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Ind AS 2 and existing AS 2

The principles laid down in Accounting Standard (AS) 2, “Valuation of Inventories”, are well established and the principles laid down in Ind AS 2, “Inventories”, are almost similar to the principles laid down in AS 2. Accounting Standard 2 basically prescribes the accounting treatment for inventories. The primary issue in accounting for inventories is the amount of cost to be recognised as an asset and carried forward until the related revenue is recognised. This standard, therefore deals with the determination of cost and its subsequent recognition as an expense, including any write-down to net realisable value. IND AS 2 apart from dealing with determination of cost also deals with cost formulas that are used to assign costs to inventories.

IND AS 2 differs existing AS 2 in certain aspects. The following are the differences between IND AS 2 i.e. “Inventories” and existing AS 2 i.e. “Valuation of Inventories:-

A. Para 4 of existing AS 2 states that machinery spares which can be used only in connection with an item of fixed asset and whose use is expected to be irregular, as such machinery spares are accounted for in accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets. However, no such explanation has been provided in IND AS 2 but Para 8 of IND AS 16 states that, "Major spare parts, stand-by equipment and servicing equipment qualify as property, plant and equipment when an entity expects to use them during more than one period."

B. IND AS 2 excludes commodity broker-traders who measure their inventories at fair value less costs to sell. Para 3 (b) states that, when such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognised in profit or loss in the period of the change. The existing AS 2 does not contain any such aspect.

Broker-traders are those who buy or sell commodities for others or on their own account. The inventories referred to in paragraph 3(b) are principally acquired with the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin. When these inventories are measured at fair value less costs to sell, they are excluded from only the measurement requirements of this Standard.

C. Para 7 of IND AS 2 differentiates Fair Value and Net Realisable Value. Net Realisable value to be an entity-specific Value whereas the fair value is market based measurement. Net realisable value refers to the net amount that an entity expects to realise from the sale of inventory in the ordinary course of business where as Fair value reflects the amount for which the same inventory could be exchanged between knowledgeable and willing buyers and sellers in the marketplace. Therefore it is clearly evident that Net Realisable Value may not be equal to Fair value (net of cost to sell).

The existing AS 2 neither contain any definition of fair value nor any such explanation has been included in the existing of AS 2.

D. Ind AS 2 provides explanation with regard to inventories of service providers whereas the existing AS 2 does not contain such an explanation. Para 8 states that In the case of a service provider, inventories include the costs of the service for which the entity has not yet recognised the related revenue. Cost of inventories of service providers are measured at the cost of their production. Cost primarily consists of labour and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable overheads. Labour and other costs relating to sales and general administrative personnel are not included but are recognised as expenses in the period in which they are incurred.

The cost of inventories of a service provider does not include profit margins or non-attributable overheads that are often factored into prices charged by service providers.

E. Existing AS 2 excludes from its scope producers’ inventories of livestock, agricultural and forest products, and mineral oils, ores and gases to the extent that they are measured at net realisable value in accordance with well established practices in those industries. Ind AS 2 excludes only the measurement of inventories held by producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products from its scope but provides guidance on measurement of such inventories. Para 4 of IND AS 2 states that such inventories are measured at  certain stages of production and explains the same by giving an example i.e. when agricultural crops have been harvested or minerals have been extracted and sale is assured under a forward contract or a government guarantee, or when an active market exists and there is a negligible risk of failure to sell. These inventories are excluded from only the measurement requirements of this Standard.

In accordance with Ind AS 41, Agriculture, inventories comprising agricultural produce that an entity has harvested from its biological assets are measured on initial recognition at their fair value less costs to sell at the point of harvest. Para 20 of IND AS 2 recognises the same to be the cost of the inventories at that date for application of this Standard.   

F. Ind AS 2 provides detailed guidance in case of subsequent assessment of net realisable value. It also deals with the reversal of the write-down of inventories to net realisable value to the extent of the amount of original write-down, and the recognition and disclosure thereof in the financial statements. Para 25 of existing AS 2 requires assessment of net realisable value at to be each balance sheet date and does not deal with such reversal. Para 33 of IND AS 2 requires a new assessment to be made of net realisable value in each subsequent period and states that 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 net realisable value because of changed economic circumstances, the amount of the write-down should be 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. This occurs, for example, when an item of inventory that is carried at net realisable value because of decline in selling price has declined, is still on hand in a subsequent period and its selling price has increased.

G. The existing AS 2 specifically provides that the formula used in determining the cost of an item of inventory should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition. Para 15 of existing AS requires the cost of inventories of items which are not ordinarily interchangeable and goods or services produced and segregated for specific projects should be assigned by specific identification of their individual costs. The cost of inventories, other than those dealt with in paragraph 14, should be assigned by using the first-in, first-out (FIFO), or weighted average cost formula and formula used should reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.

H. Ind AS 2 however does not specifically state so and requires the use of consistent cost formulas for all inventories having a similar nature and use to the entity. Cost of inventories of items that are. the cost of inventories, other than those which are not ordinarily interchangeable and goods or services produced and segregated for specific projects ( which is required to be assigned by using specific identification of their individual costs as per Para 23), shall be assigned by using the first-in, first-out (FIFO) or weighted average cost formula. It also requires entities to use the same cost formula for all inventories having a similar nature and use to the entity. However, for inventories with a different nature or use, different cost formulas may be justified.

IND AS 2 requires more disclosure as compared to the existing AS 2. Additional disclosure required by IND AS 2 which were not required by existing AS 2 are:-

a. the carrying amount of inventories carried at fair value less costs to sell;

b. the amount of inventories recognised as an expense during the period;

c. the amount of any write-down of inventories recognised as an expense in the period in accordance with paragraph 34;

d. the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense in the period in accordance with paragraph 34.

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