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CMA Intermediate · Corporate Accounting and Auditing · Audit of Various Items of Financial Statements

While testing the inventory valuation of a company that uses FIFO, the auditor finds that the overhead absorbed into finished goods is based on actual production far below normal capacity, with the whole unabsorbed fixed overhead loaded to inventory. Which is the correct audit conclusion under Ind AS 2?

The treatment is not acceptable. Ind AS 2 requires fixed production overheads to be absorbed on the basis of normal capacity, and the unabsorbed portion arising from abnormally low production must be charged to expense in the period, not carried forward in inventory valuation.

  1. AAcceptable, as all actual fixed overheads must be included in the cost of inventory
  2. BNot acceptable; fixed overhead allocation should be based on normal capacity and unallocated overheads expensed in the periodCorrect
  3. CAcceptable if disclosed in the notes to accounts
  4. DNot acceptable; no fixed overheads may be included in inventory cost at all

Explanation

Ind AS 2 requires fixed production overheads to be allocated on the basis of normal capacity of the production facilities. In periods of abnormally low production, the unallocated overhead is recognised as an expense. Loading it on inventory overstates inventory, and disclosure does not cure this. Fixed production overheads are not excluded altogether.

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