Taxpublishers.in - Monday Corner Answer to the Quiz for the week (21 Apr 2025)

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Quiz for the week (21 Apr 2025): Son Jewellers is a proprietary concern engaged in jewellery business. It was valuing the closing stock at cost or NRV whichever is less. The cost was ascertained by following FIFO method. Now due to continuous increase in price of gold, the assessee wants to adopt LIFO method for the stock of inventory held as on 31st March,2025. Is it possible to do so? What would be your answer in case it is a corporate entity? Best Answer : Section 145A of the Income-tax Act, 1961 says that for the purpose of determining the income chargeable under the head “Profits and gains of business or profession”, the valuation of inventory shall be made at lower of actual cost or net realizable value computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145. Section 145(2) empowers the Central Government to notify in the Official Gazette from time-to-time income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income. ICDS – II deals with valuation of inventories. Paragraph 14 of the ICDS says that “specific identification cost” could be used by assigning specific cost to identified items of inventory. Paragraph 16 says that cost of inventory, other than the inventory dealt with in paragraph 13 shall be assigned by using First-in-First-out (FIFO), or weighted average cost formula. The formula used shall reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition. Paragraph 17 says that the FIFO formula assumes that the items of inventory which were purchased or produced first are consumed first or sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced. Under weighted average cost formula, the cost of each item is determined from the weighted average cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average shall be calculated on a periodic basis or as each additional shipment is received, depending upon the circumstances. It is apparent from the above that either FIFO method or weighted average cost are permitted methods of ascertaining the cost of inventory and LIFO method is not recognized method of inventory valuation. AS 2 which corresponds to IAS 2 under IFRS, also mandates that inventory should be valued at cost or NRV whichever is lower and allows only FIFO and weighted average cost as acceptable methods of cost determination. Assuming the assessee is already valuing the inventory as per FIFO method it cannot change the method of valuation to LIFO method since that method is not permissible. This is applicable both for corporate and non-corporate entities. One of the drawbacks in following LIFO method is that the profit in the increasing market price of jewellery items would occur only when the oldest stocks are sold. In other words, if there is no replenishment of stock and only sale is made the oldest stock or the terminal sales would disclose huge profits. Also, the current profits would be neutralized by adopting LIFO method of inventory valuation. On the other hand, if FIFO method of inventory valuation is adopted the recent addition to the inventory is matched by the stock in hand when valued on FIFO basis and thus the volatile profit or income admission would not arise. Besides the fact that LIFO method is not permissible for inventory valuation and the assessee has to follow either FIFO method or the weighted average cost, one would take note of the fact that the jewellers these days identify the inventory by assigning unique code numbers to each item an accounting the same with respective cost of manufacture or purchase. The closing stock could also be found by means of such unique code numbers assigned to various items of stock in hand and in which case the specific identification cost is possible. This would be hassle-free and also easy to identify given that most of the jewellery units have computer assisted inventory maintenance system.

Quiz for the week (21 Apr 2025):

Son Jewellers is a proprietary concern engaged in jewellery business. It was valuing the closing stock at cost or NRV whichever is less. The cost was ascertained by following FIFO method. Now due to continuous increase in price of gold, the assessee wants to adopt LIFO method for the stock of inventory held as on 31st March,2025. Is it possible to do so? What would be your answer in case it is a corporate entity?

Best Answer :

Section 145A of the Income-tax Act, 1961 says that for the purpose of determining the income chargeable under the head “Profits and gains of business or profession”, the valuation of inventory shall be made at lower of actual cost or net realizable value computed in accordance with the income computation and disclosure standards notified under sub-section (2) of section 145.

Section 145(2) empowers the Central Government to notify in the Official Gazette from time-to-time income computation and disclosure standards to be followed by any class of assessees or in respect of any class of income.

ICDS – II deals with valuation of inventories. Paragraph 14 of the ICDS says that “specific identification cost” could be used by assigning specific cost to identified items of inventory.

Paragraph 16 says that cost of inventory, other than the inventory dealt with in paragraph 13 shall be assigned by using First-in-First-out (FIFO), or weighted average cost formula. The formula used shall reflect the fairest possible approximation to the cost incurred in bringing the items of inventory to their present location and condition.

Paragraph 17 says that the FIFO formula assumes that the items of inventory which were purchased or produced first are consumed first or sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced.

Under weighted average cost formula, the cost of each item is determined from the weighted average cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average shall be calculated on a periodic basis or as each additional shipment is received, depending upon the circumstances.

It is apparent from the above that either FIFO method or weighted average cost are permitted methods of ascertaining the cost of inventory and LIFO method is not recognized method of inventory valuation.

AS 2 which corresponds to IAS 2 under IFRS, also mandates that inventory should be valued at cost or NRV whichever is lower and allows only FIFO and weighted average cost as acceptable methods of cost determination.

Assuming the assessee is already valuing the inventory as per FIFO method it cannot change the method of valuation to LIFO method since that method is not permissible. This is applicable both for corporate and non-corporate entities.

One of the drawbacks in following LIFO method is that the profit in the increasing market price of jewellery items would occur only when the oldest stocks are sold. In other words, if there is no replenishment of stock and only sale is made the oldest stock or the terminal sales would disclose huge profits. Also, the current profits would be neutralized by adopting LIFO method of inventory valuation.

On the other hand, if FIFO method of inventory valuation is adopted the recent addition to the inventory is matched by the stock in hand when valued on FIFO basis and thus the volatile profit or income admission would not arise.

Besides the fact that LIFO method is not permissible for inventory valuation and the assessee has to follow either FIFO method or the weighted average cost, one would take note of the fact that the jewellers these days identify the inventory by assigning unique code numbers to each item an accounting the same with respective cost of manufacture or purchase. The closing stock could also be found by means of such unique code numbers assigned to various items of stock in hand and in which case the specific identification cost is possible. This would be hassle-free and also easy to identify given that most of the jewellery units have computer assisted inventory maintenance system.