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Thread: 02 Accounting Standard 2 - Valuation of Inventories - AS 2

  1. #11
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    Default Cost Formulas of Accounting Standard 2 - Valuation of Inventories - AS 2

    Cost Formulas of Accounting Standard 2 - Valuation of Inventories - AS 2


    14. The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their
    individual costs.

    15. Specific identification of cost means that specific costs are attributed to identified items of inventory. This is an appropriate treatment for items that are segregated for a specific project, regardless of whether they have been purchased or produced.However,when there are large numbers of items of inventory which are ordinarily interchangeable, specific identification of costs is inappropriate since, in such circumstances, an enterprise could obtain predetermined effects on the net profit or loss for the period by selecting a particular method of ascertaining the items that remain in inventories.

    16. The cost of inventories, other than those dealt with in paragraph 14, 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.

    17. A variety of cost formulas is used to determine the cost of inventories other than those for which specific identification of individual costs is appropriate. The formula used in determining the cost of an itemof inventory needs to be selected with a view to providing the fairest possible
    approximation to the cost incurred in bringing the itemto its present location and condition. The FIFO formula assumes that the items of inventory which were purchased or produced first are consumed or sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced. Under the weighted average cost formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average may be calculated on a periodic basis, or as each additional shipment is received, depending upon
    the circumstances of the enterprise.

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    Default Techniques for the Measurement of Cost of Accounting Standard 2 - Valuation of Inventories - AS 2

    Techniques for the Measurement of Cost of Accounting Standard 2 - Valuation of Inventories - AS 2


    18. Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate the actual cost. Standard costs take into account normal levels of consumption of materials and supplies, labour, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of current conditions.


    19. The retail method is often used in the retail trade for measuring inventories of large numbers of rapidly changing items that have similar margins and for which it is impracticable to use other costing methods. The cost of the inventory is determined by reducing from the sales value of the
    inventory the appropriate percentage gross margin. The percentage used takes into consideration inventory which has been marked down to below its original selling price. An average percentage for each retail department is often used.

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    Default

    Net Realisable Value


    20. The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined. The cost of inventories may also not be recoverable if the estimated costs of completion or the estimated costs necessary to make the sale have increased. The practice of writing down inventories below cost to net realisable value is consistent with the view that assets should not be carried in excess of amounts expected to be realised from their sale or use.


    21. Inventories are usuallywritten down to net realisable value on an itemby- item basis. In some circumstances, however, it may be appropriate to group similar or related items. This may be the case with items of inventory relating to the same product line that have similar purposes or end uses and are produced and marketed in the same geographical area and cannot be practicably evaluated separately from other items in that product line. It is not appropriate to write down inventories based on a classification of inventory, for example, finished goods, or all the inventories in a
    particular business segment.

    22. Estimates of net realisable value are based on themost reliable evidence available at the time the estimates are made as to the amount the inventories are expected to realise. These estimates take into consideration fluctuations of price or cost directly relating to events occurring after the balance sheet date to the extent that such events confirm the conditions existing at the balance sheet date.

    23. Estimates of net realisable value also take into consideration the purpose for which the inventory is held. For example, the net realisable value of the quantity of inventory held to satisfy firm sales or service contracts is based on the contract price. If the sales contracts are for less than the inventory quantities held, the net realisable value of the excess inventory is based on general selling prices. Contingent losses on firm sales contracts in excess of inventory quantities held and contingent losses on firm purchase contracts are dealt with in accordance with the principles enunciated in Accounting Standard (AS) 4, Contingencies and Events Occurring After the Balance Sheet Date.[1]


    24. Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realisable value, the materials are written down to net realisable value. In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value.

    25. An assessment is made of net realisable value as at each balance sheet date.







    1 Pursuant to AS 29, Provisions, Contingent Liabilities and Contingent Assets, becoming mandatory in respect of accounting periods commencing on or after 1-4-2004, all paragraphs of AS 4 that deal with contingencies stand withdrawn except to the extent they deal with impairment of assets not covered by other Indian Accounting Standards. Reference may be made to announcement XX under the section titled 'Announcements of the Council regarding status of various documents issued by the Institute of Chartered Accountants of India' appearing at the beginning of this Compendium.

