{"id":1118,"date":"2025-11-23T16:03:47","date_gmt":"2025-11-23T16:03:47","guid":{"rendered":"https:\/\/carohitsethi.com\/?p=1118"},"modified":"2025-11-25T18:00:05","modified_gmt":"2025-11-25T18:00:05","slug":"as-2-explained-lower-of-cost-nrv-a-complete-guide","status":"publish","type":"post","link":"https:\/\/carohitsethi.com\/index.php\/2025\/11\/23\/as-2-explained-lower-of-cost-nrv-a-complete-guide\/","title":{"rendered":"AS 2 Explained: Lower of Cost &amp; NRV \u2013 A Complete Guide"},"content":{"rendered":"\n<p>Inventory forms a major part of assets for most businesses \u2014 especially retail, manufacturing, and trading firms.<br>If inventory is valued incorrectly:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Profit becomes wrong<\/li>\n\n\n\n<li>Balance Sheet becomes misleading<\/li>\n\n\n\n<li>Taxation gets affected<\/li>\n<\/ul>\n\n\n\n<p>To avoid this, AS 2 lays down clear rules on how inventory should be valued and what costs must be included or excluded.<\/p>\n\n\n\n<p><strong>In simple words:<br><\/strong>AS 2 tells us \u2014 \u201cValue inventory at the right cost, using the right method, consistently.\u201d<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Objective of AS 2<\/h2>\n\n\n\n<p>To prescribe the accounting treatment for inventories, including:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>How to calculate the cost of inventories<\/li>\n\n\n\n<li>How to value them at the lower of cost and net realisable value (NRV)<\/li>\n\n\n\n<li>Which items to include and exclude from inventory cost<\/li>\n<\/ul>\n\n\n\n<figure class=\"wp-block-embed is-type-video is-provider-youtube wp-block-embed-youtube wp-embed-aspect-16-9 wp-has-aspect-ratio\"><div class=\"wp-block-embed__wrapper\">\n<p class=\"responsive-video-wrap clr\"><iframe title=\"AS-2 Made Easy: Quick Revision of Accounting Standards! - #CAROHITSETHI\" width=\"1200\" height=\"675\" src=\"https:\/\/www.youtube.com\/embed\/78p7thFzNU8?list=PLsLrN2ClWutyswN9be8Urss8V2w-QTz9X\" frameborder=\"0\" allow=\"accelerometer; autoplay; clipboard-write; encrypted-media; gyroscope; picture-in-picture; web-share\" referrerpolicy=\"strict-origin-when-cross-origin\" allowfullscreen><\/iframe><\/p>\n<\/div><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\">Meaning of Inventory<\/h2>\n\n\n\n<p>Inventory includes:<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>Items held for sale (finished goods)<\/li>\n\n\n\n<li>Items in the process of production (work-in-progress)<\/li>\n\n\n\n<li>Materials and supplies consumed in production (raw materials)<\/li>\n<\/ol>\n\n\n\n<h2 class=\"wp-block-heading\">Valuation Rule (Golden Rule of AS 2)<\/h2>\n\n\n\n<p>Inventory is valued at Lower of Cost and NRV.<\/p>\n\n\n\n<p>This ensures profits are not overstated.<\/p>\n\n\n\n<h4 class=\"wp-block-heading\">What is Cost of Inventory?<\/h4>\n\n\n\n<p>Cost includes three major components:<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>Cost of Purchase\n<ul class=\"wp-block-list\">\n<li>Purchase price<\/li>\n\n\n\n<li>Import duty<\/li>\n\n\n\n<li>Taxes (except GST refundable)<\/li>\n\n\n\n<li>Freight inward<\/li>\n\n\n\n<li>Trade discounts deducted<\/li>\n<\/ul>\n<\/li>\n\n\n\n<li>Cost of Conversion\n<ul class=\"wp-block-list\">\n<li>Direct labour<\/li>\n\n\n\n<li>Direct expenses<\/li>\n\n\n\n<li>Production overheads:<\/li>\n\n\n\n<li>Fixed OH allocated on normal capacity<\/li>\n\n\n\n<li>Variable OH allocated on actual production<\/li>\n<\/ul>\n<\/li>\n\n\n\n<li>Other Costs<\/li>\n<\/ol>\n\n\n\n<p>Only if necessary to bring inventory to its location and condition.<\/p>\n\n\n\n<p><strong>Costs Excluded from Inventory (Must Be Expensed)<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Abnormal wastage<\/li>\n\n\n\n<li>Storage costs (unless part of production process)<\/li>\n\n\n\n<li>Administrative overheads not related to production<\/li>\n\n\n\n<li>Selling &amp; distribution costs<\/li>\n\n\n\n<li>Interest &amp; finance charges<\/li>\n<\/ul>\n\n\n\n<p><strong>Students often forget:<br><\/strong>Interest is never included in inventory cost.