AS-2 & AS-10

Inventory Valuation & Property, Plant & Equipment

Including Depreciation Methods, Change in Method & Disclosures

Fundamentals of Accounting — Comprehensive Study Notes

PART A — AS-2 (Revised): Valuation of Inventories

1. Introduction & Objective

AS-2 (Revised) prescribes the accounting treatment for inventories. It provides guidance on: (i) determining the
value at which inventories are carried in financial statements until related revenues are recognised, and (ii) cost
formulas used to assign costs to inventories and any write-down to Net Realisable Value (NRV).

2. Definition of Inventories

Inventories are assets: (a) held for sale in the ordinary course of business, OR (b) in the process of production for
such sale, OR (c) for consumption in the production of goods or services — including maintenance supplies and
consumables (other than machinery spares/servicing/standby equipment meeting the definition of PPE under
AS-10).

Types of Inventories (by business type):

Type of Business Inventories

Trading Concern Stock-in-trade (goods purchased for resale), packaging materials, stationery.

Raw materials, Work-in-Progress (WIP/semi-finished goods), Finished goods,

Manufacturing Concern
Factory stores & spares, Loose tools.
 Work-in-progress (e.g., partially completed software, voyage costs not consumed,
Service Provider
consultancy in progress).

Exclusions from AS-2 Scope:

• Work-in-progress under construction contracts (covered by AS-7).

• Work-in-progress of service providers (e.g., voyage-in-progress costs for a shipping company).
• Shares, debentures and other financial instruments held as stock-in-trade.
• Producers' inventories of livestock, agricultural/forest products, mineral oils — valued at NRV per industry
practice.
• Spare parts, servicing equipment, standby equipment meeting the definition of PPE (covered by AS-10).

3. Cost of Inventories & Components

Cost of Inventories = Cost of Purchase + Cost of Conversion + Other Costs

Component Includes Excludes

Purchase price + Import duties + Non-refundable

Trade discounts, rebates, duty drawbacks
Cost of Purchase taxes + Other expenditure directly attributable to
and similar items.
acquisition.

Direct labour + Fixed & Variable production

Cost of Abnormal amounts of wasted materials,
overheads + Systematic allocation of fixed overheads
Conversion labour or other production costs.
based on NORMAL CAPACITY.

Exchange differences. Administrative

Cost of design for custom-made units. Borrowing
overheads. Selling and distribution costs.
Other Costs costs if inventory takes substantial time to get ready
Storage costs (unless required in
(e.g., wine).
production process).

Fixed Overhead Absorption — Normal Capacity Rule:

Situation Fixed Overhead Absorption Rate

Actual Production = Normal Capacity Normal Capacity Rate applied.

Actual Production > Normal Capacity Actual Rate (lower per unit) — inventories not measured above cost.

Normal Capacity Rate — unallocated (under-recovered) overheads

Actual Production < Normal Capacity
expensed to P&L.;

4. Valuation of Inventories

Principle of Prudence: Inventories are valued at LOWER of Cost and Net Realisable Value (NRV).

Net Realisable Value (NRV):

NRV = Estimated Selling Price in the ordinary course of business (-) Estimated costs of completion (-) Estimated
costs necessary to make the sale (e.g., brokerage, commission) (+/-) Fluctuations in cost of materials from
Balance Sheet date to event date (if they confirm conditions existing at BS date)

Scenario Valuation

NRV > Cost Anticipated profit ignored → Value at COST

NRV < Cost Anticipated loss recognised → Value at NRV

Raw Materials (if finished goods sold at or

Value at COST
above cost)

Raw Materials (if finished goods sold below

Value at REPLACEMENT COST (as proxy for NRV)
cost)

Exclusions from Inventory Value (NOT included):

• Abnormal loss/gain — recognised directly in Statement of P&L.;

• Storage costs (unless required at a production stage).
• Administrative overheads not contributing to bringing inventory to present location/condition.
• Selling and distribution costs.