    A limited revision to AS 29 was made in 2005, so as to include Onerous Contracts in the scope of the Standard. The said limited revision to AS 29 comes into effect in respect of accounting periods commencing on or after April 1, 2006.

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    Default Disclosure of Accounting Standard 2 - Valuation of Inventories - AS 2

    Disclosure of Accounting Standard 2 - Valuation of Inventories - AS 2


    26. 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.


    27. 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, and loose tools.

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    Default Limited Revision of Accounting Standard 2 - Valuation of Inventories - AS 2

    Limited Revision to Accounting Standard (AS) 2 (revised 1999)
    Valuation of Inventories
    The following is the text of the limited revision to AS 2, Valuation of Inventories, issued by the
    Institute of Chartered Accountants of India.


    In view of Accounting Standard (AS) 30, Financial Instruments: Recognition and Measurement, AS 2 (revised 1999) is modified as under (modifications are shown as doubleunderline/ strike-through):

    After the existing paragraph 12, new paragraph 12A is added as below:

    12A. An enterprise may purchase inventories on deferred settlement terms. When the arrangement effectively contains a financing element, that element, for example a difference between the purchase price for normal credit terms and the amount paid, is recognised as interest expense over the period of the financing.


    The limited revision comes into effect in respect of accounting periods commencing on or after
    the date on which Accounting Standard (AS) 30, Financial Instruments: Recognition and Measurement, comes into effect.

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    Default Accounting Standards Interpretation of Accounting Standard 2 - Valuation of Inventories - AS 2

    Accounting Standards Interpretation (ASI) 2[1]
    Accounting for Machinery Spares
    Accounting Standard (AS) 2,Valuation of Inventories and AS 10, Accounting for Fixed Assets


    ISSUE

    1. Which machinery spares are covered under AS 2 and AS 10 and what should be the accounting formachinery spares under the respective standards.

    CONSENSUS

    2. Machinery spares which are not specific to a particular item of fixed asset but can be used generally for various items of fixed assets should be treated as inventories for the purpose ofAS 2. Suchmachinery spares should be charged to the statement of profit and loss as and when issued for
    consumption in the ordinary course of operations.

    3. Whether to capitalise amachinery spare under AS 10 or notwill depend on the facts and circumstances of each case. However, the machinery spares of the following types should be capitalised being of the nature of capital spares/insurance spares –
    (i) Machinery spares which are specific to a particular item of fixed asset, i.e., they can be used only in connection with a particular item of the fixed asset, and

    (ii) their use is expected to be irregular.

    4. Machinery spares of the nature of capital spares/insurance spares should be capitalised separately at the time of their purchasewhether procured at the time of purchase of the fixed asset concerned or subsequently. The total cost of such capital spares/insurance spares should be allocated on a systematic basis over a period not exceeding the useful life of the principal item, i.e., the fixed asset to which they relate.

    5. When the related fixed asset is either discarded or sold, the written down value less disposal value, if any, of the capital spares/insurance spares should be written off.


    6. The stand-by equipment is a separate fixed asset in its own right and should be depreciated like any other fixed asset.

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    Default BASIS FOR CONCLUSIONS of Accounting Standard 2 - Valuation of Inventories - AS 2

    BASIS FOR CONCLUSIONS of Accounting Standard 2 - Valuation of Inventories - AS 2

    7. Paragraphs 8.2 and 25 of AS 10, ‘Accounting for Fixed Assets’, state as below:


    “8.2 Stand-by equipment and servicing equipment are normally capitalised.Machinery spares are usually charged to the profit and loss statement as and when consumed. However, if such spares can be used only in connection with an item of fixed asset and their use is expected to be irregular, it may be appropriate to allocate the total cost on a systematic basis over a period not exceeding the useful life of the principal item.”


    “25. Fixed asset should be eliminated from the financial statements on disposal or when no further benefit is expected from its use and disposal.”


    8. Paragraph 4 of AS 2, ‘Valuation of Inventories’, states as below:

    “4. 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.”


    9. Machinery spares of the nature of capital spares/insurance spares are capitalised. Capital spares/ insurance spares are meant for occasional use. Since they can be used only in relation to a specific item of fixed asset, they are to be discarded in case that specific fixed asset is disposed of. In
    other words, such spares are integral parts of the fixed asset.


