Valuation of Inventory
AS – 2
Contents
Ø Applicability & Nature
Ø Meaning of Inventory
Ø Valuation of Inventory
Ø Steps in Valuation Procedure.
Ø Valuation Method
Ø Important Points
Ø Disclosures
Applicability & Nature
Applicable : 01-04-1999 (Revised)
Nature : Mandatory for all
Meaning of Inventory
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Held for Sale Held in production process Held for consumptionFinished Goods Work in Process Raw Material & Supplies
Meaning of Supplies
As per AS – 2, stock of loosed tools or spare parts should also be covered under the accounting principle of AS. The main condition for the application of AS – 2 of these stocks is only the common use in the production departments. As per ASI – 2 if any spare part is related to a particular fixed assets rather than common use, amount of such spare parts should not be covered under the accounting principle of AS – 2 but principle of AS – 10 should be applied.
Valuation of Inventory
Cash or NRV whichever is lower.
Note: As per AS if any stock is to be valued at NRV then loss on valuation should be written off in P&L A/c of the same year.
Steps in Valuation Procedure
Step1: Cost Calculation
Step2: NRV Calculation
Step3: Comparison
Cost Calculation
Finished Goods: Purchase Price of Raw Material + Direct Wages + Factory Overheads = Total Cost
WIP: Purchase Price of Raw Material + Direct Wages + Factory Overheads = Total Cost
Raw Material: Purchase Price of Raw Material = Total Cost
Meaning / Calculation of Purchase Price of Raw Material
In the calculation of purchase price of material all the expenses should be included which are directly incurred for the purchase of material. For Example: Purchase price, Taxes & duty, Freight inward, Material handlings charges or any other expense related to purchase. In the calculation of purchase price amount of trade discount & refundable taxes or duties should not be included.
Meaning of Direct Wages
Amount of direct wages can be used directly from payroll sheets which are prepared in factory premises at the time of payment of wages.
Meaning of Factory Overheads
Variable Overhead
Variable overhead are always per unit fixed & amount of these overhead will be changed by change in production units. Amount of variable expenses should be calculated on the basis of actual production because these expenses are always incurred according to the size of production.
Fixed Overhead
Situation 1: Actual Production is lower than Normal Production
If any enterprise has produced lower no of units than normal capacity, per unit fixed overhead should be calculated on the basis of normal capacity & such rate should be applied on actual production. If any amount remain unallocated then such amount should be transferred to P&L a/c. but can’t be included as a part of production cost.
Example: Fixed Overhead Rs. 2,00,000
Normal Production 10,000 units
Actual Production 8,000 units
Calculate production cost
Sol: 2,00,000 / 10,000 = Rs 20 per unit
Production cost = 8,000 x Rs 20/- = Rs 1,60,000
Situation 2: Actual Production is higher than Normal Production
If actual production is higher than normal production, the total amount of actual expenses should be included as a part of production cost and rate per unit should not be calculated by normal production.
Important note: In the calculation of cost of inventories only factory cost is considered and amount of administration overhead or selling overhead should not be considered in the calculation of cost.
NRV Calculation
Net Realizable Value = Market Price – Estimated cost to complete sale
[Comment: In the calculation of NRV the entire cost which is expected to complete the sale should be deducted because market value is not comparable directly to factory cost. Amount of administrative expense & selling overhead which are expected to be incurred should be deducted out of market value to convert such price equal to factory cost.]
Comparison
(1) Finished Goods
Example Material 2,00,000
Wages 1,00,000
Factory Overhead (Variable) 1,00,000
4,00,000
Factory Overhead (Fixed) 4,00,000
Normal Capacity 1,00,000 units
Actual Capacity 80,000 units
Out of 80,000 units, the enterprise has sold the 70,000 units. Calculate value of 10,000 units which are held in the stocks assuming market price Rs 50 per unit & estimated cost to complete the sale of Rs 25,000.
Sol: Calculation of Fixed cost
Material 2,00,000
Wages 1,00,000
Factory Overhead (V) 1,00,000
Factory Overhead (F) 3,20,000 (400000 / 100000 x 80000)
7,20,000
Cost of 10000 units = 720000 / 80000 x 10000 = Rs 90,000
NRV = 500000 – 25000 = Rs 4,75,000
Valuation = Cost or NRV whichever is lower
= Rs 90,000
(2) Raw Material
Example: Finished goods are valued at cost.
