Inventory Valuation

Ashutosh Dash

Why Inventory Valuation?

Inventory influences Profit

Overvaluation of unsold stock inflates Profit and Vice Versa Has an impact on subsequent profit

Inventory Managerial Concerns

What are Inventories? How to ascertain cost of inventories?

How to determine the amount in Balance Sheet?

carrying

What to disclose in the Corporate Reports?

Which of the followings are your inventories?

Furnitutes purchased for Sale

Shares Purchased for Sale Furniture used in Cash Counter Livestock Oils & Lubricants Fiber part in store to be fixed with a machine

What are your inventories?

Inventories are assets:

for sale in the ordinary course of business; the process of production for such sale; the form of materials or supplies to be consumed in the production process or in the rendering of services

held in in

What are Inventories?

What are included? What are excluded?

Goods Purchased held for resale

and

Shares, Debentures and other financial instruments held as stock in trade

Livestock, Agricultural & Forest products, mineral oils, ores & Gases WIP of Contracts providers Construction and Service

Finished goods produced for sale Work in progress (WIP)

Raw materials, Consumables, Loose tools production

used

in

Machinery spares that are used only in connection with fixed assets

How much to show in B/S?

Inventory Items
A B

Historical cost
1,20,000 2,12,000

Realizable value
1,08,000 2,80,000

C
D

18,000
82,000

18,000
76,000

E
Total

98,000
5,30,000

1,06,000
5,88,000

What should be the carrying amount?

Inventory should be valued at the lower of Cost and Net Realizable Value

What is the carrying Amount?

Item A B C D E Lower of Cost and NRV Net Realizable Value Cost price Cost price Net Realizable Value Cost price Total Value 1,08,000 2,12,000 18,000 76,000 98,000 5,12,000

How to determine the Cost?

Cost of Purchase Purchase Price Duties Taxes Freight Cost of conversion Other Cost

Direct Labour Production Overheads Allocated Joint Cost

Cost of Designing

Produc tion Overhe ad Variable Fixed

Prodn Based on Actual Rate per Unit Overhea
Based on Normal Capacity

Calculation of Production Overheads:

Prodn Overhea

What is the cost of Conversion?

2004
Normal Capacity (Units) Variable Production Overhead (Rs) Fixed Production Overhead (Rs) Actual Production (Units) 6, 00,000 24,00,000

2005
6, 00,000 32, 40,000

14, 40,000
4, 80,000

14, 40,000
7, 20,000

How to allocate joint cost?

Aallocated amongst the products on a systematic basis like Sales value Net realizable value

Allocation of JC

In Starlight Industries Ltd., at the end of a process three products, A B and C emerge. The joint costs incurred are Rs. 4, 00,000. Details of kilograms produced and prices per kilogram are given below: A 8,000 kilos and price per kilo Rs.25 B 6,000 kilos and price per kilo Rs.40 C 10,000 kilos and price per kilo Rs.36 You are required to allocate joint costs on sales basis.

Example
A 8,000 B 6,000 C 10,000

Sales (Units)

Price/ Unit Sales Volume Ratio Cost Allocation Amount

25 2,00,000 5 400000*5/20
1,00,000

40 2,40,000 6 400000*6/20
1,20,000

36 3,60,000 9 400000*9/20
1,80,000

Exclusions from the Cost :

Interest and other borrowing costs

Abnormal amounts of waste

Storage costs
Administrative overheads Selling and distribution costs

Determining Cost An Example

Acer Company normally produces 60,000 pieces of computers in a year. In the year 2006, due to lack of demand it produced 45,000 pieces of computers and could sell only 40,000 units. For production of the computers different components were purchased for Rs 9, 00, 00,000, labour charges paid Rs 4, 50, 00,000. Fixed and variable production overheads incurred are Rs 36, 00, 00,000 and 27, 00, 00,000 respectively. The company also incurred selling expenses both fixed and variable in nature amounting to Rs 8, 00, 00,000 and 10, 00, 00,000. Ascertain the cost of inventory.

Determination of Cost
Cost Incurred (45,000 pieces) Cost of Purchase of 9, 00, 00,000 Components Cost of Conversion Labour Cost 4, 50, 00,000 Fixed Production 36, 00, 00,000 Ovhd. Variable Prodn 27, 00, 00,000 Ovhd. Other Cost Unit Cost Inventory Cost (Rs) (5,000 Pieces) 2,000 1,00,00,000

1,000 6,000* 6,000 -

50,00,000 3,00,00,000 3,00,00,000 -

Total Cost

15,000

7,50,00,000

Critical Questions?????

Different Purchases at different Price

Prodn at different times differs in cost Hence the question: Which Costs are expended in COGS? Which Cost remain in ending inventory?

Needs a cost flow assumption

Methods of Valuation:
Methods
Interchangeable Inventory Non Interchangeable Inventory

FIFO
Weighted Average Method

Specific identification Method

Other techniques allowed are either Standard cost or Retail price method if it estimates approximates the actual cost.

What is NRV?

NRV = Selling Price Less Cost of Completion Less Selling and distribution cost

Exception:

Raw Material can not be written below its cost unless Cost of FG > NRV of FG Replacement cost may be used

An Example:
Gujurat Textile Mill, Ahmedabad Three categories of Garments A, B and C COP 180, SP 250, Distn Cost 20 For falling material price competitors sell at 190
Materials For Historic cost Replacement Net Realizable cost Value

(Rs.)
A B 1,25,000 1,60,000

(Rs.)
1,00,000 1,30,000

(Rs.)
98,000 1,31,000

1,45,000

1,22,000

1,23,000

Example
Cost price of Garment Rs 180 NRV of garment = Rs 190 Rs 20 = Rs 170 So in this situation the material can be written below the cost Replacement cost can be a best measure of NRV.

Application of the Rule:

The rule can be applied in either of the ways Item by item method Cost and NRV of each and every item is considered individually. Group Method Cost and NRV of a group of similar or related items is considered for each category.

Similar or related items means inventories relating to the same product line that have same end uses and are produced and marketed in same geographical area.

What are the disclosures Required?

The accounting Policies adopted in measuring inventories, including the cost formula used. The total carrying amount of inventories and its classification appropriate to the enterprise. ..\My Documents\HUL\HUL_Annual_Report_2008.pdf

Thank You