    10. A stand-by equipment is not of the nature of a spare but is of the nature of another piece of equipmentwhich is being used in themanufacturing process. For example, a generator set kept in store as a stand-by to the generator set which is being used in the manufacturing process. Therefore, the stand-by equipment is a separate fixed asset in its own right and is depreciated
    like any other fixed asset.

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    Default Determination of cost of inventories of imported raw materials of Accounting Standard 2 - Valuation of Inventories - AS 2

    A. Facts of the Case

    1. A private limited company is engaged in the manufacture of polymerization initiators. The company uses various imported materials as well as domestically purchased materials in the manufacture of the initiators. The company makes several types of polymerization initiators and it sells these products in the domestic market as well as overseas market. Certain raw materials are used in the manufacture of more than one product and the company cannot physically identify duty-free stocks and duty-paid stocks. Also, during the manufacture of the products, it cannot be identified whether a product is meant for export or for domestic sale.


    2. The querist has informed that in the case of exports, the company gets the benefit of Advance Import License, which entitles it to import raw materials free of duty. Further, it has been informed by the querist that it is not necessary that the Advance License for import of raw materials has to be made before the end-product is exported. The only requirement is that the company should apply to Director General Foreign Trade (DGFT), for Advance License, before the date of export and after the license is obtained, it would import raw materials free of duty against the Advance License. The company can produce the goods meant for export using the raw materials purchased earlier on full payment of duty and can replenish the same with duty-free imported materials. Hence, the basic raw material can be imported by paying full duty or without payment of duty using Advance License.



    3. The querist has further stated that whenever the duty-free materials are imported, cost thereof is determined based on their landed cost, without duty. When the same material is imported with duty, its cost is at a higher value as it includes the import duty. Therefore, under the weighted average costing method, the weighted average unit cost of the raw material is obviously lower than the cost of the duty-paid raw material and higher than the cost of the duty-free material. For instance, if the company imports Rs. 100 worth of raw material, the landed cost will work out to Rs. 150.80 (25 % Customs duty + 16 % CVD and 4 % SAD) on full payment of duty and Rs. 100 only on duty-free imports resulting in a difference of Rs. 50.80 for every Rs. 100 worth of imports made.


    4. The querist has informed that for the finished products costing system, the company uses the weighted average cost of raw material and, as a result, the finished products, whether exported or sold in India, carry the same average cost. Consequently, as per the querist, the costing of the domestic sales is under-priced and that for the export sales is over-priced leading to wrong information and sometimes wrong pricing decisions.


    5. The querist has informed that the company wants to change the costing system to the following, to reflect costing of the finished goods for domestic sales and for export sales which is correct according to the company:
    (i) Open, at the time of import, a ‘Duty to be earned account’.
    (ii) Account for all the imports including the duty applicable.
    (iii) The corresponding credit for the duty applicable but not incurred would be made to ‘Duty to be earned account’.
    (iv) When exports are actually made, the duty concession earned is quantified and transferred from ‘Duty to be earned account’ to ‘Duty concession earned account’, which would reduce the cost of goods exported.
    (v) If Advance Licence is not redeemed by exports, any duty liability would be paid by debiting ‘Duty to be earned account’.
    (vi) At the end of the accounting period, the stock of imported materials would be reduced by the relevant credit lying in the ‘Duty to be earned account’ to fall in line with AS 2.

    6. As informed by the querist, the advantages of the method stated in paragraph 5 are:
    (a) Obligation incurred on duty-free imports is recognised in the books.
    (b) Cost of domestic sales and export sales gets realistically accounted for.

    7. The querist has also informed that the company will maintain separate stock records for domestic purchases and imported purchases of raw materials. The company does not plan to maintain separate stock accounts for raw materials imported duty free and imported by paying customs duty. There will be only one raw material stock account for imported raw materials. The company maintains separate General Ledger Accounts for recording domestic sales and export sales separately.

    B . Query

    8. On the basis of the above, the querist has sought the opinion of the Expert Advisory Committee as to whether the accounting treatment suggested in paragraph 5 above is acceptable.

