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Inventory - NRV and AS-2

"Value inventory at Lower of Cost or NRV - the golden rule."

After learning cost methods (FIFO, Weighted Avg), we now learn the valuation principle mandated by AS-2 (Accounting Standard 2).

AS-2: Valuation of Inventories

AS-2 is the Indian Accounting Standard that governs how inventories should be valued in financial statements.

Key Principle:
"Inventories should be valued at LOWER OF: 1. Cost, or
2. Net Realizable Value (NRV)"

What is Net Realizable Value (NRV)?

Definition: Estimated selling price in the ordinary course of business MINUS estimated costs to complete and sell.

Formula:

NRV = Estimated Selling Price - Cost to Complete - Cost to Sell

Where:

  • Cost to Complete: Remaining production/processing costs
  • Cost to Sell: Commission, transport, packing, etc.

Why Lower of Cost or NRV?

Conservatism Principle:

  • Don't anticipate profits (so don't value above cost)
  • Do anticipate losses (so write down to NRV if market fall or damage)

Example:

  • Stock purchased: ₹100 per unit
  • Current market price: ₹80 per unit
  • Valuation: ₹80 (lower of cost or NRV)
  • Loss of ₹20 recognized immediately

Calculation of NRV

Example 1: Simple NRV

Data:

  • 100 units of mobile phones
  • Cost: ₹10,000 per unit
  • Estimated selling price: ₹12,000 per unit
  • Selling expenses: ₹500 per unit

Calculation:

NRV = ₹12,000 - ₹500 = ₹11,500 per unit
Cost = ₹10,000 per unit

Valuation = Lower of ₹10,000 or ₹11,500 = ₹10,000

Total Inventory Value: 100 × ₹10,000 = ₹10,00,000

Example 2: NRV Lower Than Cost

Data:

  • 50 units of laptops
  • Cost: ₹40,000 per unit
  • Estimated selling price: ₹35,000 per unit
  • Selling expenses: ₹2,000 per unit

Calculation:

NRV = ₹35,000 - ₹2,000 = ₹33,000 per unit
Cost = ₹40,000 per unit

Valuation = Lower of ₹40,000 or ₹33,000 = ₹33,000

Total Inventory Value: 50 × ₹33,000 = ₹16,50,000

Loss to recognize: 50 × (₹40,000 - ₹33,000) = ₹3,50,000

Comprehensive Calculation

Components of Cost (AS-2)

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EXCLUDE from Cost:

  • Abnormal waste
  • Storage costs (unless necessary for production)
  • Administrative overheads (not related to production)
  • Selling & distribution costs

When to Apply NRV Test

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Comparison: Cost Methods vs NRV

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AS-2: Other Key Points

1. Disclosure Requirements

Must disclose in financial statements:

  • Accounting policies for inventory
  • Method used (FIFO/Weighted Avg)
  • Total carrying amount of inventories
  • Amount written down to NRV
  • Amount of reversal of write-down

2. Items Excluded from AS-2

AS-2 does NOT apply to:

  • Work-in-progress under construction contracts (AS-7)
  • Financial instruments (shares, bonds)
  • Biological assets (livestock, agricultural produce at harvest)

Real-World Example

Flipkart - Diwali Sale Inventory

Before Diwali:

  • 1,000 smartphones
  • Cost: ₹15,000 each
  • Market price: ₹18,000
  • Valuation: ₹15,000 (cost < NRV)

After Diwali (unsold stock):

  • 200 units remain
  • New models launched, these are obsolete
  • Can sell at: ₹12,000
  • Selling expenses: ₹500
  • NRV: ₹11,500
  • Valuation: ₹11,500 (NRV < cost)
  • Write-down: 200 × (₹15,000 - ₹11,500) = ₹7,00,000 loss

Quiz: Inventory NRV and AS-2

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