Objective
- This Standard deals with the determination of such value, including the ascertainment of cost of inventories and any write-down thereof to net realisable value.
- Determination of the value at which inventories are carried in the financial statements until the related revenues are recognised.
Scope
This Standard should be applied in accounting for inventories other than (AS-2 NOT APPLICABLE to the following):
(a) work in progress arising under construction contracts, including directly related
service contracts (see Accounting Standard (AS) 7, Construction Contracts);
(b) work in progress arising in the ordinary course of business of service providers;
(c) shares, debentures and other financial instruments held as stock-in-trade; and
(d) producers’ inventories of livestock, agricultural and forest products, and
mineral oils, ores and gases to the extent that they are measured at net
realisable value in accordance with well established practices in those
industries. EXAMPLE- when agricultural crops have
been harvested or mineral oils, ores and gases have been extracted and sale is assured
under a forward contract or a government guarantee, or when a homogenous market
exists and there is a negligible risk of failure to sell. These inventories are excluded
from the scope of this Standard.
Definitions
Inventories are assets:
(a) held for sale in the ordinary course of business; (FG)
(b) in the process of production for such sale; or (WIP)
(c) in the form of materials or supplies to be consumed in the production
process or in the rendering of services. (RM)
Net realisable value
Estimated selling price in the ordinary course of
business -
(Estimated costs of completion + estimated costs
necessary to make the sale)
Inventories include-
HINT- RM>WIP>FG, RESALE it, CONSUME less & MAINTAIN your LOOSE weight.
- Goods purchased and held for resale - Example, merchandise purchased by a retailer and held for resale, computer software held for resale, or land and other property held for resale.
- Finished goods produced, or
- Work in progress being produced, by the enterprise and include
- Materials,
- maintenance supplies,
- consumables and
- loose tools awaiting use in the production process.
Inventories does not include
HINT- 3S or its 10am do not STAND, get SPARE PARTS & SERVICE EQUIPMENT.
- Spare parts,
- Servicing equipment and
- Standby equipment which meet the definition of property, plant and equipment as per AS 10, Property, Plant and Equipment. Such items are accounted for in accordance with Accounting Standard (AS) 10, Property, Plant and Equipment.
Measurement of Inventories
Inventories should be valued at the lower, Cost and net realisable value (NRV).
Cost of Inventories
All costs of purchase
+ Costs of conversion
+ other costs incurred in bringing the inventories to their present location and condition.
1. Costs of Purchase
Purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities),
Purchase price including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities),
+Freight
inwards and
+Other expenditure directly attributable to the acquisition.
=COST OF PURCHASE
-Trade discounts,
-rebates,
-duty drawbacks and
-other similar items
2. Costs of Conversion
- include costs directly related to the units of production, such as direct labour.
- They also include a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods.
- Those indirect costs of production that remain relatively constant regardless of the volume of production, such as depreciation and maintenance of factory buildings and the cost of factory management and administration.
- Based on the normal capacity of the production facilities.
- Normal capacity is the production expected to be achieved on an average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance.
- Allocated to each unit of production is not increased as a consequence of low production or idle plant.
- Un allocated overheads are recognised as an expense in the period in which they are incurred.
- In periods of abnormally high production, the amount of fixed production overheads allocated to each unit of production is decreased so that inventories are not measured above cost.
- Those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materials and indirect labour.
- assigned to each unit of production on the basis of the actual use of the production facilities ie Actual Production.
Joint Product
- A production process may result in more than one product being produced simultaneously.
- Example, when joint products are produced or when there is a main product and a by-product.
- When the costs of conversion of each product are not separately identifiable, they are allocated between the products on a rational and consistent basis.
- The allocation may be based, for example, on the relative sales value of each product either at the stage in the production process when the products become separately identifiable, or at the completion of production.
By-products as well as
scrap or waste materials
- Most by-products as well as scrap or waste materials, by their nature, are immaterial.
- They are often measured at net realisable value and this value is deducted from the cost of the main product.
- As a result, the carrying amount of the main product is not materially different from its cost.
Other Costs
- Cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition.
- For example, it may be appropriate to include overheads other than production overheads or the costs of designing products for specific customers in the cost of inventories.
