Inventory accounting care is recommended in AS 2 valuation of inventory, which provides guidelines on how to assess the value at which inventories are carried out before the relevant sales are recognized in the financial statement.
Introduction to AS 2 – valuation of inventories
- Introduction to AS 2 – valuation of inventories
- Scope of as 2 inventories valuation
- Applicability of AS 2 Inventories Valuation
- The objective of as 2 inventories valuation
- The inventory includes:
- Valuation of Inventories
- 1. Cost of Inventories
- 2.Cost of Purchase
- 3.Conversion Costs
- 4.Other costs
- Methods of Inventory Valuation
- Differences: Indian GAAP (AS 2) and Indian Accounting Standard 2 – Valuation of inventories
- Disclosure in Financial Statements
- Example of AS-2 Inventory Valuation
IAS 2 is an international financial reporting standard that the International Accounting Standards Board (IASB) has developed and disseminated to provide guidelines on inventory valuation and classification.
Inventories are described by IAS 2 as assets which are:
- Kept in the usual course of business for sale.
- In the manufacturing process for that transaction.
- In the form of products or supplies to be consumed in the manufacturing or service rendering process.
IAS 2 needs that the properties considered as an inventory be registered at the lower cost or net realizable value of the assets. Cost involves not just the cost of purchase, but also the cost of conversion, which are the costs involved in getting inventory to its current state and location, such as direct labor. IAS 2 also allows variable overheads and fixed overheads to be capitalized as long as fixed overheads are distributed on a systematic and consistent basis and with respect to the normal rate of production. If production is smaller than anticipated, the resulting excessive overhead should be considered an expense and not capitalized, but the fixed overhead allowance should be considered when performance is abnormally high.
IAS 2 allows for two costing techniques, the regular approach, and the retail methodology. The standard technique demands that inventory be priced at the standard cost of each item; that is, at the typical production and efficiency level, the usual cost per unit. By taking its sales value and then lowering it by the applicable gross profit margin, the retail approach values the inventory. Where inventory items are not typically interchangeable or where some items are allocated to particular programs, these items are expected to be individually classified and assigned to their specific costs.
Scope of as 2 inventories valuation
Goods include goods that are reserved for sale in a general business company (finished goods), goods that are in the process of being sold are sold in the normal course of business (ongoing), and construction materials used in production (consumables). [IAS 2.6]
However, IAS 2 does not include a specific list of assets from its scope: [IAS 2.2] ongoing work arising from construction contracts (see IAS 11 Contracts) financial instruments (see IAS 39 Instruments: Recognition and Measurement) assets biology related to agricultural activity and agricultural production during harvest (see IAS 41 Agriculture).
Also, while the following is within the scope of the standard, IAS 2 does not apply to the measurement of managed lists: [IAS 2.3] producers of agricultural and forestry products, post-harvest agricultural products, and minerals and mineral products, to the extent that they are measured at the total cost (above or below cost). well-established in those industries. When those lists are measured at fair value, the change in that value is recognized in profit or loss in the period of the exchange of goods and services that the sellers estimate for their fair value fewer costs to sell. When those assets are measured at fair value rather than selling costs, changes in fair value fewer costs to sell are recognized as a gain or loss in the period of the change.
Applicability of AS 2 Inventories Valuation
In the following instances, this AS 2 Inventory Valuation does not extend to :
- Work in progress under building contracts, including service contracts directly related to them (It is specifically covered by AS-7 construction Contracts)
- Work in progress in the ordinary course of service providers’ business;
- Owned as stock-in-trade shares, debentures, and other financial instruments
- Inventories of animals, agricultural and forest products, and mineral oils, ores, and gases by producers to the degree that they are calculated in compliance with well-established practices in those industries at net realizable value.
The objective of as 2 inventories valuation
The purpose of this Standard is to administer inventory accounting care. The amount of expense to be recorded as an asset and carried forward before the relevant sales are recognized is a primary concern in accounting for inventories. This Standard deals with cost determination and its subsequent identification, including any write-down to net realizable value, as an expense. It also offers instructions on the cost formulas used for inventory distribution of costs.
The inventory includes:
- Kept in the usual course of business for sale (finished goods).
- In the manufacturing process for such a transaction (raw material and work-in-progress).
- In the form of products or equipment to be used in the production process or the manufacturing process.
- Rendition of resources (stores, spares, raw material, consumables).
- Inventories never include machinery.
Valuation of Inventories
1. Cost of Inventories
The cost of goods includes the following:
- Purchase costs
- Concession costs
- Other costs incurred in delivering inventories in their current location and condition.
2.Cost of Purchase
When determining the cost of purchase, the following should be considered:
- Purchase costs include taxes and levies (other than those that can be recoverable from the tax authorities)
- Goods go in
- Other expenditure directly incurred on the purchase
- Trade discounts, rebates, tax exemptions, and other similar deductions are deducted in determining purchase costs
Concession costs include all costs incurred during the production process to complete the raw materials into finished goods.
Conversion costs include the systematic allocation of fixed variable heads acquired by the entity during the production process.
The following are the costs of conversion:
- Direct costs
All costs are directly related to the production unit as direct workers
- Fixed High Costs
Repaired overheads are those indirect costs incurred by the business regardless of production volume. These are costs that remain constant regardless of production volume, such as depreciation, construction maintenance costs, administrative costs, etc.
The distribution of fixed production heads is based on the average volume of production areas. In the event of low production or idle crop, the distribution of these planned layers may be increased as a result.
