AN INTRODUCTION TO ACCOUNTING STANDARDS               ACCOUNTING STANDARD-2: VALUATION OF INVENTORIES

APPLICABILITY:

THIS STANDARD IS MANDATORY FOR ALL ORGANISATIONS WHETHER
(i)  SMALL AND MEDIUM COMPANIES(SMC)
(ii) NON SMC

(iii) LEVEL I,II and III ENTITIES.

SCOPE:

This Standard should be applied in accounting for inventories other

than:

(a) work in progress arising under construction contracts,

(b) work in progress arising in the ordinary course of business of

service providers;

(c) shares, debentures and other financial instruments held as

stock-in-trade; and

(d) producers’ inventories of livestock, agricultural and forest

products, and mineral oils, ores and gases.

PURPOSE:

This standard is for the determination of the carrying amount of inventories and any net realisable value.

SOME IMPORTANT DEFINITIONS:

(i) Inventories are assets:
   (a) held for sale in the ordinary course of business;
   (b) in the process of production; or
   (c) in the form of materials consumed in the production process.

(ii) Net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and estimated cost of sales.

MEASUREMENT OF INVENTORIES:

Inventories should be valued at the lower of cost and net realisable value.

ABOUT COST OF INVENTORIES:

The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

(i) COST OF PURCHASE includes the purchase price including duties and taxes (other than those recoverable), freight inwards,etc. 

(ii) COSTS OF CONVERSION include costs directly related to the units of production, such as direct labour.

EXCLUSIONS FROM THE COST OF INVENTORIES:

(a) Administration overheads
(b) Selling overheads
(c) Abnormal Loss
(d) Interest on Loans and Overdrafts
(e) storage costs, unless these costs are necessary in the production.

COST FORMULAS:

The cost of inventories should be assigned by using the first-in, first-out (FIFO), or weighted average cost formula.

NOTE: In case of specific projects the cost of inventories should be assigned by specific identification of their individual costs.

WHAT ARE THE TECHNIQUES FOR THE MEASUREMENT OF COST:

There are two techniques:
(a) Standard cost method: This techinque take into account normal levels of consumption of materials and supplies, labour, efficiency.

(b) Retail Method: This technique is often used in the retail trade for measuring inventories  that have similar margins.

DISCLOSURE:

The financial statements should disclose:
(a) the accounting policies adopted in measuring inventories and
(b) the total carrying amount of inventories.


POSTED BY,
GARV AHLUWALIA
EDITOR AT CHARTERED BLOOD

 AN INTRODUCTION TO ACCOUNTING STANDARDS

ACCOUNTING STANDARD -1: DISCLOSURE OF ACCOUNTING POLICIES

APPLICABILITY:

THIS STANDARD APPLIES TO EVERY ORGANISATION WHETHER

(i) SMALL AND MEDIUM COMPANIES (SMC)

(ii) NON SMC

(iii)LEVEL 1, 2 OR 3 ENTERPRISE

PURPOSE:

This standard deals with disclosure requirements in preparation and presentation of financial statements.

WHAT ARE ACCOUNTING POLICIES?

ACCOUNTING POLICIES are the procedures according to which the financial statements of an entity are prepared. It includes any method, systems and procedures for presenting disclosures of financial information. Every business follows different accounting policies according to its nature, e.g., an entity dealing with perishable goods should follow LIFO system of inventory rather than FIFO, etc.

WHY DISCLOSURE NEEDED?

As financial policies vary from entity to entity therefore it becomes necessary to disclose all the policies at a place so that it is appreciated by its users and can be properly understood by the users.

Also, sometimes disclosure is required by statute in some cases e.g., translation policies in respect of foreign currency items.

IS EVERY POLICY ADOPTED REQUIRED TO BE DISCLOSED SEPARATELY?

NO, not every policy is required to be disclosed in financial statements. Some disclosures are presumed by law and are known as FUNDAMENTAL ACCOUNTING ASSUMPTIONS. However they are required to be reported only if they are not followed.

Following are the FUNDAMENTAL ACCOUNTING ASSUMPTIONS

1. GOING CONCERN: An entity is presumed to carry out its operations for the foreseeable future. It is assumed that an entity don’t have any intention of closing down its business in the near future.
2. CONSISTENCY: It is also assumed that the policies once followed by the entity are consistently followed by it. This is the necessary to ensure comparability feature of financial statements.
3. ACCRUAL: It means that revenues and costs are recognized as soon as they are earned or incurred. An enterprise can recognize its costs and revenues as they are incurred or earned in the period to which it relates, e.g., if tax is due but not paid in the current year, it should be recorded in the present year instead of next year.                                                                     

The use of above discussed assumptions are presumed by law, however they need to be disclosed clearly in the financial statements only in case they are not followed.

EXAMPLES WHERE DIFFERENT ACCOUNTING POLICIES ARE USED:

•          Methods of depreciation, depletion and amortization 
•          Treatment of expenditure during construction
•          Conversion or translation of foreign currency items
•          Valuation of inventories
•          Treatment of goodwill
•          Valuation of investments

WHAT SHOULD BE CONSIDERED WHILE SELECTING ACCOUNTING POLICIES OF AN ENTITY?

The primary considerations while selecting any accounting policy to be followed are:

1. Prudence:

In the business world nothing can be predicted for future, therefore it will be a better decision that anticipated profits/ gains and revenues should not be recognized unless there is sure shot surety that they will be recovered, however if there is any expected future losses or expenses they should be accounted for immediately ,e.g. provisions for doubtful debts, etc.

2. Substance over form:

This implies that a financial transaction should clearly underlie realities of accounting standards. It just means that a financial transaction should show the clear evident position of the business and not merely complying legal entries. This principle is applied to ensure that real intent of the transaction is valid and the transaction is having some economic substance and is not merely done to hide TRUE AND FAIR VIEW of the statements from its stakeholders for some unethical task.

So, it can be said that real intention of the party should be taken in to consideration instead of just its legal compliance.

This principle plays a very important role in ensuring that the financial statements prepared are free from material misstatement and is representing TRUE AND FAIR VIEW of entity’s position.

3. Materiality:

Material items are those items, the knowledge of which may affect the financial decisions of its users. Since these items may affect the financial decisions of its users therefore, financial statements should be free from material errors or should show all the material items.

POSTED BY, 

VARUN MAHEY

EDITOR AT CHARTERED BLOOD