Wednesday, December 22, 2010

IAS 2

Accounting Standard (AS) 2

(revised 1999)

Valuation of Inventories

Contents

OBJECTIVE

SCOPE Paragraphs 1-2

DEFINITIONS 3-4

MEASUREMENT OF INVENTORIES 5-25

Cost of Inventories 6-13

Costs of Purchase 7

Costs of Conversion 8-10

Other Costs 11-12

Exclusions from the Cost of Inventories 13

Cost Formulas 14-17

Techniques for the Measurement of Cost 18-19

Net Realisable Value 20-25

DISCLOSURE 26-27

The following Accounting Standards Interpretation (ASI) relates to AS 2:

 ASI 2 - Accounting for Machinery Spares

The above Interpretation is published elsewhere in this Compendium.

Valuation of Inventories 43

Accounting Standard (AS) 2*

(revised 1999)

Valuation of Inventories

(This Accounting Standard includes paragraphs set in bold italic type

and plain type, which have equal authority. Paragraphs in bold italic type

indicate the main principles. This Accounting Standard should be read in

the context of its objective and the Preface to the Statements of Accounting

Standards1.)

The following is the text of the revised Accounting Standard (AS) 2,

‘Valuation of Inventories’, issued by the Council of the Institute of Chartered

Accountants of India. This revised Standard supersedesAccounting Standard

(AS) 2, ‘Valuation of Inventories’, issued in June, 1981.

The revised standard comes into effect in respect of accounting periods

commencing on or after 1.4.1999 and is mandatory in nature.2

Objective

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

1. This Statement should be applied in accounting for inventories other

than:

* The Standard was originally issued in June 1981.

1Attention is specifically drawn to paragraph 4.3 of the Preface, according to which

Accounting Standards are intended to apply only to items which are material.

2 Reference may be made to the section titled ‘Announcements of the Council regarding

status of various documents issued by the Institute of Chartered Accountants of India’

appearing at the beginning of this Compendium for a detailed discussion on the

implications of the mandatory status of an accounting standard.

48 AS 2 (revised 1999)

(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) producers’ 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

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.

3 This Standard has been revised and titled as ‘Construction Contracts’. The revised

Standard is published elsewhere in this Compendium.

Valuation of Inventories 49

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 Assets4 .

Measurement of Inventories

5. Inventories should be valued at the lower of cost and net realisable

value.

Cost of Inventories

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

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

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

4 See also Accounting Standards Interpretation (ASI) 2 published elsewhere in this Compendium.

50 AS 2 (revised 1999)

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

11. Other costs are included in the cost of inventories only to the extent

that 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.

Valuation of Inventories 51

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

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.

Cost Formulas

14. The cost of inventories of items that are not ordinarily

interchangeable and goods or services produced and segregated for specific

projects should be assigned by specific identification of their

individual costs.

15. Specific identification of cost means that specific costs are attributed

to identified items of inventory. This is an appropriate treatment for items

that are segregated for a specific project, regardless of whether they have

been purchased or produced.However,when there are large numbers of items

of inventory which are ordinarily interchangeable, specific identification of

costs is inappropriate since, in such circumstances, an enterprise could obtain

predetermined effects on the net profit or loss for the period by selecting a

particular method of ascertaining the items that remain in inventories.

16. The cost of inventories, other than those dealt with in paragraph 14,

should be assigned by using the first-in, first-out (FIFO), or

weighted average cost formula. The formula used should reflect the

fairest possible approximation to the cost incurred in bringing the items

of inventory to their present location and condition.

52 AS 2 (revised 1999)

17. A variety of cost formulas is used to determine the cost of inventories

other than those for which specific identification of individual costs is

appropriate. The formula used in determining the cost of an itemof inventory

needs to be selected with a view to providing the fairest possible

approximation to the cost incurred in bringing the itemto its present location

and condition. The FIFO formula assumes that the items of inventory which

were purchased or produced first are consumed or sold first, and consequently

the items remaining in inventory at the end of the period are those most

recently purchased or produced. Under the weighted average cost formula,

the cost of each item is determined from the weighted average of the cost of

similar items at the beginning of a period and the cost of similar items

purchased or produced during the period. The average may be calculated on

a periodic basis, or as each additional shipment is received, depending upon

the circumstances of the enterprise.

