Ind AS 2, which stands for Indian Accounting Standard 2, provides comprehensive guidelines on the accounting treatment for inventories. Inventories, being a significant component of current assets for any business entity, pose a critical concern in terms of accounting. The primary challenge is determining the appropriate amount of cost to be recognized as an asset and carried forward until the associated revenues are acknowledged.
The standard addresses several key aspects of inventory accounting, including the determination of cost and the subsequent recognition of this cost as an expense. It also outlines procedures for handling any necessary write-downs of inventories to their net realizable value and the potential reversal of such write-downs. Here’s a more detailed breakdown:
1. Determination of Cost:
- Ind AS 2 provides specific guidance on how to calculate the cost of inventories. This includes the costs directly attributable to bringing the inventories to their current condition and location.
- For example, if a company produces a product, the cost of raw materials, labor, and overhead costs directly associated with manufacturing that product would be included in the cost of inventory.
2. Recognition as an Asset:
- The standard emphasizes the recognition of inventory costs as assets until the related revenues are realized.
- As an illustration, if a company manufactures goods that are expected to be sold in the future, the costs incurred in producing those goods are recognized as an asset on the balance sheet until the goods are sold.
3. Write-Downs of Inventories:
- Ind AS 2 requires companies to assess the net realizable value of their inventories regularly. If the net realizable value falls below the carrying amount, a write-down is necessary.
- For instance, if a company holds perishable goods, and due to market conditions, the expected selling price decreases, the company may need to write down the value of those inventories on the balance sheet.
4. Reversal of Write-Downs:
- In certain circumstances, Ind AS 2 allows for the reversal of inventory write-downs if the conditions that led to the write-down no longer exist.
- As an example, if market conditions improve and the selling prices of certain inventories increase after a previous write-down, the standard permits the company to reverse the write-down to reflect the improved value.
Scope of Ind AS 2 – Inventories:
Ind AS 2, the Indian Accounting Standard governing inventories, establishes its reach and applicability. The standard is designed to address the accounting treatment for inventories, with certain exceptions. Here’s a detailed summary along with examples:
1. Applicability: Ind AS 2 applies to all inventories except for financial instruments covered by Ind AS 32 (Financial Instruments: Presentation) and Ind AS 109 (Financial Instruments). Additionally, biological assets related to agricultural activity and agricultural produce at the point of harvest are excluded and are subject to Ind AS 41 (Agriculture).
2. Definition of Inventories: Inventories, as per the standard, encompass assets held for sale in the ordinary course of business, those in the process of production for sale, or materials and supplies intended for consumption in the production process or the rendering of services.
Example: A manufacturing company’s raw materials, work-in-progress goods on the production line, and finished goods awaiting sale all fall under the scope of Ind AS 2.
3. Measurement at Lower of Cost and Net Realizable Value: The standard mandates that inventories shall be measured at the lower of cost and net realizable value.
Example: If the cost of producing a product exceeds its expected selling price, the inventory is valued at the lower net realizable value.
4. Cost of Inventories: The cost of inventories includes all costs of purchase, conversion costs, and other expenses incurred in bringing the inventories to their present location and condition.
Example: For a retailer, the cost of inventories includes the purchase cost of goods, transportation costs, and any additional costs incurred to prepare the goods for sale.
5. Net Realizable Value: Net realizable value is determined by subtracting the estimated selling price in the ordinary course of business from the estimated costs of completion and the estimated costs necessary to make the sale.
Example: If a company has obsolete inventory, the estimated selling price would be reduced by the costs necessary to refurbish or market the outdated products.
6. Estimates and Reliability: The estimates of net realizable value are expected to be based on the most reliable evidence available at the time of estimation. This evidence represents the amount the inventories are anticipated to realize.
Example: If market conditions change, and the selling price of certain inventories is expected to decrease, the estimates of net realizable value should consider this change in evidence.
Cost Formulae:
1. FIFO (First-In-First-Out) or Weighted Average: According to Ind AS 2, entities have the flexibility to use either the FIFO or weighted average cost formula to assign costs to their inventories. The choice depends on the nature and use of the inventory.
Example: Consider a retail business that sells electronic gadgets. Using the FIFO method, the cost of the first batch of gadgets purchased is considered first when calculating the cost of goods sold. On the other hand, the weighted average method takes into account the average cost of all gadgets available for sale.
2. Consistency in Cost Formula: An entity must maintain consistency in the use of cost formulas. If an entity chooses a particular cost formula for a specific type of inventory, it should apply the same formula to all inventories with a similar nature and use.
Example: If a company opts for the weighted average cost formula for its raw materials, it should apply the same formula consistently for all raw materials in its inventory.
Recognition as an Expense:
1. Sale of Inventories: When inventories are sold, the carrying amount (cost) of those inventories is recognized as an expense. This recognition occurs in the period in which the related revenue is recognized.
Example: If a company sells a batch of finished goods, the cost associated with manufacturing that batch is recognized as an expense in the same period in which the revenue from the sale is recognized.
2. Write-Downs to Net Realizable Value: Any write-down of inventories to their net realizable value is recognized as an expense in the period in which the write-down occurs. This is important when the estimated selling price of the inventories decreases.
Example: If the market value of certain finished goods falls below their cost, the company recognizes the difference as an expense, adjusting the value of the inventory to its lower net realizable value.
3. Reversal of Write-Downs: If there is a subsequent increase in the net realizable value of inventories that were previously written down, the amount of the reversal is recognized as a reduction in the amount of inventories recognized as an expense. This recognition occurs in the period when the reversal occurs.
Example: If the market conditions improve, and the company can now sell certain inventories at a higher price than previously estimated, the reversal of the write-down is recognized as a reduction in the expense in the current period.
Conclusion:
Ind AS 2 is instrumental in guiding companies through the complex process of inventory accounting. By adhering to the standard’s principles, companies can ensure accurate financial reporting and sound inventory management. Understanding and implementing Ind AS 2 is essential for maintaining the integrity of financial statements and supporting strategic business decisions.
Author Bio
