AS 2 (Valuation of Inventories) is the Indian Accounting Standard that prescribes how entities must account for and value inventories in their financial statements. It requires inventories to be measured at the lower of cost and net realisable value and sets out the permitted cost formulas.

The Ministry of Corporate Affairs notified revised AS 2 through the Companies (Accounting Standards) Amendment Rules, 2016. The standard applies for accounting periods beginning on or after 1 April 2017. It supersedes the original AS 2 issued in 1999.

For FY 2026-27, aggressive net realisable value (NRV) testing remains critical in industries like pharmaceuticals where inventory shelf life is limited. Entities must write down near-expiry stock to its estimated salvage value at each reporting date.

AS 2 at a Glance

AS 2 sets out the core principle that inventories must be valued at the lower of cost and net realisable value. This standard is primarily used by non-Ind AS companies across manufacturing, trading and service sectors in India.

What is AS 2: Valuation of Inventories?

AS 2 prescribes how an entity must determine the cost of inventories and measure them in its financial statements. The standard requires inventories to be valued at the lower of actual cost or their net realisable value at each reporting date.

ICAI introduced this standard to ensure uniformity in inventory valuation practices across Indian companies. The revised version aligns more closely with international standards such as IAS 2 issued by the International Accounting Standards Board (IASB), although certain differences remain.

Accountants, statutory auditors, CFOs and finance teams in non-Ind AS companies rely on this standard when preparing annual financial statements or conducting statutory audits.

Objective of AS 2

The objectives of AS 2 are:

• Prescribe the accounting treatment for inventories.
• Provide guidance on determination of inventory cost and its subsequent recognition as an expense.
• Lay down principles for measurement at the lower of cost and net realisable value.
• Specify disclosures relating to inventories in financial statements.

These objectives support faithful representation of inventory balances in accordance with Section 129 of the Companies Act, 2013. Accurate inventory valuation is essential for presenting a true and fair view and ensuring comparability across reporting periods.

Who Must Apply AS 2?

Entities covered, applicability table

AS 2 applies to all companies classified as Level I, Level II or Level III non-Ind AS enterprises under ICAI’s SME classification. Any company not required to adopt Ind AS must comply with this standard for inventory accounting.

Companies following Ind AS must apply Ind AS 2 instead. For construction contracts or specific assets like biological assets or financial instruments held as stock-in-trade, other standards apply as detailed below.

Scope exclusions

The following items are excluded from the scope of AS 2:

• Work-in-progress arising under construction contracts (covered by AS 7).
• Work-in-progress in the ordinary course of business for service providers.
• Shares, debentures and other financial instruments held as stock-in-trade.
• Producers’ inventories of livestock, agricultural/forest products or mineral oils/ores/gases measured at NRV under industry practice.

When the standard does not apply

Work-in-progress from construction contracts falls under AS 7. Service WIP is outside scope; shares/debentures as stock-in-trade are governed by relevant RBI/SEBI norms. Agricultural produce measured at NRV is scoped out; refer to industry-specific guidance or Ind AS 41 where applicable.

Key Definitions under AS 2

Recognition and Measurement under AS 2

When to recognise

An entity recognises inventories when it obtains control over goods, typically upon physical receipt or completion of production activities. The carrying amount is recognised as an expense in the period when related revenue from sale is recognised or when abnormal loss occurs.

Initial measurement

At initial recognition, inventories are measured at cost comprising:

**Cost = Costs of purchase + Costs of conversion + Other costs incurred to bring inventory to present location and condition**

Costs of purchase include purchase price, non-recoverable taxes/duties, freight inward and other directly attributable costs less trade discounts/rebates received.

Costs of conversion include direct labour plus systematic allocation of fixed/variable production overheads based on normal capacity utilisation levels.

Other costs may include design costs specific to customer requirements but exclude selling/distribution expenses and abnormal wastage, these are expensed as incurred.

Borrowing costs can only be included if they meet capitalisation criteria specified under AS 16 Borrowing Costs, for example, qualifying assets taking substantial time to get ready for sale.

Subsequent measurement

At every reporting date (quarterly/year-end), an entity measures inventories at the lower of cost or net realisable value (NRV). NRV represents expected selling price less estimated completion/selling expenses.

If NRV falls below cost due to damage, obsolescence or declining prices, as often seen with slow-moving goods, the entity must write down inventory value accordingly. This write-down is recognised immediately as an expense in profit or loss per Para 26(d).

Where circumstances causing a previous write-down no longer exist, such as market recovery, reversal up to original cost is permitted per Para 26(e).

Testing must occur item-by-item unless grouping is justified by similarity/nature/use, blanket write-downs across categories are not permitted unless clearly warranted by facts.

Cost Formulas, FIFO and Weighted Average

For interchangeable items such as raw materials or finished goods batches, only two cost formulas are permitted:

FIFO: Items purchased first are assumed sold first; closing stock comprises most recent purchases.

> Example: If steel coils bought in April/October/February at rising prices remain unsold at year-end, the February batch forms closing stock under FIFO.

. LIFO is not permitted under any circumstance.

Weighted Average Cost computes per-unit cost as a weighted average throughout the period, suited where large volumes make FIFO tracking impractical.

Specific identification applies only where items are not interchangeable or segregated for particular projects/contracts, such as custom machinery components ordered for a specific client order.

