Introduction to NAS 2: Inventories
What is NAS 2?
NAS 2 is the Nepal Accounting Standard that deals with the accounting treatment of inventories. It ensures that inventories are measured properly and that the related expenses are recognized in the correct accounting period.
Objective and Scope of NAS 2
The main objective of NAS 2 is to prescribe the accounting treatment for inventories. The standard applies to all types of inventories except for certain excluded categories, such as construction contracts (covered under NAS 11) and financial instruments.
Key Definitions under NAS 2
Meaning of Inventories
Inventories are assets held for:
- Sale in the ordinary course of business
- In the process of production for such sale
- Consumption in the production of goods or rendering of services
Types of Inventories Covered by NAS 2
- Raw materials
- Work-in-progress
- Finished goods
- Merchandise (for trading businesses)
Measurement of Inventories
Initial Recognition and Cost of Inventories
Inventories should be initially measured at cost. This cost includes:
- Purchase costs (purchase price, import duties, transportation)
- Conversion costs (direct labor and overheads)
- Other costs to bring the inventories to their present location and condition
Cost Formulas: FIFO and Weighted Average
When inventories consist of many similar items, businesses can use:
- FIFO (First In, First Out): Assumes the earliest goods purchased are sold first.
- Weighted Average: Cost is calculated by dividing the total cost by the number of units.
Net Realizable Value (NRV) and its Importance
Inventories must be valued at the lower of cost and net realizable value (NRV). NRV is the estimated selling price minus the estimated costs of completion and selling expenses.
Methods for Valuing Inventories under NAS 2
Specific Identification Method
Used when specific costs can be identified with specific items of inventory, commonly used for high-value items.
FIFO Method (First In, First Out)
Assumes that the oldest inventory items are sold first, which is practical for perishable goods.
Weighted Average Cost Method
Calculates an average cost for all inventory items, suitable for bulk or indistinguishable items.
Recognition as an Expense
When to Recognize Inventories as Expense in Profit or Loss
Inventories should be recognized as an expense when they are sold or consumed in the production process. Any loss of value due to damage, obsolescence, or NRV falling below cost should also be recognized as an expense.
Disclosure Requirements of NAS 2
Mandatory Information to Disclose in Financial Statements
- Accounting policies adopted
- Carrying amounts of inventories by classification (raw materials, finished goods, etc.)
- Amount of inventories recognized as expense
- Amount of any write-down to NRV
- Circumstances of any inventory reversals
Importance of NAS 2 for SMEs in Nepal
Why SMEs Should Follow NAS 2
For Small and Medium Enterprises (SMEs) in Nepal, proper inventory accounting is essential for several reasons:
- Ensures accurate profit calculation by matching expenses with revenue
- Helps maintain proper cash flow management by preventing over-purchasing or stock shortages
- Builds trust with lenders and investors by presenting reliable financial reports
- Facilitates compliance with tax regulations by maintaining transparency in stock valuation
Benefits of NAS 2 for SMEs
- Improved decision-making regarding stock levels and purchasing
- Better pricing strategies by knowing the true cost of products
- Avoidance of overstatement of assets, reducing the risk of penalties during audits
By adopting NAS 2, SMEs in Nepal can strengthen their financial position and gain competitive advantages in the market.
Differences Between NAS 2 and IAS 2
Key Similarities and Differences Explained
NAS 2 is largely converged with IAS 2 (International Accounting Standard 2). However, there may be slight differences in terminology or guidance specific to the Nepalese business environment.
Practical Examples and Case Studies
Example: Inventory Valuation of a Trading Company in Nepal
ABC Traders purchased 1,000 units of goods at Rs. 100 each. By year-end, the market price dropped to Rs. 90 per unit. The inventory is reported at:
- Cost = Rs. 100,000
- NRV = Rs. 90,000
- Valuation = Rs. 90,000 (lower of cost or NRV)
Example: Write-down of Inventory to NRV
A manufacturer had old stock of mobile accessories that couldn’t be sold at the original price. The business wrote down the value in their accounts to reflect the reduced selling price, in compliance with NAS 2.
Conclusion and Key Takeaways of NAS 2
Why Proper Inventory Accounting Matters for Businesses
Following NAS 2 helps ensure that a business’s assets are not overstated and that expenses are recognized properly, giving an accurate financial picture. For Nepali businesses, correct inventory valuation is essential for preparing fair financial statements and complying with regulatory requirements.
By understanding and applying NAS 2, businesses in Nepal can improve their financial reporting quality and make better-informed decisions.