Accounting Standard AS 2 Explained | Valuation of Inventories with Examples (2026)

Accounting Standard (AS) 2 – Valuation of Inventories Explained in Simple Words (2026 Guide)

Learn Accounting Standard (AS) 2 - Valuation of Inventories in simple language. Understand inventory valuation methods, FIFO, Weighted Average, Net Realisable Value (NRV), examples, and important exam & interview points.

Accounting Standard AS 2

• Valuation of Inventories

• AS 2 Explained

• Inventory Valuation Methods

• FIFO Method

• Weighted Average Method

• Net Realisable Value

• Inventory Accounting

• Accounting Standards India

• CA Inter AS 2

• B.Com Accounting Notes
  

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Accounting Standard (AS) 2 – Valuation of Inventories Explained in Simple Language

Inventory is one of the most important assets for every business. Whether you own a retail shop, manufacturing company, or wholesale business, inventory plays a major role in determining profit.

To ensure that every business values inventory correctly, the Institute of Chartered Accountants of India (ICAI) introduced Accounting Standard (AS) 2 – Valuation of Inventories.

This article explains AS 2 in easy words with practical examples.

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What is Accounting Standard (AS) 2?

Accounting Standard (AS) 2 provides the rules for valuing inventory in the financial statements.

Its main objective is to determine the correct value of inventory until it is sold.

In simple words,

AS 2 tells businesses how much value should be shown for stock in the Balance Sheet.

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What is Inventory?

Inventory means assets that are:

• Held for sale

• Under production

• Used in manufacturing

• Raw materials

• Finished goods

• Work-in-progress (WIP)

• Trading stock

Example

A mobile shop has:

• 100 mobile phones

• 50 chargers

• 40 headphones

These all are inventories.

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Objective of AS 2

The objective of AS 2 is to:

• Show the correct value of inventory.

• Calculate the actual cost of inventory.

• Avoid showing inventory at an inflated value.

• Present true financial statements.

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Scope of AS 2

AS 2 applies to almost every business that holds inventory.

However, it does not apply to:

• Construction contracts

• Financial instruments

• Shares held as stock-in-trade

• Agricultural products measured at NRV

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How Should Inventory be Valued?

According to AS 2,

Inventory should always be valued at the Lower of:

• Cost

• Net Realisable Value (NRV)

This is the most important rule of AS 2.

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What is Cost of Inventory?

Cost includes all expenses incurred to bring inventory to its present condition.

It consists of:

1. Cost of Purchase

Includes:

• Purchase price

• Import duty

• Freight charges

• Transportation

• Loading expenses

Less:

• Trade discount

• Rebates

Example

Purchase Price = ₹50,000

Freight = ₹2,000

Trade Discount = ₹1,000

Cost of Purchase = ₹51,000

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2. Cost of Conversion

Includes:

• Direct Labour

• Factory Wages

• Manufacturing Expenses

• Factory Overheads

These costs convert raw material into finished goods.

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3. Other Costs

Certain costs are included only if they help bring inventory to its present location.

Example:

• Product design costs

• Special packing

• Testing charges

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Costs NOT Included in Inventory

The following expenses are treated as period expenses:

• Abnormal wastage

• Storage expenses (unless necessary)

• Administrative expenses

• Selling expenses

• Advertisement

• Distribution expenses

• Interest cost (normally)

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Inventory Valuation Methods

AS 2 allows two methods.

1. FIFO (First In First Out)

Goods purchased first are assumed to be sold first.

The latest goods remain in inventory.

Example

Purchased:

100 units @ ₹100

100 units @ ₹120

Sold = 100 units

Cost of Goods Sold = ₹100 × 100

Closing Stock = ₹120 × 100

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2. Weighted Average Method

Average cost is calculated.

Formula:

Average Cost = Total Cost ÷ Total Units

Example

100 units @ ₹100

100 units @ ₹120

Total Cost = ₹22,000

Average Cost = ₹110

Every unit will be valued at ₹110.

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What is Net Realisable Value (NRV)?

NRV means:

Estimated Selling Price

Less:

• Cost to complete

• Selling expenses

Formula

NRV = Selling Price − Completion Cost − Selling Expenses

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Example

Selling Price = ₹500

Packing = ₹20

Commission = ₹30

NRV = ₹450

If Cost = ₹470

Inventory should be valued at ₹450.

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Lower of Cost or NRV Rule

Suppose

Cost = ₹100

NRV = ₹90

Inventory Value = ₹90

If

Cost = ₹100

NRV = ₹130

Inventory Value = ₹100

Always choose the lower value.

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Why is NRV Important?

Sometimes inventory loses value because of:

• Damage

• Expiry

• Technology changes

• Fashion changes

• Price reduction

AS 2 prevents businesses from showing unrealistic profits.

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Disclosure Requirements

Financial statements should disclose:

• Inventory valuation method

• Cost formula used

• Total inventory value

• Classification of inventory

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Practical Example

ABC Traders purchased:

Purchase = ₹5,00,000

Freight = ₹20,000

Trade Discount = ₹10,000

Total Cost

= ₹5,10,000

At year-end:

Cost = ₹5,10,000

NRV = ₹4,95,000

Inventory Value = ₹4,95,000

Loss = ₹15,000

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Advantages of AS 2

• Accurate inventory valuation

• Correct profit calculation

• Better financial reporting

• Prevents overstatement of assets

• Improves transparency

• Helps investors make informed decisions

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Common Mistakes Businesses Make

❌ Including selling expenses in inventory cost

❌ Ignoring freight charges

❌ Not calculating NRV

❌ Using incorrect valuation methods

❌ Overvaluing damaged stock

Avoiding these mistakes ensures compliance with AS 2.

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Important Exam and Interview Questions

What is AS 2?

AS 2 is the Accounting Standard that deals with valuation of inventories.

What is inventory?

Inventory includes raw materials, work-in-progress, finished goods, and goods held for sale.

What is NRV?

NRV is the estimated selling price minus completion and selling costs.

Which methods are allowed under AS 2?

• FIFO

• Weighted Average Cost

What is the golden rule of AS 2?

Inventory should always be valued at the lower of Cost and Net Realisable Value (NRV).

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Conclusion

Accounting Standard (AS) 2 is one of the most important accounting standards because inventory directly affects a company's profit and financial position. By valuing inventory at the lower of cost or Net Realisable Value (NRV), businesses can present fair, transparent, and reliable financial statements. Whether you are a student, accountant, business owner, or finance professional, understanding AS 2 helps improve financial reporting and supports better business decisions.

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Frequently Asked Questions (FAQs)

Q1. What is AS 2 in accounting?
AS 2 is the Accounting Standard that explains how inventories should be valued in financial statements.

Q2. What is the valuation rule under AS 2?
Inventory must be valued at the lower of Cost and Net Realisable Value (NRV).

Q3. Which inventory valuation methods are permitted under AS 2?
FIFO (First In, First Out) and Weighted Average Cost methods.

Q4. What is NRV?
Net Realisable Value is the estimated selling price minus the estimated costs to complete and sell the inventory.

Q5. Who should understand AS 2?
Students, accountants, auditors, business owners, finance professionals, and anyone involved in preparing financial statements.

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