In this guide
Why Two Inventory Values Are Both Correct
The same closing stock can legitimately carry two different values, one computed under Ind AS 2 for financial reporting and one under ICDS II for computing taxable income, and neither is wrong. They start from the same principle, lower of cost and net realisable value, and then diverge on what may enter cost and when a write-down is recognised. The differences are narrow but real, and they concentrate in the treatment of items where the standards took deliberately different positions. Because the two are computed for different readers under different authority, the difference is not an error to be reconciled away. It is a permanent feature of the accounts that has to be tracked, documented and carried forward, so that the figure in the financial statements and the figure in the tax computation can each be supported on its own terms when either is examined. Companies get into difficulty by maintaining only one and defending it twice.
Cost Under Ind AS 2
Cost comprises all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. Costs of purchase means the purchase price together with import duties and other taxes that are not subsequently recoverable, plus transport, handling and other costs directly attributable to acquisition, less trade discounts, rebates and similar items. Recoverable taxes are excluded, which is why input credit under GST does not form part of cost. Costs of conversion covers direct labour and the systematic allocation of fixed and variable production overheads, with fixed overheads absorbed on normal capacity rather than actual, so that a period of low output does not inflate the cost of what was produced. Certain costs are specifically excluded and must be recognised as expenses in the period incurred: abnormal amounts of wasted material, labour or other production costs, storage costs unless necessary before a further production stage, administrative overheads that do not contribute to bringing inventories to their present location and condition, and selling costs. Cost formulas permitted are specific identification for items not ordinarily interchangeable, and otherwise first-in first-out or weighted average, applied consistently for inventories of a similar nature and use.
Cost Under ICDS II
ICDS II follows Ind AS 2 closely in structure and in most of its substance, which is deliberate, and the practical work lies in identifying the narrow places where it departs. The definitions of cost of purchase and cost of conversion, the treatment of production overheads on normal capacity, and the exclusion of abnormal waste, storage, administrative and selling costs all track the accounting standard. So do the permitted cost formulas, with specific identification for non-interchangeable items and first-in first-out or weighted average otherwise. Where it departs, it departs on points that affect timing rather than principle, and the differences are of a kind that alter the period in which an amount enters taxable income rather than whether it ever does. The standard also carries its own provisions on the valuation of inventory in particular situations, including on dissolution, which have no direct counterpart in the accounting treatment. What the departure does to taxable income is therefore a timing effect in most cases. An amount deductible in one period for accounting purposes and another for tax creates a difference that reverses, and the reversal has to be tracked so that neither period's computation double-counts or omits it.
Net Realisable Value and Write-Down
Under Ind AS 2 inventories are measured at the lower of cost and net realisable value, and net realisable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. The estimate is made for the goods in their actual condition at the reporting date, and it is made item by item rather than across the whole inventory, except where items relating to the same product line have similar purposes and can reasonably be grouped. Where net realisable value falls below cost, the difference is recognised as an expense in the period the write-down occurs. Whether the tax computation allows it in the same period is the question that has to be answered separately rather than assumed, because the two bases can recognise the reduction at different times and the difference belongs in the bridge between them. Reversal is the feature that distinguishes inventory from most other write-downs. Where the circumstances that caused a write-down no longer exist and net realisable value has recovered, the write-down is reversed, limited to the amount originally written down, so the carrying value never exceeds the original cost.
Evidence Both Bases Require
Two figures need two sets of support, and the common failure is maintaining evidence for one and defending both with it. The costing records come first: the build-up showing what entered cost for each class of inventory, from purchase price through the costs of conversion and the costs of bringing the goods to their present location and condition. Because the two bases differ on what may enter that build-up, the records have to be detailed enough to show the composition rather than only the total, otherwise the difference between the figures cannot be explained. Realisable value support is the second requirement, and it has to be evidence of what the goods will actually fetch: prices achieved on comparable sales, offers received, or a documented assessment where no market transaction exists. A percentage applied by policy is not evidence of realisable value. The third is a reconciliation between the two figures, prepared each period, identifying each difference and its cause. That bridge is what allows either figure to be examined on its own terms without the other one being produced as though it were an error.
Keeping Both Numbers Defensible
Document the bridge between the two figures every year, as a standing schedule rather than as a note prepared when somebody asks. The schedule starts from the reporting figure, lists each difference with its cause and its amount, and arrives at the tax figure. Prepared annually it takes very little time; reconstructed after several years it may not be possible at all, because the composition of cost in an earlier period cannot be recovered once the underlying records have been archived. Consistency of method across periods is what makes either figure defensible. A method changed without disclosure produces a movement that looks like trading and is not, and the first question asked about any unusual movement in inventory value is whether the basis changed. Where a change is genuinely warranted, disclose it and quantify its effect in the year it is made. A valuation review is worth commissioning where the business has moved to a new reporting framework, where inventory is a large proportion of assets, or where the bridge has not been maintained and has to be rebuilt, and how we run a stock audit covers the verification side of the same question.