NRV comparison is done on an item-by-item basis (or groups of similar/related items where appropriate).
 5. Methods of Inventory Valuation

Method Description Best Used When

Each item of inventory is tracked to its actual cost Items are not ordinarily interchangeable;
Specific Identification
lot. distinct/high-value items.

Earliest purchased/produced items are assumed

First-In First-Out Perishable goods, items with frequent
to be consumed/sold first. Closing stock = most
(FIFO) technological changes.
recent costs.

Weighted Average WAP per unit = Total cost of goods available / Highly fluctuating inflation rates; large
Method (WAM) Total units available. Closing stock = units x WAP. mixed lots.

Simple Average SAP = Sum of all purchase prices / Number of Inflation is at stable rate; periodic
Method (SAM) price rates. Physical stock on FIFO basis. inventory system.

Standard Cost Pre-determined standard cost used when price Frequent price changes; approximates
Method changes frequently. actual cost.

Cost = Selling price minus estimated profit margin.

Adjusted Selling Retail businesses with large volumes of
Used in retail where individual item costs
Price / NAV similar margin items.
impractical.

6. Solved Illustration — FIFO, SAM & WAM

Data:

Date Receipt Qty Receipt Rate (Rs.) Issue Qty

Dec 4 900 50 —

Dec 5 — — 500

Dec 10 400 55 —

Dec 11 300 55 —

Dec 19 200 60 —

Dec 20 — — 600

Dec 28 800 47 —

Dec 30 — — 500

FIFO — Closing Stock:

After Dec 30 — Balance Qty Rate Amount (Rs.)

Lot from Dec 19 200 60 12,000

Lot from Dec 28 800 47 37,600

TOTAL Closing Stock 1,000 — 49,600

SAM — Closing Stock:

SAM balances progressively use simple average of rates in stock. Closing stock value = Rs.49,100 (1,000 units)

WAM — Closing Stock:

After Dec 30 Qty WAP (Rs.) Amount (Rs.)

Closing Stock 1,000 50.37 50,377

7. Disclosures under AS-2

• Accounting policies adopted in measuring inventories, including the cost formula used.
• Total carrying amount of inventories with classification into: Raw Materials, Work-in-Progress, Finished Goods,
Stock-in-trade, Stores & Spares, Loose Tools, Others (specify nature).
PART B — AS-10 (Revised): Property, Plant and Equipment (PPE)

1. Objective & Scope

AS-10 (Revised) prescribes accounting treatment for PPE. The principal issues are: (i) Recognition, (ii)
Determination of carrying amounts, (iii) Depreciation charges, (iv) Impairment losses.

AS-10 does NOT apply to:

• Biological assets (other than Bearer Plants) related to agricultural activity.

• Wasting assets including mineral rights and expenditure on exploration/extraction of minerals, oil, natural gas.

Exception: AS-10 applies to PPE used to develop/maintain the above assets. Investment property must be
accounted for using the Cost Model under AS-10.

2. Definition of PPE

PPE are tangible items that satisfy BOTH conditions: (a) Held for use in production or supply of goods/services,
for rental to others, or for administrative purposes; AND (b) Expected to be used for more than one accounting
period.

Bearer Plants — Special Category of PPE:

A Bearer Plant must satisfy ALL 3 conditions: 1. Used in production or supply of agricultural produce. 2.
Expected to bear produce for more than 12 months. 3. Has a remote likelihood of being sold as agricultural
produce (incidental scrap sales allowed). NOT Bearer Plants: Trees grown for lumber, trees grown for both fruit
and lumber, annual crops (maize, wheat).

Safety/Environmental PPE:
PPE acquired for safety or environmental reasons may not directly increase economic benefits of any particular
existing asset, but they qualify for recognition because they enable the enterprise to derive future economic
benefits from related assets. E.g., chemical handling processes installed to comply with environmental law —
recognised as an asset because without them the enterprise cannot manufacture and sell chemicals.

