AS 2 – VALUATION OF INVENTORY

CHAPTER DESIGN

 

1. OBJECTIVE
2. SCOPE
3. DEFINITIONS
4. MEASUREMENT OF INVENTORIES
5. COST OF INVENTORY
6. NET REALIZABLE VALUE
7. INVENTORY VALUATION TECHNIQUES
8. RECOGNITION AS EXPENSES
9. DISCLOSURE

1. OBJECTIVE :

The objective of this standard is to

• Prescribe accounting treatment for inventory
• Guidance on measurement of its cost
• Recognition as an expense
• Methods of cost determination (FIFO, Wt average ….)

2. SCOPE :

AS – 2 does not apply to:

1. a) WIP of Construction Contracts, (AS – 7)
2. b) WIP of Service Providers,
3. c) Shares, Debentures, other financial instruments etc. held as stock in trade.
4. 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.

3. DEFINITIONS :

1. Inventory: Inventory are assets

A. held for sale in ordinary course of business (FG)

B. in process of production for sale (WIP)

C. in form of material or supplies to be consumed in production process or in rendering the services (RM)

     2.      Net Realizable Value

Net Realizable Value = Estimated Selling Price in the ordinary course of business

(-) Estimated Cost of Completion

(-) Estimated costs necessary to make the sale.

4. MEASUREMENT :

As per IND AS 2 Inventory should be measured at

“Cost or Net realizable Value whichever is less”

Question 1 :

Cost of a partly finished unit at the end of 2016-17 is Rs 150. The unit can be finished next year by a further expenditure of Rs 100. The finished unit can be sold at Rs 250, subject to payment of 4% brokerage on selling price. Determine the value of inventory.

 

5. COST OF INVENTORY :

Cost of inventory includes

1. Cost of purchase
2. Cost of conversion
3. other cost incurred in bringing the inventory to its present condition and location.

 

1. Cost of Purchase includes :
2. Purchase price
3. Import duty and taxes (non-refundable)
4. Transport handling charges
5. Other direct cost
6. trade discounts and rebates (Subtracted)

 

2. Cost of conversion :
3. Direct Material
4. Direct Labor
5. Direct Overheads
6. Fixed Overheads
7. Variable overheads

 

Note : Fixed overheads should be absorbed at Normal (budgeted cost) or Actual production Cost whichever is lower. That is any inefficiency should be transferred to P & L A/c

 

3. Other costs :

Other cost to be included in the valuation of inventory should be only to the extent of those costs that are incurred in bringing the inventory to its present location and condition.

 

Exclusions

1. Abnormal Wastages
2. Storage cost (Costs after inventory is ready)
3. Administration cost
4. Selling cost.

 

Question 2 : Pluto Ltd.

Pluto Ltd. has a plant with the normal capacity to produce 5,00,000 unit of a product per annum and the expected fixed overhead is Rs.15,00,000. Fixed overhead on the basis of normal capacity is Rs.3 per unit (15,00,000/5,00,000). How shall u treat Fixed overheads under following circumstances a. Actual production is 5,00,000 units b. Actual production is 3,75,000 units c. Actual production is 7,50,000 units.

 

Question 3 : Venus Trading Company

Venus Trading Company purchases cars from several countries and sells them to Asian countries. During the current year, this company has incurred following expenses:

1. Trade discounts on purchase
2. Handling costs relating to imports
3. Salaries of accounting department
4. Sales commission paid to sales agents
5. After sales warranty costs
6. Import duties
7. Costs of purchases (based on supplier’s invoices)
8. Freight expense
9. Insurance of purchases
10. Brokerage commission paid to indenting agents

Evaluate which costs are allowed by Ind AS 2 for inclusion in the cost of inventory in the books of Venus.

 

Joint product and By – product

A production process may result into more than one product produced simultaneously. There may be a case where joint product or main product and by product may be produced together.

Valuation process

Scrap               = valued at scrap

By product     = Valued at NRV (Profit element should be ignored)

Joint product = the remaining cost should be allocated on rational and consistent basis.

