Ind AS 2 vs ICDS-II: How Inventory Must Be Valued for Financial Reporting and Tax

Why Two Inventory Values Are Both Correct

The same closing stock can legitimately carry two values at once: one worked out under Ind AS 2 for the financial statements and one under ICDS II for computing taxable income. Neither is wrong, because each answers to a different reader under a different authority.

Ind AS 2, Inventories, is one of the Indian Accounting Standards notified under the Companies (Indian Accounting Standards) Rules, 2015, and it decides the inventory figure in the balance sheet and the cost of goods sold of a company that reports under Ind AS. A company that does not follow Ind AS applies AS 2, the older Indian GAAP standard, instead. ICDS II, Valuation of Inventories, was notified by the Central Board of Direct Taxes in Notification No. 87/2016 of 29 September 2016 and applies from assessment year 2017-18 to assessees who follow the mercantile system of accounting, other than individuals and Hindu undivided families who are not required to have their accounts audited under section 44AB of the Income-tax Act, 1961. From tax year 2026-27, the inventory rule formerly in section 145A of the 1961 Act is section 277 of the Income-tax Act, 2025, which values inventory at the lower of actual cost or net realisable value worked out under the ICDS notified under section 276(2).

ICDS II closely follows AS 2 in structure and substance and is broadly similar to Ind AS 2; the practical work lies in the few places where it departs. Both start from the same principle, the lower of cost and net realisable value, and then diverge on what may enter cost, how a write-down that has recovered is treated, and which inventories are in scope. Because the two figures are prepared for different purposes, a difference between them is not an error to be reconciled away. It is a standing feature of the accounts that has to be identified, explained and carried forward, so that each figure can be supported on its own terms when it is examined. Businesses get into difficulty by keeping only one figure and defending it twice.

Cost Under Ind AS 2

Ind AS 2 builds cost from three parts: the costs of purchase, the costs of conversion, and the other costs incurred in bringing the inventories to their present location and condition. Each part has its own rule.

1. Costs of purchase. The purchase price, import duties and other taxes other than those the entity later recovers from the taxing authorities, plus transport, handling and other costs directly attributable to acquiring the goods, less trade discounts, rebates and similar items. Because recoverable taxes are left out, GST for which input credit is taken does not form part of cost.
2. Costs of conversion. Direct labour and a systematic allocation of fixed and variable production overheads. Fixed overheads are absorbed on the normal capacity of the facilities, so a period of low output does not load more overhead onto each unit; overhead left unallocated in such a period is an expense.
3. Other costs. Included only to the extent they are incurred in bringing the goods to their present location and condition, such as the cost of designing products for a specific customer.
4. Costs that stay out. Abnormal amounts of wasted material, labour or other production costs; storage costs, unless storage is necessary in the production process before a further stage; administrative overheads that do not contribute to bringing the goods to their present location and condition; and selling costs. These are expensed in the period they are incurred.
5. Borrowing costs. Ind AS 2 does not deal with them itself; it points to Ind AS 23, under which interest is capitalised into an inventory only if that inventory is a qualifying asset, one that necessarily takes a substantial period of time to get ready for sale.
6. Cost formulas. Specific identification for items that are not ordinarily interchangeable and for goods produced for specific projects; otherwise first-in first-out or weighted average cost, with the same formula used for all inventories of a similar nature and use. Standard cost and the retail method may be used for convenience where the results approximate cost.

Cost Under ICDS II

ICDS II uses the same three-part build-up of cost, the same normal-capacity rule for fixed overheads, the same list of excluded costs and the same cost formulas: specific identification where items are not interchangeable, and first-in first-out or weighted average otherwise, with standard cost and the retail method allowed where they approximate actual cost. The departures sit in a handful of paragraphs.

