CA Foundation · Accounting

Inventories: formula sheet

Full chapter guide

Key formulas

Definition of inventories: Inventories = assets held (i) for sale in ordinary course, (ii) in production for such sale, or (iii) as materials/supplies to be consumed in production or services; Classify by purpose of holding, not by the name of the item.
Items outside AS 2: Excluded: construction contract WIP | service providers' WIP | financial instruments held as stock-in-trade | producers' livestock, agricultural and forest products, minerals (when measured at NRV by established practice); Learn these four as a list. Questions often ask you to pick the excluded item.
Net realisable value: NRV = Estimated selling price − Estimated costs of completion − Estimated costs necessary to make the sale; Selling price is the estimate in the ordinary course of business.
Basic measurement rule: Inventories are valued at the lower of cost and NRV; Introduced here. Cost components and formulas are covered in later topics.
Cost of inventories: Cost = Cost of purchase + Cost of conversion + Other costs to bring to present location and condition; Then compare with NRV and take the lower.
Cost of purchase: Purchase price + Duties and non-recoverable taxes + Freight inwards + Other directly attributable costs − Trade discounts, rebates; Do not deduct cash discount unless the question treats it as a trade discount. Exclude recoverable taxes.
Fixed overhead absorption rate: Fixed overhead per unit = Total fixed production overheads ÷ Normal capacity (units); Use normal capacity, not actual output, when output is below normal.
Fixed overhead when output is above normal: Fixed overhead per unit = Total fixed production overheads ÷ Actual production; Applies when actual production is higher than normal capacity. This avoids valuing inventory above cost.
Variable overhead per unit: Variable overhead per unit = Variable overheads ÷ Actual production; Always on actual use of production facilities.
Joint cost allocation (relative sales value): Share of joint cost = Joint cost × (Sales value of product ÷ Total sales value); One common rational basis. Use it when the question gives no other basis.
Main product cost after by-product: Cost of main product = Total cost of production − NRV of by-product; Used when by-product value is small.
Costs excluded: Exclude: abnormal wastage, storage costs (unless needed in production), administrative overheads not related to production, selling and distribution costs; These are expensed in the period they are incurred.
Net realisable value: NRV = Estimated selling price − Estimated cost of completion − Estimated selling costs; Use costs still to be incurred. Costs already incurred are part of cost, not deducted again.
Inventory valuation rule: Value of inventory = Lower of (Cost, NRV); Apply to each item, or to a group of similar or related items. Do not offset across unrelated items.
Write-down amount: Write-down = Cost − NRV (only when NRV < Cost); Charge it to Profit and Loss in the period. No write-down if NRV is equal to or above cost.
Total valuation: Closing inventory = Σ (lower of cost and NRV for each item); Add the item-wise lower figures. Never take the lower of the two grand totals.
Specific identification: Cost of item = actual cost of that identified item; Required for items not ordinarily interchangeable and for goods segregated for specific projects.
FIFO: Closing stock = cost of the latest units purchased, up to the units on hand; Issues are costed from the oldest lot first.
Weighted average cost per unit: (Cost of opening stock + cost of purchases) ÷ (Units of opening stock + units purchased); Periodic basis: one average for the whole period. Moving basis: recalculate after every purchase.
Closing stock units: Opening units + Purchased units − Issued (sold) units; Check this before costing.
Cost of goods sold: Opening stock + Purchases − Closing stock; Use it to cross-check your answer.
LIFO: Not a permitted cost formula under AS 2; State this clearly if asked.
Standard cost method: Inventory value = Quantity on hand × Standard cost per unit; Standards must be based on normal levels and reviewed regularly. Use it only if it approximates actual cost.
Retail method: gross margin percentage: Gross margin % = Gross margin ÷ Selling price × 100; The percentage is on selling price, not on cost. This is the most common trap.
Retail method: cost of closing stock: Cost of closing stock = Closing stock at selling price − (Closing stock at selling price × Gross margin %); Equivalent: Closing stock at selling price × (1 − Gross margin %).
Closing stock at selling price (when not given): Goods available at selling price − Sales; Goods available = Opening stock at selling price + Purchases at selling price. Adjust for markdowns and returns where given.
Final valuation rule: Inventory = Lower of (cost by technique) and NRV; AS 2 still requires the lower of cost and NRV test.
Count date BEFORE balance sheet date: Closing stock = Stock at count date + Purchases (after count) − Purchase returns − Cost of sales (after count) + Cost of sales returns; All items are for the period from the count date to the balance sheet date. All figures must be at cost.
Count date AFTER balance sheet date: Closing stock = Stock at count date − Purchases (between) + Purchase returns + Cost of sales (between) − Cost of sales returns; All items are for the period from the balance sheet date to the count date. This is the reverse of the forward case.
Sales to cost, gross profit on sales: Cost = Sales × (100 − GP%) ÷ 100; Use when profit is given as a percentage of sales.
Sales to cost, mark-up on cost: Cost = Sales × 100 ÷ (100 + mark-up%); Use when profit is given as a percentage of cost.
Goods on consignment or sale or return: Include in closing stock at cost (consignment: cost plus proportionate direct expenses) if ownership has not passed; Unapproved sale or return goods are added to stock, and the sale should be reversed.
Policy disclosure: Accounting policy = measurement basis (lower of cost and NRV) + cost formula (FIFO / weighted average / specific identification); State both the basis and the formula. Do not only name one.
Total carrying amount: Total inventories = Raw materials + Work-in-progress + Finished goods + Stores and spares + Loose tools (as applicable); Show each classification relevant to the business, then the total.
Measurement basis: Carrying amount = lower of cost and net realisable value; The disclosed policy must match how the figure was actually computed.
Cost of inventories sold (background only): Cost of inventories sold = Opening stock + Purchases (and conversion costs) − Closing stock; This links stock to the cost of goods sold. Its disclosure as an expense is an Ind AS 2 requirement, not an AS 2 disclosure.