    C. Points considered by the Committee

    9. The Committee notes from the above that AS 2 prescribes only three formulae for determination of costs of inventories, namely, specific identification, first-in first-out (FIFO) and weighed average cost formula. The Committee notes from the facts of the case that specific identification formula cannot be applied in the present case since items of inventories are interchangeable and no separate records are maintained for raw materials imported free of duty and those by paying customs duty. The Committee also notes that the proposed accounting treatment as suggested by the querist in paragraph 5 above is not commensurate with costing formulae, as prescribed by AS 2. Therefore, the Committee is of the view that the company should follow either FIFO or weighted average cost formula for determining the cost of inventories which reflects the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.

    D. Opinion

    On the basis of the above, the Committee is of the opinion on the issue raised in paragraph 8 above that the accounting treatment suggested by the querist in paragraph 5 above is not acceptable and, accordingly, the imported raw materials should be recorded at the cost at which they are procured as explained in paragraph 9 above.

    Opinion finalised by the Committee on 26.5.2004

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    Default Inclusion of transportation cost from factory to stockyards as a part of the cost of inventories lying in stockyards of AS 2

    A. Facts of the Case

    1. A public sector company is engaged in the manufacture and sale of iron and steel products. The company’s plant is located at Visakhapatnam, Andhra Pradesh, with over 25 outstation branch sales offices/marketing outlets situated at different locations of the country. The company has its own stockyards at Chennai, Mumbai and Hyderabad. In other places, the stockyards are operated through consignment agents.
    2. The querist has informed that for the company owned stockyards, handling agents are appointed to handle stockyard operations and for other marketing outlets, consignment agents are appointed to provide storage and handling facility by maintaining a stockyard exclusively for storage of the materials. The materials manufactured by the company are despatched both by road and rail from headquarters under Form-‘F’ evidencing transfer of the material from the plant to the branch stockyards. Since the materials are sent to different locations on stock transfer basis, sales tax is not applicable for such stock transfers. The scope of the consignment agents/handling agents includes taking delivery of the materials from railway sidings, transporting the same to stockyards and stacking them in proper place, etc. According to the querist, the company classifies the expenditure incurred on transportation of these materials as freight outwards and the handling expenditure paid to the handling/consignment agents is classified as selling expenditure by the company.
    3. The querist has further informed that the company has been valuing inventories of finished goods lying unsold at stockyards at cost of production plus the cost of transportation of material from plant to stockyards and the handling expenditure such as unloading materials from trucks/wagons, weighing the unloaded material, bringing from railway siding to stockyards wherever applicable, stacking, etc., incurred before sale.
    4. The querist has forwarded the following comments of government auditors and the company’s reply to the same:
    Auditors’ comments

    Government Auditors, during their audit of accounts of the company for the year 2002-03, observed that the company valued its closing stock including the handling charges and the freight component incurred by the company towards transfer of material from headquarters to different marketing stockyards which is not in line with paragraph 13 of the Accounting Standard (AS) 2, ‘Valuation of Inventories’, issued by the Institute of Chartered Accountants of India, according to which the selling and distribution costs are to be excluded. The observation of the Government Auditors has been reproduced hereunder:
    "PROFIT AND LOSS ACCOUNT Income Accretion (Depletion) to Stock of Semi-finished/Finished Goods (Schedule-17) Closing Stock – Rs. 25336.44 lakh Paragraph 13 of Accounting Standard (AS) 2 provides that while determining the cost of inventories in accordance with paragraph 6 of the Accounting Standard, the selling and distribution costs, inter-alia, are to be excluded and the same are to be recognised as expenses in the period in which they are incurred. The accounting policy no. 4(a)(i) also states that the cost for this purpose is determined on the basis of average cost of production of the last six months. However, while valuing the closing stock (lying at branch sales offices) at cost (being lower than its realisable price), handling charges (Rs. 67.32 lakh), which are classified by the company itself as selling expenses and freight outwards (Rs. 881.39 lakh), which are distribution costs are also considered as a part of cost of production, which is in contravention to the Accounting Standard as well as the accounting policy. This has resulted in overstatement of closing stock, inventory and profit for the year by Rs. 948.71 lakh."
    Company’s reply