- Interest and other borrowing costs are usually considered as not relating to bringing the inventories to their present location and condition and are, therefore, usually not included in the cost of inventories.
Exclusions from the Cost of Inventories
- In determining the cost of inventories in accordance with paragraph 6, it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred.
- Examples of such costs are:
(b) storage costs, unless those costs are necessary in the production process prior
to a further production stage;
(c) administrative overheads that do not contribute to bringing the inventories to
their present location and condition; and
(d) selling and distribution costs.
Cost Formulas
- Sepecific Identification,
- FIFO,
- Weighted Average.
- Segregation is Possible- The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs. Appropriate treatment for items that are segregated for a specific project, regardless of whether they have been purchased or produced is possible.
- Segregation is not Possible- large numbers of items of inventory which are ordinarily interchangeable, specific identification of costs is inappropriate since, in such circumstances, an enterprise could obtain predetermined effects on the net profit or loss for the period by selecting a particular method of ascertaining the items that remain in inventories.
- The cost of inventories, other than those dealt with in paragraph 14, should be assigned by using the first-in, first-out (FIFO), or weighted average cost formula. The formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.
- The FIFO formula assumes that the items of inventory which were purchased or produced first are consumed or sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced.
- Under the weighted average cost formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average may be calculated on a periodic basis, or as each additional shipment is received, depending upon the circumstances of the enterprise.
Techniques for the Measurement of Cost
- Standard cost method or
- Retail method
Standard costs
- take into account normal levels of consumption of materials and supplies, labour, efficiency and capacity utilisation.
- They are regularly reviewed and, if necessary, revised in the light of current conditions.
- Is often used in the retail trade for measuring inventories of large numbers of rapidly changing items that have similar margins and for which it is impracticable to use other costing methods.
- The cost of the inventory is determined by reducing from the sales value of the inventory the appropriate percentage gross margin.
- The percentage used takes into consideration inventory which has been marked down to below its original selling price.
- An average percentage for each retail department is often used.
Net Realisable Value
- The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined.
- The cost of inventories may also not be recoverable if the estimated costs of completion or the estimated costs necessary to make the sale have increased.
- The practice of writing down inventories below cost to net realisable value is consistent with the view that assets should not be carried in excess of amounts expected to be realised from their sale or use.
- Inventories are usually written down to net realisable value on an item-by-item basis.
- In some circumstances, however, it may be appropriate to group similar or related items.
- This may be the case with items of inventory relating to the same product line that have similar purposes or end uses and are produced and marketed in the same geographical area and cannot be practicably evaluated separately from other items in that product line.
- It is not appropriate to write down inventories based on a classification of inventory, for example, finished goods, or all the inventories in a particular business segment.
- Estimates of net realisable value are based on the most reliable evidence available at the time the estimates are made as to the amount the inventories are expected to realise.
- These estimates take into consideration fluctuations of price or cost directly relating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date.
- Estimates of net realisable value also take into consideration the purpose for which the inventory is held.
- For example, the net realisable value of the quantity of inventory held to satisfy firm sales or service contracts is based on the contract price.
- If the sales contracts are for less than the inventory quantities held, the net realisable value of the excess inventory is based on general selling prices.
- Contingent losses on firm sales contracts in excess of inventory quantities held and contingent losses on firm purchase contracts are dealt with in accordance with the principles enunciated in Accounting Standard (AS) 4, Contingencies and Events Occurring After the Balance Sheet Date.
- Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. ie. If the finished goods in which raw material and supply is used is sold at cost or above the cost, then the estimated realisable value of raw material and supplies is considered more than cost.
- However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realisable value, the materials are written down to net realisable value.
- In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value. ie. It the finished goods in which raw material and supply are used is sold at below cost then the estimated realisable value of raw material or supply is equal to replacement price of raw material or supply.
- An assessment is made of net realisable value as at each balance sheet date.
- The financial statements should disclose:
(b) the total carrying amount of inventories and its classification appropriate to
the enterprise.
- Information about the carrying amounts held in different classifications of inventories and the extent of the changes in these assets is useful to financial statement users.
- Common classifications of inventories are:
(b) Work-in-progress
(c) Finished goods
(d) Stock-in-trade (in respect of goods acquired for trading)
(e) Stores and spares
(f) Loose tools
(g) Others (specify nature).
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