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)
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
NRV Test Required When:
- Damaged goods: Fire, flood, breakage
- Obsolete stock: Old models, expired goods
- Market price fall: Below cost
- Slow-moving items: Unlikely to sell at normal price
- Year-end valuation: Always test at Balance Sheet date
NRV NOT Required:
- If stock will be sold at normal price
- If market price > cost (use cost, don't anticipate profit)
Comparison: Cost Methods vs NRV
| Question | Answer |
|---|---|
| Which cost method? | FIFO or Weighted Average (as per AS-2) |
| Upper limit? | Cost (don't value above cost) |
| Lower limit? | NRV (write down if damaged/obsolete) |
| Which is applied first? | Cost method (FIFO/Avg), then NRV test |
| Can we reverse write-down? | Yes, if NRV increases later (up to original cost) |
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
Test Your Knowledge
Question 1 of 5
1. As per AS-2, inventories are valued at: