Ind AS 2 Inventories: formula sheet

Key formulas

Definition of inventories

Inventories = assets (a) held for sale in the ordinary course of business, (b) in the process of production for such sale, or (c) materials or supplies to be consumed in production or in rendering services

Test all three limbs. Purpose of holding is the deciding factor.

Net realisable value

NRV = Estimated selling price in the ordinary course of business − Estimated costs of completion − Estimated costs necessary to make the sale

Entity-specific value. Costs of completion apply only to unfinished goods.

Fair value

Fair value = price received to sell an asset in an orderly transaction between market participants at the measurement date

Market-based, not entity-specific. Defined in Ind AS 113.

Fair value less costs to sell

Fair value less costs to sell = Fair value − Costs necessary to make the sale

Used by commodity broker-traders. Changes go to profit or loss in the period of change.

Items excluded from the scope of Ind AS 2

Construction contract WIP (Ind AS 115); financial instruments (Ind AS 32/107/109); biological assets and agricultural produce at the point of harvest (Ind AS 41)

Learn these three as a fixed list. Produce is excluded only at the point of harvest. Ind AS 2 applies to it after harvest.

Items outside Ind AS 2 measurement only

Producers of agricultural and forest products, agricultural produce after harvest, and minerals, only where they measure at NRV under well-established industry practice; commodity broker-traders (fair value less costs to sell)

Otherwise post-harvest produce is under Ind AS 2, with cost equal to Ind AS 41 fair value less costs to sell at harvest. Changes in NRV or in fair value less costs to sell go to profit or loss in the period of change. Other parts of Ind AS 2, such as disclosure, still matter.

Cost of inventories

Cost = Cost of purchase + Cost of conversion + Other costs to bring to present location and condition

Lower of this and NRV is the carrying amount.

Cost of purchase

Purchase price + import duties + non-recoverable taxes + freight, handling and other directly attributable costs − trade discounts, rebates and similar items

Recoverable taxes such as GST input credit are excluded. Settlement (cash) discount is treated as a deduction only if it is similar to a trade discount or rebate; otherwise it is a financing item.

Fixed overhead absorption rate

Fixed overhead per unit = Total fixed production overheads ÷ Normal capacity (units)

Use normal capacity, not actual output, unless actual approximates normal.

Fixed overhead absorbed in inventory

Absorbed = Fixed overhead rate × Actual units produced (when actual ≤ normal)

Unabsorbed fixed overhead is an expense of the period.

Higher-than-normal production

Fixed overhead per unit = Total fixed production overheads ÷ Actual units produced (when actual > normal)

Rate is reduced so that inventory is not measured above cost.

Variable overhead

Allocated on the basis of actual use of production facilities

No normal-capacity adjustment.

Joint cost allocation (relative sales value method)

Share of joint cost = Joint cost × (Sales value of product at split-off ÷ Total sales value of all products at split-off)

Any rational and consistent basis is allowed. This is the common exam basis.

By-product

Main product cost = Total joint cost − NRV of by-product

Applies when the by-product is immaterial in value.

Cost of inventories

Cost = Purchase costs + Conversion costs + Other costs incurred in bringing inventories to present location and condition

The 'present location and condition' test decides whether any extra cost is included.

Normal vs abnormal loss

Normal loss: absorbed in cost of good output. Abnormal loss: expensed in the period

Abnormal loss is valued at the same cost per unit as good units, then charged to profit or loss.

Cost per unit with normal loss

Cost per good unit = Total cost of input ÷ (Input units − Normal loss units)

Abnormal loss units are taken out of the closing stock and expensed.

Excluded costs

Abnormal waste, storage (unless necessary in production), non-contributing administrative overheads, selling costs → expense

Storage before a further production stage can be included, such as maturing in cask before the next stage.

Borrowing costs in inventories

Capitalise per Ind AS 23 only if inventory is a qualifying asset (substantial period to get ready)

For routine, short-cycle or repetitively manufactured inventories, Ind AS 23 does not require its application, so interest is normally expensed.

Cost of harvested produce

Cost at harvest = Fair value at point of harvest − Costs to sell

Applies to produce harvested from the entity's own biological assets. It is the deemed cost for Ind AS 2 from the date of harvest.

Costs to sell

Costs to sell = incremental costs directly attributable to disposal: commissions to brokers and dealers, levies by regulators and exchanges, transfer taxes and duties (excluding finance costs and income taxes)

If the asset is in a distant market, fair value is the market price less transport costs to get it to that market. This is a separate deduction in arriving at fair value.

Service provider inventory cost

Cost = Direct labour of personnel providing the service (incl. supervisors) + Other directly attributable costs + Attributable overheads

Exclude profit margin, non-attributable overheads, and labour for sales and general administration.

Closing measurement

Carrying amount = Lower of (Cost, Net realisable value)

Applied after harvest or on service WIP at each reporting date.

Specific identification

Cost = actual cost of each identified item

Required for items not ordinarily interchangeable and for goods or services segregated for specific projects. Choosing between formulas is not allowed here.

FIFO

Closing stock cost = cost of the most recent purchases, up to the units on hand

Units sold are costed from the opening stock and earliest purchases first.

Weighted average cost

Average cost per unit = (Cost of opening stock + Cost of purchases) ÷ (Opening units + Units purchased)

Computed periodically, or after each receipt (moving average). Closing stock = units on hand × average cost.

