AS-2 Valuation of Inventories – Meaning, Cost, NRV, Methods & Examples

 

AS-2 – Valuation of Inventories (Detailed & Easy Explanation)

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1️⃣ Introduction (Very Simple Explanation)

In business, not all goods are sold immediately. Some goods remain unsold at the end of the year. These unsold goods are called Inventory (Stock).

Examples of inventory:

• Goods lying in shop

• Raw materials in factory

• Finished goods not yet sold

👉 AS-2 tells us how to value this stock while preparing financial statements.

If inventory value is wrong:

• Profit will be wrong

• Balance Sheet will be misleading

That is why AS-2 is very important.

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2️⃣ Why AS-2 Is Important (With Student Logic)

Let’s understand with a simple idea:

Profit = Sales – Cost

Closing stock reduces cost.

So:

• Higher closing stock → Higher profit

• Lower closing stock → Lower profit

If a company shows more stock value, profit increases artificially.

👉 AS-2 prevents this by giving clear valuation rules.

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3️⃣ Objective of AS-2 (Explained Clearly)

The objectives of AS-2 are:

1. To decide how inventory should be valued

2. To ensure inventory is not over-valued

3. To calculate true profit

4. To follow prudence principle

5. To maintain uniformity and comparability

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4️⃣ Scope – Who Should Apply AS-2?

AS-2 applies to:

• All enterprises

• Trading businesses

• Manufacturing businesses

• Inventory of all kinds

❌ AS-2 Does NOT Apply To:

1. Work-in-progress of construction contracts (covered by AS-7)

2. Financial instruments (shares, debentures, etc.)

3. Producers’ inventories of:

   • Agricultural products

   • Forest products

   • Mineral oils, ores, gas
     (when measured at NRV)

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5️⃣ Meaning of Inventory (As per AS-2)

Inventory includes:

✔ For Trading Business

• Goods purchased for resale

✔ For Manufacturing Business

• Raw materials

• Work-in-progress

• Finished goods

• Stores and spares

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6️⃣ Golden Rule of AS-2 (MOST IMPORTANT)

Inventory should be valued at COST or NET REALISABLE VALUE (NRV), whichever is LOWER.

📌 This rule is based on prudence (conservatism).

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7️⃣ Meaning of COST (Explained Step by Step)

Cost means total cost incurred to bring inventory to present condition and location.

🔹 Components of Cost:

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1️⃣ Cost of Purchase

Includes:

• Purchase price

• Import duties

• Non-refundable taxes

• Freight and transportation

• Handling charges

Less:

• Trade discount

• Rebates

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2️⃣ Cost of Conversion

Includes:

• Direct labour

• Direct expenses

• Factory overheads (fixed & variable)

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3️⃣ Other Costs

• Any cost necessary to bring inventory to present condition

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❌ Costs NOT Included in Inventory Cost

• Abnormal wastage

• Storage cost (unless necessary)

• Administrative expenses

• Selling & distribution expenses

• Interest cost (generally)

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8️⃣ Net Realisable Value (NRV) – Easy Meaning

Meaning:

NRV is the amount expected to be realised from sale of inventory.

Formula:

NRV = Estimated Selling Price
– Estimated Cost of Completion
– Estimated Selling Expenses

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Example:

• Selling price = ₹120

• Completion cost = ₹10

• Selling expenses = ₹5

👉 NRV = ₹120 – ₹10 – ₹5 = ₹105

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9️⃣ Comparison: Cost vs NRV

Particulars	Amount
Cost	₹110
NRV	₹105

👉 Inventory will be valued at ₹105 (lower value)

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🔟 Valuation Methods Allowed Under AS-2

✔ 1. FIFO (First In First Out)

• Old stock sold first

• Closing stock valued at latest price

• Commonly used

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✔ 2. Weighted Average Method

• Average cost calculated

• Suitable when prices fluctuate

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❌ Methods NOT Allowed:

• LIFO

• Base stock method

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1️⃣1️⃣ Practical Examples (Very Clear)

