Time table

Group	Subject	Day	Time	Number of hours	Total hours
1	Financial Accounting	Mon, Tue	9:00 AM – 12:00 PM	2 hours	4 hours
1	Applied Direct Taxes	Wed & Thu	9:00 AM – 12:00 PM	2 hours	4 hours
2	Cost & Management Accounting	Fri & Sat	9:00 AM – 12:00 PM	2 hours	4 hours
2	Applied Indirect Taxes	Sunday	2:00 PM – 4:00 PM	2hours	2 hours
Total hours per week					14 hours

Self test OM & IS June 2nd

So No	Chapter	Question	Source	Time Taken	Remarks
1	1	A shaft 1,000 mm. in length is being machined on a lathe. If the spindle executes 500 r.p.m. and the feed is 0.20 mm. per revolution, how long will it take the cutter to pass down the entire length of the shaft?	At the end of Study Material	-	-
2	1	Find the machining cost of a M. S. bar on a lathe from the following data: R. P. M. of the Job = 500. Feed of tool per revolution of job = 0.5 mm. Depth of cut = 2 mm. Diameter of raw material = 60 mm. Diameter of finished job = 40 mm. Length of Job = 1000 mm. Machining cost = Rs. 3 per hour.	At the end of Study Material	-	-
3	1	A shaft 500 mm. in diameter and 1 metre long is to be turned at a speed of 280 r.p.m. If the feed is 0.25 mm. per revolution, calculate the time taken for one pass of the cutter.	At the end of Study Material	-	-
4	1	A company is planning to undertake the production of medical testing equipments has to decide on the location of the plant. Three locations are being considered, namely, A, B and C. The fixed costs of three locations are estimated to be Rs. 300 Lakhs, 500 Lakhs and 250 Lakhs respectively. The variable costs are Rs. 3000, Rs. 2000 and Rs. 3500 per unit respectively. The average sales price of the equipment is Rs. 7000 per unit. Find (i) The range of annual production/sales volume for which each location is most suitable. (ii) Select the best location, if the sales volume is of 18,000 units.	At the end of Study Material	-	-

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OM & IS 1.0 Surface Treatment

Surface-treating processes are chemical or mechanical in nature and alter the surface characteristics of the
metal.
Eleven Types of surface treatment are briefly described below:
1) Anodizing: It is an electro-chemical process which gives a slight anticorrosion protection and improves
the appearance of the product. Unlike other types of surface treatment, this does not increase the
dimensions of the object. This gives a better finish. It is used in case of utensils, household appliances
etc.
2) Enamelling: It is a process that bakes on a white, brittle protection finish.
3) Galvanising: It is a hot-dip process which provides an anti-rust zinc coating. Zinc is used for this
purpose. This makes the surface of the metal anti-corrosive and gives a better finish.

4) Honing: It is an abrading operation for hole finishing done by a tool fitted with a bonded abrasive
stone.
5) Lapping: It is a surface smoothing operation by hand or machine.
6) Painting: It will yield protective coating and better appearance.
7) Plastic coating: This process is more durable than painting.
8) Plating: It is an electrolytic process. This can be done with the help of silver, chromium, cadmium,
nickel and copper. Plating provides anticorrosive finish.
9) Shot Blasting: Small shots usually in the form of iron balls are made to blast on the metal required for
making it resistance to wear and tear, remove the stresses and hardness.
10) Shot penning: It is air blasting the small shots against the metal surface in order to increase the hardness
of surface.
11) Tumbling: Castings are tumbled in a tumbling barrel together with an abrasive substance. The friction
created in this way will clean the surface.
Other surface treating processes may be such as:
• Buffing etc.
• Polishing,
• Power brushing,
• Sandblasting,
• Washing,
• Waxing

oM & IS 1.0 Welding Process:

Welding is a process of joining similar metals by the application of heat, with or without application of
pressure and addition of filler material.
“Welding consists of fusing metals together while they are in the plastic or molten state.” Gas and Electric
arc are used for the purpose of heat. Electrodes are used for filling in and reinforcement. There are 8
welding processes as mentioned below:
• Arc welding
• Brazing
• Flow welding
• Forge welding
• Gas welding
• Induction welding
• Resistance welding
• Thermit welding

OM & IS 1.0 Metal Working Processes:

Metal working processes involve operations on metals like cast iron, steel, brass, bronze, aluminium, etc,
with the help of machine tools like lathe, shaper, miller, grinder, planner, etc.
The following are the metal working processes:
• Finishing, plating, honing, galvanizing, anodising.
• Forming, casting, forging, hot-rolling, extruding.
• Heat treatment, hardening, tempering, annealing, normalising.
• Joining, welding, soldering, brazing, riveting.
• Machining, milling, plaining, shaping, grinding.
Metal working processes can be described as under:
Casting: A casting may be defined as a molten material that has been poured into a prepared cavity and
allowed to solidify. Casting may be classified as:
Sand Casting: It is used mainly for steel and iron and it can also be used for brass, aluminium, bronze,
copper etc. and relatively large amount of metal is to be removed.

Features of Sand Casting:
• Clay and water act as a bond.
• Compressed moist sand is used.
• Less costly.
• More machining of finished goods is required.
• More weight.
There are two methods of sand casting:
Green Sand Moulding and Dry Sand Moulding.
Green sand Moulding utilises a mould made of compressed moist sand. This method is not suitable for
large and heavy castings. In case of Dry sand Casting, the mould surfaces are given refractory coating and
are dried before the mould is closed for pouring. This method is useful for large and heavy castings.
Centrifugal Casting: The molten metal is poured into a hollow cylindrical mould, which is spinning and
the centrifugal force causes the liquid metal to flow to the outside of the mould and to remain there. Then
it is allowed to cool.
Die Casting: The dies are expensive but the advantage is that no finish machining is required in many
cases. This is limited to low melting point alloys.
Investment Casting: Machining the part made out of an alloy is very difficult and in such cases, the
investment casting is used.
Permanent Mould Casting: This is developed to avoid the above disadvantage. The advantages are smoother
finish, higher mechanical properties, good dimensional uniformity and ease of adaptability to automatic
high production. But this is having high initial cost of tooling and the size of casting is also limited by the
mould making equipment.
Plaster Mould Casting: Only one casting is made and then mould is destroyed. The advantages of plaster
are the superior surface finish, improved metal characteristics and good dimensional accuracy. But the
disadvantage is that the mould is destroyed each time.
Forming: Forming processes are those which accomplish the rough sizing or shaping of manufactured
articles. Any cutting tool which produces a desired contour on the work piece comes under forming process.
Heat Treatment: It is a process of heating and cooling metals in order to obtain certain desired properties.
Then the right combination of hardness and toughness is achieved for enabling the cutting tools to be able
to successfully machine other metals. In addition to hardness and toughness, this process will improve
heat and corrosion resistance and relieve stresses. The various types of heat treatment processes are briefly
discussed below:
1) Annealing: It refers to the heating and cooling operations which are usually applied to induce softening.
Annealing softens overly hard, overly brittle part, through heating, short of critical point, followed by
gradual cooling. Thus it relieves further the brittleness introduced by “hardening” and reduces metal
electricity slightly.
2) Case Hardening: This process involves two operations. The first is a carburizing process where carbon
is added to the outer surface by heating low carbon steel. The second operation is heat treatment of
the carburized parts so that the outer surface becomes hard.