Question 4 : Mars Ltd.

In a manufacturing process of Mars Ltd., one by-product BP emerges besides two main products MP1 and MP2 apart from scrap. Details of cost of production process are here under:

Item	Unit	Amount	Output	Closing Stock 31/3/2011
Raw Material	14,500	1,50,000	MP – I 5,000 units	250
Wages		90,000	MP – II 4,000 units	100
Fixed Overhead		65,000	BP – 2,000 units
Variable Overhead		50,000

Average market price of MP1 and MP2 is Rs.60 per unit and Rs.50 per unit respectively, by product is sold @ Rs.20 per unit. There is a profit of Rs.5,000 on sale of by-product after incurring separate processing charges of Rs.8,000 and packing charges of Rs.2,000, Rs.5,000 was realised from sale of scrap.

Required: Calculate the value of closing stock of MP1 and MP2 as on 31-03-2011

 

6. NET REALIZABLE VALUE :

Net Realizable Value= Estimated Selling Price in the ordinary course of business

(-) Estimated Cost of Completion

(-) Estimated costs necessary to make the sale.

7. INVENTORY VALUATION TECHNIQUES :

Question 5 :The trader

The trader purchased certain articles for Rs.85,000. He sold certain articles for Rs.1,05,000. The average percentage of gross margin is 25% on cost. Opening stock of inventory at cost was Rs.15,000. Calculate closing stock.

 

Question 6 :Mars Fashions

Mars Fashions is a new luxury retail company located in Lajpat Nagar, New Delhi. Kindly advise the accountant of the company on the necessary accounting treatment for the following items:

(a)        One of Company’s product lines is beauty products, particularly cosmetics such as lipsticks, moisturizers and compact make-up kits. The company sells hundreds of different brands of these products. Each product is quite similar, is purchased at similar prices and has a short lifecycle before a new similar product is introduced. The point of sale and inventory system is not yet fully functioning in this department. The sales manager of the cosmetic department is unsure of the cost of each product but is confident of the selling price and has reliably informed you that the Company, on average, make a gross margin of 65% on each line.

(b)       Mars Fashions also sells handbags. The Company manufactures their own handbags as they wish to be assured of the quality and craftsmanship which goes into each handbag. The handbags are manufactured in India in the head office factory which has made handbags for the last fifty years. Normally, Mars manufactures 100,000 handbags a year in their handbag division which uses 15% of the space and overheads of the head office factory. The division employs ten people and is seen as being an efficient division within the overall company. In accordance with Ind AS 2, explain how the items referred to in a) and b) should be measured.

 

Question 7  :Mercury Ltd.

Mercury Ltd. uses a periodic inventory system. The following information relates to 2011 – 2012

Date	Particulars	Unit	CPU	Total Cost
April	Inventory	200	10	2000
May	Purchase	50	11	550
Sept	Purchase	400	12	4800
Feb	Purchase	350	14	4900
	Total	1000		12,250

Physical inventory at 31.03.2012 400 units. Calculate ending inventory value and cost of sales using: (a) FIFO (b) Weighted Average.

Question 8 :Sun Pharma Limited

Sun Pharma Limited, a renowned company in the field of pharmaceuticals has the following four items in inventory: The Cost and Net realizable value is given as follows:

Item	Cost	Net Realizable Value
A	2000	1900
B	5000	5100
C	4400	4550
D	3200	2990

8. RECOGNITION AS EXPENSE :

1)         The amount of inventories recognised as an expense in the period will generally be:

1. carrying amount of the inventories sold in the period in which related revenue is recognised; and
2. the amount of any write-down of inventories to net realisable value and all losses of inventories shall be recognised as an expense in the period the write-down or loss occurs; reduced by the amount of any reversal in the period of any write-down of inventories, arising from an increase in net realisable value shall be recognized as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.

2)         Some inventories may be allocated to other asset accounts, for example, inventory used as a component of self-constructed property, plant or equipment. Inventories allocated to another asset in this way are recognised as an expense during the useful life of that asset through charging of depreciation on that asset.

