Under Ind AS 2, inventory is carried at the lower of cost and net realisable value (NRV), tested separately for each item or group of similar items — never at a single blended NRV for the whole inventory. The audit work has three parts: confirm the cost formula actually used (FIFO or weighted average — Ind AS 2 does not permit LIFO) is applied consistently, confirm that cost of conversion includes only production overheads allocated on normal capacity and excludes abnormal waste, and evidence the NRV comparison with actual selling prices or quotes obtained at or near the reporting date, not budgeted prices.
What 'cost' is allowed to include
| Included in cost | Excluded — expensed as incurred |
|---|---|
| Purchase price, import duties, freight inward, less trade discounts | Abnormal wastage of materials, labour or other production costs |
| Direct labour and production overheads allocated on normal capacity | Storage costs, unless necessary for a further production stage |
| Fixed overheads allocated using normal production capacity, not actual if abnormally low | Administrative overheads not contributing to bringing inventory to present location/condition |
| Other costs necessary to bring inventory to present location and condition | Selling costs |
Testing procedures
- 01Confirm the cost formula and its consistencyCheck the accounting policy note matches what the costing records actually compute, and that the same formula is used for all inventories of similar nature and use across the entity — a switch between FIFO and weighted average between periods needs a disclosed, justified reason.
- 02Recompute the overhead allocation rateTrace the fixed production overhead absorption rate to actual production volumes against normal capacity; where actual output is abnormally low, confirm unabsorbed overhead was expensed rather than loaded onto unit cost.
- 03Obtain NRV evidence dated at or after year endFor finished goods, trace to actual post-year-end sales invoices or firm orders; for raw materials, trace to current replacement cost or the NRV of the finished product they go into, not a price list management has not revisited.
- 04Test the lower-of-cost-and-NRV comparison item by itemRecompute on a sample covering high-value and slow-moving lines; a single portfolio-level write-down figure from management, without item-level support, is not sufficient evidence.
A net realisable value estimate built from budgeted or list selling prices, rather than prices actually realised or firmly quoted close to year end, is the single most common Ind AS 2 misstatement — it systematically understates the required write-down in a falling market.
This is practical guidance written for audit teams, not an authoritative statement of any standard or statute. Standards, forms and timelines change. Check the current text issued by the ICAI and the relevant authority before relying on anything here in an audit file.
Related resources
- Inventory & stockInventory valuation audit: FIFO, weighted average and cost testingTesting the cost formula actually applied against the one disclosed, NRV testing, and overhead absorption into manufacturing cost.
- Inventory & stockPhysical stock count: audit observation procedurePlanning the count date and cut-off instructions, test counts and sampling, covering multiple locations at once, and reconciling count to book quantities.
- Inventory & stockAuditing slow-moving and obsolete inventoryAgeing analysis by SKU, testing the provisioning policy against actual realization, and red flags where a policy is never applied in practice.
- Inventory & stockWork-in-progress valuation in a manufacturing auditStage-of-completion estimation challenges, testing the bill of materials and standard cost build-up, and the physical verification difficulty of WIP.
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