ICDS II : Valuation of Inventories - Income Tax - Ready Reckoner - Income Tax

ICDS II : VALUATION OF INVENTORIES This ICDS will generally apply only to assessees engaged in any business or profession whose income is chargeable to tax under the head Profits and gains of Business or profession . This Income Computation and Disclosure Standard is based on Accounting Standard 2 - Valuation of Inventories. 1. Scope:- This Income Computation and Disclosure Standard shall be applied for valuation of inventories, except the following : Work-in-progress under construction contracts (ICDS III) Work‐in‐progress which is dealt with by other ICDS Share debentures and other financial instruments held as stock-in-trade (ICDS VIII) Producers inventories of livestock, agriculture and forest products mineral oils, ores and gases to the extent that they are measured at net realisable value. Machinery spares, which can be used only in connection with a tangible fixed asset and their use is expected to be irregular (ICDS V) Note: (a) Items of inventory that have not been used in the construction work and have not become part of work-in progress of the contract will come within the scope of this ICDS and should be included as part of the inventory to be valued as per the requirements of this ICDS. (b) Provisions of ICDS II shall not apply to securities held as inventory by a person engaged in the business of insurance since profits and gains of any insurance business shall be computed in accordance with the rules contained in the First Schedule of the Act. 2. Measurement of inventories:- As per AS-2 Inventories shall be valued at cost, or net realisable value, whichever is lower . The same principle is to be applied while valuing the inventories under this ICDS. 3. Cost of Inventories:- Cost of inventories shall comprise of all costs of purchase, costs of services, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. In case services have been used in manufacture, production or processing of goods, cost of such services will form part of inventory as part of cost of conversion. 4. Cost of Purchase:- The costs of purchase shall consist of purchase price including duties and taxes, freight inwards and other expenditure directly attributable to the acquisition. Trade discounts, rebates and other similar items shall be deducted in determining the costs of purchase. 5. Costs of Services:- Where services have been utilised in manufacture, production or processing of goods, cost of such services will form part of inventory as part of cost of conversion. The costs of services shall consist of labour and other costs of personnel directly engaged in providing the service. Note: In case of service providers ICDS II will not have application and value of service not fully rendered need not be computed under this ICDS. 6. Costs of conversion:- Costs of conversion are incurred for converting raw material into finished products. These costs can be classified into three categories: costs that are directly related to the units of production variable production overheads and fixed production overheads 7. Other Costs:- Other costs shall be included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. Generally, interest or other borrowing costs are not included in the cost of inventory. However, ICDS provides that if the inventory item meets the criterion for recognition of interest as a component of the cost as specified in ICDS IX relating to `Borrowing Costs interest and other borrowing costs are included as a part of cost of the inventory. 8. Exclusion from cost of inventories:- The following costs shall be excluded and recognised as expenses of the period in which they are incurred, namely Abnormal amounts of wasted materials, labour, or other production costs Storage costs, unless those costs are necessary in the production process prior to a further production stage Administrative overheads that do not contribute to bringing the inventories to their present location and condition Selling costs Note: ICDS II does not specifically refer to distribution costs, costs such as expenses incurred at distribution depots are excluded from the costs of inventory since these are not costs incurred in bringing the inventories to their present location and condition. 9. Cost Formulae:- The Cost of inventories of items - that are not ordinarily interchangeable, and goods or services produced and segregated for specific projects shall be assigned by specific identification of their individual costs. Under the above conditions, specific costs are attributed to specific or identified items of inventory. This is not common and has limited applicability. It is used only in special circumstances, for example in valuing inventory of paintings in an art gallery. It is used where goods or services have been specifically produced and segregated for specific project. Where there are a large numbers of items of inventory which are ordinarily interchangeable, specific identification of costs shall not be made. Note: Under specific identification of cost, specific costs are attributed to identified items of inventory. 10. First-in First-out and Weighted Average Cost Formula ICDS II recognises that inventory valuation involves the process of approximation and estimation. Cost of inventories, other than the inventory dealt with in paragraph 2.3.7.1, shall be assigned by using the First-in First-out (FIFO), or weighted average cost formula. The formula used shall reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition: (a) The FIFO formula assumes that the items of inventory which were purchased or produced first are consumed or sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced. (b) Under the weighted average cost formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average shall be calculated on a periodic basis, or as each additional shipment is received, depending upon the circumstances. 11. Techniques for the Measurement of Cost (1) Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate the actual cost. Standard costs take into account normal levels of consumption of materials and supplies, labour, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of the current conditions. (2) The retail method can be used in the retail trade for measuring inventories of large number of rapidly changing items that have similar margins and for which it is impracticable to use other costing methods. The cost of the inventory is determined by reducing from the sales value of the inventory, the appropriate percentage gross margin. The percentage used takes into consideration inventory, which has been marked down to below its original selling price. 12. Net Realisable Value:- Cost of inventory determined in accordance with ICDS should be compared with the NRV and lower of the two should be taken as the value of the inventory. ICDS requires that the comparison of cost and NRV should be done on item-by item basis and not globally. Where items of inventory' relating to the same product line having similar purposes or end uses and are produced and marketed in the same geographical area and cannot be practicably evaluated separately from other items in that product line, such inventories shall be grouped together and written down to net realisable value on an aggregate basis. Note: The assessee should consider and keep appropriate evidence based on which NRV was estimated. NRV is the estimated selling price in the ordinary course of business less the cost of completion and costs necessary to make sales. If the inventories are at various geographical locations and are expected to be sold there, NRV prevailing at each such location should be considered for comparing with the cost of inventory at such geographical location. NRV of work-in-progress should be estimated by taking estimated selling price of the finished goods less estimated cost to complete and costs necessary to make the sale. 13. Value of Opening Inventory :- The value of the inventory as on the beginning of the previous year shall be (i) the cost of inventory available, if any, on the day of the commencement of the business when the business has commenced during the previous year; and (ii) the value of the inventory as on the close of the immediately preceding previous year, in any other case 14. Change of Method of Valuation of Inventory:- ICDS prescribes that unless there is reasonable cause, the method of valuation of inventories once adopted by a person in any previous year shall not be changed. Reasonable cause is will depend on the circumstances. For example change in the applicable law necessitating a change, change in the nature of business, etc. 14. Valuation of Inventory in Case of Certain Dissolutions:- ICDS provides that in case of dissolution of a partnership firm, an association of persons or a body of individuals, the inventory on the date of dissolution shall be valued at the NRV. This is irrespective of the fact whether or not on dissolution the business of the entity is discontinued. 15. Disclosure:- The following aspects shall be disclosed, namely:- the accounting policies adopted in measuring inventories including the cost formulae used. Where Standard Costing has been used as a measurement of cost, details of such inventories and a confirmation of the fact that standard cost approximates the actual cost; and the total carrying amount of inventories and its classification appropriate to a person.