Valuation of Inventory

Session Agenda
Definition of Inventory
Measurement of Inventory
Components of cost Net realisable value Cost formula

I.

Inventories

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.

Examples of Inventory for Retail Stores

Shirt, Jeans etc. for WESTSIDE
Nokia handsets for Nokia Priority Dealer Fruits, Grocery items etc. for Reliance Fresh LCD, TV etc. for CROMA

II.

Measurement of Inventories

Inventories should be valued at the lower of cost and net

realisable value. Cost of Inventories 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.
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a. Component of cost
i. Cost of Purchase
a. b. c. d. Invoice Price Transport inwards + insurance (if borne by buyer) Any other incidental expenses Less subsidy/cost borne by any other person

ii. Cost of Conversion

iii. Other Costs

b. Net realisable value

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

Net Realizable Value = Inventory Sales Value Estimated Cost of Completion and Disposal

Contd.
For example at a company's year end, if an unfinished
good that already cost Rs. 25 is expected to sell for Rs.100 to a customer, but it will take an additional Rs.20 to complete and Rs.10 to advertise to the customer, its NRV will be

NRV = Rs.100 - Rs.20 - Rs.10 = Rs.70 > Rs. 25

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 In this year's balance sheet, since the cost of the good

(Rs.25) is less than its NRV (Rs.70), the cost of the good

will get recorded as the cost of inventory.

In next year's income statement after the good was sold, this company will record a revenue of Rs.100, Cost of Goods Sold of Rs.25, and Cost of Completion and Disposal of Rs.20+Rs.10 = Rs.30. This leads to a profit of Rs.100-Rs.25-Rs.30 = Rs.45 on this transaction.

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Cost Formulas
Specific identification
FIFO LIFO Weighted Average

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Inventory of eggs with a Restaurant

Purchased 2000 units @ Rs. 2.50 per unit on March 1 Sold 1000 units @ Rs. 3.50 per unit on March 11 Purchased 3000 units @ Rs. 1.50 per unit on March 19 Sold 2500 units @ Rs. 2.50 per unit on March 21

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Fruit Store

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Art Gallary

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Furniture

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Specific identification
According to this method each identified items of inventory is assigned specific cost and hence the name specific identification. In simple words cost is attributed to each item in the inventory individually that is identifiable specifically. Here the point is to be noted that each item of inventory must be identifiable otherwise specific assignment of cost will not be possible.

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FIFO, LIFO, Weighted Average

However, when inventory items are not heterogeneous are are ordinarily interchangeable i.e. have similar nature and use then inventory at the year is usually valued using a particular cost assumption formula like First-in, First-out (FIFO) or Last-in, Firstout (LIFO).

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 Another

alternative

method

for

inventory

valuation

is weighted average method which averages the value of inventory held at the start of the period and value of inventory purchased or produced during the period.

AS 2 allows the use of specific identification method, FIFO

method and weighted average cost method to value ending inventory.

Its up to the management of the entity select the method of inventory valuation by considering relevant factors.
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FIFO

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LIFO

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Weighted Average

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Class Exercise
Opening Inventory @ Rs. 12 per unit

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Class Exercise
Calculate the cost of material consumed for the period
using
FIFO LIFO Weighted Average

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FIFO

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LIFO

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Weighted Average

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Comparing 3 Methods

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Details Of Component X
Units Rate

Opening Balance Purchase 1 Purchase 2

50 100 150

10 10.1 10.2

Consumption 1
Purchase 3 Consumption 2

100
50 100
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Class Exercise
Calculate the cost of material consumed for the period
using
FIFO LIFO Weighted Average

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