📘 Nepal Accounting Standard (NAS) 2: Inventories || CA Cap-II Notes

1. Scope

NAS 2 applies to all inventories, except:

• Work in progress under construction contracts (→ NAS 11 Construction Contracts).
• Financial instruments (→ NAS 32, NAS 39).
• Biological assets related to agriculture & agricultural produce at harvest (→ NAS 41).

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2. Definitions

(a) Inventories

Assets:

1. Held for sale in the ordinary course of business (Finished goods).
2. In process of production for sale (Work-in-progress).
3. In the form of materials/supplies to be consumed in production (Raw materials).

(b) Net Realisable Value (NRV)

= Estimated Selling Price – (Cost of Completion + Selling Costs)

👉 Represents the expected selling price in normal course of business.

(c) Fair Value

= Price that would be received to sell an asset in an orderly transaction between market participants at measurement date.

🚨 Difference: NRV = Entity-specific; Fair Value = Market-based.

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3. Measurement of Inventory

📌 Inventories are measured at the Lower of:

• Cost, or
• Net Realisable Value (NRV).

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4. Cost of Inventories

👉 Inventory Cost = Costs of Purchase + Costs of Conversion + Other Costs

1. Costs of Purchase

These are costs incurred to acquire inventory:

• Purchase price
• Import duty & non-refundable taxes
• Freight inwards & transport
• Insurance during transit
• Handling charges
  Less: Trade discounts, rebates, subsidies

📊 Example:
Invoice price = Rs. 1,00,000

• Import duty = Rs. 10,000
• Freight inwards = Rs. 5,000
  – Trade discount = Rs. 5,000
  Cost of Purchase = Rs. 1,10,000

2. Costs of Conversion

Costs incurred to convert raw materials → finished goods.

(a) Direct Costs

• Direct wages
• Direct expenses (e.g., power for machines)

(b) Production Overheads

• Variable OH → Allocated based on actual production.
• Fixed OH → Allocated on the basis of normal capacity.
• Unabsorbed portion (if production < normal capacity) → charged to P&L.

📊 Example:
Direct Wages = Rs. 50,000
Variable OH = Rs. 30,000
Fixed OH = Rs. 1,00,000
Normal capacity = 10,000 units; Actual = 8,000 units
Absorbed Fixed OH = (1,00,000 ÷ 10,000) × 8,000 = Rs. 80,000
Unabsorbed = Rs. 20,000 → P&L

Cost of Conversion = 50,000 + 30,000 + 80,000 = Rs. 1,60,000

3. Other Costs

Include only costs that bring inventories to present location & condition. Examples:

• Product design cost for specific customer
• Packing cost (if necessary for production/sale)
• Storage cost (only if necessary in production, e.g., aging of wine)

❌ Exclude abnormal waste, selling costs, general admin, interest.

📊 Format to Calculate Cost of Inventory

Particulars	Amount (Rs.)
A. Costs of Purchase
Purchase price	xx
+ Import duties & non-refundable taxes	xx
+ Freight & handling charges	xx
– Trade discounts/rebates	(xx)
Total Costs of Purchase (A)	xx
B. Costs of Conversion
Direct labour	xx
+ Direct expenses	xx
+ Variable production overheads	xx
+ Allocated fixed production overheads	xx
Total Costs of Conversion (B)	xx
C. Other Costs
Design / production-related costs	xx
Packing cost (if necessary)	xx
Total Other Costs (C)	xx
Total Cost of Inventories (A+B+C)	xx

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5. Costs Excluded (Expensed Directly)

❌ Abnormal waste of material, labour, overhead.
❌ Storage costs (unless necessary in production).
❌ Selling & distribution costs.
❌ Administrative overheads not related to production.
❌ Interest/borrowing cost (except qualifying assets under NAS 23).

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6. Allocation of Fixed Overheads

👉 Fixed overheads = Costs that remain relatively constant regardless of production volume (e.g., factory rent, supervisor salary, machine depreciation).

🔑 Rule:

• Allocate based on normal capacity (average/expected production over a period, considering downtime, maintenance, demand fluctuations).
• Do not artificially inflate or deflate per-unit costs when production varies.

1. If Actual Production = Normal Capacity

👉 No problem. Fixed OH is fully absorbed.

