Inventory Valuation When Finished Goods Are Below Cost
At 31 March 2025, Sunrise Manufacturing holds four inventory categories. Raw material X cost ₹80,000; its current replacement cost is ₹70,000. It will be used to make finished goods whose expected selling price is ₹2,60,000 and estimated costs to complete and sell are ₹55,000. Finished goods already in hand cost ₹2,40,000 and their net realisable value is ₹2,20,000. Work-in-progress cost ₹1,20,000 includes an abnormal spoilage charge of ₹15,000; its net realisable value is ₹1,35,000. Stores and consumables cost ₹18,000 and will be consumed in production. The accountant proposes to value all inventory at cost because the firm is a going concern and expects no losses. The production manager argues that raw material should be written down only if its own replacement cost falls below cost; he is unsure about the finished goods and the abnormal spoilage.
1. Determine the value of closing inventory under AS 2. Show each category and the reason for any write-down.
Read the worked answer
Apply the lower of cost and net realisable value (NRV), category by category.
- Raw material X - ₹70,000. Raw material held for production is normally valued at cost, even if replacement cost falls. But an exception applies when the finished goods into which it will be converted are expected to be sold below cost. Finished goods NRV is ₹2,20,000 against cost ₹2,40,000, so the finished goods are loss-making. Raw material X must therefore be written down to its NRV/replacement cost of ₹70,000.
- Work-in-progress - ₹1,05,000. Cost ₹1,20,000 includes abnormal spoilage ₹15,000. Abnormal spoilage is not inventory cost; it is expensed. Normal WIP cost is ₹1,05,000, which is below NRV ₹1,35,000, so inventory is carried at ₹1,05,000.
- Finished goods - ₹2,20,000. Lower of cost ₹2,40,000 and NRV ₹2,20,000 = ₹2,20,000.
- Stores and consumables - ₹18,000. Held for production; cost is below any relevant realisable value, so carry at cost.
Total closing inventory = 70,000 + 1,05,000 + 2,20,000 + 18,000 = ₹4,13,000.
2. Evaluate the accountant’s going-concern argument and the production manager’s raw-material argument under AS 2.
Read the worked answer
Going concern does not justify carrying inventory above recoverable amount. AS 2 requires inventory to be measured at the lower of cost and NRV; a going-concern assumption does not override a known decline in selling prices or obsolescence. The accountant’s approach would overstate inventory and profit.
The production manager is only partly right. For raw material held for production, replacement cost alone is not the test. The relevant question is whether the finished goods made from that material can be sold at or above cost. Here finished goods NRV is ₹2,20,000 against cost ₹2,40,000, so the raw material must be written down. The abnormal spoilage is also not an inventory cost; it must be charged to profit or loss.