ACCOUNTING STANDARD 2 – VALUATION OF INVENTORIES
1. Objective of AS-2
To prescribe the accounting treatment for valuation of
inventories.
Core issue:
• How much inventory value should appear in Balance
Sheet
2. Measurement Principle (Most Important Line of AS-2)
Inventories are valued at:
Cost OR Net Realisable Value, whichever is lower
− ICAI repeatedly tests this single line in different
–
disguises.
3. Meaning of Net Realisable Value (NRV)
NRV is the estimated selling price in the ordinary course of
business, less:
• Estimated cost of completion (if any)
• Estimated costs necessary to make the sale
NRV Formula
Net Realisable Value
= Estimated Selling Price
– Estimated Cost of Completion
– Estimated Cost to Make the Sale
4. Valuation of Finished Goods and Work-in-Progress
• Finished Goods → Valued at Cost or NRV, whichever is
lower
• Work-in-Progress → NRV is also computed similarly
–
− ICAI twist: Students forget completion cost for WIP.
5. Meaning of Cost of Inventories
Cost of inventories comprises:
1. Cost of Purchase
2. Cost of Conversion
3. Other Costs (to bring inventory to present location s
condition)
6. Cost of Purchase
Includes:
• Purchase price
• Non-refundable taxes s duties
• Direct expenses related to purchase
Less:
• Trade discounts
• Rebates
ICAI Favourite Trap
• GST / VAT refundable → NOT included
• Octroi / non-refundable duty → included
Students mix this up very often.
7. Cost of Conversion
Cost of conversion includes:
• Direct labour
• Production overheads
o Fixed overheads
o Variable overheads
8. Treatment of Fixed Production Overheads
(ICAI loves this logic question)
Fixed overheads are allocated based on normal production
capacity.
Three situations tested by ICAI:
(i) Actual Production = Normal Production
• Fixed overheads are absorbed normally
• No adjustment required
(ii) Actual Production > Normal Production (High
Production)
• Fixed overhead per unit decreases
• Inventory is valued at lower fixed overhead per unit
–
− ICAI trick: Do NOT increase total fixed overhead
(iii) Actual Production < Normal Production (Low
Production)
• Fixed overhead per unit increases artificially
• Excess fixed overhead is charged to PsL
• Inventory is valued at normal fixed overhead
–− This line is a guaranteed 2–3 marks if written correctly.
G. Treatment of Variable Overheads
Variable overheads are:
• Allocated on actual production basis
• Fully absorbed into cost
No normal capacity concept here.
10. Other Costs Included in Inventory
Included only if:
• They are incurred in bringing inventories to present
location and condition
Examples:
• Designing cost for specific customer order
• Packing cost necessary for sale
11. Costs Excluded from Inventory Cost
(ICAI loves MCQs from here)
Always excluded:
• Abnormal wastage
• Storage cost (unless necessary in production process)
• Administrative overheads
• Selling s distribution expenses
12. Treatment of Normal Loss
Key Principle
Normal loss is always part of inventory cost.
Cost Per Unit Formula (Normal Loss Case)
Cost per unit
= Total Cost
÷ (Total Units – Normal Loss Units)
–− ICAI trick: Students wrongly divide by total input units.
13. Abnormal Loss
• Abnormal loss is not included in inventory cost
• It is charged directly to Profit s Loss Account
14. Valuation of Inventory at NRV – When Applied
NRV is used when:
• Inventory is damaged
• Inventory becomes obsolete
• Selling price falls below cost
NRV is assessed item-wise, not category-wise.
15. Disclosure Requirements
An enterprise should disclose:
• Accounting policy for inventory valuation
• Cost formula used (FIFO / Weighted Average)
16. Examiner’s Favourite Tricky Areas in AS-2
ICAI usually tests:
• Normal vs abnormal loss
• Fixed overhead allocation
• NRV calculation logic
• Refundable vs non-refundable taxes
• Item-wise NRV comparison
17. Common Student Mistakes
• Valuing inventory at selling price
• Ignoring completion cost in NRV
• Capitalising abnormal loss
• Using actual capacity instead of normal capacity
• Including selling expenses in cost
18. Golden ICAI Logic (Must Remember)
Inventory valuation is about prudence,
not profit maximisation.
Lower of Cost or NRV is applied to:
➡ prevent overstatement of assets.