NAS 2 Inventories

NAS 2 Inventories
Revision Note
Relevant For CAP-II students
UNIT OVERVIEW:
objective:
•determination of cost
•its subsequent recognition as an
expenses
•provides guidance on the
techniques and acceptable
methods of determining cost
Scope: applies to all

inventories except
•NAS 32 and NFRS 9
Financial Instruments
Disclosure •NAS 41 Agriculture
•NAS 11 work in progress
arising under construction
contract
Measurement of
inventory
•valuation
Recognition as an principle
expenses •Cost
•Cost Formulas
•Net Relisable
Value
Compiled by CA. Prasant Tamang

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NAS 2 Inventories
Revision Note
Relevant Definition
1. Inventories are the assets:

a. Held for sale in the ordinary course of business (finished goods).
b. In the process of production of such sale (Work In Progress).
c. In the form of material or supplies to be consumed in the production process or in
rendering of services (Raw Material).
2. Net Reliasable value (NRV):

Estimated Selling Price in the ordinary course of business – estimated cost of
completion-estimated cost necessary to make sale.
3. Difference between NRV and FV:
S.N NRV Fair Value

1. Meaning as defined in Price that would be
point no 2 received from sale of
assets or paid to transfer a
liability in an ordinary
transaction between
market participants at
measurement date.
2. It is entity specific value
3. It may not equal FV less
cost to sell.

NAS 2 Inventories
Revision Note
Measurement of Inventories
Inventories should be measured at lower of

a. Cost or
b. NRV.
1. What is the cost of Inventories?
Cost of inventory:
Purchase cost + cost of conversion +other cost incurred in bring assets to their
present location and conditions.
Purchase cost Cost of conversion Other cost incurred in

bringing assets to their
present location and
conditions.
a. Purchase price a. Direct material
b. Import duties b. Direct labour
and other
taxes
c. Transport, c. Other direct costs
handling and
d. Other costs d. Overhead(fixed and
directly Variable production
attributable overheads)
(any trade
discounts,
rebates and
other similar
items are
deducted in
determining
cost)

NAS 2 Inventories
Revision Note
Note:
Allocation of fixed production overheads to the cost of conversion is based on the

normal capacity of the production facilities. When production levels are abnormally
low, unallocated overhead are recognized as an expenses. In period of abnormally high
production, the amount of fixed overhead allocated to each unit of production is
decreased so that inventories are not measured above cost.
Cost excluded from cost of inventories and recognized as an expenses in

profit and loss account:
a. Abnormal amount of wasted material, labor and other production cost.

b. Storage cost, unless those costs are necessary in the production process before a
further production stage;
c. administrative overheads that do not contribute to bringing inventories to their
present location and condition
d. Selling costs.
Example- Cost of inventory

X Ltd. purchases cars from several countries and sells them to Europian countries.
During the current year, this company has incurred following expenses:
1. Trade discounts on purchase
2. Handling costs relating to imports
3. Salaries of accounting department
4. Sales commission paid to sales agents
5. After sales warranty costs
6. Import duties
7. Costs of purchases (based on supplier’s invoices)
8. Freight expense
9. Insurance of purchases
10. Brokerage commission paid to indenting agents
Evaluate which costs are allowed by NAS 2 for inclusion in the cost of inventory in
the books of X Ltd.
Answer:
Salaries of accounting department, sales commission and after sale warranty cost
are excluded in cost of inventory and recognized as expenses.
Items number 1, 2, 6, 7, 8, 9, 10 are allowed by NAS 2 for the calculation of cost of inventory.
The ABC Ltd., while valuing its finished inventory at the year-end wants to include
interest on Bank Overdraft as an element of cost, for the reason that overdraft has
been taken specifically for the purpose of financing current assets like inventory and
for meeting day to day working expenses. (ICAN June 2019)
Answer:

NAS 2 Inventories
Revision Note
As per NAS 2 “Inventories”, cost of inventories comprises all costs of purchase, costs
of conversion and other costs incurred in bringing the inventories to their present
location and condition.
NAS 23 borrowing costs identifies circumstance where borrowing costs can be
included in the cost of inventories. Such borrowing cost shall be directly attributable
to the inventories and would have been avoided if the expenditure on inventory had
not been made.
In light of these provisions, in given case, overdraft was taken for financing current
assets and meeting day to day working expenses, not necessarily directly for
inventory only. Therefore, the proposal of ABC Ltd. to include interest on bank
overdraft as an element of cost of inventory is not acceptable because it does not
form part of cost of production.
In a production process, normal waste is 5% of input. 5,000 MT of input were put in

