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Inventories are assets:

(a) Held for sale in the ordinary course of business


(b) In the process of production for such sale

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

Inventories encompass goods purchased and held for resale, for example, merchandise purchased by a retailer and held for resale, computer software held for resale, or land and other property held for resale. Inventories also encompass finished goods produced, or work in progress being produced, by the enterprise and include materials, maintenance supplies, consumables and loose tools awaiting use in the production process. Inventories do not include machinery spares which can be used only in connection with an item of fixed asset and whose use is expected to be irregular; such machinery spares are accounted for in accordance with Accounting Standard (AS) 10, Accounting for Fixed Assets.

The inventories of a trading concern primarily consist of the finished goods purchased for resale, whereas the inventories of a manufacturing concern consist of raw-materials, work-in-progress, finished goods, stores and spares. The significance of valuation of inventory arises mainly because it serves two purposes (a) To determine true income and (b) To determine true financial position.

Meaning of Cost for Inventory Valuation

For inventory valuation, cost may mean historical, current (replacement) or standard cost. Historical cost represents the cost actually incurred at the date of acquisition. Current replacement cost represents the replacement price on the date of its consumption. Standard cost represents the pre-determined cost that should be incurred at a given level of efficiency and capacity utilization. But with regard to the objectivity, verifiability and effectiveness in line with the realisation concept, the historical cost basis is almost universally accepted and used. Historical cost represents an appropriate combination of:


(a) The cost of purchase

(b) The cost of conversion

(c) The other costs incurred in the normal course of business in bringing the inventories up to their    present location and condition.

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