Raw Material (10000) Rs 10/- Cost
Raw Material Rs 8/- S.P.
Valuation of RM ?
Comments: In the given case valuation of raw material should be carried at cost only even if market price of such material is lower than cost. Raw material are purchased only for consumption purpose and after consumption such material will be converted into finished goods which are valued at cost. It means that there is no loss on finished goods due to which loss can’t be recorded on direct material.
Example: Finished goods are valued at NRV
Raw Material (cost) Rs 10/-
(i) Market Price Rs 12/-
(ii) Market Price Rs 8/-
Comments: Finished goods are valued at NRV due to which valuation of raw material should be made as per valuation principle. In the first case valuation should be carried at Rs 10 per unit because cost is lower. In second case valuation should be made at market price because cost is higher.
(3) Working in Process
Valuation of WIP should always be made at cost because market price estimation may not be accurate for these goods.
Important Points
(1) If any enterprise is having units of contract sale then independent market price should be ignored for the valuation of contract sale of unit. Valuation of these units should be considered only by contract price.
(2) As per AS – 2 interest can’t be capitalized in the cost of inventory because such amount is not related to production but interest can be capitalized in the cost of inventory as per the provision of AS – 16.
Valuation Method
FIFO
Weighted Average
Retail Value (For Mall)
Example: Retail Value
Particulars RV Cost
Op. Stock 10000 2000
Purchase 50000 25000
60000 27000
Retail Value Sold = Rs 50000
Stock value = 25000 / 50000 x 10000 = Rs 5000
Avg base = 27000 / 60000 x 10000 = Rs 4500
Disclosures
(1) Accounting policy should be disclosed. (FIFO / Weighted Avg / Retail Value)
(2) If any stock has been valued at NRV then description of such stock should also given in the note to accounts.
By fair value (subject to conditions and should be included in Goodwill
specified below)
(ii) Fair value of intangible asset can be recognized by active market or latest transaction price.
(iii) If active market is available then full amount of intangible asset should be recognized.
(iv) If latest transaction price is used for recognition then cost can be recognized to the extent by which capital reserve is not created. (The above provision can be applicable only for amalgamation in the nature of purchase)
Purchased by Govt Grant
If any intangible asset is purchased by Govt grant then cost of intangible asset can be recorded by net approach or gross approach specified in AS – 12.
Balance Sheet (Disclosure) [Net Approach]
Intangible Asset xxxx
Less: Grant xxxx xxxx
Balance Sheet (Disclosure) [Gross Approach]
Deferred Grant xxxx Intangible Asset xxxx
(Full amount)
Internally Generated Intangible Asset
If any intangible asset is generated internally by the enterprise, then it is generated under two different phases.
1) Research Phase: Research phase is the planed investigation carried by enterprise to create new application of business activities. Research activities may include invention of new products, production techniques, technical system or any other finding for cost saving or future benefits to enterprise. (All the expenses during research phase should be written off in P&L a/c immediately because it is not certain during research phase that any result will be obtained or not from research.)
2) Development Phase: Development phase is the verified application of research activities and all the expenses during the development phase should be capitalized in the cost of intangible asset. Before capitalizing the expenditure during development phase the following conditions should be satisfied.
- Technical should be available with the enterprise.
- The
- After completion of intangible the enterprise should be able to use or sell intangible.
- Future economic benefit should be measured by suitable assumption.
- Financial Resources should be proper to complete the asset.
- There will be proper system to record the cost during development phase.
(i) Cash/Bank/Grant Receivable Dr
To Govt Grant
(ii) Grant A/c Dr
To Deferred Grant A/c (It is transferred to reserve &surplus)
(iii) Deferred Grant A/c Dr
To P&L A/c
Refund of Grant:
Deferred Grant A/c (O/s Bal) Dr
P&L A/c (which is already used) Dr
To Cash/Bank/Grant Receivable
Note: At the time of refund of grant total benefit should be reversed in the current period in total irrespective the effect of these transaction on current year profits.
Disclosure:
(i) Accounting policy should be disclosed separately in relation to classification of nature of grant.
(ii) If any refund has been made during the period then amount of refund should be also disclosed.
Difference between AS/IAS/US GAAP:
If any grant is related to promoter’s contributions then accounting of such grant should be made as capital profits as per as-12. The same grant should be recognized as revenue profits as per other statements. Revenue profits should be recognized on deferred basis as per management intention.
