Understanding IND AS 2: Inventory Valuation

Introduction to IND AS 2:

Introduction to IND AS 2 IND AS 2 is a financial reporting standard that deals with the valuation and presentation of inventory in a company’s financial statements. This standard applies to all entities that prepare their financial statements in accordance with the Indian Accounting Standards (Ind AS).

Objective of IND AS 2:

The objective of IND AS 2 is to provide guidance on the determination of the cost of inventory and its subsequent recognition as an expense in the income statement. This standard aims to ensure that inventories are valued correctly and reported in a consistent and appropriate manner in the financial statements of companies following the Indian Accounting Standards. Additionally, IND AS 2 provides guidance on the measurement of inventory at the lower of cost or net realizable value and the treatment of write-downs and reversals. By following the provisions of IND AS 2, entities can ensure that their inventory is valued accurately, providing users of the financial statements with reliable and relevant information.

Scope of IND AS 2:

The scope of IND AS 2 applies to all inventories, including raw materials, work­in-progress, finished goods, and goods held for resale. The standard also applies

to entities that prepare their financial statements in accordance with the Indian Accounting Standards (Ind AS).

However, IND AS 2 does not apply to the following types of inventories:

>  Work in progress arising under construction contracts, including directly related service contracts (see Ind AS 11, Construction Contracts;

>  Financial instruments (see Ind AS 39, Financial Instruments: Recognition and Measurement and Ind AS 32, Financial Instruments: Presentation);

>  Biological assets (i.e., living animals or plants) related to agricultural activity and agricultural produce at the point of harvest (see Ind AS 41, Agriculture 1)

The standard provides guidance on the measurement and recognition of inventory, including the determination of cost, the treatment of write-downs, and

the disclosure requirements for inventory in the financial statements. This Standard does not apply to the measurement of inventories held by:

(a) producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value in accordance with well-established practices in those industries. When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change.

(b) commodity broker-traders who measure their inventories at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change.

Key Provisions of IND AS 2:

The key provisions of IND AS 2 include:

• Measurement of inventories: IND AS 2 requires entities to measure inventories at the lower of cost and net realizable value. Cost includes all costs of purchase, costs of conversion, and other costs incurred to bring the inventories to their present location and Net realizable value is the estimated selling price in the ordinary course of business, less estimated costs of completion and estimated costs necessary to make the sale.
• Write-downs and reversals: When the net realizable value of inventories falls below their cost, the standard requires entities to recognize a write­down in the income statement. When the circumstances that previously caused the write-down no longer exist, the standard allows entities to reverse the write-down.
• Methods of inventory valuation: IND AS 2 allows entities to use any one of the following methods to value their inventory: First-In, First-Out (FIFO), Last-In, First-Out (LIFO), or Weighted Average Cost (WAC). The choice of method should be applied consistently and disclosed in the financial statements.
• Disclosure requirements: IND AS 2 requires entities to disclose the accounting policies adopted for the valuation of inventory, the carrying amount of inventories classified into appropriate categories, the amount of any write-down of inventories recognized as an expense in the income statement, the amount of any reversal of a write-down of inventories, and the carrying amount of inventories pledged as security for liabilities.

Methods of Inventory Valuation:

IND AS 2 provides three methods for the valuation of inventory, which are:

• First-In, First-Out (FIFO): Under this method, the first inventory purchased or produced is considered the first to be sold. The cost of the oldest inventory is matched with the revenue earned from the sale of the oldest inventory. This method assumes that the inventory that remains at the end of the period is the most recent inventory and reflects current market prices.
• Last-In, First-Out (LIFO): Under this method, the most recent inventory purchased or produced is considered the first to be sold. The cost of the newest inventory is matched with the revenue earned from the sale of the newest inventory. This method assumes that the inventory that remains at the end of the period is the oldest inventory and reflects the historical cost.
• Weighted Average Cost (WAC): Under this method, the cost of inventory is calculated as the weighted average of the cost of all units of inventory available for sale during the period. The weighted average cost is calculated by dividing the total cost of inventory available for sale by the total number of units of inventory available for sale.

The choice of inventory valuation method depends on various factors such as the nature of the business, the type of inventory, and the market conditions. However, the selected method should be applied consistently and disclosed in the financial statements. The consistency of the inventory valuation method enables users of the financial statements to compare the financial performance of the entity across different periods.

Recognition as an expense:

As per Para 34 of IND AS 2, When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. 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. The amount of any reversal of any write-down of inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.

As per Para 35 of IND AS 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.

