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Verma Ltd has a normal capacity of 20,000 units per year and fixed production overheads of ₹6,00,000. In the current year, due to a strike, it produced only 15,000 units. Variable conversion cost is ₹40 per unit. Which of the following gives the correct per-unit conversion cost for inventory valuation under AS 2?

The conversion cost is ₹70 per unit. AS 2 allocates fixed production overhead on normal capacity, giving ₹6,00,000 ÷ 20,000 = ₹30, plus variable cost of ₹40. The unabsorbed fixed overhead from the lower actual output is charged to the period's expenses, not added to inventory.

  1. A₹70 per unit, because fixed overhead is allocated at ₹30 per unit based on normal capacityCorrect
  2. B₹80 per unit, because fixed overhead is allocated at ₹40 per unit based on actual output
  3. C₹40 per unit, because fixed overheads are always treated as period costs
  4. D₹60 per unit, because fixed overhead is allocated at ₹20 per unit based on half the capacity

Explanation

Fixed overhead per unit is based on normal capacity: 6,00,000 ÷ 20,000 = ₹30. Adding variable cost ₹40 gives ₹70 per unit. The unabsorbed fixed overhead of 5,000 × 30 = ₹1,50,000 is expensed in the period. Using actual output (₹40) would load inventories with the inefficiency cost of low production, which AS 2 does not permit.

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