Inventory Valuation (Ind AS 2)
Inventory valuation under Ind AS 2 requires measuring inventories at the lower of cost and net realisable value (NRV), using either the First-In First-Out (FIFO) or weighted average cost formula — explicitly prohibiting the LIFO method used in some international jurisdictions.
Ind AS 2 (Inventories) governs how Indian listed companies measure and disclose inventory on the balance sheet. The standard prohibits LIFO (Last-In First-Out), which was permitted under Indian GAAP pre-2015 and is still allowed under US GAAP. This prohibition ensures Indian inventory figures are more comparable internationally and prevents the LIFO reserve manipulation that can occur when companies liquidate old LIFO layers during price downturns.
Cost of inventory under Ind AS 2 includes all costs of purchase (including import duties and non-recoverable taxes, minus trade discounts), costs of conversion (direct labour and allocated production overheads based on normal capacity), and other costs directly attributable to bringing inventory to its present location and condition. Idle capacity costs and abnormal waste are expensed, not capitalised into inventory.
The difference between FIFO and weighted average cost methods can meaningfully affect reported gross margins during periods of price volatility. In an inflationary commodity environment (steel, aluminium, chemicals), FIFO recognises older (lower-cost) inventory first, producing higher gross margins and inventory book values. Weighted average smooths the impact. Indian steel companies like JSW Steel and Tata Steel disclosed their inventory cost method, and analysts adjusted comparisons between companies using different methods during commodity price cycles.
Net realisable value (NRV) testing requires companies to write down inventory to NRV whenever NRV falls below cost. NRV = estimated selling price − estimated costs of completion and sale. In fashion retail, end-of-season markdown risk requires regular NRV assessment. For pharmaceutical companies, inventory with impending expiry dates requires NRV write-downs. Such write-downs directly reduce gross margins and in some quarters, several Indian pharmaceutical distributors recognised material NRV write-downs on drugs nearing expiry during the COVID-disrupted supply chain period.
Inventory disclosures in the notes to financial statements include the accounting policy for cost formula, carrying amount by category (raw materials, WIP, finished goods, consumables), amount recognised as expense during the period (COGS), and amount of any write-downs or reversals. Analysts use these disclosures to reconstruct inventory build-up trends, estimate COGS quality, and identify potential channel-stuffing practices in distribution-intensive businesses.