3) Hardening Steel: Hardening is the process of heating a metal to the decalescence point, soaking it for
a considerable time to allow thorough penetration of the heat in the metal structure and then suddenly
quenching it in cold liquid.
4) Normalising: Normalising is the process, in which parts are allowed to cool in still air at room
temperature.
5) Quenching: Quenching is the process of rapidly cooling the metal from a high temperature. Rapid
cooling is required for obtaining high strength and hardness and the purpose is to harden steel so that
it can withstand wear and tear.
6) Tempering: Heat treatment should relieve stress as stated above. But after quenching, the metal is
hard and brittle. It requires reheating. Tempering is the process of reheating which will reduce the
brittleness and soften the steel.

(OM & IS ) 1.0 Fabrication Process

Fabrication (metal) Wikipedia


Fabrication is the process of forming, casting, machining and welding of metals.

A fabricating process modifies the physical characteristics of materials with the help of certain labour or
machine operations. It is generally applied in metal working industries. The fabricating process involves
changing the shape of materials and connecting the parts. Fabrication work involves several operations
like forging, gas welding, flame-cutting, etc.

Classification of Fabrication processes:


(A) Fabrication process concerning Iron Smelting: Metals are widely used for fabrication purposes in
most of the modern industries. Various metals like iron have-to be smelted to get them in virgin form.
Iron is obtained in free state as oxide and it is smelted in a Blast Furnace with the help of coke and
limestone.
(B) Fabrication Process concerning Making of Steel: Steel making involves re-melting the pig iron and
processing the molten iron to reduce the carbon content. Several other metals are then added to give
physical characteristics to the iron. This process is used in manufacturing high grade alloy steel because
of the improved control.
(C) Fabrication Process concerning Rolling of Steel: In this process, liquid steel is cast into ingots. These
rectangular pyramids are then rolled into blooms which square section lengths of steel. Blooms are
further heated and rolled into billets of smaller cross-section, which are then converted into various
fabricated lengths like beams, angles, rods, flats, sheets, plates, etc.
(D) Fabrication of Steel: The fabrication requirements are designed based and depends upon the
complexity of the process. It is done when steel materials are to be shaped in different forms.

OM & IS

Subject	OM & IS (Operation Management and Information System)
Study Note 1	Overview of Production Process
Index	Overview of Production Process
	1.0 Fabrication Process Metal working process, Forming, Heat treatment, Welding, Surface treatment

Capital and Revenue Losses

While ascertaining profit, revenue losses are differentiated from capital losses, just as revenue
profits are distinguished from capital profits. Revenue losses arise from the normal course of
business by selling the merchantable at a price less than its purchase price or cost of goods sold
or where there is a declining in the current value of inventories. Capital losses may result from
the sale of assets, other than inventory for less than written down value or the diminution or
elimination of assets other than as the result of use or sale (flood, fire, etc.) or in connection
with raising capital of the business (issue of shares at a discount) or on the settlement of iabilities
for a consideration more than its book value (debenture issued at par but redeemed at a premium).
Treatment of capital losses are same as that of capital profits. Capital losses arising out
of sale of fixed assets generally appear in the Profit and Loss Account (being deducted from
the net profit). But other capital losses are adjusted against the credit balance of capital profits.
Where the capital losses are substantial, the treatment is different. These losses are generally
shown on the balance sheet as fictitious assets and the common practice is to spread that over
a number of accounting years as a charge against revenue profits till the amount is fully exhausted.

Capital and Revenue Profits

While ascertaining the trading profit of a business for a particular period, a proper distinction
is to be made between capital and revenue profits. If profit arises out of an ordinary nature,
being the outcome of the ordinary function and object of the business, it is termed as ‘revenue
profit’. But, when a profit arises out of a casual and non-recurring transaction, it is termed as
capital profit. Revenue profit arises out of the sale of the merchandise that the business deals
in.
Generally, capital profits arise out of the sale of assets other than inventory at a price more than
its book value or in connection with the raising of capital or at the time of purchasing an
existing business. For example, if an asset, whose book value is Rs 5,000 on the date of sale, is
sold for Rs 6,000—Rs 1,000 will be considered as capital profit. Likewise, issue of shares at a
premium is also a capital profit. Revenue profits are distributed to the owners of the business
or transferred to General Reserve Account, being shown in the balance sheet as a retained
earning. Capital profits are generally capitalised-transferred to a capital reserve account which
can only be utilised for setting off capital losses in future. Capital profits of a small amount
(arising out of selling of one asset) is taken to the Profit and Loss Account and added with the
revenue profit-applying the concept of materiality.

Capital and Revenue Receipts

A receipt of money may be of a capital or revenue nature. A clear distinction, therefore,
should be made between Capital receipts and revenue receipts.

A receipt of money is considered as capital receipt when a contribution is made by the proprietor
towards the capital of the business or a contribution of capital to the business by someone
outside the business. Capital receipts do not have any effect on the profits earned or losses
incurred during the course of a year. Capital receipts can take one or more of the following
forms:
Additional capital introduced by the proprietor; by partners, in case of partnership firm, by
issuing fresh shares, in case of a company; and, by selling assets, previously not intended for
resale.
A receipt of money is considered as revenue receipt when it is received from customers for
goods supplied or fees received for services rendered in the ordinary course of business, which
is a result of the firm’s activity in the current period. Receipts of money in the revenue nature
increase the profits or decrease the losses of a business and must be set against the revenue
expenses in order to ascertain the profit for the period.

