IND AS 2 IND AS 2: INVENTORIES. Applies To All inventories excepta) Financial Instruments (Ind AS 32/ Ind AS 109)

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1 IND AS 2: INVENTORIES 1. OBJECTIVE: The main objective of this standard is to prescribe accounting treatment of inventories and to determine cost of the inventories and its subsequent recognition as an expense. This standard also provides guidance on the cost formulas to be adopted and writing down of inventories to NRV. 2. SCOPE: IND AS 2 Applies To All inventories excepta) Financial Instruments (Ind AS 32/ Ind AS 109) b) Biological Assets & agricultural produce at the point of harvest (Ind AS 41) Does not apply to * Agriculture/Forest/Mineral Products & agricultural produce after harvest (if they are measured at NRV) Commodity Broker Trader (if they are measured at FV less cost to sell) c) WIP arising under construction contracts (Ind AS 11) * These inventories are excluded only from the measurement requirements. P r i v a t e & C o n f i d e n t i a l P a g e 1

2 3. DEFINITION: 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. Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 4. MEASUREMENT: Inventories shall be measured at the lower of cost and net realisable value. A. COST OF INVENTORIES The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. B. COST OF PURCHASES It consists of the purchase price, import duties and other taxes (other than those recoverable from tax authorities), transport, handling and other costs directly attributable to the acquisition of inventory. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase. P r i v a t e & C o n f i d e n t i a l P a g e 2

3 C. COST OF CONVERSION This includes costs directly related to the units of production, such as direct labour and a systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods. The allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities. The amount of Fixed overhead allocated to each unit of production shall not be increased as a consequence of low production or idle plant. Conversely, in periods of abnormally high production, the amount of fixed overhead allocated to each unit of production is decreased so that inventories are not measured above cost. Variable Production overheads are allocated to each unit of production on the basis of the actual use of the production facilities. In case of a Joint / By-product where cost of conversion is each product is not separately identifiable, they are allocated between the products on a rational and consistent basis. For e.g.: On the basis of sale value of the products either at the stage of separation or on completion of production, etc. When by-products are considered immaterial or of a negligible value, they are often measured at NRV and this value is deducted from the cost of the main product. D. OTHER COST Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. Certain costs should be excluded from the cost of inventories and recognised as expense in the period in which they are incurred. P r i v a t e & C o n f i d e n t i a l P a g e 3

4 For e.g.: a) Abnormal Waste b) Storage Cost c) Admin overhead d) Selling costs IND AS 23 on Borrowing Costs, identifies limited circumstances where borrowing costs are included in the cost of inventories. An entity may purchase inventories on deferred settlement terms. When the arrangement effectively contains a financing element, that element, for example a difference between the purchase price for normal credit terms and the amount paid, is recognised as interest expense over the period of the financing. E. COST OF INVENTORIES TO SERVICE PROVIDERS Service providers shall measure inventories at the costs of their production which primarily includes labour and other cost of production directly engaged in providing the services. Costs of sales and general administrative personnel are generally not included in inventories but are recognised as an expense in the period in which they are incurred. 5. COST OF AGRICULTURAL PRODUCE: Cost of agricultural produce which is already harvested and is not sold at the point of harvest is valued at Fair value less Cost to sell at point of harvest (as per provisions of IND AS 41) P r i v a t e & C o n f i d e n t i a l P a g e 4

5 6. TECHNIQUES FOR MEASUREMENT OF COST: Techniques Standard Cost Method Retail Method This method takes into account normal levels of material and supplies, labour, efficiency and capacity utilization These are regularly reviewed and revised if necessary in light of current conditions Here, cost of inventory is determined by reducing from the sales value of inventory, an appropriate percentage of gross margin. 7. COST FORMULAS: An entity shall use the same cost formulas for all inventories having similar nature and use to the entity. For inventories with different nature/use different cost formulas may be justified. Cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs The cost of inventories, other than those dealt above, shall be assigned by using the first-in, first-out (FIFO) or Weighted Average Cost (WAC) formula. P r i v a t e & C o n f i d e n t i a l P a g e 5

6 8. NET REALISABLE VALUE (NRV) As defined earlier, NRV is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. The practice of writing inventories down below cost to net realisable value is consistent with the view that assets should not be carried in excess of amounts expected to be realised from their sale or use. Inventories are usually written down to net realisable value item by item. In some circumstances, however, it may be appropriate to group similar or related items. Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost. However, when a decline in the price of materials indicates that the cost of the finished products exceeds net realisable value, the materials are written down to net realisable value. In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value. When the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in realisable value because of changed economic circumstances, the amount of the write-down is reversed (i.e. the reversal is limited to the amount of the original write-down) so that the new carrying amount is the lower of the cost and the revised net realisable value. P r i v a t e & C o n f i d e n t i a l P a g e 6

7 9. RECOGNITION AS EXPENSE When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. The amount of any write-down of inventories to net realisable value and all losses of inventories shall be recognised as an expense in the period the write-down or loss occurs. The amount of any reversal of any write-down of inventories, arising from an increase in net realisable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs. 10. DISCLOSURE REQUIREMENTS The financial statements shall disclose: - The accounting policies adopted in measuring inventories, including the cost formula used the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity the carrying amount of inventories carried at fair value less costs to sell amount of inventories recognised as an expense the amount of any write-down of inventories recognised as an expense the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense circumstances or events that led to the reversal of a write-down of inventories carrying amount of inventories pledged as security for liabilities. P r i v a t e & C o n f i d e n t i a l P a g e 7

8 11. KEY DIFFERENCE BETWEEN IND AS & AS TOPIC IND AS 2 AS 2 IND AS 2 specifically provides exemption to commodity broker trader who value their stocks at FV less cost to sell 1. Applicability to commodity broker 2. Agricultural Produce 3. WIP arising in ordinary course of service provider s business 4. Deferred Settlement Terms 5. Reversal of write down of Inventory IND AS 2 specifically exempts agriculture produce at the point of harvest from its scope; and agricultural produce after harvest if they are measured at NRV IND AS 2 does not exclude it from its scope IND AS 2 says that when inventories are acquired on deferred settlement basis, then the difference between the purchase price (for normal credit period) and the amount paid for deferred settlement is to be recognized as interest expense. The amount of any reversal of write down of inventories arising from an increase in NRV should be recognized as a reduction in the amount of inventories recognized as an expense in the period in which the reversal occurs AS 2 does not contain any exclusion relating to inventories held by commodity broker trader No such exemption provided AS 2 specifically excludes it from its scope There is no express requirement under AS 2 specifying treatment of inventories acquired on deferred settlement basis AS 2 does not deal specifically with the issues relating to reversal of write down of inventory to its NRV The write-up does not aim to discuss the entire complex accounting rules and implications, which may arise from implementation of the IND AS. This write-up must not be relied upon as a substitute for reading the text of IND AS standards. If any specific issue is faced, it is recommended to seek appropriate expert professional advice. Before reaching any decision on how your specific organization may be affected by the application of IND AS, you should first take into consideration specific facts and circumstances, and thereafter consult GBCA or your professional advisors, who are familiar with your state of affairs, for advice. P r i v a t e & C o n f i d e n t i a l P a g e 8