valuation of inventories

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jasmine (Querist)
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21 August 2010 people, plz try solving the following question and provide an explanation for ur answer;
Raw materials inventory of a company includes certain material is on decline and replacement cost of the inventory at the year end is Rs.75 per kg. Is it possible to convert the material into finished product at conversion cost of Rs.125.Decide whether to make the product r not to make the product, if the selling price is (1)Rs.175 and (2)Rs.225.Also find out the value of inventory in each case.

CA PRAMOD SARAOGI

CA PRAMOD SARAOGI (Expert)
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21 August 2010 If the selling price is 175 : the net inflow is negative (175-75-125) and If the selling price is 225 the net inflow is 25 (225-75-125) Thus in the second option one should go for manufacture as There is recovery of Rs. 25 out of the Raw material cost.
However, one has to keep in mind the composition of cost in terms of Fixed and Variable. In other words if the conversion cost represent major chunk of Fixed Overheads then one may go for further manufacture even if the selling Price is Rs. 175 so as to recover some of the Fixed Overhead contained in the conversion cost

CMA Ramesh Krishnan

CMA Ramesh Krishnan (Expert)
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21 August 2010 As per AS-2 Valation of Inventory Cost or Net realisable value which ever is lower

For making the product your total cost is

Rs. 125 = Rs. 125

If the product sold
Realisable value is

Rs. 175 - Rs. 125 = Rs. 50

Rs. 225 - Rs. 125 =Rs.75

So actual replacement cost is Rs. 75

So Answer is

1 case Value of inventory Rs. 50 per kg

2 case Value of Inventory Rs. 75 Per Kg

CA PRAMOD SARAOGI

CA PRAMOD SARAOGI (Expert)
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21 August 2010 Example :
Cost of raw material X
Replacement Cost 75
Conversion cost 125
Total cost X + 200
At S.P. Rs 175 Loss = -X-25
Here even the cash cost of Rs. 75+ 125 has not been recovered
At S.P. Rs. 225 Loss = -X + 25
Here Cash cost has been recovered and even the cost of RM is also recovered by rs. 25

CMA Ramesh Krishnan

CMA Ramesh Krishnan (Expert)
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21 August 2010 Dear Pramod ji

In my understanding author is asking about the Valuation of Material only not for the final product

CA PRAMOD SARAOGI

CA PRAMOD SARAOGI (Expert)
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CA PRAMOD SARAOGI

CA PRAMOD SARAOGI (Expert)
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21 August 2010 May be you are right Mr. ramesh but going through the question it seems that the Author wants to know whether one should make the product or not. I think the second part of the question pertains to the valuation of Inventory.

CMA Ramesh Krishnan

CMA Ramesh Krishnan (Expert)
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21 August 2010 Not a matter, Author can take in anyway answers. Thanks

jasmine

jasmine (Querist)
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21 August 2010 thanks mr. pramod and mr.ramesh, however mr.ramesh do you mean to say that in case of selling price of rs.175 there is no profit element included?

CMA Ramesh Krishnan

CMA Ramesh Krishnan (Expert)
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21 August 2010 No In your query it has been told the selling price only. the selling price always include the profit element, but we cannot consider the total selling price becasue AS-2 clearly defining the net realiable value is the sale value less the cost incurring to realise that such sale, so sale vaule Rs.225, but for making such sale you need to incurr the coversion cost Rs.125, hence to relaisable value Rs.75

Any more

jasmine

jasmine (Querist)
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21 August 2010 so basically you are assuming that profit element is excluded and hence after deducting conversion cost from the sales value we attain the nrv of inventories.

CMA Ramesh Krishnan

CMA Ramesh Krishnan (Expert)
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21 August 2010 yes. the NRV or cost which ever is lower will be the value of inventory

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