The following are the points of distinction between capital receipts and revenue receipts

Capital Receipts	Revenue Receipts
1. Capital receipts are not available for distri bution as profits	1. Revenue receipts are available for distri distribution as profits only after deducting revenue expenses.
2. Capital receipts cannot be utilised for creating a reserve fund.	2. Revenue receipts can be utilised for creating a reserve fund after deducting revenue expenses.
3. A business can survive without any accounting period.	3. The survival of a business mainly de capital receipts during an pends on the revenue  receipts during an accounting period.
4. Capital receipts are the sources for creating capital reserves.	4. Revenue receipts are the sources for  creating revenue reserves.

Deferred Revenue Expenditures

Deferred revenue expenditures represent certain types of assets whose usefulness does not
expire in the year of their occurrence but generally expires in the near future. These types of
expenditures are carried forward and are written off in future accounting periods. Sometimes,
we make some revenue expenditure but it eventually becomes a capital asset (generally of an
intangible nature). If one undertake substantial repairs to the existing building, the deterioration
of the premises may be avoided. We may employ our own employees to do that work and
pay them at prevailing wage-rate, which is of a revenue nature. If this expenditure is treated as
a revenue expenditure and the current year’s-profit is charged with these expenses, we should
be making the current year absorb the entire expenses, the benefit of which will be enjoyed for
a number of accounting years. To overcome this difficulty, the entire expenditure is capitalised
and is added to the asset account. Another example is an insurance policy. A business can pay
insurance premium in advance, say, for a 3 year period. The right does not expire in the accounting
period in which it is paid but will expire within a fairly short period of time (3 years).
Only a portion of the total premium paid should be treated as a revenue expenditure (portion
pertaining to the current period) and the balance should be carried forward as an asset to be
written off in subsequent years.

Replacement of Fixed Assets

The above rules of capital and revenue expenditure do not hold good when an existing asset is
replaced for another. If an asset is replaced with a similar kind of asset, the expenditure incurred
is treated as Revenue Expenditure. For example, if a set of weighing machines in a shop
becomes defective and is replaced with a similar set, the cost of replacement should be treated
as revenue expenditure and it should be charged to the Profit and Loss Account. However, if
an asset is replaced with an asset which is superior than the previous one, the expense is partly
capital and partly revenue. For example, if a manual typewriter costing Rs 5,000 is replaced
with an electronic typewriter costing Rs 15,000, then Rs 5,000 will be revenue expenditure and
the excess value of the new typewriter over the old one, Rs 10,000 will be capital expenditure.

Some examples of revenue expenditure

(1) Salaries and wages paid to the employees; (2) Rent and rates for the factory or office
premises; (3) Depreciation on plant and machinery; (4) Consumable stores; (5) Inventory of
raw materials, work-in-progress and finished goods; (6) Insurance premium; (7) Taxes and
legal expenses; and (8) Miscellaneous expenses.

Rules for Determining Revenue Expenditure

Any expenditure which cannot be recognised as capital expenditure can be termed as revenue
expenditure. A revenue expenditure temporarily influences only the profit earning capacity of
the business. An expenditure is recognised as revenue when it is incurred for the following
purposes:
Expenditure for day-to-day conduct of the business, the benefits of which last less than one
year. Examples are wages of workmen, interest on borrowed capital, rent, selling expenses,
and so on.
Expenditure on consumable items, on goods and services for resale either in their original or
improved form. Examples are purchases of raw materials, office stationery, and the like. At the
end of the year, there may be some revenue items (stock, stationery, etc.) still in hand. These
are generally passed over to the next year though they were acquired in the previous year.
Expenditures incurred for maintaining fixed assets in working order. For example, repairs,
renewals and depreciation.

Some examples of capital expenditure:

(1) Purchase of land, building, machinery or furniture; (2) Cost of leasehold land and building;
(3) Cost of purchased goodwill; (4) Preliminary expenditures; (5) Cost of additions or extensions
to existing assets; (6) Cost of overhauling second-hand machines; (7) Expenditure on
putting an asset into working condition; and (8) Cost incurred for increasing the earning capacity
of a business.

Rules for Determining Capital Expenditure

An expenditure can be recognised as capital if it is incurred for the following purposes:
An expenditure incurred for the purpose of acquiring long term assets (useful life is at least
more than one accounting period) for use in business to earn profits and not meant for resale,
will be treated as a capital expenditure. For example, if a second hand motor car dealer buys a
piece of furniture with a view to use it in business; it will be a capital expenditure. But if he
buys second hand motor cars, it will be a revenue expenditure because he deals in second hand
motor cars.
When an expenditure is incurred to improve the present condition of a machine or putting an
old asset into working condition, it is recognised as a capital expenditure. The expenditure is
capitalised and added to the cost of the asset. Likewise, any expenditure incurred to put an
asset into working condition is also a capital expenditure.
For example, if one buys a machine for Rs 5,00,000 and pays Rs 20,000 as transportation charges
and Rs 40,000 as installation charges, the total cost of the machine comes upto Rs 5,60,000.
Similarly, if a building is purchased for Rs 1,00,000 and Rs 5,000 is spent on registration and
stamp duty, the capital expenditure on the building stands at Rs 1,05,000.
If an expenditure is incurred, to increase earning capacity of a business will be considered as of
capital nature. For example, expenditure incurred for shifting ‘the ‘factory for easy supply of
raw materials. Here, the cost of such shifting will be a capital expenditure.
Preliminary expenses incurred before the commencement of business is considered capital
expenditure. For example, legal charges paid for drafting the memorandum and articles of
association of a company or brokerage paid to brokers, or commission paid to underwriters for
raising capital.
Thus, one useful way of recognising an expenditure as capital is to see that the business will
own something which qualifies as an asset at the end of the accounting period.

