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AS – 2
VALUATION OF INVENTORY
Inventories
are assets:
held for sale in
ordinary course of business;
in the process
of production fro such sale (WIP);
in the form of
materials or supplies to be consumed in the production process or in the
rendering of services.
However,
this standard does not apply to the valuation of following inventories:
(a)
WIP arising under construction contract (Refer AS
– 7);
(b)
WIP 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 realizable value in accordance with well established practices
in those industries.
Inventories
should be valued at the lower of cost and net realizable value.
The
cost of inventories should comprise
(a)
all costs of purchase
(b)
costs of conversion
(c)
other costs incurred in bringing the inventories to
their present location and condition.
The costs
of purchase consist of
(a)
the purchase price
(b)
duties and taxes ( other than those subsequently
recoverable by the enterprise from the taxing authorities like CENVAT credit)
(c)
freight inwards and other expenditure directly
attributable to the acquisition.
Trade
discounts (but not cash discounts), rebates, duty drawbacks and other similar
items are deducted in determining the costs of purchase.
The costs
of conversion include direct costs and systematic allocation of fixed and
variable production overhead.
Allocation
of fixed overheads 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.
Under Recovery:
Unallocated overheads are recognized as an expense in the period in which they
are incurred.
Example: Normal capacity = 20000 units
Production = 18000 units
Sales = 16000 units
Closing Stock = 2000
units
Fixed Overheads = Rs. 60000
Then,
Recovery rate = Rs60000/20000 = Rs 3 per unit
Fixed Overheads will be bifurcated into
three parts:
Cost of
sales : 16000*3 = 48000
Closing stock : 2000 *3
= 6000
Under recovery : Rs 6000 ( to be charged to P/L)
(Apparently
it seems that fixed cost element in closing stock should be 60000/18000*2000
=Rs 6666.67. but this is wrong as per AS-2)
Over Recovery: In period of high production, the
amount of fixed production overheads is allocated to each unit of production is
decreased so that inventories.
Example: Normal
capacity = 20000 units
Production = 25000 units
Sales = 23000 units
Closing Stock = 2000
units
Fixed Overheads = Rs 60000
Recovery
Rate = Rs 60000/20000 = Rs 3 per unit
But,
Revised Recovery rate = Rs
60000/25000 = Rs. 2.40 per unit
Cost
of sales :
23000*2.4 = Rs 55200
Closing
Stock : 2000 *2.4 =
Rs. 4800
Joint or by products:
In
case of joint or by products, the costs incurred up to the stage of split off
should be allocated on a rational and consistent basis. The basis of allocation
may be sale value at split off point or sale value at the completion of
production. In case of the by products of negligible value or wastes, valuation
may be taken at net realizable value. The cost of main product is then joint
cost minus net realizable value of by product or waste.
The
other costs are also included in the cost of inventory to the extent they
contribute in bringing the inventory to its present location and condition.
Interest
and other borrowing costs are usually not included in cost of inventory.
However, AS-16 recommends the areas where borrowing costs are taken as cost of
inventory.
Certain
costs are strictly not taken as cost of inventory.
(a)
Abnormal amounts of wasted materials, 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
Formula:
ð Specific
identification method for determining cost of inventories
Specific
identification method means directly linking the cost with specific item of
inventories. This method has application in following conditions:
·
In case of purchase of item specifically
segregated for specific project and is not ordinarily interchangeable.
·
In case of goods of services produced and
segregated for specific project.
ð
Where Specific Identification method is not
applicable
The
cost of inventories is valued by the following methods;
FIFO ( First In
First Out) Method
Weighted Average
Cost
Cost of inventories in certain conditions:
The following methods may be used for convenience if the
results approximate actual cost.
ð
Standard Cost: It takes into account
normal level of consumption of material and supplies, labour, efficiency and
capacity utilization. It must be regularly reviewed taking into consideration
the current condition.
ð
Retail Method: Normally applicable for
retail trade
Cost of inventory is determined by reducing the gross margin from the
sale
value of inventory.
Net
Realisable Value means the estimated selling price in ordinary course of
business, at the time of valuation, less estimated cost of completion and
estimated cost necessary to make the sale.
Comparison
between net realizable value and cost of inventory
The
comparison between cost and net realizable value should be made on item-by-item
basis. (In some cases, group of items-by-group of item basis)
For
Example:
Cost NRV Inventory Value as per AS-2
Item
A 100 90 90
Item
B 100 115 100
Total 200 205 200 190
Raw
material valuation
If
the finished goods to which raw material is applied, is sold at profit, RAW
MATERIAL is valued at cost irrespective of its NRV level being lower to its
costs.
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