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a) The Inventory valuation method used in this question is as per AS 2 issued by the ICAI. The
inventory is valued at Cost or Net Realisable Value whichever is lower. The Opening Stock,
Purchases and Closing Stocks come in handy to calculate the amount of material used in production
for the current year. They are also used in calculating the inventory turnover ratio which tells the
rate at which the company is able to turn the inventory into finished goods. The higher the ratio,
the better it is for the company.
b) As per AS 2, if the items have become obsolete and you do not expect to sell them at the given cost,
it is advised and mandated to measure them at their net realisable value. It does not make sense to
keep valuing such items at their cost because the business knows that it cannot recover the same if
and when these items are sold.
c) Yes, the company will have ‘Change in stocks’ item in its cash flow statement under the header of
change in working capital under Cash flow from Operating Activities. An increase in the inventories
means a reduction/decrease in Cash flow from Operating Activities. An increase in inventories
means that a company has invested in more current assets which involves utilisation of cash and
hence a decrease in Cash flow from Operating Activities.