process resulting in wastage of 300 MT. Cost per MT of input is Rs. 1,000. The entire
quantity of waste is on stock at the year end. State with reference to Accounting
Standard, how will you value the inventories in this case? (December 2016) (for
5 marks)
Answer:
As per of NAS- 2,” Inventories”, abnormal amount of wasted materials, labour and
other production costs are excluded from cost of inventories and such costs are
recognized as expenses in the period in which they are incurred.
In this case, normal waste is 250 MT and abnormal waste is 50 MT. The cost of 250
MT will be included in determining the cost of inventories (finished goods) at the
year end. The cost of abnormal waste (50MT x 1,052.63 = Rs 52,632) will be
charged to the profit and loss statement.
Cost per MT (Normal Quantity of 4,750 MT) = 50,00,000 / 4,750 = Rs 1,052.63
Total value of inventory = 4,700 x Rs 1,052.63 = Rs 49,47,361.
2. Allocation of cost to joint products and by-products:
 Joint cost allocated between the products on a rational and consistent basis. For
example- on the relative sales value of each product either at the stage in the
production process when the products become separately identif iable, or at the
completion of production.
 Most by-products, by their nature, are immaterial- measured at NRV and this value
is deducted from the cost of the main product.
In a manufacturing process of A Ltd., one by product BP emerges besides two main products
MP 1 and MP 2 apart from scrap. Details of cost of production process are here under:
Items Unit Amount Output Closing stock as on
2076-03-32
Raw material 14,500 150,000 MP 1- 5000 units MP 1: 250 units

NAS 2 Inventories
Revision Note
Wages 90,000 MP 2 -4000 units MP 2: 100 units
Fixed Overhead 65,000 BP- 2000 units
Variable Overhead 50,000
Average market price of MP 1 and MP 2 is NRs 60 per unit and NRs. 50 per unit respectively,
by- product is sold @ NRs 20 per unit. There is profit of NRs 5000 on sale of by -product
after incurring separate processing charges of NRs. 8000 and packing charge s of NRs. 2000,
NRs 5000 was realised from sale of scrap.
Required:
Calculate value of closing stock of MP 1 and MP 2 as on 2076-03-32.
Answer:
As per NAS 2 ‘Inventories’, most by-products as well as scrap or waste materials, by their
nature, are immateria l. They are often measured at net realizable value and this value is
deducted from the cost of the main product.
1) Calculation of NRV of By-product BP
Selling price of by-product 2,000 units x 40,000
Less: 20 per unit
Separate processing charges of by- product BP (8,000)
Packing charges (2,000)
Net realizable value of by-product BP 30,000
2) Calculation of cost of conversion for allocation

between joint products MP1 and MP2
Raw material 1,50,000
Wages 90,000
Fixed overhead 65,000
Variable overhead 50,000
Less: NRV of by-product BP (See calculation 1) 30,000
Sale value of scrap 5,000 (35,000)
Joint cost to be allocated between MP1 and MP2 3,20,000
3) Determination of “basis for allocation” and allocation of joint cost to MP1
and MP2
MP I MP 2
Output in units (a) 5,000 4,000
Sales price per unit (b) 60 50
Sales value (a x b) 3,00,000 2,00,000
Ratio of allocation 3 2
Joint cost of 3,20,000 allocated in the ratio of 3:2 (c) 1,92,000 1,28,000
Cost per unit [c/a] 38.4 32
4) Determination of value of Closing stock of MP1 and MP2:

Particulars MP 1 MP 2
Closing stock in units 250 units 100 units
Cost per unit 38.4 32
Value of closing stock 9,600 3,200

NAS 2 Inventories
Revision Note
3. Measurement Techniques:
 Retail Method:
Cost is determined by reducing the sales value of the inventory by the
appropriate percentage gross margin. The percentage used takes into
consideration inventory that has been marked down to below its original
selling price. This method is often used in the retail industry for measuring
inventories of rapidly changing items that have similar margins.
 Standard cost method:

Cost is based on normal levels of materials and supplies, labor
efficiency and capacity utilization. They are regularly reviewed and revised
where necessary
From the information given below you are required to estimate the cost of
inventory of Hari Lal as on 31s t December 2018
Beginning inventory: 400 items at NRs 19.5 cost; Retail price NRs. 30
Purchase for the year: 1200 items at NRs. 25 cost; Retail price NRs. 35
Net Sales for the year NRs. 45,000
Answer:
Particulars Cost price Retail Price
Opening inventory (400*19.5)=7,800 (400*30)=12,000
Purchase (1200*25)= 30,000 (1200*35)= 42000
Available for sales 37,800 54,000
Net sales 45,000
Closing inventory (9000/54000*37800)=6,300 9,000
Cost of inventory under retail method= NRs. 6,300
M/s X, Y and Z are in retail business, following information are obtained from
their records for
the year ended 31st March, 2011:
Goods received from suppliers
(subject to trade discount and taxes) ` 15,75,500
Trade discount 3% and sales tax 11%
Packaging and transportation charges ` 87,500
Sales during the year ` 22,45,500
Sales price of closing inventories ` 2,35,000
Find out the historical cost of inventories using adjusted selling price method.
Answer:
Determination of cost of purchases:
Goods received from suppliers 15,75,500
Less : Trade discount 3% (47,265)

