AS 2 Valuation of Inventory: formula sheet

Key formulas

Definition of inventories

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

Test every item against these three limbs and the purpose of holding.

Net realisable value

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

For finished goods, costs of completion are nil. Deduct only costs still to be incurred.

Measurement rule (link)

Inventories are valued at the lower of cost and net realisable value

The scope and definitions you learn here feed this rule. It is studied in detail in the NRV topic.

Scope exclusions

Excluded: construction contract WIP (AS 7); shares, debentures and other financial instruments held as stock-in-trade; producers' inventories of livestock, agricultural and forest products, and mineral oils, ores and gases measured at NRV

Service providers' WIP is not excluded. It is inside AS 2 and measured at cost of the service. Exam questions usually test one of the exclusions.

Fair value

Fair value = amount for which an asset could be exchanged between knowledgeable, willing parties in an arm's length transaction

Do not use it as a synonym for NRV.

Cost of inventory

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

Use this as the master list for every question.

Cost of purchase

Purchase price + Duties and non-recoverable taxes + Freight inward + Handling and other direct costs − Trade discounts, rebates

Recoverable taxes such as credit-eligible GST are not part of cost.

Fixed overhead absorption rate

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

Use normal capacity, not actual output, unless actual output is close to normal.

Fixed overhead included in inventory

Fixed overhead in inventory = Fixed overhead per unit (normal capacity) × Units in inventory

Unabsorbed overhead from low production is expensed in the period.

Variable overhead rate

Variable overhead per unit = Total variable overhead ÷ Actual production (units)

Variable overheads follow actual use of the facilities.

Excluded costs

Exclude: abnormal wastage, storage costs (unless needed before a further production stage), administrative overheads not related to production, selling and distribution costs

These are charged to expense when incurred. Interest follows AS 16 and is not covered by this formula.

Joint cost allocation

Share of joint cost = Total joint cost × (Sales value of product ÷ Total sales value)

Relative sales value is one rational basis. Apply it consistently.

Weighted average cost per unit (periodic)

(Cost of opening stock + Cost of all purchases) ÷ (Opening units + Units purchased)

Use this when the question values stock at the end of the period. For a moving average, recompute after every purchase.

FIFO closing stock

Closing units valued at the most recent purchase prices, working backwards

Start from the latest lot and move to earlier lots until all closing units are costed.

Cost of goods sold or issued

Opening stock + Purchases − Closing stock

Cross-check: this must equal the cost of the units issued under the same formula.

Retail method: closing stock at cost

Closing stock at selling price × (100% − gross margin % on selling price)

The margin must be a percentage of selling price. If the question gives margin on cost, convert it first.

Rules to remember

Specific identification: non-interchangeable items. FIFO or weighted average: interchangeable items. LIFO: not permitted.

Standard cost and retail method are allowed only if the result approximates cost.

Final carrying amount

Lower of cost and net realisable value

The cost formula gives only the cost. Compare with NRV afterwards, item by item or group by group.

Net realisable value

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

Use selling price in the ordinary course of business. Costs of completion apply to work in progress and semi-finished goods.

Inventory valuation rule

Carrying amount = Lower of (Cost, NRV)

Apply item by item, or to similar or related items grouped together where appropriate. Never offset a gain on one item against a loss on another.

Write-down amount

Write-down = Cost − NRV, only where NRV < Cost

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

Raw materials rule

If finished goods are expected to sell at or above cost: raw materials stay at cost. Otherwise: raw materials at lower of cost and NRV (replacement cost may be the best measure of NRV)

Test the finished product, not the raw material price alone.

Reversal limit

Increase on re-assessment = Lower of (cost, revised NRV) − Carrying amount after the earlier write-down

AS 2 has no explicit reversal paragraph. NRV is re-assessed at each balance sheet date, and the item is carried at the lower of cost and revised NRV. Explicit reversal is in Ind AS 2. You can never carry the item above original cost.

Stock at balance sheet date from a later count

Stock at B/S date = Stock on count date + Cost of goods sold (count date interval) − Purchases (count date interval)

Use net figures: purchases less purchase returns, and sales less sales returns, with sales converted to cost.

Cost of sales from sales

Cost of sales = Net sales × (100 − Gross profit % on sales) ÷ 100, or Net sales × 100 ÷ (100 + Mark-up %)

Check whether the profit rate is on sales or on cost. Convert to the same base before using it.