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Methods of Valuation Accepted under AS 2<\/h2>\n\n\n\n<p><strong>AS 2 allows consistent use of:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>FIFO (First In First Out)<\/li>\n\n\n\n<li>Weighted Average Cost Method<\/li>\n<\/ul>\n\n\n\n<p><strong>Not Allowed:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>LIFO (Last In First Out)<\/li>\n\n\n\n<li>Base stock method<\/li>\n\n\n\n<li>Any method resulting in unrealistically low or high value<\/li>\n<\/ul>\n\n\n\n<h4 class=\"wp-block-heading\">Numerical Example (Very Important for Exams)<\/h4>\n\n\n\n<p><strong>Example:<\/strong> FIFO vs Weighted Average<\/p>\n\n\n\n<p><strong>A company purchases:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>100 units @ \u20b910<\/li>\n\n\n\n<li>100 units @ \u20b912<\/li>\n\n\n\n<li>Issues 120 units<\/li>\n<\/ul>\n\n\n\n<h5 class=\"wp-block-heading\">FIFO Method<\/h5>\n\n\n\n<p>Issue:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>100 units \u00d7 \u20b910 = \u20b91,000<\/li>\n\n\n\n<li>20 units \u00d7 \u20b912 = \u20b9240<\/li>\n<\/ul>\n\n\n\n<p>Cost of Issue = \u20b91,240<\/p>\n\n\n\n<p>Closing Stock = 80 units \u00d7 \u20b912 = \u20b9960<\/p>\n\n\n\n<h5 class=\"wp-block-heading\">Weighted Average Method<\/h5>\n\n\n\n<p>Total cost = 100\u00d710 + 100\u00d712 = \u20b92,200<br>Avg rate = 2,200 \/ 200 = \u20b911 per unit<br>Issue = 120 \u00d7 \u20b911 = \u20b91,320<br>Closing Stock = 80 \u00d7 11 = \u20b9880<\/p>\n\n\n\n<p>Notice how valuation methods impact profit and stock value.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">What is NRV?<\/h2>\n\n\n\n<p>NRV (Net Realisable Value) = Selling Price \u2212 Selling Expenses \u2212 Completion Cost<\/p>\n\n\n\n<p>If NRV &lt; Cost \u2192 Value at NRV<br>If NRV \u2265 Cost \u2192 Value at Cost<\/p>\n\n\n\n<h4 class=\"wp-block-heading\">Special Cases under AS 2<\/h4>\n\n\n\n<p>&#8211;<strong>Raw Materials<\/strong>:<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li><\/li>\n<\/ol>\n\n\n\n<p><strong>If NRV of finished goods \u2265 cost \u2192<br><\/strong>Raw material valued at cost<\/p>\n\n\n\n<p><strong>If NRV of finished goods &lt; cost \u2192<br><\/strong>Raw material valued at replacement cost<\/p>\n\n\n\n<p>&#8211;<strong>Work-in-Progress:<\/strong><\/p>\n\n\n\n<ol start=\"2\" class=\"wp-block-list\">\n<li><\/li>\n<\/ol>\n\n\n\n<p>Include:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Materials<\/li>\n\n\n\n<li>Labour<\/li>\n\n\n\n<li>Proportionate overheads<\/li>\n<\/ul>\n\n\n\n<p>Exclude:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Storage, abnormal losses<\/li>\n<\/ul>\n\n\n\n<p>&#8211;<strong>By-Products \/ Scrap:<\/strong><\/p>\n\n\n\n<ol start=\"3\" class=\"wp-block-list\">\n<li><\/li>\n<\/ol>\n\n\n\n<p>Value them at NRV and reduce cost of production.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\">Disclosure Requirements<\/h2>\n\n\n\n<p><strong>A business must disclose:<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Accounting policy for inventory valuation<\/li>\n\n\n\n<li>Formula\/method used (FIFO or Weighted Average)<\/li>\n\n\n\n<li>Classification of inventory (FG, WIP, Raw Materials)<\/li>\n<\/ul>\n\n\n\n<p><strong>Common Exam Mistakes<\/strong><\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Confusing cost and NRV<\/li>\n\n\n\n<li>Including abnormal losses in inventory cost<\/li>\n\n\n\n<li>Forgetting that fixed overheads are allocated on normal capacity<\/li>\n\n\n\n<li>Including interest in inventory cost<\/li>\n\n\n\n<li>Using LIFO (strictly not allowed)<\/li>\n<\/ul>\n\n\n\n<h4 class=\"wp-block-heading\">Exam Tip<\/h4>\n\n\n\n<p>A very common exam question:<\/p>\n\n\n\n<p>\u201cExplain how fixed overheads are allocated in inventory valuation.\u201d<\/p>\n\n\n\n<p><strong>Correct answer:<br><\/strong>On the basis of normal capacity, not actual production.<\/p>\n\n\n\n<h5 class=\"wp-block-heading\">Motivational Note<\/h5>\n\n\n\n<p>\u201cInventory is like blood in a business. If it\u2019s valued wrongly, everything else becomes unhealthy.\u201d \u2013 CA Rohit Sethi<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Inventory forms a major part of assets for most businesses \u2014 especially retail, manufacturing, and trading firms.If inventory is valued incorrectly: To avoid this, AS 2 lays down clear rules on how inventory should be valued and what costs must be included or excluded. In simple words:AS 2 tells us \u2014 \u201cValue inventory at the [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":1119,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[24],"tags":[],"class_list":["post-1118","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-ca-intermediate","entry","has-media","owp-thumbs-layout-horizontal","owp-btn-normal","owp-tabs-layout-horizontal","has-no-thumbnails","has-product-nav"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.6 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>AS 2 Explained: Lower of Cost &amp; NRV \u2013 A Complete Guide - carohitsethi<\/title>\n<meta name=\"description\" content=\"A complete and simple guide to AS 2 \u2013 Valuation of Inventories. 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