 

9. DISCLOSURE :
10. Accounting Policy
11. Analysis of Carrying Amount
12. Inventories carried at fair value less cost to sell
13. Amounts recognised in Profit and Loss Account
14. Inventories pledged as security

 

PRACTICAL QUESTIONS

 

Question 9 :

The company deals in three products, A, B and C, which are neither similar nor interchangeable. At the time of closing of its account for the year 2016-17, the Historical Cost and Net Realisable Value of the items of closing stock are determined as follows:

 

Items	Historical Cost	Net Realisable Value
A	40	28
B	32	32
C	16	24

What will be value of Closing stock?

 

Question 10 :X Co. Limited

X Co. Limited purchased goods at the cost of Rs.40 lakhs in October, 2016. Till March, 2017, 75% of the stocks were sold. The company wants to disclose closing stock at Rs.10 lakhs. The expected sale value is Rs.11 lakhs and a commission at 10% on sale is payable to the agent. Advise, what is the correct closing stock to be disclosed as at 31.3.2017.

 

Question 11 :

In a production process, normal waste is 5% of input. 5,000 MT of input were put in process resulting in wastage of 300 MT. Cost per MT of input is Rs.1,000. The entire quantity of waste is on stock at the year end. State with reference to Accounting Standard, how will you value the inventories in this case?

 

Question 12  :

You are required to value the inventory per kg of finished goods consisting of:

Rs per kg.

Material cost                                     200

Direct labour                                      40

Direct variable overhead                  20

Fixed production charges for the year on normal working capacity of 2 lakh kgs is Rs 20 lakhs. 4,000 kgs of finished goods are in stock at the year end.

 

ANSWERS 

 

Answer 1 :

Net Selling price                                            Rs 250

– estimated cost of completion                   Rs 100

Rs 150

– Brokerage (4% on 250)                              Rs 10

Net Realizable Value                                     Rs 140

Cost                                                                Rs 150

Lower of Cost or NRV                                   Rs 140

 

Answer 2 :

Budgeted        =  = Rs 3 per unit

 

1. Actual production = 15,00,000

 

CPU =  = Rs 3 per unit and budgeted was also @ Rs 3 per unit. The Fixed cost should be absorbed @ 3 per unit.

 

i.e 5,00,000 x 3 = Rs 15,00,000 of fixed overheads should be included in calculating the cost of inventory

 

2. Actual Production = 3,75,000

 

CPU =  = Rs 4 per unit and budgeted was also @ Rs 3 per unit. The Fixed cost should be absorbed @ 3 per unit.

 

i.e 3,75,000 x 3 = Rs 11,25,000 of fixed overheads should be included in calculating the cost of inventory. Also 15,00,000 – 11,25,000 = 3,75,000 is inefficiency and that should be recorded through P & L Account.

 

3. Actual Production = 7,50,000

 

CPU =  = Rs 2 per unit and budgeted was also @ Rs 3 per unit. The Fixed cost should be absorbed @ 2 per unit.

 

i.e 7,50,000 x 2 = Rs 15,00,000 of fixed overheads should be included in calculating the cost of inventory.

 

Answer 3 :

Allowed          = 1, 2, 6, 7, 8, 9 and 10

Not Allowed   = 3, 4, and 5

 

Answer 4 :

1. Total Cost

Raw material                         1,50,000

Wages                                        90,000

Fixed overheads                       65,000

Variable overheads                  50,000

3,55,000

 

2. Scrap             =          should be valued at Scrap = Rs.5,000

 

3. By product =          should be valued at NRV – cost incurred to bring the product to its

conditions and location

=          (2,000 x 20) – 8,000 – 2,000 = 30,000 (profit should be ignored)

 

4. Balance cost =          3,55,000 – 30,000 – 5,000 = 3,20,000 should  be  allocated  to  joint                                      product on

rational and consistent basis. The most rational and consistent basis is Sales value approach

 