Stock at B/S date from an earlier count

Stock at B/S date = Stock on count date + Purchases (interval) − Cost of goods sold (interval)

Use this when the count date is before the balance sheet date.

Lower of cost and NRV

Carrying amount = Lower of cost and NRV, item by item (or group of similar items)

The write-down is an expense. A reversal is limited to the original cost.

Expense recognition rule

Carrying amount of inventory sold → expense in the period the related revenue is recognised

Write-downs and losses → expense when they occur. Reversals → reduce expense when they occur.

Disclosure rule

Disclose (a) accounting policies including cost formula; (b) total carrying amount with suitable classification

Classes like raw materials, WIP, finished goods and stores are typical classifications.

Quick revision

• Inventory is valued at the lower of cost and net realisable value.
• Cost includes purchase cost, conversion cost and other costs to bring inventory to its present location and condition.
• Trade discounts and rebates are deducted from the purchase cost.
• Recoverable taxes such as input credit are not part of cost.
• Abnormal wastage, selling costs and general administrative overheads are excluded from cost.
• Fixed production overheads are allocated on the basis of normal capacity.
• Specific identification is the cost formula for items that are not ordinarily interchangeable; FIFO or weighted average applies to the others.
• Standard cost and the retail method are techniques of cost measurement, not cost formulas, and are used only if the result approximates cost.
• FIFO assumes the earliest purchased items are issued first, so closing stock holds the latest costs.
• Weighted average cost is total cost of available items divided by total units available.
• NRV = estimated selling price − estimated costs of completion − estimated costs necessary to make the sale.
• Compare cost and NRV item by item; write down only where NRV is lower.
• Raw materials held for use in production are not written down if the finished goods will sell at or above cost.
• Disclose the accounting policy and cost formula used, and the carrying amount by classification.

Common mistakes

• Treating every item in the godown as inventory. Fix: Apply the purpose test. Items held for long-term use are PPE, not inventory.
• Saying shares held by a share trader are covered by AS 2. Fix: Financial instruments held as stock-in-trade are excluded from AS 2. Name the exclusion in your answer.
• Dividing fixed overhead by actual production when output is low Fix: Divide fixed overhead by normal capacity. Charge the unabsorbed amount to profit and loss for the period.
• Including GST input credit in purchase cost Fix: Include only taxes that are not recoverable from tax authorities. Credit-eligible GST is left out.
• Choosing LIFO as an acceptable method under AS 2 Fix: Remember that AS 2 allows only specific identification, FIFO and weighted average. Any LIFO option in an MCQ is wrong.
• Using weighted average on opening stock plus purchases but dividing by the wrong units Fix: Divide total cost of opening stock and purchases by total units available, before any issue.
• Ignoring selling costs and completion costs when computing NRV. Fix: Always subtract completion costs and costs necessary to make the sale, such as commission, before comparing with cost.
• Netting gains on some items against losses on others. Fix: Compare item by item, or by similar groups. Items with NRV above cost stay at cost, and only shortfalls are written down.
• Adding purchases and deducting sales when the count is later Fix: Think physically. Purchases after the date are in the count but were not in stock on the date, so deduct them. Goods sold after the date were in stock on the date, so add their cost.
• Deducting sales at selling price instead of cost Fix: Always convert net sales to cost using the gross profit or mark-up rate before adjusting.

Exam tips

• Start every classification answer with the definition in one line, then decide item by item. This structure earns marks even if one conclusion is wrong.
• Memorise the three exclusions: construction contract WIP, financial instruments held as stock-in-trade, and producers' inventories at NRV. Questions often hide one of them, such as a contractor's WIP or a share dealer's holdings.
• In NRV problems, list selling price and each future cost on separate lines. Do not subtract costs already incurred.
• For MCQs, read for purpose of holding. The same item can be inventory in one case and PPE in another.
• When an item is excluded, name where it is dealt with, for example AS 7 for construction contracts or AS 10 for PPE.
• Always show the include and exclude lists. Many questions give 8 to 10 cost items and test whether you can sort them. Marks follow the sorting.
• When you see normal capacity and actual output in the same question, check which is lower. If actual is lower, absorb fixed overhead on normal capacity. If actual is higher, use actual.
• Never include selling and distribution cost, even if the question says it relates to the stock. This is a common one-mark MCQ trap.