NAS 2 Inventories
Revision Note
15,28,235
Add : Sales Tax 11% 1,68,106
16,96,341
Add : Packaging and
transportation charges 87,500
17,83,841
Determination of estimated gross profit margin:
Sales during the year 22,45,500
Closing inventory at the selling price 2,35,000
24,80,500
Less : Purchases ( 17,83,841)
Gross profit 6,96,659
Gross profit margin 28.09%
Inventory valuation:
Selling price of closing inventories 2,35,000
Less : Gross profit margin 28.09% ( 66,012)
1,68,988
4. Cost Formulas:
Inventory
valuation
Technique
Ordinarily Not Ordinarily

Interchangeable Interchangeable
Specific
Historical Cost Non Historical
identification
Method Cost Method
method
Retail Inventory/
Weighted Standard cost
FIFO Adjusted selling
Average method
price method
Note:
 FIFO method: items of inventory that were purchased or produced first are sold
first, and consequently the items remaining in inventory at the end of the period are
those most recently purchased or produced.

NAS 2 Inventories
Revision Note
 Weighted average: 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 entity.
A Ltd. uses a periodic inventory system. The following information relates to 2018-
19.
Date Particulars Unit Cost per unit
April Inventory 200 10
May Purchases 50 11
September Purchases 400 12
February Purchases 350 14
Total 1,000 12,250
Physical inventory as on 31.03.2019 400 units. Calculate ending inventory value and
cost of sales using:
a. FIFO and
b. Weighted average
Answer:
a. Under FIFO
method
Inventory on 31.03.2019 350@14= 4,900
50@12= 600
5,500
Cost of sales Opening inventory +
purchase- closing stock 6,750
12250-5500
b. Under weighted
average method:
Inventory on
31.03.2019
Cost per item 12,250/1000= 12.25
Closing inventory 400*12.25= 4900
Cost of sales 12250-4900= 7350
5. Writing inventories down to net realisable value:

NAS 2 Inventories
Revision Note
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. However, when a decline in the price of materia ls
indicates that the cost of the finished products exceeds net realisable value of FG, the
materials are written down to net realisable value. In such circumstances, the
replacement cost of the materials (latest purchase price) may be the best available
measure of their net realisable value.
A Ltd. purchased raw material @ NRs. 400 per kg. Company does not sell raw
material but uses in production of finished goods. The finished goods in which raw
material is used are expected to be sold at below cost. At the end of the accounting
year, company is having 10,000 kg of raw material in inventory. As the company
never sells the raw material, it does not know the selling price of raw material and
hence cannot calculate the realizable value of the raw material fo r valuation of
inventories at the end of the year. However, replacement cost of raw material is `
300 per kg. How will you value the inventory of raw material?
Answer:
As per NAS 2 “Inventories”, 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. 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 realizable value, the materials are
written down to net realizable value. In such circumstances, the replacement cost
of the materials may be the best available measure of their net realizable value.
In the given case,
Purchase cost of raw material: 10000*400 per kg= NRs. 40,00,000
However, finished goods in which raw material is used are expected to be sold at
below cost.
Hence material are written down to net relisable value. In such circumstances, the
replacement cost of the materials (latest purchase price) may be the best available
measure of their net realisable value.
Therefore, in this case, A Ltd. will value the inventory of raw material at 30,00,000
(10,000 kg. @ 300 per kg.).
Rahul Trading gives the following information relating to items forming part of
inventory as on 32-3-2075. His factory produces Product X using Raw material A.
i) 600 units of Raw material A (Produce @ Rs. 120). Replacement cost of raw
material A as on 32-3-2075 is Rs. 90 per unit.