    The company explained to the Government Auditors that the method of valuation of inventories followed by the company is in line with AS 2 since paragraph 11 states that the cost of inventories should comprise all costs of purchase, costs of conversion and other costs in bringing the inventories to their present location and condition.
    The company’s reply to the observation of Government Auditor is given hereunder:
    "As per AS 2, 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 which is stated at paragraph 6. The Standard speaks of the exclusions in paragraph 13 which inter-alia include selling and distribution costs. Paragraph 11 of the Standard states that other costs to the extent they are incurred in bringing the inventories to their present location and condition are to be included in the cost of inventories. Paragraph 17 also states that the formula used in determining the cost of an item of inventory needs to be selected with a view to providing the fairest possible approximation to the cost incurred in bringing the item to its present location and condition. The freight and handling costs are necessarily incurred for bringing the material to the relevant location without which the material would not have reached that location and condition. Further, it is pertinent to note that even the excise duty liability depends on the place of sale. The accounting policy of the company referred to by the auditors reads as follows: ‘Cost is determined on the basis of average cost of production of the last six months during the year considering normal capacity.’ This clearly brings out the basis for arriving at the cost of production. The railway freight and handling charges incurred for transporting the material to the stockyards of the company are necessarily to be incurred up to the point of sale and cannot be termed as distribution costs. The sale price is also determined based on the point of sale and hence the costs incurred up to this point are to be considered in valuing the inventory.In view of the above, audit is requested to drop the comment".(Emphasis supplied by the querist.)

    Views of the Government Auditors

    The argument of the Government Auditors is based on paragraph 13(d) of AS 2 according to which selling and distribution costs are to be excluded from the cost of inventories and since the company has classified handling charges incurred at stockyards as selling expenditure and the freight incurred in transfer of materials from plant to different marketing offices as freight outwards, these would take the nature of distribution cost.
    Views of the company
    Selling and distribution costs as mentioned in AS 2 clearly refer to the costs incurred after the sale is effected and all the costs incurred up to the point of making the product available for sale are not to be considered as selling and distribution expenses. The costs incurred by the company for transfer of material from plant to marketing stockyards represent other costs as cited at paragraph 11 of AS 2 which states that the cost incurred for bringing the inventories to their present location and condition are rightly to be included in the cost of inventories. (Emphasis supplied by the querist.) The company’s accounting policy on valuation of inventories is reproduced hereunder:
    "Finished/semi-finished goods are valued at lower of cost (excluding interest and administrative expenses) and net realisable value. Cost is determined on the basis of average cost of production of the last six months during the year considering normal capacity. Normal capacity is based on the average production of the preceding three years of main production units, excluding abnormal years. Abnormal year is the year in which the actual production is less than 40% of the installed capacity. Coke and other by-products are valued at net realisable value wherever cost is not determined except in the case of stock of BF granulated slag at dump yard for which no value is assigned. Products in respect of which there is no sale, are valued at cost. No credit is taken for the value of material in process except those lying at mills".
    The querist has stated that the accounting policy framed by the company only intends to bring out the basis for cost of production since various methods of arriving at the cost exist and since paragraph 26(a) of AS 2 also states that the formula adopted in measuring inventories is to be disclosed.

    5. The querist has referred to the opinions given by the Expert Advisory Committee published in Volume IX of the Compendium of Opinions, vide Queries No. 1.16 and 1.25 wherein it was opined by the Committee that costs that are incurred and related to in effecting the change in location and condition of inventory items are to be included in the cost for the purpose of valuation of inventories. The querist has also referred to another opinion published in Volume XX of the Compendium of Opinions (Query No. 8), wherein the Committee has stated that the test for determining whether or not the cost of carrying out a particular activity should be included in the cost of inventories is whether the activity contributes to the present location and condition of the inventory. The ‘nomenclature’ of the activity or the place where the activity is carried out is not relevant. In view of the above opinion, it is felt that the transportation charges incurred in moving the inventories from the manufacturing point (where the company’s plant is located) to its stockyards, termed as freight outwards and the handling charges incurred towards unloading the goods transported, stacking them, etc., at the stockyards, before sale, termed as selling expenses, need to be included necessarily in the cost of inventories as per AS 2, since mere expressions freight outwards, and selling expenses do not, per se, qualify them as distribution cost and selling expenses resulting in exclusion of these expenses from the cost of inventories (paragraph 13(d) of AS 2).B . Query
    6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

    (a) Whether the freight incurred for transfer of materials from plant to different marketing locations of the company and the handling expenditure towards unloading of the material, stacking and segregating at the stockyard before sale are to be considered as selling and distribution costs and not to be included in the valuation of inventories.
    (b) Whether the accounting policy of the company on valuation of inventories needs to be amplified further to disclose inclusion of other costs in addition to cost of production.