The accounting treatment of capital and revenue expenditure are as under:

Revenue expenditures are charged as an expense against profit in the year they are incurred or
recognised. Capital expenditures are capitalised-added to an asset account.
The following are the points of distinction between capital expenditure and revenue expenditure:

Capital Expenditure	Revenue Expenditure
1. Capital expenditures are incurred.	1. Revenue expenditures are incurred for more than one accounting for a particular accounting period. period.
2. Capital expenditure are of	2. Revenue expenditures are of non-recurring nature. recurring nature.
3. All capital expenditures eventually	3. Revenue expenditures are not generally become revenue expenditures. capital expenditures.
4. Capital expenditures are not	4. All revenue expenditures are matched matched with capital receipts. with revenue receipts.
5. Capital expenditures are incurred	5. Revenue expenditures are incurred before or after the commencement always after the commencement of of the business. the business.

Capital and Revenue Expenditures

Capital expenditure is the outflow of funds to acquire an asset that will benefit the business
more than one accounting period. A capital expenditure takes place when an asset or service is
acquired or improvement of a fixed asset is effected. These assets are expected to provide
benefits to the business in more than one accounting period and are not intended for resale in
the ordinary course of business. In short, it is an expenditure on assets which is not written off
completely against income in the accounting period in which it is incurred.
Revenue expenditure is the outflow of funds to meet the running expenses of a business and it
will be of benefit for the current period only. A revenue expenditure is incurred to carry on the
normal course of business or maintain the capital assets in a good condition.
It may be pointed out here that an expenditure need not necessarily be a payment made to
somebody in cash - it may be made by cash, by the exchange of another asset, or by incurring
a liability. Expenditure incurrence and expenditure recognition are distinct phenomena. Expenditure
incurrence refers to the receipt of goods and services, whereas expenditure recognition is a
matter to be decided whether the expenditure is of capital or revenue nature, for example, the
buying of an asset is a capital expenditure but charging depreciation against profit is a revenue
expenditure, over the entire life of that asset. Most of the capital expenditures made by a business
become revenue expenditures. On the application of periodicity, accrual and matching
concepts, accountants identify all revenue expenditures for a given period for ascertaining
profit. An expenditure which cannot be identified to a particular accounting period is considered
of capital nature.

1.4. DISTINCTION BETWEEN CAPITAL AND REVENUE

Introduction
The concepts of capital and revenue are of fundamental importance to the correct determination
of accounting profit for a period and recognition of business assets at the end of that
period. The distinction affects the measurement of profit in a number of accounting periods.
Capital has been defined by economists as those assets which are used in the production of
goods and services for further production of assets. In accounting, on the other hand, the
capital of a business is increased by that portion of the periodic income which has not been
consumed by the owner.
The relationship between capital and revenue is that between a tree and its fruits. It is the tree
which produces the fruits, and it is the fruit that can be consumed. If the tree is tendered with
care, it will produce more fruits, conversely, if the tree is destroyed, there will be no more
fruits. Likewise, revenue comes out of capital and capital is the source of revenue. Capital is
invested by a person in the business so that it may produce revenue. Moreover, as a fruit may
give birth to another new tree, different revenues may also produce further new capital.
Capital can be brought in by a person into the business in different forms-cash or kind. When
capital is brought in the form of cash, it is spent away on various items of assets that make the
business a running concern. Capital of the firm is thus, represented by its inventory of assets.
Capital of a business can be increased in a two fold way:
1. When the owner brings in more capital to the business; and/or
2. When the owner does not consume the entire periodic income.
When the owner brings in further capital to his business, the amount is credited to the Capital
Account.
Likewise, the net income for a period is credited to the Capital Account, and if his drawings
are less than that income, the capital is increased by the difference.
The difference between the two terms ‘revenue’ and ‘receipt’ should be carefully distinguished.
A receipt is the inflow of money into business, whereas revenue is the aggregate exchange
value received for goods and services provided to the customers.

Valuation of Stock as on the Balance Sheet Date

1. Stocktaking should be made on the date of the close of a financial period. It should
include every item of goods of which the business is the owner. If there are any goodsin-
transit or goods with the selling agent or goods sent on approval for which the sale
is yet to be confirmed such goods should be included in stock. On the other hand, goods
sold but not yet delivered should be excluded.
Goods purchased within the accounting period and recorded in the accounts should be
included in stock. Thus physical stock in the godown of the business may not be the
actual value of stock to be included in the final accounts.
2. If stock taking is made on a date a few days before or after the date of the close of the
financial period, Purchases, Purchase Returns, Sales and Sales Return between these
two dates should be adjusted (to arrive at the value of the stock on the closing date of
the accounting period).
The sales and Sales Return should be taken at cost price or market price whichever is lower.
Notes
1. Where any sale has been made at a loss or at a profit not conforming to the normal rate
of profit, the cost price of the goods thus sold should be separately ascertained.
2. For valuation of inventory the principle of Cost Price or Net Realisable Price whichever
is lower should be applied.
3. Adjustments for undercasting /overcasting of stock, goods held for consignment basis,
etc., should also be made.

Methods of Ascertaining Net Realisable Value (NRV)

For ascertaining the net realisable value of different items of stock any one of the following
methods may usually be followed :
1. Total Inventory Method : The aggregate of the total cost of all items is found out. It is
compared with the total net realisable value of such items. The lower of the two is
applied for inventory valuation.
2. Group Method : Items of same nature are grouped. The cost and NRV of each group are
separately compared and the lower amount for each group is applied for stock valuation.
3. Individual Identification Method : For each item of stock, corresponding cost and net
realisable value are compared and the lower of the two is considered for valuation of
the individual stock.

If Inventory is Valued at a Notional Price

Notional Price is not the cost or market price. It is a price ascertained on some notional basis. It
may be—
(a) Standard Price Method: The standard price is fixed on the basis of the specific nature of
the product or service and the factors related to that. All issues during an accounting
period are charged at the Standard Price. The stock is valued as the balancing amount of
(1) costs of materials purchased or received at different rates and
(2) the value of quantities issued at standard price.
(b) Inflated Price Method : Issues are priced at an inflated rate. Such rate is calculated after
considering—
(1) addition of proportionate stock holding or carrying costs like costs of inspecting,
issuing. etc.
(2) deduction of natural or normal losses of materials, like leakage, evaporation, etc.
The cost of material issues is computed first by applying any method discussed earlier.
The adjustments [(1) and (2) as stated above] are made to find out the inflated price. The
inventory is valued by deducting the issues priced at inflated rate from the total cost of
materials purchased during a period.

