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Accounting Standards

AS – 2: Inventory Valuation

AS – 4: Events occurring after Balance Sheet date

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VALUATION OF INVENTORY – AS 2

Standard Specifies:

a. What cost of Inventory should consist

b. How Net Realisable value is determined

AS – 2 , Valuation of Inventories was first issued in June 1981 which was then revised and made

mandatory for all enterprises commencing business on or after April 1999.

Costs incurred in an organization form a major part to account and vouch for in financial statements

of any concern. Cost of closing stock , cost of work in progress , cost of finished goods are costs

which are incurred in current accounting period and carried forward to the next accounting period.

Similarly cost of opening Inventory which was incurred in previous accounting year is brought

forward in the current accounting year.

As assets are classified as resources which will enable cash inflow and economic growth to the

enterprise, costs form inseparable part of the assets. Costs to be included in Inventory costs are

those costs which are expected to generate future economic benefits to the enterprise. Such costs

include

1. Cost of acquisition

2. Cost of Change in location of the Inventory

3. Costs incurred in transforming the raw material into finished goods

AS 2 explains, costs incurred in maintaining the inventory do not generate any economic benefits to

the enterprise and hence are not included in the inventory costs. It becomes important to value

Inventory as it considerably impacts profit and loss for an accounting period. Higher the value of

closing stock, lower is the cost of goods sold, consequently high profits.

The Principle of prudence says that no profit should be booked while all foreseeable losses should be

recognised. Thus if net realisable value of inventory is less than inventory cost, inventory is valued

at net realisable value to reduce the booked profit in anticipation of loss and on the contrary if net

realisable value of the inventory is more than inventory cost, the anticipated profit is ignored and

inventory is valued at cost. Hence, Inventory is valued at cost or net realisable value whichever is

less.

Measurement of Inventories

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Net realisable value is the estimated selling price in normal/ordinary course of business less

estimated costs of completion and required costs to make the sale. The Valuation of Inventory is

based on the very fact that no assets should be carried at a value which is in excess of the value

realisable by its use or sale or both.

Example 1: Cost of semi-finished unit at the end of 2012-13 is Rs. 800. The unit can be finished next year by a further expenditure of Rs. 100. The Unit can be sold at Rs. 250, subject to payment of 4% brokerage on selling price. Determine the Value of Inventory. Solution 1: Rs. Net Selling Price 250

- Cost of completion 100

150

- Brokerage on Selling (4%) 10

Net Realisable Value 140 Cost of Inventory 800 Value of Inventory: Rs. 140 Disclosures - The accounting policies adopted in measuring inventories

- The cost formula used - Total carrying amount of inventories - Appropriate Classification

In comparison with Indian GAAP, US GAAP and IAS Indian GAAP : AS – 2 US GAAP : ARB 43 IAS : IAS – 2 Method of Inventory Valuation ● Unlike Indian GAAP, LIFO method is allowed in US GAAP and IAS ● Reversal of Impairment is allowed in IAS

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Fundamental Differences US GAAP & IAS : No Standalone financial statements are prepared EVENTS OCCURING AFTER BALANCE SHEET DATE – AS 4 Standard Specifies:

a. Events occurring after Balance Sheet date The standard was issued in November 1982, later it was revised and made mandatory for all enterprises in respect of accounting periods commencing on or after April 1995. On April 2004 a new standard on contingencies came into effect which made all paragraphs on contingencies in AS 4 withdrawn. Transactions are financial in nature. It is obvious that all financial events up to the balance sheet date should be taken into consideration in preparation of financial statements for an accounting period. There may be certain events which occur after balance sheet date the knowledge of which is important for making assessment of performance and affairs of the enterprise during the accounting period and also for making projections for the future. It becomes important to communicate such developments to the users of financial statements. It is impractical to require enterprises to report events after approval of financial statements because such a requirement will necessitates fresh approval of financial statements and thus start an endless cycle of change of report and fresh approval. Adjusting Events Events occurring after balance sheet date are those events, which are significant yet may be favourable or unfavourable to the enterprise which occur between the balance sheet date and date on which financial statements are approved by the Board of Directors. Such events can be reported either by

