AS 2 is the Accounting Standard for inventories valuation and accounting treatment. Read this blog to know everything related to the same.
Inventory accounting care is advised in the AS 2 valuation of inventories, which provides instructions on evaluating the value at which inventories are carried out before any relevant sales are recognized in the accounting records. In other words, the valuation of inventories is governed by AS 2, i.e., Accounting Standards 2.
What Does AS 2 Valuation of Inventories Mean?
No matter what level a company is at (Level I, II, and III), it must adhere to this accounting standards. This standard establishes the criteria for determining the value at which inventories are carried in the financial statements and the accounting treatment for inventories.
This standard, except the following, should account for all inventories:
- Construction work that is still in progress, including directly connected service contracts
- Service work that is still in progress (consulting, banking, etc.)
- Debentures, shares, and other financial assets held as stock in trade
- Inventories such as livestock, forest and agricultural goods, mineral oils, and so on
Note: These inventories are valued at their net realisable value.
Definition of Accounting Standards 2 Valuation of Inventories
AS 2 is the Accounting Standards for inventories’ valuation and accounting treatment. The methods used to value a company’s inventory and disclose it in the financial statements are covered by this accounting standards. The general guideline addresses valuation inventory, that is, closing a company’s stock at cost or market value, whichever is lower.
The following items are considered as ‘inventory’ according to the AS 2 definition;
- Products that are regularly held for sale, i.e., finished items
- Products currently being produced or ‘work in progress’
- Raw materials that are utilised in the process of producing services or production (including consumable store items).
3 Methods of Accounting Standards 2 Inventory Valuation
Here are the methods used in the AS 2 valuation of inventories.
First-in First-out (FIFO) Method
According to the First In, First Out Method, products are utilised in the order in which they were purchased. It means that pre-purchased products are used in a manufacturing setting, and in a sales setting, they are sold first. Because of this, the most recent purchases are included in this method’s end-to-end list.
Clear Identification Method
Every item sold and in the closure must be capable of clear identification for a certain identification method to be applied. This tactic is only applicable if the organization has the space to physically partition its various purchases.
That’s why it’s possible to factor in the price at which things were sold throughout the accounting period. Further, the value of any unsold or unspent inventory might be included in the asset list.
Companies working with or manufacturing high-priced, flexible products can benefit from this method of measurement. Products like these range from automobiles to furnishings to jewelry.
Weighted Average Cost Method (WAC)
It involves figuring out what the typical selling price is for all of the products on sale. These costs are derived from an estimate of what it would cost to purchase or produce the same goods throughout the year, as well as the value of the products obtained at the beginning of the year.
Also factored into the average price is any unsold stock from the previous day’s closing inventory as well as any unsold stock from the previous day. Also, the estimated rate is calculated as frequently as possible, or whenever a new message is received.
What Are the Benefits of As 2?
Here are a few advantages of the AS 2 valuation method for inventories;
Gross Profit Determination
You can calculate the gross profit by adding the cost of goods sold (COGS) to the direct revenue received. To continue, you must determine the cost of the goods sold to complete the formula for computing gross profit.
Helps in Maintaining Statutory Compliance
The company must provide the following information regarding inventory following the AS-2 and Ind AS-2 (valuation of inventories) guidelines:
- Carrying quantity of inventories
- Accounting principles applied in the measurement
- Reversal of inventory write-down
- Inventories to be considered as expenses.
Determine the Financial Position of the Business
Inventories are included in the profit and loss statement and the balance sheet. That is why the valuation should be done correctly to avoid displaying an inaccurate financial position.
Helps in the Liquidity Analysis
Inventory makes up a significant portion of working capital. Inventory is not intended to be held for an extended period because it is a current asset. Inventory is utilised to estimate the company’s liquidity levels. In general, the stock turnover ratio needs to be higher than usual.
Difference Between AS 2 and Ind AS 2: Inventory Valuation
- In contrast to Accounting Standards 2, Ind AS 2 needs more information about things like the number of goods used as collateral and the amount of inventory write-down accepted as a cost
- Even though Ind AS did not include the word “distribution expenses” in the cost of sale and distribution, the goal of both standards is the same, so the cost of sale and distribution cannot be included even under Ind AS 2
- Accounting Standards 10 says that machine parts that are rarely used but are needed to run another piece of fixed equipment must be recorded as a separate fixed asset (AS 10). Ind AS 16 (Property, Plant, and Equipment) has a much broader definition of what fixed assets are, so many spares that are considered inventory under AS 2 would be considered fixed assets under Ind AS.
Conclusion
To wrap it up, we have learned that AS 2 focuses on inventory valuation and how it is beneficial. We also learned what inventories are, how to work in progress, finished products and raw materials are priced in the case of manufacturers, and how finished goods are priced as inventory in the case of traders.
In most cases, the cost is used to value inventory. Depending on the nature of the business and the method employed for inventory valuation, cost calculation may become challenging.
Therefore, the firm must first calculate the amount of inventory it has at every stage of production before it can calculate the total cost of inventory. You must assess inventory supplies, labour, and other expenses. Moreover, you must also choose an inventory valuation method.
However, it is still not easy for regular people to do this process efficiently. So, it would be best if you considered reaching out to Vakilsearch to assist you. Make your valuation process easier and quicker with us.
