A Training Course Accounting Standard 2 (Revised) : Valuation of Inventories On Intensive Course on Accounting Standards Organised by FRRB alongwith Ahmedabad

Branch, ICAI Presented By Shri Rakesh Agarwal, Associate Director, PricewaterhouseCoopers (India) Pvt. Limited

Applicability & Scope of the Standard

Mandatory in nature for accounting periods commencing on or after 1.4.1999 This Statement should be applied in accounting for inventories other than:
(a) work in progress arising under 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 & forest products, etc.

Implementation Issues
1. If financial Statements are used by Customs, Excise, WTO,etc whether the valuation principles of those agencies is required to adopted ? (take inferences from Guidance Note on Excise, Depreciation Computation for IT, SBI Financials, Phd Scholars finally the preface to accounting standard. Also in line with Prominent GAAPs) 2. Can the Stock be measured at NRV which is above cost ? (para 1.d) 3. If the standard is N.A. can the Company still adopt it ? ( EAO Vol IX /Industry Practice)

Practice Aid 1. Scope of the Standard

Sr. No. Particulars 1 Unbilled Revenue in Software Industry 2 Industries like telecom, electricity, Insurance, etc. 3 Shares, Debenture and other financials held as stock in trade Applicability Rem arks Para 1.a. Example, Infosys, Satyam, M astek, etc. Example: M TNL, VSNL, etc. Note: M TNL has voluntarily adoted Example: M utual funds like Kotak M ahindra, SBI. These entities follow AM FI Guidelines. It may be mentioned that even AS 13 on investments do not deal with the valuation of investments held as Stock in Trade W here the tea leaves, Coffee Seeds, etc are plucked from garden these can be valued at NRV but where these are traded these are to valued as per AS 2. ( EOA VOL X Page 77) Para 1.d. Also refer Industry practice and PhD Scholars

4 Stock of Industries like, tea, coffee, rubber, etc.

5 Industries Like Gold, Oil, etc.

Sources: Published Financials, Phd. Scholars recommended by President, ICAI, Expert Advisory Opinion . Also in line with IAS and US GAAP

Meaning of Inventory

Inventories are assets:

(a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. (Para 3)

Questions
Does Inventory include machinery spares ? (Refer, ASI 2/2002) Does Inventory include stock of packages and empties ? (Refer, EOA VOL IV Page 8)

Measurement and Cost of Inventories

Measurement of Inventory Inventories should be valued at the lower of cost and net realisable value. Cost of Inventories The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

Cost of Inventory
Practice Aids 2: Elements of Cost (Part 1)
No. Particulars P.U. Cost Eligible Remarks
Para 7 Para 7

Cost of Purchase
Purchase Price Taxes & Duties (not recoverable) Modvat, VAT, A potion of Custom duty (Recoverable) Freight Inward Trade Discount Rebates Cash discounts Discretionary Discounts

137
100 40 10 4 -5 -6 -4 -2

133

Indirectly from Para 7

Para 7 Para 7 Para 7 Industry View & Sch VI indirectly Industry View

Cost of Conversion
Factory Overhead Actual Factory Overhead other than that for normal Capacity (Rs. 10) Recovery of by product (on basis of NRV)

40
50 0 -10

30
To be adjusted with normal capacity Para 9 Para 10

Cost of Inventory
Practice Aids 2: Elements of Cost (Part 2)
Sr. No. Particulars P.U. Cost Eligible Remarks Para 11 read with AS 16 Extention of Above

Other Cost
Interest (Where inventory do not take substantial period of time) Storage (Where inventory do not take substantial period of time)

4
2 2

Specific items (exclusion or otherwise)

Abnormal waste Administrative overheads Selling and Distribution cost Total

32
5 15 12 213

0
Para 13 Para 13 Para 13 163

Cost Formulas v/s Techniques of Measurement

Specific Identification cost method shall be used for items
that are not ordinarily interchangeable and goods or services produced and segregated for specific projects.

In all other cases the cost of inventories,

first-in, first-out (FIFO), or weighted average cost formula.

Techniques for the Measurement of Cost

Standard cost method or the retail method, may be used for convenience if the results approximate the actual cost.

Questions
Is technique of measurement an acceptable cost formula ? Is the list of permissible cost formula limited ? Is the management having discretion to adopt any of the permissible methods ?

