📑 Topics on this page (Jump to Topic):
📌 1. Inventories & AS 2
- Inventories = assets (i) held for sale in the ordinary course of business (finished goods), (ii) in the process of production for such sale (work-in-progress), (iii) materials and supplies to be consumed in production.
- Basic rule (AS 2): inventories are valued at cost or net realisable value (NRV), whichever is lower — based on the conservatism convention.
- NRV = estimated selling price − estimated cost of completion − estimated costs needed to make the sale.
| Included in cost | Excluded from cost |
|---|---|
| Purchase price, import duties and non-refundable taxes, freight inward | Abnormal wastage (materials, labour) |
| Conversion cost — direct labour, production overheads (fixed and variable) | Storage costs (unless necessary in production) |
| Other costs to bring to present location and condition | Administrative overheads, selling and distribution costs |
| Net of trade discounts and rebates | Refundable GST input tax credit |
📌 2. Cost Formulas
| Method | Assumption | Status under AS 2 |
|---|---|---|
| Specific identification | Actual cost of each item | For non-interchangeable items (jewellery, special orders) |
| FIFO (first in, first out) | Earliest purchases issued first; closing stock at latest prices | Permitted |
| Weighted average cost | Total cost ÷ total units | Permitted |
| LIFO (last in, first out) | Latest purchases issued first | Not permitted (revised AS 2 and Ind AS 2) |
Example: bought 100 units @ ₹10 then 100 units @ ₹12; sold 150. FIFO closing stock = 50 × 12 = ₹600. Weighted average = (1,000 + 1,200) ÷ 200 = ₹11 → 50 × 11 = ₹550.
- In rising prices, FIFO gives a higher closing stock, lower cost of goods sold and higher profit.
- Retail method — selling price less gross margin; for large numbers of fast-moving items. Standard cost may be used if close to actual cost.
📌 3. Inventory Systems & Effects
| System | Feature |
|---|---|
| Periodic | Stock found by physical count at period-end; COGS = opening stock + purchases − closing stock |
| Perpetual | Stores ledger/bin card updated on every receipt/issue; stock known at any time |
- Closing stock overstated → profit that year is higher and next year's profit lower (it becomes the opening stock).
- Closing stock is shown on the credit side of the Trading A/c and as a current asset in the balance sheet.
⚠️ Exam Traps:
- AS 2 does not apply to WIP under construction contracts, WIP of service providers, financial instruments like shares/debentures, agricultural produce etc.
- Exams ask LIFO as "not permitted" — do not mix it up with FIFO.
- Cost and NRV are compared item by item, not usually on the total.
💡 Memory Tip: "Cost or NRV, whichever is lower" = conservatism; FIFO = "old goes out first, new stays in stock".
📌 4. Worked Examples
Example: FIFO and weighted average (periodic system)
Opening stock 100 units @₹10; January purchase 200 @₹12; February purchase 100 @₹15; 250 units sold. Total cost = 1,000 + 2,400 + 1,500 = ₹4,900; 400 units available; closing stock 150 units.
| Method | Closing stock | Cost of goods sold |
|---|---|---|
| FIFO | 100 @15 + 50 @12 = ₹2,100 | 4,900 − 2,100 = ₹2,800 |
| Weighted average | 4,900 ÷ 400 = ₹12.25; 150 × 12.25 = ₹1,837.50 | ₹3,062.50 |
In rising prices FIFO gives a higher closing stock and profit. If the NRV of closing stock is ₹2,000, stock under FIFO is shown at ₹2,000 (lower than cost ₹2,100).
📌 5. Practice MCQs
📝 Practice MCQs (prepared by SF Prep — not PYQs)
Q1. Under AS 2, inventories are valued at: Practice
Correct answer: (D)
In line with conservatism.
In line with conservatism.
Q2. The accounting standard on inventories is: Practice
Correct answer: (A)
AS 2 — Valuation of Inventories.
AS 2 — Valuation of Inventories.
Q3. Which method is NOT permitted under revised AS 2? Practice
Correct answer: (D)
LIFO was removed; also not allowed in Ind AS 2.
LIFO was removed; also not allowed in Ind AS 2.
Q4. Bought 100 units @ ₹10 and 100 @ ₹12; sold 150. Closing stock under FIFO is: Practice
Correct answer: (A)
The remaining 50 units are at the latest ₹12.
The remaining 50 units are at the latest ₹12.
Q5. Using the same data, closing stock under weighted average is: Practice
Correct answer: (B)
Average ₹11; 50 × 11 = 550.
Average ₹11; 50 × 11 = 550.
Q6. Net realisable value is: Practice
Correct answer: (C)
NRV is the net amount realisable.
NRV is the net amount realisable.
Q7. Which is NOT included in the cost of inventories? Practice
Correct answer: (C)
Selling costs are period expenses.
Selling costs are period expenses.
Q8. In a period of rising prices, FIFO gives: Practice
Correct answer: (D)
Older cheaper costs go to COGS; newer dearer ones stay in stock.
Older cheaper costs go to COGS; newer dearer ones stay in stock.
Q9. For non-interchangeable items like jewellery, the suitable method is: Practice
Correct answer: (A)
The actual cost of each item is known.
The actual cost of each item is known.
Q10. Overstating closing stock makes the current year's profit: Practice
Correct answer: (B)
Cost of goods sold falls.
Cost of goods sold falls.
Q11. Overstated closing stock affects next year's profit by making it: Practice
Correct answer: (A)
It becomes next year's overstated opening stock.
It becomes next year's overstated opening stock.
Q12. Under the perpetual inventory system: Practice
Correct answer: (C)
Stock balance is known at any time.
Stock balance is known at any time.
Q13. Under the periodic system, cost of goods sold equals: Practice
Correct answer: (D)
The basic formula.
The basic formula.
Q14. An item costs ₹500 and its NRV is ₹420. It is valued at: Practice
Correct answer: (B)
Whichever is lower.
Whichever is lower.
Q15. Work-in-progress is part of inventories because it is: Practice
Correct answer: (B)
The second part of the AS 2 definition.
The second part of the AS 2 definition.
Q16. AS 2 does NOT apply to: Practice
Correct answer: (C)
Financial instruments fall under other standards.
Financial instruments fall under other standards.
Q17. Closing stock appears in the balance sheet as a: Practice
Correct answer: (D)
It is expected to be sold within a year.
It is expected to be sold within a year.
Q18. The "lower of cost and NRV" rule is based on: Practice
Correct answer: (A)
It provides for probable losses.
It provides for probable losses.
Q19. Abnormal wastage in inventory cost is: Practice
Correct answer: (D)
Abnormal loss is a period expense.
Abnormal loss is a period expense.
Q20. For retail trade with many fast-moving items, AS 2 allows the: Practice
Correct answer: (A)
Cost = selling price less gross margin.
Cost = selling price less gross margin.