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Inventory: Meaning
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.
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.
Valuation of Inventories
Inventories should be valued at the lower of cost and net realisable value.
Cost
The cost of inventories under this method comprises of costs of purchase, costs of conversion
and other costs incurred in bringing the inventories to their present location and condition.
Cost of Purchase
Cost of Purchase=Purchase price+ Taxesduties on purchase+ freight inward+other expenses directly attributable
Cost of Conversion
Variable production overheads are those indirect costs of production that vary directly, or
nearly directly, with the volume of production, such as indirect materials and indirect labour.
And they are assigned to each unit of production on the basis of the actual use of the
production facilities.
Fixed production overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, such as depreciation and maintenance of
factory buildings and the cost of factory management and administration. Under normal
circumstances, they are charged on the basis of recovery rate.
Recovery rate=
Production o /h
Normal Production
Other Costs
Any cost whether production or not but is incurred in bringing the inventories to their present
location and condition is included in the cost of inventories.
Fair Value
Reflects the price at which an orderly transaction to sell the same inventory in the most
advantageous market between market participants at the measurement date
Cost Techniques
The following formula may be used if they reflect the fairest possible approximation to the
cost.
Cost Formulas
Specific Identification Method
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.
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.
Agricultural Produce
Recognition as an expense
When inventories are sold, the carrying amount of inventories shall be recognized as an
expense in the period in which the related revenue is recognised. The amount of any writedown to net realisable value and all losses of inventories shall be recognised as an expense in
the period in which the write-down or loss occurs. The amount of any reversal of any writedown of inventories, arising from an increase in net realisable value, shall be recognised as a
reduction in the amount of inventories recognized as an expense in the period in which the
reversal occurs.
Disclosure
Practice Questions
Question 1
Normal Production Capacity: 10,000 units
Total Annual Fixed Manufacturing Overheads: Rs.1,00,000/Total goods in process at the end of the year : 100 units
Percentage of completion: 75%
Find the fixed manufacturing overheads attributable to the stock in process?
Question 2
HUL has a stock of 100 packets of soap. Its Retail price is Rs. 90 per packet and the Gross
Profit ratio is 25%. Find the value of closing stock?
Question 3
HUL manufactures LUX shampoo. In the month of march, it produced 100,000 packets of
shampoo.
Direct Material of chemicals consumed
600,000
Direct Labour used in shampoo division
200,000
Indirect Material (bottles)
100,000
Fixed production overheads
250,000
Transportation cost to bring raw material to the site
50,000
Normal production of shampoo bottles
120,000
Calculate cost per unit and the value of closing stock of 1000 bottles, assuming that the
shampoo is sold for Rs. 15 per bottle and Rs. 2000 would be spend more to sell these bottles.
Question 4
Calculate the value of inventory using both FIFO or Weighted Average Method
1 Mar
Opening Inventory Nil
2 Mar
Bought 10 units @Rs. 30 each
7 Mar
Bought 20 units @ Rs. 40 each
10 Mar
Sold 15 Units @ Rs. 80 each
13 Mar
Bought 20 units @ Rs. 50 each
17 Mar
Sold 5 units @ Rs. 80 each