NAS 2 Inventories
Revision Note
ii) 500 units of partly finished goods in the process of producing X and cost incurred
till date Rs. 260 per unit. These units can be finished next year by incurring
additional cost of Rs. 60 per unit.
iii) 1500 units of finished product X and total cost incurred Rs. 320 per unit. Expected
selling price of Product X is Rs. 300 per unit.
Determine how each item of inventory will be valued as on 32-3-2075. Also calculate
the value of total inventory as on 32-3-2075. (ICAN Dec 2018) (For 5 marks)
Answer:
As per NAS 2, Inventories are valued at lower of cost and net realizable
value.(provision 1)
Materials and other supplies held for use in the production of inventories are not
written down below cost if the finished products in which the will be incorporated
are expected to be sold at cost or above 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 realizable value, the materials are written down to net
realizable value. In such circumstances, the replacement cost of the materials may
be the best available measure of their net realizable value.(provision 2)
In the given case, selling price of product X is Rs. 300 and total cost per unit for
production is Rs.320.
Hence valuation will be:
a. For raw material: (provision 2 applies), so RM written down to replacement
cost i.e. NRs. 90 per unit.
b. WIP goods(partly finished goods): Cost or NRV whichever is lower:
Cost of WIP= 260
NRV of WIP =net selling price of FG- estimated cost of completion- estimate
selling cost
=300-60
=240
Valued at NRs 240 per unit
c. Finished goods: Cost or NRV whichever is lower
Cost of FG= 320
NRV of FG= net selling price of FG-estimated selling cost
=300-0
=300
Valued at NRs. 300 per unit
Hence:
Units Valuation per unit Value
Raw material A 600 90 54,000
Partly Finished 500 240 1,20,000
Goods
Finished goods 1,500 300 450,000
X
Total value of 6,24,000
inventory

NAS 2 Inventories
Revision Note
Additional topics:
 Reversals of write-downs:
A new assessment is made of net realisable value in each subsequent period.

When
a. previously caused inventories to be written down below cost no longer exist
b. or when there is clear evidence of an increase in net realisable value because of
changed economic circumstances,
the amount of the write-down is reversed (i.e. the reversal is limited to the amount of
the original write-down)
So that the new carrying amount is the lower of the cost and the revised net realisable
value.)
 Recognition as an expenses:
1. The amount of inventories recognised as an expense in the period will generally be:
a. carrying amount of the inventories sold in the period in which related revenue is
recognised; and
b. the amount of any write-down of inventories to net realisable value and all losses of
inventories shall be recognised as an expense in the period the write -down or loss
occurs; reduced by
c. the amount of any reversal in the period of any write-down of inventories, arising
from an increase in net realisable value.
2. Some inventories may be allocated to other asset accounts, for example, inventory
used as a component of self-constructed property, plant or equipment. Inventories
allocated to another asset in this way are recognised as an expense during the useful
life of that asset through charging of depreciation on that asset.
An item of inventory costing 20,000 as covered under NAS 2 is consumed in the

construction of self-constructed property to be account ed as Property, plant and
equipment under NAS 16. The cost of such property, plant and equipment other
than inventories is 80,000. Such Inventory needs to be capitalized in the cost of
Property, plant and equipment. The useful life of the property is 5 yea rs. The
depreciation on such property charged to profit and loss account is 20,000 per
annum (i.e. 1,00,000/ 5)
Disclosure Requirement:
The financial statement shall disclose in notes to account:

a. Accounting policies adopted in measuring inventories, including cost formula used
b. Analysis of carrying amount
c. Inventories carried at NRV
d. Amount recognized in profit or loss
e. Inventories pledged as security


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NAS 2 Inventories

Scope: applies to all

Compiled by CA. Prasant Tamang

1. Inventories are the assets:

2. Net Reliasable value (NRV):

3. Difference between NRV and FV:

S.N NRV Fair Value

Compiled by CA. Prasant Tamang

Inventories should be measured at lower of

1. What is the cost of Inventories?

Purchase cost Cost of conversion Other cost incurred in

Compiled by CA. Prasant Tamang

Allocation of fixed production overheads to the cost of conversion is based on the

Cost excluded from cost of inventories and recognized as an expenses in

a. Abnormal amount of wasted material, labor and other production cost.

Example- Cost of inventory

Compiled by CA. Prasant Tamang

In a production process, normal waste is 5% of input. 5,000 MT of input were put in

Cost per MT (Normal Quantity of 4,750 MT) = 50,00,000 / 4,750 = Rs 1,052.63

Total value of inventory = 4,700 x Rs 1,052.63 = Rs 49,47,361.

2. Allocation of cost to joint products and by-products:

Compiled by CA. Prasant Tamang

2) Calculation of cost of conversion for allocation

4) Determination of value of Closing stock of MP1 and MP2:

Compiled by CA. Prasant Tamang

 Standard cost method:

Cost of inventory under retail method= NRs. 6,300

Compiled by CA. Prasant Tamang

Ordinarily Not Ordinarily

Compiled by CA. Prasant Tamang

Cost of sales 12250-4900= 7350

5. Writing inventories down to net realisable value:

Compiled by CA. Prasant Tamang

In the given case,

Purchase cost of raw material: 10000*400 per kg= NRs. 40,00,000

Compiled by CA. Prasant Tamang

Compiled by CA. Prasant Tamang

A new assessment is made of net realisable value in each subsequent period.

An item of inventory costing 20,000 as covered under NAS 2 is consumed in the

The financial statement shall disclose in notes to account:

Compiled by CA. Prasant Tamang

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