Inventories are those assets that are:

(a) held for sale in the ordinary course of business;

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or the rendering of services.

The inventories are used by the entity for the production of any goods, rending any services, and sale & purchase in the ordinary course of business. This asset differs from the fixed asset.

For example- there is a merchant who is dealing with the ready-made clothes;he sells these clothes to the retailer. He purchases fabric, trims, and greige for the production of such ready-made garments. He has the stock of fabric, trims and greige then such stock will be known as inventory.

The inventory includes finished goods, raw materials, and work in progress.Inventories do not include machinery spares that are used irregularly.

Measurement and the valuation of the inventory

The inventories are valued at the cost or net realizable value (NRV) whichever is lower.

What is Net Realizable Value (NRV)

Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale i.e.

Estimated selling price                                                 : xxxx

Less: estimated costs of completion                          : xxxx

Less: estimated costs necessary to make the sale  : xxxx

Net Realizable Value (NRV)                                       : XXXX

What is the cost of inventory

The cost of the inventory includes-

Cost of purchase

Cost of conversion

Other costs, which are incurred in bringing the inventories to their present location and condition

Cost of the purchase– The costs of purchase of any goods will consist of the purchase price with duties and taxes other than those taxes and duties which are recoverable subsequently by the enterprise from the taxing authorities, freight inwards, and other expenditures which are directly related to the acquisition of the inventory. If there are any trade discounts, rebates, duty drawbacks, and other similar items then it will be reduced from the cost of purchase.

Cost of conversion– conversion cost of the inventories includes those costs which are directly related to the production of the goods just like direct material cost, direct labor cost, and other direct costs,and it also includes fixed and variable production overheads that are incurred in converting materials into finished goods.

Fixed overheads are those indirect costs that are incurred irrespective of production volume. Fixed overheads are those cost that remains constant regardless of the volume of production, just like the amount of depreciation, building maintenance cost, administration cost, etc. are the example of fixed overheads.

Variable overheads are those indirect costs incurred at the time of production and which vary directly with the volume of production. These costs are incurred based on the actual production just like packing materials, and indirect labour, etc.

Other costs– Other costs are those costs thatare incurred in bringing the inventories to their present location and condition.

What will exclude from the cost of inventory

When we will calculate the cost of the inventory then we will exclude certain costs and we will recognize these costs as an amount of the expense in the year in which it is incurred. The examples of these costs are-

(i) Selling and distribution costs.

(ii) Administrative overheads that do not contribute to bringing the inventories to their present location and condition

(iii) Administrative overheads that do not contribute to bringing the inventories to their present location and condition

(iv)Storage costs,which are necessary before the production.

Method of valuation of inventory

The cost of inventories of items is assigned by specific identification method. All other items cost are assigned by using the first-in, first-out (FIFO), or weighted average cost (WAC) formula.