j55 7.3.3 Methods of Valuation of Inventories According to International Accounting Standard: 2 (IAS: 2), the inventories should be valued at the lowest of historical cost' and 'net realizable value 55 7.3.4 Historical Cost Historical cost of inventories is the aggregate of cost of purchase, cost of conversion, and other costs incurred in bringing the inventories to their present location and condition Thus, Historical Cost includes not only the price paid for acquisition of inventories but also all costs incurred for bringing and making them fit for use in production or for sale, e.g., transportation costs, duties paid, insurance, manufacturing expenses, wages or manufacturing expenses incurred for converting raw materials into finished products, etc. Selling expenses such as advertisement expenses or storage costs should not be included. A major objective of accounting for inventories is the proper determination of income through the process of matching appropriate costs against revenues. It requires assigning of proper costs to inventory as well as goods sold. However, it should be noted that assigning of such costs need not conform to the physical flow of goods. The various methods for assigning historical costs to inventory and goods sold are being explained below: 1. Specific identification methodAccording to this method, each item of inventory is identified with its cost. The total of the various costs so identified constitutes the value of inventory. This method is generally used when the materials or goods have been purchased for a specific job or customer. Such materials or goods are earmarked for the job and sold to that particular job or customer whenever demanded. 1. Cost Accounting & Costing Methods, 13th edition, p.60. 2. International Accounting Standard: 2. This technique of inventory valuation can be adopted only by a company which is handling a small number of items. In case of a manufacturing company having a number of inventory items, it is almost impossible to identify the cost of each individual item of inventory. Thus, this method is inappropriate in most cases on account of practical considerations. Moreover, the method opens door to income manipulation when like items are purchased at different prices. For example, a company purchases 10,000 units of an item in equal lots of 2,500 each at costs Rs 2.50, Rs 3, RS 3.50, and Rs 4 per unit. It sells 7,500 units at Rs 4 per unit. In case the management follows this method for valuation of inventory, it can determine the income reported for the period by selecting that lot of units which will produce the desired objective. If it is assumed that the inventory consists oft the last lot purchased the value of the inventory would be a sum of Rs 10,000 as compared to the presumption that the inventory consists of units purchased in the first lot in which case the value of inventory would be Rs 6,250. The working of the system can be understood with the help of the following illustration Illustration 7.1. The following is the record of receipts of certain materials during February, 2003: Feb. 1 Received 400 units for Job No. 12 @ Rs 10 per unit. Feb. 4 Received 300 units for Job No. 13 @ Rs 11 per unit. Feb. 16 Received 200 units for Job No. 14 @ Rs 12 per unit. Feb. 25 Received 400 units for Job No. 15 @ Rs 13 per unit. During February 2003, the following issue of materials is made: Feb. 10 Issued 200 units to Job No. 12. Feb. 15 Issued 100 units to Job No. 13. Feb, 17 Issued 200 units to Job No. 12 Feb. 20 Issued 200 units to Job No. 14. Feb. 26 Issued 100 units to Job No. 13. Feb. 28 Issued 200 units to Job No. 15. Show how these transactions will appear in the Stores Ledger and state the amount of inventory of Feb. 28, 2003