• Duties and taxes in the purchase price. Paragraph 5 describes the cost of purchase as the purchase price including duties and taxes, freight inwards and other directly attributable expenditure, less trade discounts and rebates. It does not carry the words of Ind AS 2 that leave out taxes later recovered. For the tax computation, section 277(1)(ii) and (4) of the Income-tax Act, 2025 (formerly section 145A of the 1961 Act) require purchases, sales and inventory to include any tax, duty, cess or fee actually paid or incurred, even where input credit is available on it. A business whose books leave recoverable taxes out of cost adjusts for this in the tax computation, which usually leaves taxable profit unchanged because purchases, sales and stock are all adjusted.
  ICDS II para 5
• Borrowing costs. Paragraph 11 keeps interest and other borrowing costs out of the cost of inventories unless they meet the conditions of ICDS IX on borrowing costs. ICDS IX treats an inventory as a qualifying asset only when it requires twelve months or more to be brought to a saleable condition, a fixed period where Ind AS 23 asks for a substantial one.
  ICDS II para 11 · ICDS IX
• Change of method. Paragraph 23 says the method of valuation shall not be changed without reasonable cause, so a change made for the tax computation needs its own justification on the file.
  ICDS II para 23
• Opening inventory. Paragraph 22 fixes the opening value: the cost on the day a business starts during the year, otherwise the closing value of the previous year.
  ICDS II para 22
• Dissolution of a firm. Paragraph 24 values inventory at net realisable value on the dissolution of a partnership firm, an association of persons or a body of individuals, whether or not the business is discontinued. Ind AS 2 has no counterpart.
  ICDS II para 24

Where the Two Standards Differ

Set side by side, the differences fall under six headings. Each is the reason a line can appear in the bridge between the two closing stock figures.

Net Realisable Value and Write-Down

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. Under both standards the comparison with cost is made item by item. Items of the same product line with similar purposes or end uses, which cannot practically be evaluated apart from other items in that line, may be grouped; whole classes such as "all finished goods" may not.

The estimate rests on the most reliable evidence available when it is made. Price changes after the period end count only to the extent they confirm conditions that existed at the period end. Under Ind AS 2, the purpose for which stock is held matters as well: goods held against a firm sales contract are measured against the contract price, and raw materials are not written down below cost where the finished products they go into are expected to sell at or above cost.

Reversal is where inventory differs from most other write-downs. Under Ind AS 2, when the circumstances that caused a write-down no longer exist, or there is clear evidence that realisable value has increased, the write-down is reversed, limited to the amount originally written down, so the carrying amount never exceeds cost. ICDS II contains no such paragraph. For tax, none is needed: section 277(1)(i) of the Income-tax Act, 2025 values inventory at the lower of actual cost or net realisable value at each valuation date, so when realisable value recovers the next closing stock is simply valued higher, never above cost, and the gain falls in the tax year in which that higher value is recorded. Slow-moving and obsolete stock is where most write-downs start; how that stock is identified and written down is covered separately.

Evidence Both Bases Require

Two figures need two sets of support, and the common failure is keeping evidence for one and defending both with it. Four kinds of record carry the weight.

1. Costing records showing what entered cost for each class of inventory, from the purchase price through conversion to the costs of bringing the goods to their present location and condition. Because the two bases differ on what may enter cost, the records have to show the composition, not only the total; otherwise the difference cannot be explained.
2. Realisable value support for every item written down: comparable sale prices, offers, or a documented assessment where no market transaction exists, prepared for the goods in their actual condition at the reporting date.
3. Borrowing cost workings for any inventory treated as a qualifying asset, showing the period the goods took to become saleable and the interest allocated to them under each standard.
4. Verified quantities. Both figures multiply a quantity by a cost. If the quantity on the stock records does not match what is on the floor, both values are wrong in the same way, and no amount of valuation work corrects it.

Keeping Both Numbers Defensible

Keep the bridge between the two figures as a standing schedule, updated every year, rather than as a note prepared when somebody asks. It starts from the closing stock in the financial statements, lists each difference with its cause and amount, and arrives at the closing stock used for the tax computation. Prepared annually it takes little time; reconstructed after several years it may not be possible at all, because the composition of cost in an earlier year cannot be recovered once the underlying records are archived.

Consistency is what makes either figure defensible. A change of cost formula produces a movement that looks like trading and is not, and the first question asked about an unusual movement in inventory value is whether the basis changed. Under Ind AS a change of accounting policy follows Ind AS 8; for the tax computation, ICDS II asks for reasonable cause. Where a change is genuinely warranted, disclose it and quantify its effect in the year it is made.

A review of the valuation is worth commissioning when the business moves to a new reporting framework, when inventory is a large part of its assets, or when the bridge has not been kept and has to be rebuilt. If the quantities themselves are in doubt, value is not the place to start: an independent stock audit checks the stock both figures are built on.