Entities must consistently apply chosen formula across all similar-nature/use inventories within a reporting period per Para 24(b).

Worked Examples on AS 2

Example 1: NRV write-down on slow-moving finished goods

Krishna Steel Industries holds closing finished goods inventory comprising cold‑rolled steel,1,000 MT purchased/manufactured at Rs 60,000 per MT during FY 2025‑26. At year-end market prices drop sharply; management estimates likely selling price at Rs 55,000 per MT with Rs 1,500 per MT required selling expenses due to slow movement.

Inventory should be valued at lower of cost (Rs 600 lakh) or NRV (Rs 535 lakh). Write-down required = Rs 65 lakh.

Journal Entry:

Dr Cost of Goods Sold / Inventory Write-down Rs 65 lakh

>

Cr Inventory Rs 65 lakh

Example 2: Application of FIFO to raw material valuation

Sundaram Auto Components Pvt Ltd acquires steel sheets during FY 2025‑26 in three lots:

• April: 1,000 MT @ Rs 50,000/MT
• October: 1,500 MT @ Rs 52,000/MT
• February: 1,200 MT @ Rs 54,000/MT

Closing raw material stock at year-end stands at just one batch,800 MT.

800 MT @ Feb rate | | Rs 4.32 crore |

Under FIFO method prescribed by Para 24(a), closing stock comprises most recently acquired material:

800 MT × Rs 54 000 = Rs 4 32 00 000 disclosed as “Raw Materials” inventory.

No journal entry required except year-end classification:

Closing stock disclosed at Rs 4.32 crore (“Raw Materials”) in Balance Sheet

Disclosure Requirements under AS 2

Disclosures under AS 2 are critical for transparency and comparability in financial statements, as mandated by Schedule III to the Companies Act, 2013. Entities must present inventory details and valuation methods clearly, enabling users and statutory auditors to assess the appropriateness of inventory accounting policies and their impact on reported profits.

Auditors must verify these disclosures as part of their reporting responsibility under SA 700 to ensure true and fair presentation.

Common Mistakes & Industry-Specific Considerations

Common errors auditors flag

• Inclusion of selling and distribution overheads in the cost of inventory (these must be expensed)
• Failure to apply NRV testing at the end of each reporting period at the individual item level
• Inconsistent application of cost formulas across similar inventory categories
• Treating abnormal wastage as part of inventory cost rather than a period expense
• Inclusion of borrowing costs without satisfying the AS 16 capitalisation criteria

Industry application notes

Manufacturing: Allocation of fixed production overheads must be based on normal capacity. If production is below normal levels, unabsorbed overheads are treated as a period expense. Auditors frequently observe errors where idle capacity costs are incorrectly included in inventory valuation.

Real estate (under AS framework): Land and construction work-in-progress held for sale qualifies as inventory under AS 2. Developers must distinguish between WIP covered by AS 7 (construction contracts) and units held for sale as inventory. Misclassification can materially affect reported profits.

Pharmaceuticals: Inventory with limited shelf life requires rigorous NRV testing. Near-expiry or expired stock must be written down to its estimated salvage or disposal value at every reporting date. Patron's clients in this sector have found that timely write-downs prevent overstatement of assets.

AS 2 vs Ind AS 2 vs IFRS: Key Differences

The table below summarises key differences between AS 2, Ind AS 2, and IFRS (IAS 2):

India's notified standards generally align with IFRS on core principles for inventory measurement. However, differences exist around detailed guidance, notably treatment of major spares (AS 10 vs Ind AS 16), disclosure depth, and certain industry carve-outs reflecting local regulatory priorities.

Latest Amendments to AS 2 (FY 2026-27)

No amendments have been notified to AS 2 for FY 2026-27 as of 2026-05-02. The standard continues to apply in its existing form.

Related Standards You Should Know

• [Ind AS 2](/ind-as-2-inventories/), Equivalent standard for Ind AS-applicable companies, substantively similar to AS 2.
• [AS 7](/as-7-construction-contracts/), Construction-contract WIP scoped out of AS 2.
• [AS 10](/as-10-property-plant-and-equipment/), Spares meeting AS 10 criteria are accounted as PPE rather than inventory.
• [AS 16](/as-16-borrowing-costs/), Borrowing-cost capitalisation criteria for qualifying inventories.

Need Help with AS 2 Compliance?

Patron Accounting LLP supports Indian businesses with all aspects of AS 2 compliance, from drafting robust inventory policies to ensuring accurate disclosures for statutory audit. Our team combines technical expertise with real-world experience across manufacturing, trading, real estate, and pharma sectors.

Services include:

• Statutory Audit
• Financial Reporting & Schedule III support
• Disclosure Review
• Ind AS Advisory

Schedule a 30-minute consultation with our Ind AS team, Pune · Mumbai · Delhi · Gurugram.

About This Article

Reviewed by CA & CS Team · Patron Accounting LLP

Technical reviewer: CA Sundram Gupta, FCA

Last reviewed: 2026-05-02

Sources: ICAI Compendium of Accounting Standards · MCA Notification (Companies (Accounting Standards) Amendment Rules, 2016 (revised AS 2) and Companies (Accounting Standards) Rules, 2021) · IFRS Foundation