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Accounting Standard 2 (AS 2) – Valuation of Inventories

by | Apr 26, 2024 | Income Tax | 0 comments

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Important Keyword: AS 2, Business and Profession Income, Income Tax.

Accounting Standard 2 (AS 2): Valuation of Inventories

Accounting Standard 2 (AS 2) addresses the valuation and accounting treatment of inventories in a business. It provides guidelines on how to value inventory and disclose it in financial statements. The fundamental principle of Accounting Standard 2 (AS 2) is to value inventories, particularly closing stock, at the lower of cost or market value.

Key Concepts:

  1. Cost of Inventories: The cost of inventories comprises all costs incurred in bringing the inventories to their present location and condition. This includes purchase costs, conversion costs, and other expenses directly attributable to bringing the inventories to their current state.
  2. Market Value: Market value refers to the replacement cost of inventories or the net realizable value, whichever is lower. Replacement cost is the cost to purchase or reproduce the inventories at the balance sheet date, while net realizable value is the estimated selling price less any estimated costs necessary to make the sale.

Valuation Methods:

Accounting Standard 2 (AS 2) allows for several methods to value inventories, including:

a. First-In-First-Out (FIFO): Under FIFO method, the inventories are valued based on the assumption that the first units purchased or produced are the first to be sold.

b. Last-In-First-Out (LIFO): LIFO method assumes that the most recently acquired or produced units are the first to be sold. However, LIFO method is not permitted under Indian Accounting Standards.

c. Weighted Average Cost: This method calculates the average cost of inventories on a periodic basis, which is then used to value the closing stock.

d. Specific Identification: Under this method, each unit of inventory is individually identified, and its cost is used to value the closing stock.

Disclosure Requirements:

AS 2 also mandates disclosure requirements regarding inventories in the financial statements. These disclosures include the accounting policies adopted for inventory valuation, the carrying amount of inventories, and the amount of any write-downs.

AS 2: Valuation of Inventories

Applicability:

AS 2 applies to the valuation of the following types of inventory:

  1. Raw Materials: Input goods or services used in the production process or rendering of services.
  2. Work in Progress: Goods or services that are in the process of production.
  3. Finished Goods: Final goods or services held for sale in the normal course of business.
AS 2 is not applicable in the following cases:
  1. Work in progress in the construction business.
  2. Work in progress in the service business.
  3. Shares, debentures, or other financial instruments held as stock-in-trade.
  4. Stock of livestock, mineral oils, agricultural and forest products, etc.
Valuation Process:
  1. Calculate Cost of Inventory: This includes purchase cost, conversion cost, and other direct costs to bring the inventory to its present condition.
  2. Calculate Net Realisable Value (Market Value): This is the estimated selling price of the inventory in the market.
  3. Choose the Lower of Cost or Net Realisable Value: Inventory is valued at the lower of cost or net realisable value.
Terms to Understand:
  1. Purchase Cost: Price at which inventory is purchased, including related expenses.
  2. Conversion Cost: Cost incurred to convert raw materials into finished goods.
  3. Other Cost: Additional expenses directly related to bringing the inventory to its current state.
  4. Net Realisable Value: Estimated selling price of the inventory after deducting costs of completion and sale.
Methods of Inventory Valuation:
  1. First In First Out (FIFO): Assumes goods purchased first are sold first.
  2. Weighted Average Cost Method (WAC): Calculates the average cost of each sale item.
  3. Specific Identification Method: Values each item in the closing inventory individually if easily identifiable.
Accounting Disclosure:

Financial statements must disclose:

  1. Accounting policy and valuation method for inventory.
  2. Classification of inventory (raw material, work-in-progress, or finished goods).
  3. Carrying amount of inventory.
  4. Amount of inventory recognized as an expense.
  5. Amount of inventory written down and recognized as an expense.
  6. Reversal amount of write-downs identified as a reduction in inventory.
Accounting Standard 2( AS 2) for Manufacturers & Traders:

Manufacturing or trading businesses must:

  1. Calculate opening stock, purchases, sales, and closing stock.
  2. Calculate gross profit.
  3. Deduct other expenses to determine net profit for tax filing.

By adhering to Accounting Standard 2 (AS 2), businesses ensure accurate valuation and disclosure of inventory, enhancing transparency in financial reporting.

Read More: AS 22 – (Accounting Income) Accounting for Taxes on Income

Web Stories: AS 22 – (Accounting Income) Accounting for Taxes on Income

Official Income Tax Return filing website: https://incometaxindia.gov.in/

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