Example 1: Lower of Cost or NRV

• Cost = ₹1,00,000

• NRV = ₹90,000

👉 Inventory value = ₹90,000
👉 Loss = ₹10,000

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Example 2: FIFO Method

Purchases:

• 100 units @ ₹10

• 100 units @ ₹12

Closing stock = 100 units

👉 Value = 100 × ₹12 = ₹1,200

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1️⃣2️⃣ Journal Entries (VERY IMPORTANT FOR EXAM)

When NRV is Lower than Cost:

Profit & Loss A/c     Dr   ₹10,000
   To Inventory A/c          ₹10,000

(Being inventory written down to NRV)

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1️⃣3️⃣ Disclosure Requirements (AS-2)

Financial statements should disclose:

• Accounting policy for inventory valuation

• Cost formula used (FIFO / Weighted Average)

• Total value of inventory

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1️⃣4️⃣ Effect of Inventory Valuation on Profit

Situation	Effect
Overvaluation of closing stock	Profit increases
Undervaluation of closing stock	Profit decreases

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1️⃣5️⃣ Exam-Oriented Points (Write & Score)

• AS-2 is based on prudence

• Valuation at lower of cost or NRV

• LIFO not allowed

• NRV calculated item-wise

• Inventory affects P&L and Balance Sheet

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1️⃣6️⃣ Common Mistakes Students Make

• Valuing inventory at selling price

• Ignoring NRV

• Including selling expenses in cost

• Using LIFO

• Forgetting journal entry

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1️⃣7️⃣ FAQs (Student-Friendly)

Q1. Why inventory is valued at lower value?
To avoid showing unrealised profit.

Q2. Is FIFO compulsory?
No, FIFO or Weighted Average both allowed.

Q3. Does AS-2 apply to services?
No, services have no inventory.

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📊 Revision Charts & Tables 

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📌 1. Golden Rule of AS-2

Rule	Meaning
Lower of Cost or NRV	Inventory is valued at the lower value to avoid unrealised profit

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📌 2. Components of Cost

Cost Element	Included / Not Included
Purchase price	✅ Included
Freight & handling	✅ Included
Direct labour	✅ Included
Factory overheads	✅ Included
Administrative expenses	❌ Not included
Selling & distribution expenses	❌ Not included
Abnormal wastage	❌ Not included

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📌 3. Cost vs NRV Comparison

Particulars	Amount
Cost	₹1,00,000
NRV	₹90,000
Inventory Value	₹90,000

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📌 4. Valuation Methods Allowed

Method	Allowed under AS-2
FIFO	✅ Yes
Weighted Average	✅ Yes
LIFO	❌ No
Base Stock	❌ No

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📌 6. Journal Entry (Quick Revision)

Situation	Entry
NRV < Cost	P&L A/c Dr → To Inventory A/c

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📌 7. AS-2 Applicability Table

Item	AS-2 Applicable
Trading inventory	✅ Yes
Manufacturing inventory	✅ Yes
Construction WIP	❌ No
Financial instruments	❌ No

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1️⃣8️⃣ Conclusion

AS-2 ensures that inventory is valued safely, logically, and honestly. By following the rule of lower of cost or NRV, it prevents overstatement of profits and helps users trust financial statements. For students, AS-2 is one of the most scoring accounting standards.

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📩 Further Contact

If you have any doubts, questions, or need more clarification regarding AS-2 – Valuation of Inventories, feel free to reach out to us. We aim to explain accounting standards in a simple and easy-to-understand way for students.

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⚠️ Disclaimer

This article is written only for educational and informational purposes to help students understand AS-2 – Valuation of Inventories in an easy and simplified manner. The content is based on general accounting principles and academic understanding. It should not be considered as professional accounting, financial, or legal advice. Accounting standards and guidelines may change from time to time, so students are advised to refer to official ICAI publications, textbooks, or notifications for exam and professional use. The author is not responsible for any decisions taken based on this information.

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