When should raw materials be written down under AS 2?

Raw materials are written down to replacement cost only if the finished goods in which they will be used are expected to be sold at a loss (i.e., cost of finished goods exceeds NRV).

Can an entity use LIFO method under AS 2?

No. AS 2 permits only FIFO (First-In, First-Out) and Weighted Average Cost formulas. LIFO is strictly prohibited.

Should inventory valuation comparison be done globally or item-by-item?

Comparison between Cost and NRV must be performed on an item-by-item basis or by groups of similar items, not on a total inventory portfolio basis.

AS 2 Valuation of Inventories: Cost Formulas, NRV & Joint Products Allocation

Accounting Standard (AS) 2 prescribes the accounting treatment for inventories under historical cost systems. In CA Intermediate exams, AS 2 questions test tricky NRV adjustments for raw materials, joint products cost allocation, and abnormal wastage exclusions.

Key Concept Flowchart & Decision Tree

1. Fundamental Measurement Principle: Lower of Cost and NRV

Inventories should be valued at the lower of cost and net realizable value (NRV). Cost of inventories comprises all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.

Costs of purchase include purchase price, import duties, other non-recoverable taxes, handling costs, and freight inwards. Trade discounts, rebates, and subsidies are deducted in determining the cost of purchase.

2. Costs Excluded from Inventory Valuation

Examiners routinely test whether students accidentally include period costs into inventory valuation. AS 2 explicitly excludes the following costs from inventory:

Abnormal amounts of wasted materials, labour, or other production costs: Recognized immediately as an expense in P&L.
Storage costs: Unless those costs are necessary in the production process prior to a further production stage (e.g. wine maturation).
Administrative overheads: That do not contribute to bringing inventories to their present location and condition.
Selling and distribution costs: Such as delivery freight, sales commission, and showroom rent.

3. Special Rule for Raw Materials and Supplies

Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold at or above cost.

However, when there has been a decline in the price of materials and it is estimated that the cost of the finished products will exceed net realizable value, the materials are written down to net realizable value. In such circumstances, the replacement cost of the materials may be the best available measure of their net realizable value.

AS 2 Inventory Valuation Summary

Inventory Category	Cost Components	Net Realisable Value (NRV) Determination	Exclusions
Raw Materials	Purchase price + Freight + Taxes (non-creditable)	Replacement Cost (only if FG is sold at a loss)	Storage & abnormal waste
Work-in-Progress (WIP)	Raw material cost + Proportionate conversion cost	Estimated Selling Price - Cost to complete - Selling costs	Administrative overheads
Finished Goods	Full absorption production cost (materials + labour + overheads)	Estimated Selling Price - Estimated selling costs	Distribution & selling expenses

⚠️ Common Examiner Pitfalls

Avoid vague general explanations. Always cite applicable statutory sections or Accounting Standard numbers, draw proper working notes, and state underlying assumptions clearly.

🎯 Scoring Exemption Checklist

Present answers with clear step numbers, highlight key final figures with boxes, write formal conclusions, and verify cross-references before moving to the next question.