joint cost in a common process for different output then allocation of joint cost over each product can be made on the basis of following Ratios: -


Sales value at separation -- Point is goods are not further processed

NRV Ratio if goods are further processed

HRV = {Sales after further processing – Further processing cost}

Conversion cost

Factory Overheads

  1. Variable Factory Overheads

  2. Fixed Factory Overheads

Factory overheads can be ascertained through the following steps

Step -1

Recovery rate P.U. =

Fixed Overhead

Nornal output or actual output whichever is higher

Step – 2

Recovered O/H as a part of cost of inventory = No. of units actual produced × Recovery Rate p.u.

Direct labour

The amount of direct wages should be taken as per factory records (that is (i.e. Pay Roll sheets, wages register etc.

Costs excluded from the cost of inventories and recognized as expenses

  1. Abnormal amounts of wasted material, labour, or other production costs;

  2. Storage costs, unless the production process requires such storage;

  3. Administrative overheads that do not contribute to bringing the inventories to their preset location and condition;

  4. Selling and distributing costs.

Costing Formulas

  1. FIFO

  2. Weighted Average method

  3. Retail value method

Explanation on Retail Value Method: -

In case the enterprise deals with large quantity & variety of goods (i.e. Departmental stores etc.) then valuation of Closing stock at cost for these enterprises shall be made as follows: -

Weighted Average method = Total cost × Retail value of Closing Stock

                                                     Total Retail Value


FIFO = Cost for Pruchased Goods × Retail value of Closing Stock

Retail Value for purchased goods

Measurement of Inventories

Raw Materials At cost (if finished goods are sold at or above cost), otherwise at replacement cost

Finished Goods and Work in progress

Lower of Cost OR Net Realisable Value

Net realisable value means the Realisable Value less Selling Expenses less estimated cost of completion


Information about the carrying amounts held in different classification of inventories and the extent of changes in these assets must be disclosed in financial statements.

  1. Stock-in-trade (in respect of goods acquired for trading),

  2. Finished Goods,

  3. Work in progress,

  4. Raw materials and components,

  5. Common Classification of inventories

  6. Stores and Spares,

  7. Lose tools,

  8. Others

The financial statements should disclose

  1. Accounting policies adopted in measuring inventories, including the cost formula used.

  2. The total carrying amount of inventories together with its classification appropriate to the enterprise.

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