Valuation of Inventories Accounting Standard: 2 Valuation of Inventories

Accounting Standard-2 deals with: Determination of value at which inventories are carried in Financial Statements, Ascertainment of cost, Situation in which carrying cost of inventories is written below cost.

Scope Other than WIP arising under construction contracts (AS – 7) WIP arising in ordinary course of business of service provider (AS – 9) Shares debentures and other financial instruments held as stock in trade (AS – 13 / 30) Inventories of livestock, agricultural forest product, mineral oil ores and gases valued at NRV as per estabilished practices in those industries

Inventories are assets: held for sale in ordinary course of business, in the process of production for such sale,or in the form of material or supplies to be consumed in the production process or in the rendering of services.

Measurement: Inventories should be valued at lower of Cost and Net realizable value. Net Realizable Value = Estimated selling price – Estimated cost necessary to make sale.

Cost of Inventories: These include all cost of purchase, cost of conversion and other cost incurred in bringing the inventories to their present location and condition. But does not include: i) abnormal amount, ii) storage cost unless necessary in the production, iii) administrative overhead, iv) selling and distribution cost. Abnormal amount = wastage Storage cost = cold storage Administrative cost = telephone, salary, etc

Cost of Purchase: Purchase price net of Trade discount, Rebate, + duties & Taxes (non-cenvatable) + freight, any other cost attributable to acquisition. Cost of conversion: include cost directly related to unit of production i.e. variable overhead, allocable fixed overhead. Variable Overheads are to be allocated on the basis of actual production. Fixed Overheads are to be allocated on the basis of normal production.

Joint Product and By Product Joint Product: If cost is separately identifiable then on actual basis or else on rational basis i.e. sales value at the time when product becomes separately identifiable or at completion of product. By Product / scrap / waste: It is normally measure at NRV and this value is deducted from the cost of main product.

Cost Formula: Valuation of inventories depend on cost formula used by entity: a) Specific identification method, b) FIFO, c) Weighted Average, d) Standard Cost, e) Retail Method (for retail trader). Specific identification – Projects FIFO – Expiry Weighted Average – Commodity type of material Standard Cost – FG

Application of formula: Cost formula is applied item by item. Inventories are not written down below cost if finished product of such inventory are expected to be sold at above cost.

Disclosure: Accounting policy adopted in measuring including cost formula used, Total carrying cost of inventories and its classification.

Expert Opinion on determination of Normal Capacity and Fixed Over heads Case referred to is of PSU controlled by Ministry of Steel. Before 31.12.2005 company was producing 7.5 MT of concentrate per year and 3 MT of pelletisation per year from their mines and plants. After SC judgement the company had to shutdown it mines and its activities were restricted only to producing pellets by procuring ores from outside source. Company allocated the FOH based on actual production for the financial year adjusted to the average production of last five years.

Expert Opinion on determination of Normal Capacity and Fixed Over heads Company considered following expenses in Fixed overhead in Valuation of Inventories: General Expenses : Expenditure on township maintenance and healthcare, Printing & Stationery, Books & periodicals, conveyance, training, legal, consultancy, courier, freight and other office expenses. Tender notice & advertisement: for hiring various services & procurement of material Other Income: Interest on Loans & advances given to the employees. In 2010-11 CAG expressed its opinion that company should reassess its normal capacity for valuation of Inventory further it should also exclude the above expense.

Opinion Given by Expert Committee The normal capacity may be determined at the average of production of last 5 years provided it approximates the production expected to be achieved in the future periods also. However, if there are significant changes in circumstances,then such an estimation would not be appropriate. In such a situation, budgeted production should also be considered for determining normal capacity. The staff welfare expenditure to the extent these are used by the employees of factory/production unit who render their services in relation to production activities, should be considered for inclusion in the cost of inventories Tender notice advertisement expenses cannot be included in the cost of inventories as these expenses relates to cost prior to procurement of inventories. Regards interest income recovered from the employees, the Committee is of the view that these are part of ‘other income’ and, therefore, should not be adjusted in the cost of inventories.

THANKS.