EPFO EO/AO 2023 General Ability Test · Question 76 of 120

Correct — B, (b) Storage costs which are necessary in the production process prior to a further production stage. The stem is printed with a colon at the end rather than a question mark, and 'Cost of Inventory' is in single quotation marks, as in the booklet. The four options are not a random assortment. Three of them are lifted almost word for word from paragraph 13 of Accounting Standard 2, which lists what must be kept OUT of the cost of inventories, and the fourth is the exception buried inside that list. Paragraph 6 of AS 2 sets the rule: 'The cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.' That last phrase is the test everything else answers to. Paragraph 13 then says that in determining the cost of inventories in accordance with paragraph 6 'it is appropriate to exclude certain costs and recognise them as expenses in the period in which they are incurred', and gives four examples: (a) abnormal amounts of wasted materials, labour or other production costs; (b) storage costs, unless those costs are necessary in the production process prior to a further production stage; (c) administrative overheads that do not contribute to bringing the inventories to their present location and condition; and (d) selling and distribution costs. Option (b) is clause (b) turned inside out. Storage costs are ordinarily excluded, because warehousing a finished good does nothing to bring it to its present condition — but the standard's own 'unless' carves out storage that IS necessary in the production process before a further stage of production. Wine or whisky maturing in a cask, cheese ageing, timber seasoning, a chemical intermediate held for a required period: in each case the storage is part of making the product, not a cost of holding it after it is made, so it is included in the cost of inventory. Option (b) states exactly that carve-out, so it is the one item on the list that goes into cost. The other three options reproduce clauses (c), (d) and — in option (d) — the parenthesis in paragraph 7, and every one of them is a cost the standard puts outside inventory.

• (a)Administrative overheads that do not contribute to bringing the inventories to their present location and condition — This is paragraph 13(c) of AS 2 verbatim, and it is a cost the standard excludes. Note where the negation sits — 'do not contribute' — because it is what makes the option a mirror image of the answer rather than a parallel to it. Administrative overheads that DO contribute to bringing inventories to their present location and condition are includible under paragraph 6; those that do not are excluded by paragraph 13(c). The option quotes the excluded half, so it cannot be the answer.
• (c)Selling and distribution costs — Paragraph 13(d) excludes these outright, with no qualification of any kind — the only one of the four exclusions that carries no 'unless' or 'that do not'. The reason is the paragraph 6 test: selling and distribution costs are incurred to move goods away from their present location after they are finished, not to bring them to it. They are period expenses, recognised when incurred. Because this exclusion is absolute, it is the easiest option on the list to eliminate.
• (d)Duties and taxes paid on purchases, subsequently recoverable by the enterprise from the Tax Authorities — This comes from paragraph 7 rather than paragraph 13, and it is excluded by that paragraph's own parenthesis: the costs of purchase consist of the purchase price 'including duties and taxes (other than those subsequently recoverable by the enterprise from the taxing authorities)', freight inwards and other expenditure directly attributable to the acquisition, with trade discounts, rebates, duty drawbacks and similar items deducted. A recoverable tax is not a cost to the enterprise at all — it is a receivable from the government, which is why input tax credit under GST never enters the value of stock. Non-recoverable duties and taxes, by contrast, are part of the cost of purchase and would have been includible.

AS 2 governs the valuation of inventories, and its central rule is that inventories are carried at the lower of cost and net realisable value. Cost is built up in three layers under paragraph 6 — costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. Paragraph 7 defines the first layer: purchase price including non-recoverable duties and taxes, freight inwards and directly attributable expenditure, less trade discounts, rebates, duty drawbacks and other similar items. Paragraph 8 defines the second: costs directly related to the units of production, such as direct labour, plus a systematic allocation of fixed and variable production overheads incurred in converting materials into finished goods. Paragraph 13 then polices the boundary by listing what is excluded and expensed in the period incurred — abnormal waste, storage costs, non-contributing administrative overheads, and selling and distribution costs — with the storage exclusion qualified by the words 'unless those costs are necessary in the production process prior to a further production stage'. Every one of these rules is an application of the same test: does the cost bring the inventory to where and what it now is? If it does, it is capitalised into stock; if it merely accompanies ownership or disposal, it is charged to the profit and loss account.

The accountancy block of the EO/AO paper draws heavily on the Accounting Standards, and AS 2 is its most frequently used because inventory valuation touches both financial reporting and audit. The examiner's method here is to take a list of exclusions and hide the single inclusion inside it as a qualifying clause, which tests whether the candidate has read the standard or a summary of it — summaries routinely print 'storage costs are excluded' without the 'unless'. The habit rewarded is reading exceptions as carefully as rules, since an exception is the only part of a list an examiner can key without argument.

• AS 2, paragraph 5 — inventories should be valued at the lower of cost and net realisable value.
• AS 2, paragraph 6 — the cost of inventories comprises all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.
• AS 2, paragraph 7 — costs of purchase are the purchase price including duties and taxes other than those subsequently recoverable from the taxing authorities, freight inwards and other directly attributable expenditure; trade discounts, rebates, duty drawbacks and similar items are deducted.
• AS 2, paragraph 8 — costs of conversion include costs directly related to units of production, such as direct labour, plus a systematic allocation of fixed and variable production overheads.
• AS 2, paragraph 13(a) — abnormal amounts of wasted materials, labour or other production costs are excluded from the cost of inventories.
• AS 2, paragraph 13(b) — storage costs are excluded UNLESS those costs are necessary in the production process prior to a further production stage.
• AS 2, paragraph 13(c) — administrative overheads that do not contribute to bringing the inventories to their present location and condition are excluded.
• AS 2, paragraph 13(d) — selling and distribution costs are excluded, without qualification.
• Excluded costs are recognised as expenses in the period in which they are incurred.

• Remembering 'storage costs are excluded' without the 'unless'. The qualification is the whole question.
• Missing the negation in option (a). Administrative overheads that DO contribute to bringing inventories to their location and condition are includible; the option quotes the ones that do not.
• Capitalising recoverable taxes. Input tax credit is a receivable, not a cost, so it never enters the value of stock.
• Treating abnormal waste as part of cost. Only normal loss is absorbed into the cost of the good units; abnormal amounts are expensed.

AS 2 appears in EO/AO in three forms — which cost is included in inventory, which cost formula is permitted, and a numerical valuation at the lower of cost and net realisable value. All three are answered from paragraphs 6, 7, 13 and the cost-formula paragraphs, so read those four passages in the standard itself rather than in a summary.

No directly related past PYQ was found.

• practice — not a real PYQ

  Which one of the following is excluded from the cost of inventories under Accounting Standard-2 ?

  • (a)Freight inwards on purchase of raw materials
  • (b)Direct labour in converting materials into finished goods
  • (c)Abnormal amounts of wasted materials
  • (d)Non-recoverable duties paid on purchases

  Answer(c) Abnormal amounts of wasted materials

• practice — not a real PYQ

  Under Accounting Standard-2, inventories should be valued at :

  • (a)Cost
  • (b)Net realisable value
  • (c)Lower of cost and net realisable value
  • (d)Higher of cost and net realisable value

  Answer(c) Lower of cost and net realisable value