In the kingdom of Commerce, Merchants and traders stored their fabrics to make a living. These fabrics, known as Inventories, were crucial to their prosperity. But there was chaos in the land because no one could agree on how to value these inventories. Some merchants overstated their treasure’s worth to impress investors, while others undervalued it to reduce taxes.
The wise sage IND AS 2 came to the kingdom and shared his principles for valuing inventories.
Ravi was a cloth merchant who owned a large shop in the city. He stored fabrics of various colours, designs, and quality. Every month, he needed to calculate the value of his inventory, but he wasn’t sure how to do it correctly.
IND AS 2 visited Ravi’s shop and explained, “Your inventory is your treasure, but to value it properly, you must follow these golden rules.”
Rule 1: What is Inventory?
First, understand what qualifies as inventory. It includes:
1. Goods held for sale (like your fabrics).
2. Work-in-progress (unfinished garments being stitched).
3. Raw materials (threads and buttons in your stock).
Ravi nodded, realizing that all these items were part of his inventory.
Rule 2: Measure at Cost or Net Realizable Value (NRV), whichever is Lower
To value your inventory compare:
1. Cost: What you spent to purchase or produce the goods.
2. NRV: The estimated selling price minus costs to complete and sell the goods.
Always record the lower of these two values. This ensures you don’t overstate your inventory.
For example, Ravi bought silk for ₹500 per meter but later found it could only be sold for ₹450 per meter due to market changes. He valued his silk inventory at ₹450 per meter (the NRV). Ravi asked, “What should I include in the cost of inventory?”
Rule 3: Include All Costs
IND AS 2 replied, the cost includes:
1. Purchase Price: The Price paid to buy the fabric.
2. Conversion Costs: Labour cost and overheads incurred to turn raw materials into finished goods.
3. Other Costs: Any costs incurred to bring the inventory to its current location and condition (e.g., transportation charges).
But exclude costs like storage costs (unless necessary), administrative overheads, or marketing expenses.
Ravi was confused about how to track the cost of inventory. IND AS 2 suggested two methods
Rule 4: FIFO or Weighted Average
1. FIFO (First-In, First-Out): Assume the first goods you bought are the first you sold.
2. Weighted Average: Calculate an average cost for all inventory items, weighted by the quantities purchased.
Ravi chose FIFO because it suited his business.
IND AS 2 warned, “If any of your inventory is damaged, obsolete, or unsellable, reduce its value immediately. This is called writing down inventory. It ensures your financial statements reflect the true value of your stock.”
Rule 5: Write Down Obsolete Stock
Ravi discovered some old, torn fabrics in his shop. He wrote them down to zero value.
Special Circumstances
1. Joint Costs: Ravi sometimes bought bundles of fabric with mixed quality. IND AS 2 advised him to allocate the costs fairly based on their relative value.
2. Borrowing Costs: If Ravi used loans to purchase expensive stock, interest on those loans could be added to inventory costs if it was directly related to production.
Thanks to IND AS 2, Ravi and other merchants in the kingdom valued their inventories fairly and consistently. Investors trusted their accounts, taxes were calculated correctly, and businesses avoided disputes.
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