    B . Query

    6. The querist has sought the opinion of the Expert Advisory Committee on the following issues:

    (a) Whether the freight incurred for transfer of materials from plant to different marketing locations of the company and the handling expenditure towards unloading of the material, stacking and segregating at the stockyard before sale are to be considered as selling and distribution costs and not to be included in the valuation of inventories.
    (b) Whether the accounting policy of the company on valuation of inventories needs to be amplified further to disclose inclusion of other costs in addition to cost of production.

    C. Points considered by the Committee

    12. The Committee is of the view that the wording of the accounting policy with regard to valuation of inventories followed by the company indicates that cost for the purpose of valuation of inventories includes only cost of production, which, in view of the facts of the case, is not correct. The Committee, therefore, recommends that wording of the accounting policy should be changed to bring out the fact that the cost also includes other costs incurred in bringing the inventories to their present location and condition. The Committee, however, does not comment on other aspects included in the accounting policy since those have not been raised by the querist.

    D. Opinion

    13. On the basis of the above, the Committee is of the following opinion on the issues raised in paragraph 6 above:

    (a) The freight incurred for transfer of materials from plant to different marketing locations of the company and handling expenditure towards unloading and stacking of the material at the stockyards before sale is effected should be included in the cost for the purpose of valuation of inventories. Expenditure incurred on segregation of inventories at the stockyards should be included in cost if such expenditure is incurred for changing the location of the inventories prior to effecting the sale. The Committee is further of the opinion that it would be appropriate for the company to change the nomenclature so that the said expenditure should not appear to be of the nature of selling and distribution expenses.
    (b) The wording of the accounting policy should be changed as suggested in paragraph 12 above.

    Opinion finalised by the Committee on 27.1.2004.

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    Default Cost formula to be used for valuation of inventories of catalyst of Accounting Standard 2 - Valuation of Inventories - AS 2

    A. Facts of the Case


    1. A company is engaged in transmission, processing and marketing of natural gas. Besides sale to different customers, natural gas is also used internally by the company as a major raw material for the manufacture of LPG, polymers and other value added products and also as a fuel.


    2. The query relates to applicability of paragraphs 14 and 16 of revised Accounting Standard (AS) 2, ‘Valuation of Inventories’, to a catalyst used by the company in its production process. Paragraph 14 of AS 2 requires the use of specific identification method in determining the cost of those items of inventories that are not ordinarily interchangeable. For other items of inventories, paragraph 16 of AS 2 requires the cost to be assigned using the first-in first-out (FIFO) or weighted average cost formula, as appropriate.


    B. Query

    3. The querist has sought the opinion of the Expert Advisory Committee on the issue whether specific identification method should be used in the case of items of inventories of a catalyst which can be used only in connection with the manufacture of a particular product and which is procured in different lots based on its consumption, or whether the cost should be assigned using FIFO or weighted average cost formula.

    C. Points Considered by the Committee

    4. AS 2 defines the term ‘inventories’ as follows (paragraph 3):

    “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.”
    The Committee presumes that the nature of the catalysts in question is such that it meets the above definition of the term ‘inventories’.


    5. Paragraph 14 of AS 2 requires that “the cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs”. Paragraph 15 of AS 2 notes that specific identification of costs is “an appropriate treatment for items that are segregated for a specific project, regardless of whether they have been purchased or produced. However, when there are large numbers of items of inventory which are ordinarily interchangeable, specific identification of costs is inappropriate since, in such circumstances, an enterprise could obtain predetermined effects on the net profit or loss for the period by selecting a particular method of ascertaining the items that remain in inventories". Paragraph 16 of AS 2 requires that the cost of inventories other than those dealt with in paragraph 14 of the Standard “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”.

    D. Opinion

    6. On the basis of the above, the Committee is of the opinion that the cost of different batches of catalyst that can be used interchangeably in the manufacturing process should be assigned using first-in, first-out (FIFO) or weighted average cost formula as is appropriate under the circumstances. For example, where catalyst is physically issued on a first-in, first-out basis (i.e., lots of the catalyst received first are issued to production first), FIFO formula should be used.
    Opinion finalised by the Committee on 22.4.2000.

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