1. Making Appropriate Adjustments in the financial statements. 2. Report of Approving Authority.

An event after the balance sheet date may require adjustment of reported values of assets, liabilities, expenses, income and equity for the accounting period, if the event is such as to provide more substantial and corroborative evidence of conditions that existed at the balance sheet date. For example: if a fraud during the accounting period is detected after the balance sheet date but before the approval of financial statement, it is mandatory to recognise the loss and change the reported values concerned elements of the financial statement.

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Example 1: A ltd. whose accounting year ends on 31/03/2012. Agreed in principle to sell a plot of land on 18/03/2012 at a price to be determined by an independent valuer. Pending the agreement for sale and due non receipt of valuer’s report, the sale of land could not be completed up to 31/03/2012.The company received the report on April 7 , 2012 and the agreement was signed on April 10,2012.The Financial statements for 2011-12 were approved by the board on May 12 , 2012. Solution 1: The event of sale of land is an event occurring after the balance sheet date. Also, the condition which led to the sell existed on the balance sheet date. The signing of the agreement provides further evidence as to the condition existed on the balance sheet date. The sale of land after the balance sheet date is an adjusting event, which means transaction should form part of books of account of A ltd. for the purpose of its financial statement for the year 2011-12. Non-Adjusting Events Events after balance sheet date may result from conditions arising subsequent to the balance sheet date. Such events do not justify change in the reported values of assets, liabilities, expenses, income or equity. Such events if they represent material changes affecting financial position of the enterprise. Should be disclosed in the report of approving authority. For example; An announcement after balance sheet date but before approval of financial statement of a formal plan to discontinue an operation does not justify adjustment of financial statement of the accounting period already over, but it is indicative of material change in future. Such events do not form part of financial statements but should form part of report of approving authority. Such report should contain nature of the event along with the financial estimate that will affect the enterprise and where such estimate cannot be made the report should state the fact that such estimate cannot be made. Example 2: Hypothetical Situation A company follows April – March as its financial year. The company recognises cheques dated 31 March or before received from customers after balance sheet date but before approval of financial statement by debiting cheques in hand a/c and crediting the Debtors a/c. The cheques in hand is shown in balance sheet as an item of cash and cash equivalents. All cheques in hand are presented to bank in the month of April and are also realised in the same month in normal course after deposit in the bank. Even if the cheques bear the date 31 March or before the cheques received after 31 March do not represent any condition existing on 31 March. Thus the collection of cheques after balance sheet date is not an adjusting event. Moreover, the collection of cheques after balance sheet date does not represent any material change or commitments affecting financial position of the enterprise, so no disclosure of such collections in the Director’s report is necessary. Exceptions to rule: Events occurring after Balance sheet date Events which contradict going concern assumption

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An event occurring after balance sheet date shall be an adjusting event even if it does not reflect any condition existing on the balance sheet date, if the event is such as to indicate that the fundamental accounting assumption of going concern is no longer appropriate. Example 3: A fire occurred in the factory of an enterprise after 31/03/2012 but before approval of financial statements for the year 2011-12. The loss on fire is of such a magnitude that it is not reasonable to expect the enterprise to start operations again. Since the fire occurred after 31/03.2012 the loss on fire is not a result of any condition existing on 31/03/2012, yet the loss should be recognized in the statement of profit and loss for 2011-12 and the assets lost should be written off from the balance sheet as on 31/03/2012. Proposed Dividend The Director’s propose dividends after balance sheet date for the obvious reason that no dividend can be proposed till the year is over and profit ascertained. The dividends proposed by the directors however, do not reflect any condition existing on the balance sheet date. But as per AS – 4, the proposed dividend should be incorporated in the statement of profit and loss for the year as appropriation of profit and be recognized in balance sheet as provisions.