3. Recognition Criteria for PPE

The cost of an item of PPE should be recognised as an asset if, and only if: (a) It is probable that future
economic benefits associated with the item will flow to the enterprise, AND (b) The cost of the item can
be measured reliably.

• Individually insignificant items (moulds, tools, dies) may be aggregated and the criteria applied to the
aggregate value.
• An enterprise may expense an item that qualifies as PPE if the expenditure is not material.
• Recognition applies at time of initial acquisition AND when subsequent costs (additions, replacements,
servicing) are incurred.

Spare Parts, Stand-by Equipment, Servicing Equipment:

Case Treatment

Meet the definition of PPE (AS-10) Recognised as PPE — capitalised.

Do NOT meet the definition of PPE Classified as Inventory under AS-2.
 4. Measurement of PPE at Recognition (Cost Model)

An item of PPE that qualifies for recognition should be measured at its COST.

Cost Element Includes Excludes

Purchase Price Import duties + Non-refundable purchase taxes. Trade discounts and rebates.

Employee benefit costs (AS-15) from Costs while asset is not yet in use or
construction/acquisition. Site preparation. Initial operated at less than full capacity. Initial
Directly
delivery and handling. Installation and assembly. operating losses. Costs of
Attributable Costs
Testing costs (net of proceeds from items produced relocating/reorganising enterprise
during testing). Professional fees. operations.

Decommissioning Costs incurred as a consequence of using

Initial estimate of dismantling, removing the item and
, Restoration & the item to produce inventories (covered
restoring the site (per AS-29).
Similar Liabilities by AS-2).

Costs that are NEVER capitalised (not PPE cost):

Cost Type Reason

Inauguration/opening costs Not related to bringing asset to working condition.

Advertising and promotional costs for new

Revenue in nature.
product/service

Staff training costs for new location/customer

Revenue in nature.
class

Administration and general overhead costs Not attributable to specific asset.

Self-Constructed Assets:

• Cost determined using same principles as for an acquired asset.

• If similar assets are made for sale in normal course of business, cost = construction cost for sale (per AS-2).
• Internal profits eliminated in arriving at cost.
• Abnormal wastage of materials/labour NOT included in asset cost.
• Borrowing costs during construction period may be capitalised per AS-16.

Illustration — Omega Ltd. Machine Capitalisation:

Particulars Basis Rs.

Purchase Price Given 1,58,00,000

Site Preparation Cost Directly attributable 1,40,000

Technician Salary (Rs.45,000 x 3 months) Specific/attributable overhead 1,35,000

Initial Delivery Cost (Transportation) Directly attributable 50,000

Professional Fees (Architect) Directly attributable 30,000

Total Cost of Machinery 1,61,55,000

5. Measurement after Recognition

Model Description
Cost Model Asset carried at cost less accumulated depreciation less accumulated impairment losses.

Asset carried at revalued amount (fair value at date of revaluation) less subsequent depreciation
Revaluation Model
and impairment. Revaluations must be made with sufficient regularity.
 PART C — AS-10: Depreciation — Concepts, Methods & Recording

1. Key Terminology

Term Definition

Systematic allocation of depreciable amount over the useful life. Charged to P&L; (or
Depreciation
included in cost of another asset in some cases).

Amortisation Gradual writing-off of intangible assets (e.g., patents, goodwill, copyrights) over useful life.

Value of wasting assets extracted (e.g., coal from a coal mine). Extraction reduces available
Depletion
quantity.

Depreciable Amount Cost of asset (or revalued amount) MINUS Residual Value.

Estimated amount currently obtainable from disposal at end of useful life (net of disposal
Residual Value
costs).

Useful Life Period asset is available for use OR number of production units expected from the asset.

Cost (or revalued amount) less accumulated depreciation less accumulated impairment
Carrying Amount
losses.

Key Rules: Depreciation starts when asset is AVAILABLE FOR USE (location and condition ready for intended
use) — not actual date of use. Depreciation ceases at the EARLIER of: (i) asset retired from active use and held
for disposal, or (ii) asset derecognised. No depreciation if residual value >= carrying amount. Freehold land is
NOT depreciated (infinite useful life). Significant parts of an asset are depreciated SEPARATELY (component
approach).

Case — Commencement of Depreciation:

B Ltd. constructs a machine for its own use. Construction completed 1st November 2021 but not used until 1st
March 2022. Depreciation begins on 1st November 2021 — the date the machine was ready for use. The fact that
it was not actually used is irrelevant.

Factors determining Useful Life:

• Expected usage time and production capacity.

• Expected physical wear and tear.
• Technical or commercial obsolescence.
• Legal or similar limits (e.g., lease period for leased assets).

2. Methods of Charging Depreciation

Basis Straight Line Method (SLM) Diminishing Balance Method (DBM / WDV)

Equal depreciation each year; cost expires at a Fixed percentage on reducing (written-down)
Concept
steady (straight-line) function of time. value; higher depreciation in early years.

Formula (Cost - Residual Value) / Useful Life Opening WDV x Fixed Rate %

Nature Constant amount each year. Decreasing amount each year.

Asset renders uniform service throughout its

Assumption Asset loses more value in early years of use.
life.
 Leases, patents, copyrights; assets with Assets that deteriorate faster in early years;
Best for
uniform use and low maintenance. repairs increase over time.

Result at end of Book value approaches but never reaches zero

Book value = Zero or Residual Value.
life (small residual).

3. Methods of Recording Depreciation

Method A — Without Provision for Depreciation Account (Direct Charge to Asset):

• Depreciation credited directly to Asset Account (reduces asset value).

• Asset appears in Balance Sheet at Written Down Value (WDV).

Entry Dr. Cr.

1. Depreciation Depreciation A/c Asset A/c

2. Transfer to P&L; Profit & Loss A/c Depreciation A/c

Method B — With Provision for Depreciation / Accumulated Depreciation Account:

• Depreciation credited to Accumulated Depreciation Account (Asset Account NOT reduced).

• Asset appears in Balance Sheet at original Cost; Provision for Depreciation shown separately.
• On expiry of useful life: Accumulated Depreciation A/c Dr. / Asset A/c Cr. (to close both).

Entry Dr. Cr.

1. Depreciation Depreciation A/c Accumulated Depreciation A/c

2. Transfer to P&L; Profit & Loss A/c Depreciation A/c

 4. Profit & Loss on Disposal of Assets

Without Provision for Depreciation Account:

Ste
Entry Dr. Cr.
p

1 Transfer asset to disposal A/c Asset Disposal A/c (original cost) Asset A/c

2 Depreciation on current year Depreciation A/c P&L; A/c

3 Sale proceeds received Bank A/c Asset Disposal A/c

4a If Profit on sale Asset Disposal A/c P&L; A/c

4b If Loss on sale P&L; A/c Asset Disposal A/c

With Provision for Depreciation Account:

Ste
Entry Dr. Cr.
p

1 Transfer asset Asset Disposal A/c (original cost) Asset A/c

2 Transfer accumulated dep. Accumulated Depreciation A/c Asset Disposal A/c

3 Current year depreciation Depreciation A/c P&L; A/c

4 Current year dep. transfer Depreciation A/c P&L; A/c

5 Sale proceeds Bank A/c Asset Disposal A/c

6a If Profit Asset Disposal A/c P&L; A/c

6b If Loss P&L; A/c Asset Disposal A/c

5. Change in Method of Depreciation

The Principle of Consistency requires accounting policies to be applied consistently. Any change in the method
of depreciation is treated as a change in accounting estimate (per AS-5), NOT a change in accounting policy.
Management should review the depreciation method at the end of each financial year.

