This accounting standard is applicable to all companies irrespective of their level (Level I, II and III). This standard prescribes the accounting treatment for inventories and sets the guidelines to determine the value at which the inventories are carried in the financial statements. It explains the different methods of accounting the inventory or closing stock which has a huge impact on the business revenue and the assets. Topics discussed in this article: In this article, we cover the following topics:
This Standard should be applied in accounting for all inventories except the following : (a) work in progress in the construction business, including directly related service contracts (b) work in progress of service business (consulting, banking etc) (c) shares, debentures and other financial instruments held as stock in trade (d) Inventories like livestock, agricultural and forest products, mineral oils etc These inventories are valued at net realizable value
I. Definition of the Inventory includes the following:
A. Held for sale in the normal course of business i.e finished goods
B. Goods which are in the production process i.e work in progress
C. Raw materials which are consumed during production process or rendering of services (including consumable stores item)
II. Net Realisable Value (NRV):
“Net realizable 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”
Inventories should be valued at lower of cost and net realizable value. Following are the steps for valuation of inventories: A. Determine the cost of inventories B. Determine the net realizable value of inventories C. On Comparison between the cost and net realizable value, the lower of the two is considered as the value of inventory. A comparison can be made the item by item or by the group of items. (Refer Case studies given at the end of the article) Let’s discuss the important items of Inventory valuation in detail:
A. Cost of Inventories
The cost of inventories includes the following
B. Cost of Purchase While determining the purchase cost, the following should be considered:
C. Cost of Conversion Cost of conversion includes all cost incurred during the production process to complete the raw materials into finished goods. Cost of conversion also includes a systematic allocation of fixed and variable overheads incurred by the enterprise during the production process. Following are the categories of conversion cost:
I. Direct Cost
All the cost directly related to the unit of production such as direct labor
II. Fixed Overhead Cost
Fixed overheads are those indirect costs which are incurred by the enterprise irrespective of production volume. These are the cost that remains relatively constant regardless of the volume of production, such as depreciation, building maintenance cost, administration cost etc.
The allocation of fixed production overheads is based on the normal capacity of the production facilities. In case of low production or idle plant allocation of these fixed overheads are not increased consequently.
III. Variable Overhead Cost
Variable overheads are those indirect costs of production that vary directly with the volume of production. These are the cost that will be incurred based on the actual production volume such as packing materials and indirect labor.
D. Other Cost
All the other cost which are incurred in bringing the inventories to the current location and condition. For (eg) design cost which is incurred for the specific customer order. If there are by-products during the production of main products, their cost has to be separately identified. If they are not separately identifiable, then allocation can be made on the relative sale value of the main product and the by-product. Some of the cost which should not be included are:
a. Cost of any abnormal waste materials cost
b. Selling and distribution cost unless those costs are necessary for the production process
c. A normal loss which occurs during the production process is apportioned over the remaining no of units and abnormal loss is treated as an expense
(Refer Case studies given at the end of the article)
The cost of inventories of items which can be segregated for specific projects should be assigned by specific identification of their individual costs (Specific identification method). All other items cost should be assigned by using the first-in, first-out (FIFO), or weighted average cost (WAC) 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. However, when it is difficult to calculate the cost using above methods, Standard cost and Retail cost can be used if the results approximate the actual cost.
The following should be disclosed in the financial statements:
Given below are some of the key differences between As 2 and Income Computation and Disclosure Standards (ICDS):
|1||Methods of Valuation||Standard Cost and Retail cost methods are allowed if its close to actual cost||Standard Cost method is not allowed to be used|
|2||Change in method of valuation||Allowed if it provides more appropriate presentation||Not allowed unless there is a reasonable cause|
|3||Opening Inventory of New Business||Value of opening inventory should be “Nil”||Shall be the cost of inventory available on the day of commencement of business|
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