Disclosure Requirements:

IND AS 2 requires entities to disclose the following information in the financial statements:

• Accounting policies: Entities should disclose the accounting policies adopted for the measurement of inventory, including the method of inventory valuation used (FIFO, LIFO, WAC), the cost formula used, and any change in the accounting policies.
• Carrying amount: The carrying amount of inventory should be disclosed, classified into appropriate categories such as raw materials, work-in-progress, finished goods, and goods held for resale.
• Write-down of inventories: The amount of any write-down of inventory that is recognized as an expense in the income statement should be
• Reversal of write-down of inventories: The amount of any reversal of a write-down of inventory that is recognized as a reduction in the cost of sales should be disclosed.
• Carrying amount of inventories pledged as security: The carrying amount of inventory that is pledged as security for liabilities should be
• Net realizable value: The basis used for determining the net realizable value of inventory and the amount of any write-down to net realizable value should be disclosed.

The disclosure requirements of IND AS 2 aim to provide users of financial statements with relevant and reliable information about the entity’s inventory, enabling them to make informed decisions. By providing complete and transparent disclosures, entities can improve the transparency and comparability of their financial statements.

Conclusion:

IND AS 2 plays an essential role in the financial reporting of inventory for companies following the Indian Accounting Standards. It provides guidance on the measurement and valuation of inventory and requires entities to disclose relevant information in their financial statements. Entities should ensure that they comply with the provisions of the standard and provide sufficient disclosure to enable users to understand the impact of inventory on the financial statements.

FAQs on IND AS 2: Inventory Valuation

1 : What is the objective of IND AS 2?

A: The objective of IND AS 2 is to prescribe the accounting treatment for inventories and to ensure that they are measured at the lower of cost and net realizable value.

2 : What are the methods of inventory valuation under IND AS 2?

A: The methods of inventory valuation under IND AS 2 include First-In, First-Out (FIFO), Last-In, First-Out (LIFO), and Weighted Average Cost (WAC).

3 : What are the costs excluded from the costs excluded from the cost of inventories and recognised as expenses?

A. Following costs excluded from the cost of inventories and recognised as expenses in the period in which they are incurred are:

(a) abnormal amounts of wasted materials, labour or other production costs;

(b) storage costs, 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; and

(d) selling costs.

4 : Can an entity change its inventory valuation method?

A: Yes, an entity can change its inventory valuation method if the change results in providing more reliable and relevant information about the entity’s financial performance. However, any change in the inventory valuation method should be applied retrospectively and disclosed in the financial statements.

5 : How does IND AS 2 define net realizable value?

A: Net realizable value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and estimated costs necessary to make the sale.

6 : What are the disclosure requirements under IND AS 2?

A: The disclosure requirements under IND AS 2 include the accounting policies adopted for the measurement of inventory, the carrying amount of inventory classified into appropriate categories, the amount of any write-down of inventory recognized as an expense in the income statement, the amount of any reversal of a write-down of inventory, and the carrying amount of inventory pledged as security for liabilities.

7 : Is it mandatory for entities to follow IND AS 2?

A: Yes, it is mandatory for entities to follow IND AS 2 if they are required to comply with Indian Accounting Standards (Ind AS) under the Companies Act, 2013.

8: How does IND AS 2 affect the financial statements of an entity?

A: IND AS 2 affects the financial statements of an entity by ensuring that the inventory is valued accurately, any write-downs or reversals are recognized appropriately, and relevant disclosures are provided in the financial statements. This provides users of the financial statements with reliable and relevant information about the entity’s inventory.

9.Which of the following is the objective of IND AS 2?

A. To prescribe the accounting treatment for intangible assets

B. To prescribe the accounting treatment for inventories

C. To prescribe the accounting treatment for financial instruments

D. To prescribe the accounting treatment for income taxes

Answer: B. To prescribe the accounting treatment for inventories

10.Which of the following methods of inventory valuation is not allowed under IND AS 2?

A. First-In, First-Out (FIFO)

B. Last-In, First-Out (LIFO)

C. Weighted Average Cost (WAC)

D. Specific Identification

Answer: D. Specific Identification

11.What is net realizable value under IND AS 2?

A. The selling price of inventory in the market

B. The estimated selling price of inventory in the ordinary course of business, less the estimated costs of completion and estimated costs necessary to make the sale

C. The historical cost of inventory

D. The replacement cost of inventory

Answer: B. The estimated selling price of inventory in the ordinary course of business, less the estimated costs of completion and estimated costs necessary to

make the sale

12.What should an entity disclose in its financial statements under IND AS 2?

A. Accounting policies, carrying amount of inventory, and net realizable value

B. Accounting policies, carrying amount of inventory, and replacement cost

C. Accounting policies, carrying amount of inventory, and gross profit margin

D. Accounting policies, carrying amount of inventory, and selling price of inventory

Answer: A. Accounting policies, carrying amount of inventory, and net realizable value

13.Is it mandatory for entities to follow IND AS 2?

A. Yes

B. No

Answer: A. Yes