It is to be noted that :
1. Inventories mean any tangible property held for sale, in the process of production for
such safe or for consumption in the production of goods or services for sale.
Maintenance supplies and consumables shall be included. But machinery spares should
be excluded.
2. Valuation of Inventories is required at the end of each accounting period for
(1) determining profit / loss during that period; and (2) for representing these as assets
in the Balance Sheet.
3. The contents of AS 2 mandatory w.e.f. 1.4.1999, should be complied with by all
enterprises for Valuation of Inventories.
4. The method of valuation should be consistent but should not be rigid.
5. In India, inventories should normally be valued at historical cost or net realisable value
whichever is lower.
6. Historical cost is the combination of : (a) Cost of Purchase; (b) Cost of Conversion and
(c) any other cost incurred in the normal course of business for bringing the inventories
up to their present location and condition.
7. Net Realisable value is the Actual or Estimated Selling Price less cost of completion
of works and cost to be incurred to complete the sale.
8. Inventories are to be classified normally in the financial statements as :
(1) Raw materials and components;
(2) Work-in-Process;
(3) Finished goods; and
(4) Stores and spares
9. Where an Inventory is carried at net realisable value, it should be disclosed in the
financial statements separately.
10. By-products should be valued at cost or Net Realisable Value, whichever is lower. But
if the cost of byproducts cannot be ascertained separately, their stock should be valued
at Net Realisable Value.
11. If there is any scope of reprocessing, the inventory of re-usable scrap should be valued
at cost (of material) less reprocessing cost. But if there is no such scope, the inventory
of re-usable scrap should be valued at Net Realisable Value.
12. Inventory of non-reusable scrap should be valued at Net Realisable Value

13. Perishable goods may be valued even below cost if conditions demand

If Inventory is Valued at Market Price (not recommended by AS 2)

Issues of materials may be priced at the current market price. This may again be :
(a) Replacement Price or Purchase Price: It is the price existing at the time of issue. If materials
are consumed in the process of production or sale, replacement has to be made by new
purchase from the market. So the replacement cost is given importance for inventory
valuation.
(b) Realisable Price or Sale Price Method : It is the price which can be realised if the materials
issued to different jobs or work orders are sold out.

8. Latest Purchase Price Method & Next In First Out (or NIFO) Method :

Under this
method stock is not valued at any historical cost already incurred. Rather valuation of
inventory is made at a price which is the probable price of the goods to be received next
to the issue of the inventory.
This method is found to exist very rarely. Its only advantage is that stock valuation is made
at the up-to date replacement cost.
There are some more methods where stock valuation is made at cost. These are

(a) Highest in First Out or HIFO Method : Under this method it is assumed that the lot of
materials whose price is the maximum is to be issued first. The date of actual price of such
materials need not be considered. Thus cost of production is charged at the highest rate
but inventory is valued at the lowest price.
During a period when the price level changes rapidly, this method becomes useful.
(b) Moving Average Method : This may also be Simple Moving Average or Weighted Moving
Average. A moving period is ascertained from a study of past move ments of materials.
Then the average is calculated on the basis of such period.

7. Adjusted Selling Price (also Called Retail Inventory) Method:

It is used in retail business
or in business where the stock consists of items whose individual costs cannot be
readily asertained. At first, the retail price of the goods is ascertained and from that the
anticipated gross margin of profit on such goods is deducted. The calculation of the said
gross margin may be made for individual items or groups of items or by the individual
departments where departmental accounting is possible.
This method may also be used in manufacturing organisations which like to value inventory
of finished products held against forward sale contracts.

6. Standard Cost Method :

Under this method a rate is predetermined and considered as
the standard rate for valuing cost of sales and inventories. It uses some anticipated
rates. According to AS—2, such rates should be realistic and should be reviewed regularly.
There should be sufficient scope of analysing and reconciling the variances between
actual costs and standard costs. It is usually found in job and process type of
industries.

5. Specific Identification Method :

As per Para 11 of AS 2 “The specific identification
formula attributes specific costs to identified goods that have been bought or manufactured
and are segregated for a specific purpose.” Thus, under this method valuation is
made at the original or actual cost price for the specific quantity of identified goods.This
method has limited applications. The scale of operation should not be large and identification
of goods must be possible. There should not be frequent receipts and issues
of materials. The inventories should not be interchangeable and these have to be earmarked
for specific purposes.
Its greatest advantage is that it renders a correct valuation of stock and at the same time
ensures correct matching of costs with revenues.
It involves difficulties and clerical errors if The movement of goods is frequent and if
there are considerable price fluctuations.

4. Base Stock Method :

Under this method,, according to Para 10 of AS 2, it is assumed that
a minimum quantity of inventory (or base stock) must be held at all times to carry on
business. Up to this quantity the inventory is valued at the cost at which it was acquired.
Any excess over this base stock may be valued under FIFO or LIFO method.
As this method assumes that a minimum level of stock must be maintained at all times, it
has a limited application. Where some basic raw materials are required and these are of
the same type. This method is suitable. It is applied in processing industries where processing
takes a considerable time.

Advantages:
(1) As already said this method is ideal for processing industries like refineries, taneries, etc.
(2) Base stock is always valued at its cost of acquisition.
(3) The additional stock over the basic requirement can be valued under any suitable method.
Disadvantages:
(1) Base stock is valued at historical cost. It is treated as a fixed asset, but there is no scope of
depreciating it.
(2) The disadvantages of FIFO or LIFO exist regarding the valuation of additional stock.
(3) This method is somewhat rigid. It requires necessary changes to cope with changes of
production capacity and policy matters regarding stock.

3. Weighted Average Method

For finding out the weighted average rate for stock valuation
both quantity and price of different lots of materials existing in the stock are considered.
The weighted average rate is found by adding the costs of all lots held at the time of issue
and then dividing that total cost by the total quantity of the materials held. Once a rate is
calculated it is applied until a new purchase is made. It does not consider whether the
quantities purchased earlier have already been consumed.

Advantages:
(1) If prices fluctuate considerably and issue of materials has to be made in several lots, this
method becomes very much useful.
(2) Weighted average rate is mathematically sound as it considers both quantity and price.
(3) During inflation, the value of stock becomes much more realistic.
(4) One rate can be consistently applied till a new purchase is made.