5. Sales Value = MP 1 = 5,000 x 60                         = Rs.3,00,000

= MP 2 = 4,000 x 50                         = Rs.2,00,000

= Ratio of 3 : 2

= i.e 1,92,000 for MP1 and 1,28,000 for MP2

 

7. CPU for MP1 and MP2 = MP1             =  = Rs 38.4 / unit

= MP2             =  = Rs 32 / unit

 

8. Closing Stock = MP1             = 250 x 38.4   = Rs.9600

= MP2             = 100 x 32      = Rs.3,200

 

Answer 5 :

Sales                                                   1,05,000

– Gross profit (1/5 on sales)            21,000

Cost of goods sold                            84,000

 

Closing inventory      = Opening stock + Purchase – cost of goods sold

= 15,000 + 85,000 – 84,000

= Rs.16,000

 

Answer 6 :

Mars fashion, is required to use Non-historical method to value inventory.

1. For beauty products we shall be using Retail inventory method.
2. For hand bags we shall be using standard costing method.

 

Answer 7 :

1. FIFO :

 

Closing Stock = 400 units

350 x 14         = 4,900

50 x 12           = 600

Total               = 5,500

 

Cost of Sales = Opening Stock + Purchase – closing stock

= 12,250 – 5,500 = 6,750

 

2. Weighted Average Method :

 

Weighted Average    =  = Rs 12.25 / unit

 

Closing Stock             = 400 x 12.25 = 4,900

 

Cost of sales              = 12,250 – 4,900 = 7,350

 

Answer 8 :

1. Item wise

            Item                Cost                NRV                Valued

A                      2,000              1,900              1,900

B                      5,000              5,100              5,000

C                      4,400              4,550              4,400

D                      3,200              2,990              2,990

Total                           14,290

 

2. Group wise

Item                Cost                NRV                 Valued

A                      2,000              1,900

B                      5,000              5,100

C                      4,400              4,550

D                      3,200              2,990

Total               14,600            14,540            14,540

 

Note: As per IND 2, inventory valuation should be done item by item, if possible.

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Answer 9 :

As per AS 2 (Revised) on ‘Valuation of Inventories’, inventories should be valued at the lower of cost and net realisable value. Inventories should be written down to net realisable value on an item-by-item basis in the given case

Items	Historical Cost	Net Realisable Value	Closing Stock
A B C	40 32 16	28 32 24	28 32 16
Total	88	84	76

Hence, closing stock will be valued at Rs.76 lakhs.

 

Answer 10 :

As per AS 2 (Revised) “Valuation of Inventories”, the inventories are to be valued at lower of cost or net realisable value.

In this case, the cost of inventory is Rs.10 lakhs. The net realisable value is 11,00,000 × 90% = Rs.9,90,000. So, the stock should be valued at Rs.9,90,000.

 

Answer 11 :

As per AS 2 (Revised), abnormal amounts of wasted materials, labour and other production costs are excluded from cost of inventories and such costs are recognised as expenses in the period in which they are incurred.

In this case, normal waste is 250 MT and abnormal waste is 50 MT. The cost of 250 MT will be included in determining the cost of inventories (finished goods) at the year end. The cost of abnormal waste (50 MT x 1,052.6315 = Rs.52,632) will be charged to the profit and loss statement.

Cost per MT (Normal Quantity of 4,750 MT) = 50,00,000 / 4,750 = Rs.1,052.6315 Total value of inventory = 4,700 MT x Rs.1,052.6315 = Rs.49,47,368.

 

Answer 12 :

In accordance with AS 2 (Revised), the cost of conversion include a systematic allocation of fixed and variable overheads that are incurred in converting materials into finished goods. The allocation of fixed overheads for the purpose of their inclusion in the cost of conversion is based on normal capacity of the production facilities.

Cost Per kg of finished goods

                                                            

Material: 200 Rs.

Direct Labour: 40

Direct Variable cost: 20

Fixed Overhead cost                         10                    70

Total                                                                           270

 

Hence the value of 4,000 kgs. of finished goods = 4,000 kgs x Rs 270 = Rs.10,80,000