Question 2 (a)

Inventory (AS 2) and the significance of its valuation

6 marks

Time to write
About 12 minutes
Topic
Inventory valuation and AS 2
Notes
Crux notes

Question

Question 2 (a) · 6 marks

Define the term Inventory as given in AS 2. Also, explain the significance of the valuation of inventory.

Reworded from the university paper; the task is the same. The original paper belongs to the University of Delhi. See DU's question bank.

Before you write

Read off the question and its marks

12 minfor 6 marks

Read from the question

  • Define…Explain…2 asks, each with its own marks below. Answer both.

Write it in this order

  1. Read; underline the asks; jot your points 1 min
  2. 1 Definition of inventory as per AS 2 2 marks 2 min
  3. 2 Significance of inventory valuation four points 4 marks 8 min
  4. Check: every ask answered, key terms underlined 1 min

Easy marks

  • Definition of inventory as per AS 2 (step 1, 2 marks): a clear definition and a line on what it covers. It opens the answer, so it takes a minute or two.

Short on time? Cut step 2 short rather than leave anything out.

Try it first. About 12 minutes for 6 marks. Write it out, then open the solution.

Solution

Hover or tap a marked figure, like 72,000, to see how it is made and where else it appears.

Inventory (AS 2). “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” (AS 2, para 3.1). They include goods bought for resale, finished goods, work in progress, raw materials, stores and loose tools.

Significance of inventory valuation.

  1. Determination of income. Gross profit is found by setting the cost of goods sold against revenue, and the cost of goods sold depends on the opening and closing inventory; a wrong value of stock gives a wrong profit.
  2. Financial position. Closing stock is shown on the credit side of the trading account and on the asset side of the balance sheet; inventory is often the largest current asset, so its value shapes the balance sheet.
  3. Control of operations. Both excess and shortage of inventory affect production and profitability, so its value must be known and watched.
  4. Compliance with AS 2. The standard requires inventories to be valued at the lower of cost and net realisable value (AS 2, para 5), so the figure in the accounts must meet that rule.

Where the 6 marks sit

#ComponentMarks
1Definition of inventory as per AS 22
2Significance of inventory valuation (four points)4
Total6
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