Quick revision

Inventories are goods held for sale, in production, or as materials to be consumed in production or services.
Value inventories at the lower of cost and net realisable value.
Cost includes purchase cost, conversion cost and other costs to bring stock to its present location and condition.
Trade discounts and rebates are deducted from purchase cost.
Abnormal wastage, storage costs (unless necessary in production), administrative overheads that do not contribute to bringing inventories to their present location and condition, and selling costs are excluded from cost.
NRV is estimated selling price less estimated costs of completion and costs necessary to make the sale.
Compare cost and NRV item by item or by group of similar items, not on the grand total, unless items are closely related.
FIFO assumes the oldest stock is sold first, so closing stock is valued at the latest prices.
Weighted average cost is total cost of available units divided by total units available.
Specific identification is used for items that are segregated for specific projects, and for goods or services that are not ordinarily interchangeable.
Standard cost and retail methods are allowed only if the result approximates actual cost.
For a count on another date, adjust for sales and purchases between that date and the balance sheet date, at the right basis.

Common mistakes

Treating all assets of a trader as inventory. Fix: Apply the purpose test. Items held for use over several periods are fixed assets, even if the dealer sells the same item as stock.
Applying AS 2 to shares held by a share dealer. Fix: Financial instruments held as stock-in-trade are excluded from AS 2. Remember the exclusion by its wording.
Including recoverable GST or similar credit in cost of purchase. Fix: Add only taxes that cannot be recovered from tax authorities. Exclude credit-eligible taxes.
Absorbing fixed overheads on actual output when output is below normal capacity. Fix: When output is lower than normal, use normal capacity for the rate. The unallocated fixed overhead is an expense of the period.
Comparing total cost with total NRV of all items Fix: Compare item by item. A gain on one item cannot cancel a loss on another.
Not deducting selling expenses while computing NRV Fix: Always subtract estimated costs to make the sale, such as commission and packing for sale, along with completion costs.
Treating LIFO as an allowed method under AS 2 Fix: Write that AS 2 permits only specific identification, FIFO and weighted average. LIFO is not a permitted formula.
Taking the simple average of purchase rates in weighted average Fix: Divide total cost by total units. Weights are the quantities.
Applying the gross margin percentage on cost instead of selling price. Fix: Under the retail method, margin is a percentage of selling price. If the question gives mark-up on cost, convert: mark-up ÷ (100 + mark-up).
Valuing closing stock at selling price and forgetting to convert it to cost. Fix: Always write a separate line for 'less: margin' and show stock at cost as the final line.

Exam tips

Learn the three inventory groups and the four exclusions word for word. Short questions come straight from these lists.
Always give a reason with your conclusion. A bare yes or no earns few marks in a subjective paper.
Name the group when you classify an item: finished goods, WIP, raw materials, or stores and spares.
When a question mentions a contract, a service business or shares, check the exclusion list first.
Write the NRV definition in full with both deductions. It often appears as a 2 to 3 mark theory question.
Read the capacity data first. Many questions test whether you use normal or actual capacity for fixed overheads.
Write a short reason beside each excluded item. This earns marks even if your total is off.
Show trade discount, freight and duty on separate lines. Examiners give step marks for each.