Question 2 (a)

The important points of AS 2

6 marks

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

Question

Question 2 (a) · 6 marks

Explain the important points of AS2 Accounting for Inventories.

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

  • ExplainEach point stated, then explained in a line or two.

What the paper leaves open

AS 2 is titled "Valuation of Inventories"; the paper's "AS2 Accounting for Inventories" is read as that standard.

Write it in this order

  1. Read; underline the asks; jot your points 1 min
  2. 1 Title, objective, scope and meaning of inventories points 1–2 1 mark 2 min
  3. 2 Lower of cost and net realisable value point 3 1 mark 2 min
  4. 3 Cost: what it includes and excludes points 4–5 2 marks 3 min
  5. 4 Cost formulas, write-down and disclosure points 6–8 2 marks 3 min
  6. Check: every ask answered, key terms underlined 1 min

Short on time? Trim steps 3 and 4 evenly rather than skip one: each is capped at its own marks.

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.

AS 2 is titled Valuation of Inventories. Its objective is to settle the value at which inventories are carried until the related revenue is recognised, including the cost of inventories and any write-down to net realisable value. Its important points are these.

Picture itThe important points of AS 2

1On the shelf, each blue vase stands by its little stack of coins—stock, priced.

Basic rule of measurementInventories are valued at the lower of cost and net realisable value.

2Clay arriving, the potter at the wheel, the kiln burning—every step adds to cost.

What cost includesCosts of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

3The spoiled batch swept from the kiln floor counts nowhere—abnormal waste stays out.

What cost excludesAbnormal amounts of wasted materials, labour or other production costs.

4A cracked vase on the table: it goes in the books at what it can still fetch.

Write-down to net realisable valueInventories are written down below cost if they are damaged or obsolete, or if their selling prices have fallen.

  1. Scope. It applies to all inventories except work in progress under construction contracts and service contracts, shares, debentures and other financial instruments held as stock-in-trade, and producers' inventories of livestock, agricultural and forest products and mineral ores measured at net realisable value under well-established industry practice.
  2. Meaning of inventories. Assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in production or in rendering services. Spare parts and standby equipment that meet the definition of property, plant and equipment are not inventory; they fall under AS 10 (AS 2, scope).
  3. Basic rule of measurement. Inventories are valued at the lower of cost and net realisable value. “Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and” (AS 2, para 3.2) of making the sale.
  4. What cost includes. “All costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition” (AS 2, para 6). The costs of purchase include the purchase price, duties and taxes that are not recoverable, and freight inwards, less trade discounts and rebates. Fixed production overheads are allocated on the normal capacity of the production facilities.
  5. What cost excludes. Abnormal amounts of wasted materials, labour or other production costs (AS 2, para 13). Also excluded are storage costs (unless needed in the production process), administrative overheads that do not help bring the inventory to its present location and condition, and selling and distribution costs.
  6. Cost formulas. Items that are not ordinarily interchangeable, and goods or services produced and segregated for specific projects, are valued by specific identification. All other inventories are valued by FIFO or weighted average cost, whichever gives the fairest approximation to the cost incurred. The standard cost method or the retail method may be used for convenience if the results approximate actual cost.
  7. Write-down to net realisable value. Inventories are written down below cost if they are damaged or obsolete, or if their selling prices have fallen, usually item by item, because assets should not be carried at more than they are expected to realise. Net realisable value is reassessed at each balance sheet date.
  8. Disclosure. The financial statements disclose the accounting policies used in measuring inventories, including the cost formula, and the total carrying amount of inventories classified as suits the enterprise.

Where the 6 marks sit

#ComponentMarks
1Title, objective, scope and meaning of inventories (points 1–2)1
2Lower of cost and net realisable value (point 3)1
3Cost: what it includes and excludes (points 4–5)2
4Cost formulas, write-down and disclosure (points 6–8)2
Total6
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