📊 Example:

• Fixed OH = Rs. 1,00,000
• Normal Capacity = 10,000 units
• Actual = 10,000 units

Absorption rate = 1,00,000 ÷ 10,000 = Rs. 10 per unit
Total absorbed = Rs. 1,00,000
(No over/under absorption)

2. If Actual Production > Normal Capacity

👉 Absorb only up to normal level.
👉 The “extra” fixed OH is not absorbed into inventory → charged as expense in P&L.

📊 Example:

• Fixed OH = Rs. 1,00,000
• Normal Capacity = 10,000 units
• Actual = 12,000 units

Absorption rate = 1,00,000 ÷ 10,000 = Rs. 10 per unit
Applied to 12,000 units = Rs. 1,20,000 → but only Rs. 1,00,000 can be absorbed.

⚡ Excess Rs. 20,000 = expensed in P&L (not included in inventory).

3. If Actual Production < Normal Capacity

👉 Allocate fixed OH based on actual production, but do not increase the per-unit cost beyond normal rate.
👉 Any under-absorbed OH → charged to P&L.

📊 Example:

• Fixed OH = Rs. 1,00,000
• Normal Capacity = 10,000 units
• Actual = 8,000 units

Normal absorption rate = 1,00,000 ÷ 10,000 = Rs. 10 per unit
Applied to 8,000 units = 8,000 × 10 = Rs. 80,000

⚡ Unabsorbed Rs. 20,000 → charged to P&L.
📌 Important: We don’t increase rate to Rs. 12.5 (1,00,000 ÷ 8,000) because that would artificially inflate inventory value.

📊 Tabular Illustration

Scenario	Fixed OH	Normal Capacity (units)	Actual Production (units)	Absorption Rate (Rs./unit)	Absorbed OH	Unabsorbed/Excess OH
Actual = Normal	1,00,000	10,000	10,000	10	1,00,000	Nil
Actual > Normal	1,00,000	10,000	12,000	10	1,00,000	20,000 (expense)
Actual < Normal	1,00,000	10,000	8,000	10	80,000	20,000 (expense)

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7. Deferred Settlement Terms

👉 When inventories are bought with deferred payment terms (credit period longer than normal), the difference between:

• Purchase price under normal credit terms (cash price), and
• Amount actually payable (including the extra for long credit period)

…is not included in inventory cost.

Instead:

• Inventory → recorded at cash price equivalent
• Extra amount (interest component) → recognized separately as finance/interest expense in P&L over the credit period

📊 Example 1: Normal vs Deferred Payment

• Normal credit price (cash price) = Rs. 100,000
• Supplier offers 2 years deferred payment = Rs. 120,000

➡️ Inventory recognized at Rs. 100,000 (not 120,000)
➡️ Extra Rs. 20,000 → interest expense allocated over 2 years (Rs. 10,000 each year).

📊 Example 2: Import with Extended Credit

Suppose a company imports raw material:

• CIF Price (normal cash price) = Rs. 5,00,000
• Payment after 3 years = Rs. 6,50,000

➡️ Inventory recorded = Rs. 5,00,000
➡️ Finance expense = Rs. 1,50,000 spread across 3 years (Rs. 50,000/year).

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8. Treatment of Settlement Discount

• If settlement discount is received (early payment benefit),
  👉 Deduct it from purchase cost of inventory.

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9. Joint Products, By-products & Scrap

 (a) Definitions

1. Joint Products
• Two or more products of significant value produced simultaneously from the same process or input.
• Example: Crude oil refining → produces petrol, diesel, kerosene.
2. By-products
• Secondary products of minor value compared to main products.
• Example: Sawdust from timber industry; Molasses from sugar manufacturing.
3. Scrap
• Residual waste material with very small value.
• Example: Metal shavings in a machine shop.

(b) Allocation of Joint Costs

👉 When several products are produced from a common process, the joint costs (e.g., material, labor, overhead before split-off point) must be allocated.

Common Methods:

1. Relative Sales Value at Split-off → Allocate based on proportion of sales value.
2. Net Realizable Value (NRV) method → Deduct further processing cost, then allocate.
3. Physical Measure (e.g., weight, volume, units) → less common.

(c) Treatment of Immaterial By-products

• If by-product value is immaterial →
  Value them at NRV and deduct from joint cost.
• This reduces cost of main product(s).