Retail method – cost to retail ratio

Cost-to-retail % = (Opening stock at cost + Purchases at cost) ÷ (Opening stock at retail + Purchases at retail ± markups/markdowns)

Closing stock at cost = closing stock at retail × cost-to-retail %. Adjust retail figures for markdowns consistently with the entity's policy.

Retail method – gross margin form

Cost of inventory = Selling price of inventory × (1 − gross margin %)

Use the average percentage for each retail department, and adjust where prices have been marked down below original selling price.

Standard cost

Inventory cost = units × standard cost per unit

Allowed only if it approximates actual cost. Review and revise standards regularly.

LIFO

Not permitted

Ind AS 2 does not allow the last-in, first-out cost formula.

Measurement rule

Carrying amount = lower of (Cost, NRV)

Applied item by item, or to groups of similar items. Do not net gains on one item against losses on another.

Net realisable value

NRV = Estimated selling price − Estimated costs of completion − Estimated costs necessary to make the sale

Use the ordinary-course selling price, less only costs still to be incurred.

Write-down

Write-down = Cost − NRV (only if Cost > NRV)

Recognised as an expense in the period of the write-down.

Materials for production

Write down materials to NRV only if finished goods NRV < finished goods cost

Replacement cost of the materials is often the best measure of their NRV.

Reversal

Reversal = lower of (Original write-down, Revised NRV − Written-down carrying amount)

Credited to inventory expense in the period of reversal. Carrying amount never exceeds original cost.

Quick revision

• Inventories are measured at the lower of cost and NRV.
• Scope excludes financial instruments, contract work in progress under Ind AS 115, and biological assets and produce at the point of harvest (Ind AS 41). Commodity broker-traders measuring at fair value less costs to sell are outside the measurement requirements.
• Cost includes purchase cost, conversion cost and other costs to bring inventories to present location and condition.
• Trade discounts and rebates are deducted in arriving at purchase cost.
• Import duties and non-refundable taxes are included; taxes later recoverable from tax authorities are not.
• Fixed production overheads are allocated on normal capacity; unallocated overheads are expensed.
• Abnormal waste, storage costs (unless needed in production), administrative overheads and selling costs are excluded.
• Agricultural produce harvested from biological assets is measured at fair value less costs to sell at harvest (Ind AS 41); that amount is its cost under Ind AS 2 afterwards.
• Specific identification of costs is required for items not ordinarily interchangeable and for goods or services produced and segregated for specific projects.
• For all other inventories, FIFO or weighted average is used; LIFO is not permitted.
• Use the same cost formula for inventories of similar nature and use.
• Standard cost and retail methods are allowed only if the result approximates cost.
• NRV is selling price less estimated costs of completion and costs necessary to make the sale.
• Materials held for use in production are not written down if the finished goods will sell at or above cost.
• A write-down is reversed when NRV rises, but only up to the original write-down amount, and the reversal is recognised as a reduction in expense.

Common mistakes

• Treating all assets held by a trader as inventories. Fix: Ask why the specific item is held. A computer used in the office is PPE even in a computer dealer's books.
• Saying commodity broker-traders are completely outside Ind AS 2. Fix: Only the measurement requirements are excluded. They use fair value less costs to sell, with changes in profit or loss.
• Dividing fixed overheads by actual production when output is below normal capacity. Fix: Use normal capacity as the denominator. Expense the unabsorbed fixed overhead in the period.
• Including GST paid on purchases in cost even though input credit is available. Fix: Include only taxes that are not recoverable from the tax authorities. Exclude recoverable GST.
• Including abnormal wastage in the cost of closing stock Fix: Only normal loss is absorbed. Value abnormal loss at the cost of good units and charge it to profit or loss.
• Excluding all storage costs Fix: Include storage that is necessary in the production process before a further production stage, such as maturing before the next stage.
• Using actual cost of growing as the cost of harvested produce. Fix: For produce from own biological assets, cost is fair value less costs to sell at harvest, not the cost of cultivation.
• Forgetting to deduct costs to sell. Fix: Always deduct commission, levies and transfer taxes and duties to reach cost.
• Using LIFO because the question mentions rising prices Fix: State that Ind AS 2 prohibits LIFO and use FIFO or weighted average.
• Using FIFO or weighted average for an item that is not interchangeable Fix: If items are not ordinarily interchangeable or are segregated for a project, use specific identification.

Exam tips

• In MCQs, scan the case for the purpose of holding first. Many options are built on PPE versus inventory confusion.
• Remember the three scope exclusions as a list: Ind AS 115 WIP, financial instruments, and Ind AS 41 biological assets and produce at the point of harvest.
• When a question names a commodity broker-trader, write that measurement is at fair value less costs to sell with changes in profit or loss.
• For the NRV versus fair value difference, always use the terms entity-specific and market-based. These earn the marks.
• In case-scenario MCQs, scan for traps: recoverable GST, abnormal wastage, storage costs, and settlement discounts. Each is usually the one item that changes the answer.
• Always show the normal-capacity rate as a separate line. Examiners award marks for the rate and for expensing the unabsorbed overhead.
• For written answers, quote the principle first, then apply it to the facts, then conclude with the figure.
• State your basis for joint cost allocation in one line. If the question names a basis, use it; if not, use relative sales value at split-off and say so.