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Accounting Standard (AS) 2 Notes

Accounting Standard (AS) 2, Valuation of Inventories (Revised)


The objective of this standard is to formulate the method of computation of cost of inventories/stock, to determine the value of closing stock/ inventory at which, the inventory is to be shown in balance sheet till its’ sale and recognition as revenue.

Accounting Standard-2 is not applicable in following cases

  • Work-in-progress arising under construction contract including directly related to service contract (AS-7 Construction contracts).
  • Work-in-progress arising in ordinary course of business for service providers (Incomplete consultancy services, Incomplete merchant bank activities, Medical services in progress).
  • Financial Instrument held as stock-in-trade (Shares, Debentures, Bonds etc.).
  • Producer’s inventories like livestock, agricultural and forest products, mineral oils, ores and gases. Such inventories are valued at net realisable value.

Inventories include

  • Held for sale in the ordinary course of business (finished goods).
  • In the process of production of such sale (raw material and work-in-progress).
  • In the form of materials or supplies to be consumed in production process or in the rendering of services (stores, spares, raw material, consumables).
  • Inventories do not include machinery.

Spare parts and servicing Equipments

Inventories consists of –

  • goods purchased and held for resale.
  • Inventories also consists finished goods produced, or work in progress being produced, by the enterprise and include materials, maintenance supplies, consumables and loose tools held for use in the production process.
  • Inventories do not include spare parts, servicing equipment and standby equipment which meet the definition of property, plant and equipment as per AS-10, Property, Plant and Equipment (PPE).
  • Machinery spares, not specific to a particular item of fixed asset and which can be used generally for various items of fixed assets, should be treated as inventories for the purpose of AS-2. Such machinery spares should be charged to the statement of profit and loss as and when issued for consumption in the ordinary course of operations.

Inventories should be valued at lower of cost and net realisable value.

Steps for valuation of Inventories

1. Determination of cost of inventories;

2. Determination of net realisable value;

3. Comparison between the cost and net realisable value. The comparison should be made item by item or by group of items.

Cost of inventory consists the following

1. Cost of purchase

2. Cost of conversion

3. Other costs incurred in bringing the inventories to their present location and condition

1. Cost of purchase includes

Purchase price, Duties and Taxes, Freight inward, other expenditures directly attributable to the acquisition.


Duties and taxes recoverable by enterprises from taxing authorities, Trade discount, Rebate, Duty drawback, Other similar items.

2. Cost of conversion

It consists of the cost directly related to the units + Systematic Allocation of fixed and variable production overheads that are incurred in converting material into finished goods.

Fixed Production overhead means Indirect cost of production that remains relatively constant regardless of volume of production. Allocation of fixed production overhead is done on normal capacity.

Variable Production overhead means indirect cost of production that varies directly or nearly directly with the volume of production. Allocation of variable production overhead is done on actual production.

In aces of Joint-products, when the cost of conversion of each product is not identifiable separately, total cost of conversion is allocated between the products on the rational and consistent basis.

If by-products, scrap or waste materials are not of material value, they are measured at net realisable value, then the net realisable value is deducted from cost of conversion. Net cost of conversion is distributed among the main products.

3. Other costs

Cost incurred in bringing the inventories to their present location and condition.

Items to be excluded from the cost of Inventories

  • Abnormal amounts of wasted materials, labour, other production costs;
  • Storage cost;
  • Administrative overhead;
  • Selling and distribution cost;
  • Interest and borrowing cost. However, if AS-16 allows such cost to be included it, can form part of the cost.

Cost formula

Specific identification method means directly linking the cost to the specific item of inventories.

If in any case, specific identification method is not applicable the cost of inventories is valued by the following methods:

⇒ FIFO (First In First Out)

⇒ Weighted Average cost.

When it is not practical to calculate the cost, the following methods may be followed to ascertain cost:

⇒ Standard Cost

⇒ Retail Method

Net Realisable Value

Net realisable value means the estimated selling price in ordinary course of business, less estimated cost of completion and estimated cost necessary to make the sale. It is estimated on the basis of most reliable evidence at the time of valuation. The estimation of net realisable value also considers the purpose for which the inventory is held. The estimation is made as at each balance sheet date.

Estimation of net realisable value

If finished product in which raw material and supplies used is sold at cost or above cost, then the estimated realisable value of raw material and supplies is considered more than its cost. Therefore inventories of raw material will be valued at cost.

If finished product in which raw material and supplies used is sold below cost. Then the estimated realisable value of raw material or supplies is equal to replacement price of raw material or supplies and this raw material will be valued at replacement price.

Disclosure in the financial statement

Accounting policy adopted in measuring inventories.

Cost formula used.

Classifications of inventories are:

(i) Raw materials and components

(ii) Work-in-progress

(iii) Finished goods

(iv) Stock-in-trade (in respect of goods acquired for trading)

(v) Stores and spares

(vi) Loose tools

(vii) Others (specify nature)

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