📊 Illustrations

Illustration 1: Joint Cost Allocation (Sales Value Method)

• Joint cost = Rs. 1,00,000
• Output:
• Product A (Sales Value Rs. 80,000)
• Product B (Sales Value Rs. 20,000)

👉 Total Sales Value = 1,00,000

Allocation:

• A = (80,000 ÷ 1,00,000) × 1,00,000 = Rs. 80,000
• B = (20,000 ÷ 1,00,000) × 1,00,000 = Rs. 20,000

Illustration 2: By-product NRV Deduction (Immaterial Value)

• Joint cost = Rs. 1,00,000
• Main product = Rs. 80,000
• By-product = Rs. 20,000
• By-product NRV = Rs. 5,000

👉 Treatment:

• Deduct NRV of by-product (5,000) from joint cost.
• Net joint cost = 1,00,000 – 5,000 = Rs. 95,000
• Entire Rs. 95,000 allocated to Main product A.

So,

• Main Product A = Rs. 95,000
• By-product B = Rs. 5,000 (NRV → directly recorded in income).

Illustration 3: Scrap

• Scrap metal sold for Rs. 1,000
• Treatment: Credit scrap value (1,000) to factory overheads or deduct from joint cost.

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10. Techniques for Measurement of Cost

NAS 2 allows certain techniques to estimate inventory cost when direct tracking is impractical. The two main techniques are:

1. Standard Cost Method

Definition:

• Inventory cost is calculated using predetermined standard rates for materials, labour, and overheads.
• Standards reflect normal levels of consumption and efficiency.
• Periodically revised to reflect actual costs.

Key Points:

• Useful when inventory is produced continuously or in large quantities.
• Variances (difference between standard cost and actual cost) are analyzed separately:
• Material Variance → price & usage differences
• Labour Variance → efficiency & rate differences
• Overhead Variance → fixed & variable differences

Example:

• Standard cost of 1 unit =
• Materials = Rs. 50
• Labour = Rs. 20
• Overhead = Rs. 10
• Total standard cost/unit = Rs. 80
• Produced 1,000 units → Standard Inventory Cost = 1,000 × 80 = Rs. 80,000
• Actual cost = Rs. 82,000 → Rs. 2,000 variance analyzed separately

2. Retail Price Method

Definition:

• Inventory cost is estimated by reducing the selling price by the gross profit margin.
• Commonly used by retail businesses where inventory is difficult to track individually (e.g., supermarkets, clothing stores).

Formula:

Steps:

1. Record inventory at retail price (selling price)
2. Calculate cost-to-retail ratio (COGS ÷ retail value of goods available)
3. Apply ratio to inventory at retail → estimate inventory at cost

Example:

• Goods available for sale:
• Cost = Rs. 3,00,000
• Retail price = Rs. 4,00,000
• Cost-to-Retail Ratio = 3,00,000 ÷ 4,00,000 = 0.75
• Closing inventory at retail = Rs. 50,000
• Inventory at cost = 50,000 × 0.75 = Rs. 37,500

11. Cost Formula

(a) Specific Identification

• Used for non-interchangeable items (e.g., cars, jewelry).

(b) Interchangeable Goods

When inventory items are similar or interchangeable (e.g., bulk raw materials, identical products), NAS 2 allows cost formulas to assign cost to inventory and COGS.

1. FIFO (First-In, First-Out)

Definition:

• Assumes that oldest inventory (first purchased/produced) is sold first.
• Closing inventory consists of the most recent purchases/production.

Example:

Date	Units Purchased	Unit Cost (Rs.)	Total Cost (Rs.)
Jan 1	100	50	5,000
Jan 5	100	55	5,500
Jan 10	100	60	6,000

• Total Units = 300
• Sold 180 units → COGS = 100×50 + 80×55 = 9,400
• Closing Inventory = 20×55 + 100×60 = 11,000

2. Weighted Average Cost (WAC)

Definition:

• Assigns a weighted average cost to all units available during the period.
• Closing inventory and COGS valued at same average cost per unit.

Formula:

Example:

Date	Units Purchased	Unit Cost (Rs.)	Total Cost (Rs.)
Jan 1	100	50	5,000
Jan 5	100	55	5,500
Jan 10	100	60	6,000

• Total Units = 300
• Total Cost = 5,000 + 5,500 + 6,000 = 16,500
• Weighted Average Cost per Unit = 16,500 ÷ 300 = 55
• Sold 180 units → COGS = 180 × 55 = 9,900
• Closing Inventory = 120 × 55 = 6,600

❌ LIFO not allowed under NAS 2.

(c) Change of Method

• From FIFO to Weighted Average allowed if results in better presentation & disclosure required.