- High Variable Costs
Flexible fabrics are those indirect production costs that directly differ from the product capacity. These are costs that will be incurred based on actual production capacities such as packaging materials and indirect performance.
All other costs incurred in bringing the goods into place and current status. For (e.g.) construction costs incurred in a specific customer order.
If there are products from which the main products are made, their cost should be indicated separately. If they do not appear different, then the allocation can be made to the estimated sales value of the main product and the manufactured product.
Other costs that should not be included are:
- Cost of any uncommon waste costs
- Cost of sales and distribution unless costs are significant in the production process
- The general losses that occur during the production process are divided over the remaining units and the non-standard losses are considered to be costs
Methods of Inventory Valuation
Various methods of measuring assets include:
- Clear Identification Method
In order to use a specific identification method, it is important that each item sold and each item in the closure is easily identified. Such an approach only applies to situations where it is possible to physically separate the various purchases made by the business.
Therefore, items sold at a certain cost during the accounting period may be included in the cost of the goods sold. And the cost of certain items leftover or in hand can be included in the asset list. Companies that produce or handle expensive, easily diversified items can effectively use this measurement method. Such items include cars, furniture, jewelry, etc.
- First Out First (FIFO)
The First In First Out Method assumes that the goods are used in the order in which they are purchased. That means pre-purchased goods are consumed first in production concern and are sold first in the event of a sales company.
As a result, under this approach, the recently purchased goods are part of the end-to-end list.
- Moderate Expenditure Method (WAC)
Under this method, the average cost of each item available for sale is calculated. Such costs are calculated by taking into account the estimated cost of the same items received at the beginning of the year and the cost of the same items purchased or made during the year. In addition, units less than the cost of the goods sold and the closing inventory are taken at the average cost calculated.
Additionally, the estimated rate is calculated periodically or when each new post arrives as possible.
Differences: Indian GAAP (AS 2) and Indian Accounting Standard 2 – Valuation of inventories
- Additional disclosures: Compared to AS 2, Ind AS 2 includes additional disclosures such as the amount of write-down of inventories recognized as a cost, the reversal of such write-down and reasons for reversal, the number of inventories promised as protection.
- While Ind AS excluded the word distribution costs from the cost of sale and distribution, the standard’s purpose remains the same, so the cost of selling and distribution can not be included even under Ind AS 2.
- Under AS 10, Accounting for Fixed Assets, machinery spares that can be used in conjunction with an object of fixed assets and whose usage is abnormal are accounted for as fixed assets. The description of what comprises fixed assets under Ind AS 16 (Property, Plant, and Equipment) is broader, so many spares classified as inventory under AS 2 would be classified under Ind AS as fixed assets.
Disclosure in Financial Statements
As per Accounting Principle 2 (AS 2), with respect to inventories, the financial statements shall report the following details:
- Accounting policies on the calculation of inventories. This also entails the inventory valuation approach adopted.
- A number of inventories in a given time, taken as an expense.
- The complete carrying quantity of inventories and carrying quantities in the classification as applicable to the entity, such as raw material, work in progress, finished products, and spares.
- The quantity of inventories held at market value decreases the cost of sale.
- Any amount of inventory write-down reported as a cost in the period.
- Also, any amount of inventory written down is known as a cost in the era.
- Any amount of a write-down reversal that is known as a decrease in the number of inventories defined in the period as a cost.
- Events that contribute to inventory write-down reversals.
- Carrying inventories of the sum promised as security for liabilities.
Example of AS-2 Inventory Valuation
Jain Ltd sells the commodity Notebook and Pens, wood is the raw materials used in the manufacture of notebooks, plastic in the case of pens. The cost is Rs 10 and Rs 50 for wood and plastic, respectively. Wood and plastic have a realizable value of Rs. 8 and Rs.35 respectively. However, the Notebook is projected to be realized at 15% of gross profit, while Pen is expected to make a loss of 10% of the overall cost. What would the importance of understanding wood and plastic in books be?
- According to AS-2, the materials and materials produced in the manufacture of goods are not recorded at cost if the finished products to be imported are expected to be sold at or above cost.
- In the case of wood, the cost is Rs.10 and the net profit is Rs. 8. As the price of finished goods is expected to be higher than the cost even though the NRV is small, the Company will measure the wood to Rs. 10 (Cost)
- However, when there is a decrease in the cost of equipment and it is estimated that the cost of finished goods will exceed the carrying amount, those items should be recorded at their carrying amount. In these cases, replacement costs may be the most significant measure of their carrying amount.
- Therefore, in the case of plastic, the cost is Rs.50 and the apparent residual value is Rs.35, as the last Pen product is expected to be sold for less than its cost, the Company will disclose the plastic at the estimated cost (Replacement costs) of Rs. 35 at the end of the year. 12/07/2020 12
- Accounting policy adopted in asset valuation (Cost or fair value)
- Cost formula used.
- The total value of joint assets management.
- The classification of inventories is:
- Materials and components
- Ongoing work
- Completed goods
- Stock trading (in respect of assets acquired in trading)
- Stores and warehouses
- Loosening tools
- Other (describe environment)
In the financial statement on the closing day, we hear that AS 2 deals with inventory valuation and how we need to do inventory valuation. What inventories are, how raw materials, work in progress (WIP), and finished products are priced in the case of manufacturers and finished goods as inventory in the case of traders. Think of taking the help of the experts at LegalRaasta with accounting and bookkeeping services, where we aim to simplify your legal journey. Call +91-8750008585 to get started with fair company incorporation and accounting services packages.