Net Realisable Value

Definition: Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. Implementation Issues
Are NRV compared on item by Item basis or global basis ? (Refer para 21) What is the treatment of surplus inventory i.e. though not obsolete ? (Refer EOA VOL XIV Page 35) Are committed contracts for sale to be taken into account in arriving NRV ? (Refer Para 22) How the NRV for Raw Material is computed. (Refer Para 24) Are subsequent prices taken into account while arriving at NRV. If so, to what extent or under what circumstances ? (Refer AS 4) Is Negative NRV Possible (e.g. Onerous contracts, Para 23) Where Inventory once written down to NRV can it be Written Back (Refer Indian GAAP Framework , IAS 2)

Disclosures

The financial statements should disclose:

the accounting policies adopted in measuring inventories, the cost formula used; and total carrying amount of inventories and its classification appropriate to the enterprise.

Practice Aids 3: Accounting Policy for Measuring Inventory

Sr. No.

Common Classification Measurement Policy

Cost Formula FIFO FIFO FIFO Specific Identification NRV FIFO FIFO

Carrying Amount 100 50 200 10 NA NA NA

1 Raw material 2 Work in progress 3 Finished Goods 4 Loose tools 5 Packages and Empties 6 Machinery Spares 7 Stock given on Loan

Cost or Under/NRV Cost or NRV Cost or NRV Cost Not applicable Not applicable (may be) Not applicable (may be)

Corporate Examples: .
A. Hindustan Lever Limited: Extracts from Annual Report December 31, 20XX Significant Accounting Policies: Inventories Inventories are valued at the lower of cost, computed on a weighted average basis, and the estimated net realizable value, after providing for the cost of obsolescence and other anticipated losses, wherever considered necessary. Finished goods and work in progress include costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Extracts from Balance Sheet Schedules Schedule VI INVENTORIES (at lower of cost and net realisable value) Stores and spare parts, etc. Raw material Packing material WIP Processed chemicals Finished goods Property development activity- WIP Total Rs Mil 313 5,562 645 459 58 5,600 136 12,773 2002 Rs Mil 288 5,101 581 477 108 5,771 72 12,398 2001

Checklists ..
Checklist for Compliance With Accounting Standard 2: Valuation of Inventories
Sr. No. Com pliance Test for AS 2 (To be tailor m ade for each client) W hether due care is taken to asses whether standard is applicable or not. Refer Para 1 Refer Practice Aid 1 6 W hether adequate disclosure has been made Refer Para 14 & 16 Refer Practice Aid 3 Y/ N/ N.A. W ork Ref. Paper

Responded by ___________ Reviewed by ___________

Dated________ Dated________

Special Treatments as stated in other Accounting Standards

Accounting Standard 11, Accounting for the Effects of Changes in Foreign Exchange Rates Accounting Standard 14, Accounting for Amalgamations Accounting Standard 16, Borrowing Cost Accounting Standard 21, Consolidated Financial Statements

Special Treatments as stated in Expert Advisory Opinion

Determination of Normal Capacity EOA VOL XVI Page 34 & EOA - Accounting for Waste Products EOA VOL XII Page 46 Goods in Transit EOA VOL XII Page 32 Accounting for Goods Sent on Approval EOA VOL XII Page 44 Materials Given on Loans EOA VOL IV Page 8 Valuation of Empties EOA VOL X Page 77 Valuation of rubber and tea EOA VOL XVI Page 41 Valuation of books by publishing company EOA VOL IX Page 88 Valuation of Inventories in an extractive industry EOA VOL XIV Page 35 Valuation of Spares EOA VOL XIII Page 77 Factory Administration Cost and Valuation of Inventory
EOA VOL VII Page 58 -

Comparison with IAS & US GAAP

Framework
Indian GAAP : AS 2 US GAAP: : ARB 43, IAS : IAS 2 Overall these framework are similar

Method of Inventory Valuation

Unlike Indian GAAP, LIFO method is allowed in IAS & US GAAP Reversal of Impairment is specifically allowed in IAS

Fundamental Differences
U.S. GAAP: No Standalone Financial Statements are prepared under US GAAP IAS GAAP : None

Building Up Best Practices for Your Client

1. Consider
the adoption of Non-Mandatory disclosures stated in the Accounting Standard e.g. para 27 of AS 2

2. Consider alternate accounting guidance available in other pronouncements

like auditing standards, guidance notes, etc.

3. Consider the practices adopted by highly regarded corporate entities 4. In absence/ non-clarity of authoritative guidance refer to practices adopted
by other GAAP
1. US GAAP 2. IAS GAAP Accounting Research Bulletin (ARB) 43 International Accounting Standards (IAS) 2

A Resolution from All of You How to take ourselves forward for making the disclosure an Area of Excellence

Thank You
Shri Rakesh Agarwal, Associate Director, PricewaterhouseCoopers (India) Pvt. Limited Rakesh.r.agarwal@in.pwc.com