Prospective Method (Without Retrospective Retrospective Method (With

Basis
Effect) Retrospective Effect)

Change applied from date of purchase of

Meaning Change applied only from current year onwards.
the asset.

Past depreciation recalculated under new

Past entries No adjustment for past depreciation.
method; difference adjusted.

Depreciation charged by new method from current Future depreciation charged by new
Future entries
year. method.

Requires quantification and full disclosure

AS Reference Treated as change in accounting estimate per AS-5.
in footnotes.
Disclosure Required for Change in Depreciation Method (AS-1 / AS-5): 1. Justification for the change. 2.
Financial effect (quantified) of the change. 3. Effect included in determination of net profit/loss: (a) in the period of
change only if change affects only that period, OR (b) in the period of change AND future periods if change
affects both.

Case — Delhi Transport Ltd.:

Delhi Transport Ltd. has 20 diesel buses operating in NCR. New pollution legislation will ban them from NCR from
1st April 2022, reducing their useful lives. The company must accelerate depreciation and review residual values.
This is a revision in estimates — no effect on prior periods, but depreciation of current and future years will
increase.

6. Disclosures under AS-10 (PPE)

General Disclosures (for each class of PPE):

• Measurement basis used (cost model or revaluation model) for determining gross carrying amount.
• Depreciation methods used.
• Useful lives or depreciation rates used (if different from statutory rates, specific mention required).
• Gross carrying amount and accumulated depreciation (including impairment losses) at beginning and end of
period.
• Reconciliation of carrying amount showing: additions, retirements, acquisitions through business combinations,
revaluation changes, impairment losses/reversals, depreciation, exchange differences, other changes.

Additional Disclosures:

• Existence and amounts of restrictions on title, and PPE pledged as security for liabilities.
• Amount of expenditure recognised in carrying amount during course of construction.
• Contractual commitments for acquisition of PPE.
• Compensation from third parties for items of PPE that were impaired, lost or given up (if not separately
disclosed in P&L;).
PART D — Quick Revision: AS-2 vs AS-10 at a Glance

Parameter AS-2: Inventory AS-10: PPE

Standard Valuation of Inventories Property, Plant and Equipment

Nature of Asset Current asset (short-term) Non-current/Fixed asset (long-term)

Valuation Basis Lower of Cost and NRV Cost Model or Revaluation Model

Purchase price + Directly Attributable

Cost Components Purchase + Conversion + Other costs
+ Decommissioning

FIFO or Weighted Average (Specific ID where Depreciation: SLM or DBM

Allocation Method
possible) (component approach)

Impairment loss (P&L; or Revaluation

Write-down Treatment Write down to NRV (P&L; charge)
Surplus)

Abnormal losses, storage, admin OH, selling Inauguration, advertising, training,

Excluded Costs
costs admin OH

Included if substantial time for readiness Included during construction period

Borrowing Costs
(AS-16) (AS-16)

Depreciation method; useful life; gross

Key Disclosure Cost formula used; classification of inventory
carrying amount; reconciliation

Depreciation Quick Reference

Topic Key Point

SLM Formula (Cost - Residual Value) / Useful Life years

DBM Formula Opening WDV x Fixed Rate %

When to Start When asset is AVAILABLE FOR USE (ready, not actual use)

When to Stop Earlier of: retirement from use OR derecognition

Component Approach Each significant part depreciated separately

Change in Method Treat as change in estimate (AS-5); prospective or retrospective; disclose

Without Prov. A/c Asset shown at WDV in Balance Sheet

With Prov. A/c Asset shown at original Cost; Prov. shown separately in B/S

No Depreciation on Freehold land (infinite life)

Depreciation in COGS Manufacturing plant depreciation included in conversion cost (AS-2)

Study Notes compiled from: AS-2 Inventory Accounting | AS-10 PPE Basics | Depreciation Methods & Recording | Change in Method |
Additional Theory Notes