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12. Net Realisable Value (NRV)

(a) NRV vs Fair Value

• NRV: Selling price – costs of completion & selling.
• Fair value: Market-based exit price.

(b) Item by Item Approach

• Each item valued separately → cannot offset one item’s loss against another’s profit.

(c) Raw Material & Supplies

1. Finished Goods Expected to Sell at Cost or Above

Rule:

·         Raw materials can be recorded at cost.

·         Reason: The cost of raw material will be fully recovered in the sale of finished goods.

Example:

·         Raw material cost = Rs. 50,000

·         Expected finished goods sale price = Rs. 80,000

·         Expected cost of finished goods = Rs. 60,000

✅ Since finished goods will sell at cost or above, raw material is recorded at Rs. 50,000 (cost).

2. Finished Goods Expected to Sell Below Cost

Rule:

·         Raw materials must be written down to NRV.

·         Reason: If finished goods are sold below cost, some raw material cost cannot be recovered → reduce inventory value to NRV.

Example:

·         Raw material cost = Rs. 50,000

·         Finished goods expected cost = Rs. 60,000

·         Expected sale price = Rs. 55,000

·         NRV of finished goods = Rs. 55,000

·         Raw material proportion = (50,000 ÷ 60,000) × 55,000 = Rs. 45,833

⚡ Raw material written down from Rs. 50,000 → Rs. 45,833

🔑 Key Points

Situation	Valuation of Raw Material
Finished goods expected to sell ≥ cost	Keep at cost
Finished goods expected to sell < cost	Write down to NRV (recoverable portion)

(d) Events After Reporting Period

Definition:

·         Events after the reporting period are events that occur between the balance sheet date and the date when financial statements are authorized for issue.

·         Some of these events provide evidence about the inventory value at the balance sheet date.

1. Sale After Year-End as Evidence

Rule (NAS 2):

·         If inventory is sold after the balance sheet date at a price lower than cost, this is considered evidence that NRV at the balance sheet date was lower than cost.

·         Inventory must then be written down to NRV at the reporting date.

Example 1: Finished Goods Sale After Year-End

·         Balance Sheet Date: 31 Dec 2025

·         Inventory Cost: Rs. 100,000

·         January 2026: Inventory sold for Rs. 90,000

Analysis:

·         The sale shows that the recoverable amount at 31 Dec 2025 was likely ≤ Rs. 90,000

·         Adjust Inventory value at 31 Dec 2025 = Rs. 90,000 (write-down of Rs. 10,000)

Example 2: Multiple Units

·         Inventory: 500 units × Rs. 200/unit = Rs. 1,00,000

·         After year-end, 100 units sold at Rs. 180/unit → indicates NRV < cost

·         NRV for sold portion = Rs. 18,000

·         Write-down inventory = (Cost – NRV for sold portion) = (100 × 200 – 100 × 180) = Rs. 2,000

Remaining inventory (400 units) → assessed separately for NRV

🔑 Key Points

1.       Post-year-end sale at lower price → NRV at reporting date must be adjusted downward.

2.       Post-year-end sale at higher price → No upward adjustment allowed (cannot inflate inventory above cost).

3.       Ensures conservatism principle: inventory not overstated.

(e) Firm Sales Contracts

• If contract price < cost → inventory valued at contract price (NRV evidence).

(f) Review of NRV

• At each reporting date, reassess NRV.
• If write-down reasons no longer exist → reversal allowed (up to original cost).

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13. Disclosure Requirements

Financial statements must disclose:

• Accounting policies for inventory measurement.
• Cost formula used (FIFO / WAC).
• Total carrying amount of inventories, classified as:
• Raw materials
• Work in progress
• Finished goods
• Stores/spares
• Amount of inventory recognized as expense (COGS).
• Write-downs and reversals.

📊 Example of Disclosure Table:

Particulars	Amount (Rs.)
Raw Materials	50,000
WIP	30,000
Finished Goods	70,000
Spares & Consumables	20,000
Total Inventory	1,70,000

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🔑 Quick Exam Capsule

• Rule: Inventory = Lower of Cost or NRV.
• Methods: FIFO, WAC, Specific. (LIFO ❌)
• Exclusion: Abnormal cost, selling cost, admin, interest.
• NRV ≠ Fair Value (entity-specific vs market-based).
• By-product: Deduct NRV from main product cost.
• Reversal allowed if NRV increases later.

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