Disadvantages :
(1) The prices at which goods are issued do not reflect their actual costs.
(2) Closing stock cannot show the current market price.
(3) Where purchases and receipts of materials are frequent, this method results into mathematical
complications.
(4) If arithmetical accuracy is ignored at the time of calculating the weighted average rate,
unrealised profit or loss may creep into the value of materials.

2. Last in First out (abbreviated as LIFO) method :

Here the materials received last are assumed
to be issued first from the stores. So, the issue price becomes the price of that lot of
materials which has entered last into the stores. The current cost of materials is charged
against revenue. The unsold stock is valued at an old price which, generally becomes
lower than the current cost price.
It is a method used for ‘pricing of issues’. The physical issue of materials may not follow the
principle that goods received last are to be issued first. Its emphasis is on the use of latest or
current cost for computing cost of production. If it is followed, the replacement of used stock
does not involve additional cost. So, it is also known as Replacement Cost Method.
Advantages:
(1) Cost of production is charged at current price. If the price level shows an increasing trend,
higher amount is charged against revenue for cost of materials used.
(2) Closing Stock is valued at an earlier or old price. So, the valuation will conform to minimum
realisable price and shall not include any profit element.
(3) During inflation, application of this method gives more pragmatic result.
(4) Current cost is matched against revenue. So, the matching cost principle can be used more
effectively.

Disadvantages:

(1) If the price level is decreasing or fluctuating, this method gives inaccurate result.
(2) The closing stock can never reflect current market price.
(3) In India AS 2 does not approve it. The Income Tax Authorities do not allow it. In USA the
Generally Accepted Accounting Principles allow it for use in Tax Returns only.

1. First in First out (abbreviated as FIFO) method :

Under this method, the goods which are
produced first or acquired first are sold first or used first for production. The sequence of
issue of goods for sale or production follows the sequence or order in which they have
been received. The goods which remain as unsold stock are valued at current cost price.
According to Littleton and Paton “the cost factors move through the business in procession
fashion” under FIFO method.


Advantages

(1) Stock represents goods purchased recently. So the valuation is made at current purchase
price,
(2) Accounting involves recording of transactions in a chronological manner. FIFO conforms
to that order.
(3) It is a simple method approved by Tax and other authorities.
(4) As issues are priced in the same order in which materials have been acquired, the issues
are made at actual cost.
(5) Where the nature of materials is slow moving or bulk items are not issued, this method is
very useful.

Disadvantages

(1) Where the price level goes up steadily or it fluctuates, this method is not useful.
(2) The prices of issues do not reflect the current market prices.
(3) Matching of current costs with current revenues does not become possible.

Methods of Inventory Valuation

As per AS-2, the following two methods of inventory valuation are recommended :
1. FIFO.
2. Weighted average cost.

Cost Formulae
Inventory should be valued at cost price or net realisable price whichever is lower.
If inventory valuation is made at cost any one of the following methods may be adopted

Valuation of Inventory

AS 2 and its implications
Before going into any discussion regarding any method of inventory valuation the epitome
of Indian Accounting Standard 2 (AS 2) should be understood. It says that—
(1) Inventory should normally be valued at historical cost or net realisable value whichever
is lower.
(2) Historical Cost is the combination of (a) cost of purchase; (b) cost of conversion; and (c)
any other cost incurred in the normal course of a business to bring the inventories up
to their present location and condition.
(3) Net realisable value represents the actual or the estimated selling price less cost of
completion and sale.
(4) By Products should be valued as the lower of cost and net realisable value. Consumable
stores and maintenance supplies should generally be valued at cost.
Re-usable wastes should be valued at net realisable value, if reprocessing is possible.
Goods which are not interchangeable and which are manufactured for a specific purpose
should be valued at specific costs.
Where there is a scope of analysing the difference between the Standard Cost and Actual
Cost (that is, Variance Analysis) direct costing or absorption Costing may be applied.
(5) Cost of Purchase = Purchase Price + Duties and Taxes (unless recoverable from taxing
authorities like CENVAT credit) + Other expenses directly related to the acquisition of
goods (-) Trade Discounts, Rebates, etc.
(6) Cost of Conversion includes any cost related to, production including any overhead
cost.
(7) For retail businesses, adjusted selling price (that is, selling price less gross margin of
profit) may be applied.
(8) Production Overheads should be included only to the extent which has brought the inventory
to the present condition or location. It may be illustrated as—
(a) Production Overheads may be Fixed or Variable by nature.
(b) Fixed Overheads should normally be spread over units produced on the basis of
normal capacity.
For example, if the normal capacity is 10,000 units, actual production is 6,000 units, units sold
is 5,000 units and Fixed Overhead is Rs. 30,000—
Normal Recovery Rate should be Rs.30,000 /10,000 or Rs. 3 per unit. In the case of actual production
overhead recovered becomes 6,000 × Rs. 3 or Rs. 18,000 (at normal rate). The under
recovery of Rs. 30,000 — Rs. 18,000 or Rs. 12,000 is treated as an expense of the year. For valuation
of Stock (in this case 6,000 — 5,000 = 1,000 units), Fixed Production Cost is
1,000 × Rs. 3 = Rs. 3,000.
BUT if actual production is abnormally high say 20,000 units, the overhead rate applicable for
stock valuation should be based on the actual production. It should be Rs. 30,000 / 20,000 or
Rs. 1.50 per unit.
(c) Variable Overheads should be based on the actual units produced.
(3) Inventory carried at net realisable value should be separately disclosed.

1.3 ACCOUNTING FOR INVENTORY

Introduction
Inventory means any stock held by a manufacturing business to meet its production requirements.
A trading concern holds stock of goods for sale.
As per Indian Accounting Standard 2 [AS.-2] Inventories mean tangible property held
(i) for sale in the ordinary course of business, or
(ii) in the process of production for such sale, or
(iii) for consumption in the production of goods or services for sale, including maintenance
supplies and consumables other than machinery spares.

