01 August 2024
Under **Accounting Standard 2 (AS 2)**, which deals with the valuation of inventories, the cost of inventory includes all costs incurred to bring the inventory to its present location and condition. Here’s a detailed breakdown of the cost parameters to consider for inventory valuation:
### **1. Cost of Inventories:**
**A. For Raw Materials:** - **Purchase Cost:** Includes the price paid for raw materials or goods, including taxes, duties, and other charges. - **Freight and Handling Costs:** Costs incurred to transport raw materials to the company’s premises. - **Storage Costs:** If necessary for bringing the inventory to its present condition, but generally not included unless specifically required. - **Other Direct Costs:** Costs directly attributable to the acquisition of raw materials.
**B. For Work-in-Progress (WIP):** - **Direct Materials:** The cost of materials used in the production process. - **Direct Labor:** The wages and salaries of employees directly involved in manufacturing the product. - **Manufacturing Overheads:** Includes both fixed and variable overheads directly related to production, such as depreciation of production equipment, utilities, and indirect materials and labor.
**C. For Finished Goods:** - **Direct Materials:** Costs of raw materials used in producing the finished goods. - **Direct Labor:** Wages and salaries of workers directly engaged in producing the finished goods. - **Manufacturing Overheads:** As with WIP, this includes overheads related to the production of finished goods, both fixed and variable.
### **2. Costs Excluded from Inventory Valuation:**
**A. Selling and Distribution Costs:** - Costs related to selling and marketing activities, such as advertising expenses, sales commissions, and distribution costs are not included in inventory valuation.
**B. Administrative Overheads:** - General administrative costs, such as office rent, administrative salaries, and office supplies, are not included in the cost of inventories.
**C. Abnormal Wastage:** - Costs associated with abnormal wastage of materials or labor are excluded from inventory valuation.
**D. Finance Costs:** - Interest on loans or finance charges is not included in the cost of inventories.
### **3. Cost Formulas:**
AS 2 provides different methods for valuing inventory:
- **First-In, First-Out (FIFO):** Assumes that the earliest goods purchased or produced are the first to be sold. The inventory is valued at the cost of the most recent purchases.
- **Weighted Average Cost:** Computes an average cost of all inventory items available for sale during the period, which is then used to value both ending inventory and cost of goods sold.
- **Specific Identification:** Used when inventory items can be specifically identified (e.g., for unique or high-value items). The actual cost of each item is assigned to the inventory.
### **4. Inventory Valuation Techniques:**
- **Cost Formula Application:** Select an appropriate cost formula (FIFO, Weighted Average, Specific Identification) based on the nature of the inventory and company policy.
- **Regular Review:** Ensure regular review and adjustment of inventory costs to reflect accurate valuation in the financial statements.
### **Summary:**
Under AS 2, the cost of inventory should include all costs necessary to bring the inventory to its present location and condition. This encompasses the purchase cost of raw materials, direct labor, and manufacturing overheads for WIP and finished goods. Costs that are unrelated to production or acquisition, such as selling, administrative costs, abnormal wastage, and finance costs, should be excluded from inventory valuation.
Adhering to these principles will ensure accurate and compliant inventory valuation in your financial statements.
CAclubindia
