As 2 - Valuation of Inventories

7/31/2019 As 2 - Valuation of Inventories

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Accounting Standard 2

Valuation of Inventories


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Objective:

Objective is to formulate the method ofcomputation of cost of inventories/ stock,determining the value of closing stock/inventory at which, the inventory is to beshown in the balance sheet till it is not sold.


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Definition of Inventory:

Consists of following:

1. Anything held for sale in ordinary course ofbusiness

2. Materials in the process of production of suchsale

3. Materials or supplies to be consumed inproduction process or rendering of services

(M/c not included)


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Except:

1. Work-in-progress arising out ofconstruction contracts.

2. Work-in-progress arising in ordinarycourse of business for service providers

3. Financial instruments held as stock-in-trade (e.g. shares, debentures etc.)

4. Producers inventories like live stock,agricultural, forest products, Mineral oils,gases and ore.


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How to measure:

Inventories are to be valued at cost or

net realizable value whichever is

less.


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Important Points:

Determining cost of Inventories

Determining realisable value of inventory

Comparison between cost or realisablevalue


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Cost of Inventories:

Cost includes:

1. Cost of Purchase

2. Cost of Conversion3. Other costs incurred in bringing in

inventories to their present location andcondition


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Cost of Purchase:

Cost includes:1. Purchase Price

2. Duties and Taxes3. Freight and purchase expenses

Less:1. Tax rebate

2. Trade Discount

3. Duty Drawback


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Conversion Costs:

Conversion costs largely constitutes twotypes of costs:

Direct costs:

Cost directly related to the units

(mainly Materials, Labour and Direct Expenses)

Indirect cost: (Overheads)

Systematic allocation offixed and variableProduction overheads incurred for conversion


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Fixed Production Overheads:

Indirect cost of production that largelyremains fixed irrespective of the output.For eg. Rent of factory, depreciation ofmachinery, rent of godown.

Allocation of Fixed overhead is to be doneon the basis of NORMAL CAPACITY,


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Variable Production Overheads:

Indirect cost of production that varies withthe output, like indirect materials, indirectwages etc.

Allocation of Variable overhead is to bedone on the basis ofACTUALPRODUCTION.


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Example:1

A Compact Disc manufacturer Sony Ltd.manufactures a CD which includes materialsworth Rs. 5, wages worth Rs. 2, and other

direct cost like packing box etc.. Cost Rs. 1per unit. Rent of the factory, depreciationand other fixed costs amounts to Rs. 2,00,000p.a. The company if working at 100%

capacity can produce 1 million CDs a year.On 31.3.2005 the company had 50,000 CDs instock. You are required to value the stock of

finished goods at the end of the year.


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Joint Products:

Joint product represent tow or more productseparated in the course of same processingoperation, e.g.. Petrol, kerosene, diesel etc.are joint product processing the crude oil.

When total conversion cost of each product isnot separately identifiable then, total cost of

conversion is allocated between the productson the rational and consistent basis.


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By- Products:

Any saleable or usable value incidentallyproduced in addition to the main product.E.g. in making ground nut oil the

waste/reminder after crushing the groundnut.

By-products are valued at Net RealisableValue, then the net realisable value is

deducted from the cost of conversion ofmain product.


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Not included in cost of inventories:

Abnormal Amount of wasted material orlabour or overheads.

Storage Costs. Administrative Overheads.

Selling and distribution costs.

Interest and Borrowing costs


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Cost Formula:

Specific Identification Method:

Other Methods:

FIFO Weighted Avg. Cost


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Specific Identification Method:

Directly linking the cost with the specificitem of inventory:

In case of purchase of item specificallysegregated for specific project and is notordinarily interchangeable

In case of goods or services produced andsegregated for specific purpose.


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Other Methods:

Where specific identification methoddoesnt apply other method applies:

FIFO (First In First Out)

Weighted Average Cost


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Standard Cost:

It takes into account normal level ofconsumtion of material and supplies,labour, efficiency and capacity utilisation.

It must be regularly revies and revisedtaking into account current conditions.


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Retail Method:

Generally used in retailing business;

when it is difficult to ascertain the cost ofindividual item,

Inventories are rapidly changing items andhave similar margins for which it isimpracticable to use other costing methods

Cost is determined by reducingapproximate gross profit margin from theoriginal selling price.


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Net Realizable Value:

The estimated selling price in ordinarycourse of business

less:

Estimated cost of completionEstimated cost necessary to make the sale

Estimation of NRV is done on the basis ofmost reliable evidence at the time ofvaluation


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Estimation of NRV:

The NRV of the materials and other supplies heldfor use in producion of finished goods If finished product in which rawmaterial and supplies

used is sold at cost or above the cost, then the estimatedrealisable value of rawmaterial and supplies isconsidered more than its cost.

If finished product in which raw material and suppliesused is sold below the cost. Then the estimated realisable

value of rawmaterial or suppoies is equal to therepalcement cost.


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Example 2:

Raw material XGwas purchased at Rs. 250Kg. for making Product C. The price ofXG goes down in the market. Because of

this Product C would also be sold belowthe cost. At the end of the year there are1500 kgs. of XG was in the stock. The

replacement cost is Rs. 200 per kg.Determine the value of inventory.


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Example 3:

In a production process normal wastage is10% of the input. Actually 10000mtrs. wasput into process resulting a wastage of 1200

mtrs. The input cost per mtr. is Rs. 100.The waste realises Nil. Calculate the cost ofinventory.


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Example 4:

In an inventory of finished goods the costconsists of Rs. 10 for materials, Rs. 4 forwages and Rs. 2 for variable overheads.

The comapany has a normal capacity ofmaiking 1,00,000 units p.a. A fixedoverhead is incurred at Rs. 50,000 p.a. At

the end of the year 1750 units are in thestock detemaine the value of stock.


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Thank you

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As 2 - Valuation of Inventories