28 April 2021
Case History: WIP inventory for which sale price is less than the cost of final product. Inventory valued as per Ind As 2 by reducing proportionate value as market price vs cost considered. In this case whether provision for onerous contract as per Ind As 37 is required to be done. Requesting to advice. the
09 July 2024
In the scenario described, where work-in-progress (WIP) inventory is valued at an amount higher than the expected sale price of the final product, and considering the application of Ind AS 2 (Inventories), there are a few considerations related to the need for provisions under Ind AS 37 (Provisions, Contingent Liabilities and Contingent Assets).
### Understanding Ind AS 2 - Inventories
Ind AS 2 prescribes the accounting treatment for inventories, including the measurement of inventories at the lower of cost and net realizable value (NRV). NRV is defined as the estimated selling price in the ordinary course of business, less the estimated costs of completion and estimated costs necessary to make the sale.
### Provision for Onerous Contracts under Ind AS 37
Ind AS 37 deals with provisions, contingent liabilities, and contingent assets. A provision should be recognized in the financial statements when:
1. **Onerous Contract Definition:** A contract is considered onerous when the unavoidable costs of meeting the obligations under the contract exceed the economic benefits expected to be received from it.
2. **Recognition Criteria:** A provision for onerous contracts should be recognized when an entity has a present legal or constructive obligation as a result of past events, it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation, and a reliable estimate can be made of the amount of the obligation.
### Application to the Case
In your case:
- **WIP Inventory Valuation:** The WIP inventory is valued at an amount that exceeds the expected sale price of the final product.
- **Lower of Cost and NRV:** Ind AS 2 requires inventories to be measured at the lower of cost and NRV. If the NRV (estimated selling price less costs to complete and sell) is lower than the cost, the inventory should be written down to NRV.
- **Provision for Onerous Contract:** Given that the WIP inventory is valued at an amount higher than the expected sale price (NRV), this could indicate that the contract under which the goods are being produced (or intended to be sold) might be onerous.
### Steps to Consider:
1. **Assessment of Onerous Contract:** Evaluate whether the contract (or the production of the goods) is expected to generate economic benefits that are lower than the unavoidable costs associated with fulfilling the contract.
2. **Criteria for Provision:** Determine if the conditions for recognizing a provision under Ind AS 37 are met: - Present obligation as a result of past events (e.g., entering into the contract), - Probable outflow of economic benefits to settle the obligation, - Reliable estimate of the obligation amount.
3. **Measurement of Provision:** If an onerous contract is identified, measure the provision at the present value of the unavoidable costs less the expected economic benefits to be derived from the contract.
4. **Disclosure:** Ensure proper disclosure in the financial statements about the provision for onerous contracts, including the nature of the obligation, the expected amount and timing of outflows, and uncertainties surrounding the estimates made.
### Conclusion
In conclusion, based on the information provided and the principles of Ind AS 2 and Ind AS 37, if the expected sale price of the final product is lower than the cost at which the WIP inventory is valued, it may indicate an onerous contract situation. Therefore, consideration should be given to recognizing a provision for onerous contracts in accordance with Ind AS 37, subject to meeting the recognition criteria outlined. It is advisable to consult with a qualified professional accountant or auditor to ensure compliance with accounting standards and proper financial reporting.
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