DISPOSAL OF AN ASSET

Sometimes, a firm may sell an asset because of obsolescence or inadequacy or any other reason.
In such cases, the cost of the asset is transferred to a separate account called ‘Asset Disposal
Account’. The entry is passed as under :

Asset Disposal A/c ... Dr.
To Asset A/c
The amount of depreciation provided on this asset from the date of purchase to the date of sale
is also transferred from the ‘Provision for Depreciatio Account’ to the ‘Asset Disposal Account’
the entry being :
Provision for Depreciation A/c ... Dr.
To Asset Disposal A/c
When cash is realised on sale of asset, it is credited to Asset Disposal A/c entry being :
Bank A/c ... Dr.
To Asset Disposal A/c
Loss on disposal is transferred to Profit and Loss Account by passing the following entry :
Profit & Loss A/c ... Dr.
To Asset Disposal A/c
Profit on disposal is transferred by reversing the above entry, i.e.,
Asset Disposal A/c ... Dr.
To Profit & Loss A/c
Profit on disposal represents excess depreciation provided in the past years now credited back
to profit and loss account, whereas loss on disposal represents depreciation not provided for in
the ealier years.

11. Insurance Policy Method

(1) It has a close similarity with the Sinking Fund Method. But, here money is not used for
investment in securities It is used to pay premium on an Insurance Policy which assures
funds necessary for replacement. It may also be called Depreciation Fund Policy Method.
(2) An insurance policy for an assets is taken on the basis of (a) the specific number of years
over which the asset will he used, and (b) the amount that will he required as the
replacement cost of the asset.
(3) At the end of the specific working life of the asset, the policy matures and the Insurance
Company pays the amount including bonus, if any.
(4) Depreciation is substituted by the annual premium on the policy.

Journal Entries : 1st year and subsequent years
1. Profit & Loss A/c Dr.
To Depreciation Fund A/c
[amt. of depreciation]
2. Insurance Policy A/c Dr.
To Bank A/c
[Premium paid at the beginning of the yr.]
At the end of working life of the asset (1) and (2) same as above
3. Bank A/c Dr.
To Insurance Policy A/c
[amt. received on maturity of policy]
4. Insurance Policy A/c Dr.
To Depreciation Fund A/c
[Profit or Bonus received]
5. Depreciation Fund A/c Dr.
To Asset A/c [for closing these accounts]
6. If the asset is sold out—
Bank A/c Dr.
To Asset A/c

If Depreciation is based on the Market Price of asset
1. Revaluation Method
Annual Depreciation is considered to be the reduction in the value of an asset during
a year, or Annual Depreciation is the shortfall in the closing value of an asset from its
opening value.
2. Repairs Provision Method
(1) This method computes depreciation on an asset on the basis of (a) the cost of the asset
and (b) the estimated total cost of repairs to be needed throughout the working life of
the asset.
(2) The expenses for repairs and renewals do not become the same every year. Rather the
amounts spent in different years should be different.
The total cost of repairs for an asset throughout its working life is estimated first.
(3) With total estimated depreciation this total estimated cost of repairs is added.
(4) The result is divided by the working life of the asset to find out annual depreciation.
Thus, Annual Depreciation = (Depreciation + Repairs Cost) / Working Life of the Asset
[*Estimated Total Depreciation = Cost of Acquisition — Scrap Value]
(5) Whatever may be the actual cost of repairs paid in a year, the Annual Depreciation
amount as calculated above is debited to Profit & Loss Account and credited to Provision
for Depreciation and Repairs Account.
The actual amount paid for repairs is debited to Provision for Depreciation and Repairs
account.
(6) After the expiry of the working life of the asset, the balance of the above mentioned
Provision Account is transferred to the Asset Account.
(7) Some concerns create Provision for Repairs & Renewals Account separately with out
including depreciation.

10. Annuity Method

Cost of an asset is considered to be an investment. such investment would earn interest if invested
outside the business.

D = Ci(1+i)n / (1+i)n -1


D= Depreciation
C= Cost of the asset
i= Rate of Deprecition
n= Life of the asset

Journal entries
1. Depreciation A/c Dr.
To Asset A/c
(Calculated from annuity table)
2. Asset A/c Dr.
To Interest A/c
(Calculated on diminishing values)

3. Profit & Loss A/c Dr. .
To Depreciation A/c

4. Interest A/c Dr.
To Profit & Loss A/c


Under Annuity Method:

Annual Depreciation = Ci (1 + i)n = 40,000 x 10% x 1.4641 = 12,619
----------- ----------------
(1+i) n -1 1.4641 - 1


In case of Annuity Method, the amount of Rs.12,619 shall not be invested outside the
business.
It shall have to be taken as an yearly appropriation. The total amount to be appropriated
over a period of 4 years = Rs.12,619 x 4 = Rs.50,476.
Cost of Capital = Total Appropriation - Actual Cost of the Asset = Rs.50,476 -40,000 =
Rs.10,476.

9. Sinking Fund Method

Annual depreciation is considered as a source of providing the replacement cost of an asset. It becomes a means of maintaining capital.

D = Ci.
_______
(1+i)n -1.

D= Depreciation.
C= Cost of the asset.
i= Rate of Deprecition.
n= Life of the asset.





Notes:
(1) No investment is made in the last year as the investments are to be sold out.
(2) Sinking Fund Account may be called Depreciation Fund Account also. It is to be shown
on the liability side of Balance Sheet.
(3) Sinking Fund Investments Account may be called Depreciation Fund Investments Account
also. It is to be shown on the Asset side of the Balance Sheet.
(4) Annual Contribution (charged in lieu of annual depreciation) = Original Cost x Present
Value of Re. 1 at given interest rate.
Illustration: Cost of an Asset Rs.40,000 Life:4 years. Depreciation 10% p.a.
Under Sinking Fund Method:
Annual Depreciation = Ci
------
(1+i) n -1
This amount shall be invested at the end of years 1,2 and 3. The amount of investment shall fetch 10% interest p.a. which will lead to accumulation of Rs.40,000 at the end of the 4th year.

The amount of Rs.8,619 shall not be invested at the end of the 4th year.

8. Service Hours Method

Under this method the expected “service hours or running
time is considered as the basis of charging depreciation. For example, a locomotive
engine renders effective service for some definite running hours. In case of aircrafts
“flying hours” are pre-calculated.

Depreciation per Service Hour = Total Cost —Residual Value / Total Running time or Service hours


And Annual Depreciation = Rate of depreciation per hour x service hours rendered during the period.