Techniques for the Measurement of Cost

18. Techniques for the measurement of the cost of inventories, such as the

standard cost method or the retail method, may be used for convenience if

the results approximate the actual cost. Standard costs take into account

normal levels of consumption of materials and supplies, labour, efficiency

and capacity utilisation. They are regularly reviewed and, if necessary, revised

in the light of current conditions.

19. The retail method is often used in the retail trade for measuring

inventories of large numbers of rapidly changing items that have similar

margins and for which it is impracticable to use other costing methods. The

cost of the inventory is determined by reducing from the sales value of the

inventory the appropriate percentage gross margin. The percentage used

takes into consideration inventory which has been marked down to below

its original selling price. An average percentage for each retail department

is often used.

Net Realisable Value

20. The cost of inventories may not be recoverable if those inventories are

damaged, if they have become wholly or partially obsolete, or if their selling

prices have declined. The cost of inventories may also not be recoverable if

the estimated costs of completion or the estimated costs necessary to make

the sale have increased. The practice of writing down inventories below cost

Valuation of Inventories 53

to net realisable value is consistent with the view that assets should not be

carried in excess of amounts expected to be realised from their sale or use.

21. Inventories are usuallywritten down to net realisable value on an itemby-

item basis. In some circumstances, however, it may be appropriate to

group similar or related items. This may be the case with items of inventory

relating to the same product line that have similar purposes or end uses and

are produced and marketed in the same geographical area and cannot be

practicably evaluated separately from other items in that product line. It is

not appropriate to write down inventories based on a classification

of inventory, for example, finished goods, or all the inventories in a

particular business segment.

22. Estimates of net realisable value are based on themost reliable evidence

available at the time the estimates are made as to the amount the inventories

are expected to realise. These estimates take into consideration fluctuations

of price or cost directly relating to events occurring after the balance sheet

date to the extent that such events confirm the conditions existing at the

balance sheet date.

23. Estimates of net realisable value also take into consideration the purpose

for which the inventory is held. For example, the net realisable value of the

quantity of inventory held to satisfy firm sales or service contracts is based

on the contract price. If the sales contracts are for less than the inventory

quantities held, the net realisable value of the excess inventory is based on

general selling prices. Contingent losses on firm sales contracts in excess of

inventory quantities held and contingent losses on firm purchase contracts

are dealt with in accordance with the principles enunciated in Accounting

Standard (AS) 4, Contingencies and Events Occurring After the Balance

Sheet Date5 .

24. Materials and other supplies held for use in the production of

inventories are not written down below cost if the finished products in

5 Pursuant to AS 29, Provisions, Contingent Liabilities and Contingent Assets, becoming

mandatory in respect of accounting periods commencing on or after 1-4-2004, all

paragraphs of AS 4 that deal with contingencies stand withdrawn except to the extent

they deal with impairment of assets not covered by other Indian Accounting Standards.

Reference may be made to Announcement XX under the section titled 'Announcements

of the Council regarding status of various documents issued by the Institute of

Chartered Accountants of India' appearing at the beginning of this Compendium.

A limited revision to AS 29 was made in 2005, so as to include Onerous Contracts in the

scope of the Standard. The said limited revision to AS 29 comes into effect in respect of

accounting periods commencing on or after April 1, 2006.

54 AS 2 (revised 1999)

which they will be incorporated are expected to be sold at or above cost.

However, when there has been a decline in the price of materials and it is

estimated that the cost of the finished products will exceed net realisable

value, the materials are written down to net realisable value. In such

circumstances, the replacement cost of the materials may be the best

available measure of their net realisable value.

25. An assessment is made of net realisable value as at each balance sheet

date.

Disclosure

26. The financial statements should disclose:

(a) the accounting policies adopted in measuring inventories,

including the cost formula used; and

(b) the total carrying amount of inventories and its classification

appropriate to the enterprise.

27. Information about the carrying amounts held in different classifications

of inventories and the extent of the changes in these assets is useful to

financial statement users. Common classifications of inventories are raw

materials and components, work in progress, finished goods, stores and

spares, and loose tools.

No comments:

Post a Comment