1.9       Query

Valuation of work-in-progress and finished goods.

1.A partnership firm, registered as a small-scale industrial unit, is engaged in the manufacture of consumer durables and dairy equipments. For its first accounting year ended 31^st August, 1982, the firm has valued its work-in-progress and finished goods at raw materials cost. The querist feels that this method of valuation is appropriate since, in the present case, only the raw materials cost varies in direct proportion to production; the other expenses, like the employees’ cost, rents, rates and taxes, depreciation, repairs and maintenance etc. being fixed in nature are period costs and should therefore be matched against the period’s income.

2.The querist has sought the opinion of the Expert Advisory Committee whether in the circumstances, the aforementioned method of valuation of work-in-progress and finished goods is appropriate.

                                                                   Opinion                                                     April 12, 1983

1. The Committee notes that Para 27 of Accounting Standard 2 of the Institute of Chartered Accountants of India on “Valuation of Inventories” provides that “the historical cost of manufactured inventories may be arrived at on the basis of either direct costing or absorption costing.” The Committee is of the view that this should be interpreted with reference to the following definitions of ‘historical cost’ and ‘cost of conversion’ given in the aforesaid Standard:

“6.2.            ‘Historical Cost’ represents an appropriate combination of the

                      a) cost of purchase;

                       b)            cost of conversion; and

                      c) other costs incurred in the normal course of business in bringing the inventories upto their present location and                       condition.”

                      “6.4            ‘Cost of Conversion’ consists of

                      i) costs which are specifically attributable to units of production, i.e., direct labour, direct expenses and sub-contracted                       work; and

                      ii) production overheads, ascertained in accordance with either the direct costing or absorption costing method.”

It is apparent from the above that historical cost of inventories always includes raw materials, direct labour and direct expenses. However, the production overheads should be ascertained and included in the historical costs on the basis of either direct costing or absorption costing.

2.The Committee is of the opinion that it is not proper to value work-in-progress and finished goods at raw materials cost. Therefore, the inventories of work-in-progress and finished goods should also include direct labour costs, other direct expenses and the relevant production overheads besides the raw materials cost when direct costing method is followed

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