6. Mileage Method

(1) It considers the total distance in miles or kilometeres to be run by a vehicle, like bus, car, lorry etc.

(2) Depreciation per mile/km = Cost Price —Scrap Value / Total miles or kms. expected to be run by the vehicle

(3) Annual Depreciation = Depn. per mile or km x distance covered during the year

7. Depletion Unit Method

Depreciation or Depletion per unit = Cost of acquisition and development cost —Residual value / Estimated units to be raised or extracted

Annual Depreciation = Depreciation per unit × units produced or raised or extracted
during the week.

5. Working Hours Method

Features :
The Hourly Rate of Depreciation of an asset is calculated as—
Acquisition Cost — Scrap Value
________________________________
Estimated Total Working Hours


Annual Depreciation is found out as— Hourly Rate of Depreciation x actual working
hours rendered by the asset during the year.
It may also be called a Machine Hour Rate where total machine hours of a machine are
estimated.

4. Double Declining Balance Method :

Features :
(1) Depreciation is charged at a fixed rate and it is calculated on the written down value
of an asset brought forward on the opening date of an accounting year.
(2) The Rate of Depreciation becomes the double of the rate under fixed instalment method.
It may be illustrated as follows:.

3. Sum of Years Digit Method

Features :
(1) It is a revised form of Reducing Balance Method.
(2) Here also the working life of an asset has to be pre-estimated and Total Depreciation is
considered as Cost of the Asset (—) Residual or Scrap Value.
(3) The amount of annual depreciation goes on decreasing with the use. For calculating
depreciation, the denominator becomes the sum of the digits repre senting the life of the
asset. Thus if an asset has a life of 5 years, the denomina tor should be I + 2 + 3 + 4 + 5 or
15.





Depreciation = (Remaining Life of the Asset x Depreciable Amount)/Sum of the Year’s Digit
Where,
Depreciable Amount = Cost of the Asset – Estimated Scrap Value
Sum of the Years’ Digit = n(n+1)/2
n = estimated life of the asset

Example:
If an asset costs Rs. 50,000, it has a residual value of Rs. 5,000 and working life of 5 years
the depreciation will be—
1st year 5/15 of (50,000 —5,000) or Rs. 15,000;
2nd year 4/15 of (50,000 —5,000) or Rs. 12,000;
3rd year 3/15 of (50,000 —5,000) or Rs. 9,000;
4th year 2/15 of (50,000 —5,000) or Rs. 6,000;
5th year 1/15 of (50,000 —5,000) or Rs. 3,000.

2. Reducing / Diminishing Balance Method OR Written Down Value Method

Features :
(1) Depreciation is calculated at a fixed percentage on the original cost in the first year. But
in subsequent years it is calculated at the same percentage on the written down values
gradually reducing during the expected working life of the asset.
(2) The rate of allocation is constant (usually a fixed percentage) but the amount allocated
for every year gradually decreases.

I. Fixed / Equal Instalment OR Straight Line Method

Features :
(1) A fixed portion of the cost of a fixed asset is allocated and charged as periodic depreciation.
(2) Such depreciation becomes an equal amount in each period.
Depreciation = (V-S)/n
Where,
V= Cost of the Asset
S= Residual value or the expected scrap value
n= estimated life of the asset.

Methods of Charging Depreciation

There are different concepts about the nature of depreciation. Moreover, the nature of all
fixed assets cannot be the same. As a result, different methods are found to exist for charging
depreciation. A broad classification of the methods may be summarised as follows
Capital /Source of Fund :
1. Sinking Fund Method
2. Annuity Method
3. Insurance Policy Method
Time Base
1. Fixed Instalment method
2. Reducing Balance Method
3. Sum of Years’ Digit Method
4. Double Declining Method
Use Base
1. Working Hours method
2. Mileage Method
3. Depletion Unit method
4. Service Hours Method
Price Base
1. Revaluation Method
2. Repairs Provision Method

“Depreciation Accounting” (AS 6) (Revised)

The Accounting Standard regarding depreciation was issued at first in 1982. But it was
revised in 1994.
The revised standard (AS 6) is now mandatorily applicable to all concerns in India for
accounting periods commencing on or after 1.4.1995. The important matters to be noted from
(AS 6) are
1. “Depreciable Assets” are the assets which : -
(a) are expected to be used for more than one accounting period; and
(b) have limited useful life; and
(c) are held by an enterprise for use in production or supply of goods and services, for
rental to others or for administrative purposes but not for sale in the ordinary
course of business.
2. “Useful Life” of a depreciable asset may be either :
(a) the period of its expected working life, or
(b) the number of production or similar units expected to be obtained from the use of
the asset by the enterprise.

3. (a) The total amount to be depreciated from the value of a depreciable asset should be
spread over its useful life on a systematic basis.
(b) The method selected for charging depreciation should be consistently followed.
However, if situations demand (like change of statute, compliance with Accounting
Standard, etc.) a change of method may be made. In that case, the depreciation
should be recalculated under the new method with effect from the date of the asset
coming into use, that is, with retrospective effect.
If Depreciation is overcharged earlier, then the following adjustment entry should be made:
Asset A/c…….Dr.
To Profit & Loss Adjustment A/c
If Depreciation is undercharged earlier, then the following adjustment entry should
be made:
Profit & Loss Adjustment A/c…..Dr
To Asset A/c
(c) For ascertaining the useful life of a depreciable asset, these factors should be considered
:
(1) expected physical wear and tear;
(2) obsolescence; and
(3) legal or other limits on the use of the asset.
Useful lives of major depreciable assets may be reviewed periodically.
(d) Any addition or extension essential for an existing asset, should be depreciated
over the remaining life of the asset.
(e) If the historical cost of an asset changes due to exchange fluctuations, price adjustments,
etc. the depreciation on the revised unamortised depreciable amount should
be provided prospectively for the rest of the life of the asset.
(f) For any asset revalued, the provision for depreciation should be made on the
revalued amount for the remaining useful life of the asset.
(g) In the financial statements, the matters to be disclosed are
(1) The historical cost or any amount substituting it;
(2) Total depreciation for the period for each class of depreciable assets; and
(3) The related accumulated depreciation.
The method of charging depreciation should also be disclosed.