Accounting Standard -2

A primary issue in accounting for inventories is the

determination of the value at which inventories are
carried in the financial statements until the related
revenues are recognised

 This Standard should be applied in accounting for inventories other than:

(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-intrade; 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

 The following terms are used in this Standard with the

meanings specified: 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.
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.

 Inventories encompass goods purchased and held for resale, for

example, merchandise purchased by a retailer and held for resale,
computer software held for resale, or land and other property held for
resale.
Inventories also encompass 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 do not include machinery spares which can be used only
in connection with an item of fixed asset and whose use is expected to
be irregular; such machinery spares are accounted for in accordance
with Accounting Standard (AS) 10, Accounting for Fixed Assets.

 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.
Costs of Purchase : The costs of purchase consist of the 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. Trade discounts, rebates, duty drawbacks and other
similar items are deducted in determining the costs of purchase

Costs of conversion
Costs of Conversion : The costs of conversion of inventories
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.
Fixed production overheads are 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.
Variable production overheads are those indirect costs of
production that vary directly, or nearly directly, with the volume
of production, such as indirect materials

Exclusion from the cost of

inventories
In determining the cost of inventories in accordance 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:
(a) abnormal amounts of wasted materials, labour, or other
production costs;
(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.

 The cost of inventories, 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.

Disclosures
The financial statements should disclose:
(a) the accounting policies adopted in measuring
inventories, including the cost formula used; and
(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 raw
materials and components, work in progress, finished
goods, stores and spares

Inventory valuation and Income

measurementHow do you treat inventory?
What is an operating cycle?

Ashok Leyland

Ashok Leyland- Inventory

Current assets

As on 31st March,
2016(Rs. Inlakhs)

Current investments

---

As on 31st March 2015

(Rs. In lakhs)
40,845.20

Inventories

173,059.40

139,852.72

Trade receivables

125,094.95

124,266.94

Cash and bank balances

156,813.14

75,128.79

Short term loans and

advances

62,614.67

56,367.58

Other current assets

11,478.36

32,838.29

Notes to inventory- Ashok Leyland

INVENTORIES

31-3-2016

31-3-2015

(a) Raw materials and Components

(including patterns and dies)
(b) Work-in -progress
(c) Finished goods

49,326.92

63,687.96

1,529.99

4,163.19

92,361.39

43,898.51

(d) Stock-in-trade - Traded goods

(i) Commercial vehicles

944.96

1,563.37

(ii) Spare parts and auto components

(including works made)

21,151.64
22,096.60

(e) Stores, spares and consumable tools 7,744.50

Total of inventories

173,059.40

18,489.46
20,052.83
8,050.
139,852.72

Inventories- Infosys
Current assets
Current investments

As on 31-3-2016 (Rs in
crores)
2

As on 31-3-2015 (Rs. In
crores)
749

Trade receivables

9798

8627

Cash and cash equivalents

29176

27722

Short term loans and

advances

7121

5654

Sub total of current assets

46097

42752

Total assets

72767

61813

Cost of goods sold

Inventory at the beginning of the year is opening
inventory.
Inventory at the end of the year is closing inventory
Ending inventory appears in the balance sheet as an
asset
The years beginning inventory is last years closing
inventory
Cost of goods available for sale= opening stock + net
cost of purchases during the year
Cost of goods sold = opening stock + purchases +
direct expenses closing stock

The periodic inventory system

Under the periodic inventory system, the merchandise
inventory account is updated only periodically after a
physical count has been made. Hence the name.
Usually the physical count takes place at the end of the
reporting period. Some stores, particularly the smaller
ones, use the periodic inventory system.

Net cost of purchases

The term net cost of purchases means purchases less discounts and
purchase returns and allowances plus transport and handling costs on
the purchases.
Government levies such as import duties, purchase taxes, value added
tax, goods and service tax also form part of the cost of purchases if
they are not recoverable by the buyer when he sells goods.
The term net purchases refers to purchases less discounts, returns and
allowances.
Transportation costs are often an important part of the cost of
merchandise purchased. The cost of merchandise includes any
transportation charges necessary to bring the goods to the buyers
place of business.

Illustration Suman electronics

The merchandise inventory on Jan 1st, 2015 was
Rs.47,300. Assume purchases of Rs.326,900, purchase
returns and allowances of Rs.13,200 and purchase
discounts of Rs.1400. So the amount of net purchases is
Rs.3,12,300. Freight paid on purchase is Rs.28,100.
what is the net cost of purchases?
what is the cost of goods available for sale?
If the closing inventory is Rs.89,000 what is the cost of
goods sold?

Suman electronics
Particulars
Merchandise inventory as on 1st Jan

Amount
47300

Net purchases
312300
Add freight
28100
Net cost of purchases

340400

=cost of goods available for sale

387700

Less closing stock

=cost of goods sold

89000
298,700

Suman electronics Statement of

profit and loss
Particulars

Amount

Revenue (Net Sales)

439,120

Less cost of goods sold

298700

=Gross profit

140420

Less operating expenses

= Profit before interest and tax
Less interest expense

76800
63,620
4700

=profit before tax

58,920

Less income tax

26,000

Net profit

32,920

Compute the missing amounts from

the information available
Particulars

Case 1

Case 2

Case 3

Case 4

Case 5

Sales

79,000

43,700

13,900

63,500

Beginning
inventory

2,400

8,500

280

9,600

Net cost of
purchases

34,700

79,400

14,710

Cost of goods 61,300

available for
sale

35,550

14,990

97,000

Ending
inventory

960

2,300

Cost of goods 56,600

sold

85,600

14,880

95,000

Gross profit

22,400

10,500

(980)

Operating
expenses

16,800

9,470

9,200

4,000

4,700

Prepare a statement of P&L and comment on the performance of

the business pointing out the areas of improvement
The following is a partial list of account balances of Vision opticals for the year ended June 30,
2016

particulars

Amount

sales

710000

Sales returns and allowances

20,000

Sales discounts

21,000

purchases

583,000

Purchase returns and

allowances

68,000

Purchase discounts

3000

Office salaries

48000

Sales salaries

96000

Office rent

12000

Freight in

43000

Freight out

18000

 The beginning and ending inventories were Rs.47000

and Rs.69000 respectively.

Effect of Inventory error

An error in the value of the year-end inventory will
misrepresent the cost of goods sold, gross profit, net
profit, current assets. Since the ending inventory of one
year becomes the beginning inventory of the next, the
error will carry forward and affect the profit for the next
period.
Besides, major errors in the inventory values will
substantially undermine the credibility of the financial
statements.

Effect of inventory error

particulars

2014

2015

2014

2015

Net sales

10000

15000

10000

15000

Beginning
inventory

2000

2500

2000

1500

purchases

8500

9500

8500

9000

Cost of goods
available for
sale

10500

12000

10500

11000

Less ending
inventory

2500

1000

1500

1000

COGS

8000

11000

9000

10000

Gross profit

2000

4000

1000

5000

Operating

400

500

400

500

Cost of goods
sold

Cost formula
Specific identification
First in first out
Last in first out
Weighted average cost

Specific identification
This method assigns specific cost to each unit sold and
each unit on hand. The specific identification method is
particularly suited to inventories of high vale, low
volume items e.g., Jewellery and designer dresses.
Each unit of inventory must be affixed with an
identification tag
The method is costly to implement and does not involve
any assumption about cash flow

Weighted average cost

The weighted average method assumes that goods
available for sale are homogenous.
Example
Cost of goods available for
sale

Rs.2000

Number of units available for

sale

500

Weighted average unit cost

4 (2000/500)

Ending inventory

150 untis

Ending inventory value

150 x 4 = Rs.600