CA Guide: Inventory Valuation When Shelf Life Is a Factor

The Audit Finding Your Client Dreads

"Inventory valuation not in accordance with Ind AS 2. Near-expiry and slow-moving stock not written down to net realizable value."

For Chartered Accountants, this audit observation is increasingly common. Retail and distribution clients carry inventory with expiry dates, and proper valuation requires considering those dates.

This guide covers what CAs need to know about inventory valuation when shelf life is a factor.

Ind AS 2: The Core Requirements

Paragraph 9: "Inventories shall be measured at the lower of cost and net realizable value."

Paragraph 28: "The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined."

Paragraph 29: "The practice of writing inventories down below cost to net realizable value is consistent with the view that assets should not be carried in excess of amounts expected to be realized from their sale."

For expiring inventory:

• Cost = What was paid for the item
• Net Realizable Value (NRV) = Expected selling price minus costs to sell
• **As expiry approaches, NRV declines—often below cost**

Carrying near-expiry inventory at full cost overstates assets and profits.

NRV Calculation for Expiring Stock

Standard NRV formula:

NRV = Estimated Selling Price − Estimated Costs of Completion − Estimated Costs to Sell

For expiring inventory:

NRV = Discounted Selling Price × Probability of Sale − Disposal Costs

Example:

• Product cost: ₹100
• Normal MRP: ₹150
• Days to expiry: 15
• Historical data: 60% of stock within 15 days of expiry sells at 50% discount
• If unsold: Disposal cost ₹5

NRV = (₹75 × 0.6) + (₹0 × 0.4) − (₹5 × 0.4) = ₹45 − ₹2 = ₹43

This stock should be valued at ₹43, not ₹100. The ₹57 write-down hits current period profit.

The Shelf Life Valuation Matrix

Framework for systematic valuation:

Adjustments needed for:

• Industry (pharmacy vs. grocery vs. FMCG)
• Product category (perishables vs. packaged goods)
• Historical liquidation success
• Seasonal factors

Audit Procedures

Risk assessment:

• Understand client's inventory profile
• What percentage has shelf life < 1 year?
• What categories are most at risk?
• What's historical expiry loss rate?

• Evaluate controls
• Does client track expiry dates at item level?
• Is there systematic monitoring of aging?
• What's the protocol for near-expiry stock?

• Identify high-risk areas
• Perishables and dairy
• Pharmaceuticals
• Seasonal products
• Slow-moving SKUs

Substantive procedures:

• **Inventory aging analysis**
• Obtain expiry-wise inventory listing
• Calculate days to expiry for each batch
• Identify items within 90 days of expiry

• **NRV testing**
• Select sample of near-expiry items
• Compare carrying value to estimated NRV
• Verify management's discount assumptions

• **Historical comparison**
• Analyze actual expiry losses vs. provisions
• Check if provisions are consistently adequate
• Look for patterns of under-provisioning

• **Physical verification**
• During stock count, note expiry dates
• Identify expired stock on premises
• Verify segregation of near-expiry items

• **Subsequent events review**
• Check post-year-end sales of near-expiry stock
• Verify actual selling prices vs. assumptions
• Adjust provisions if material differences

Documentation Requirements

Management representations:

• Inventory is valued at lower of cost and NRV
• Appropriate provisions made for slow-moving and near-expiry stock
• No expired inventory included in reported figures
• Disclosure of valuation methodology is accurate

Working papers should include:

• Expiry-wise inventory listing as at year-end
• NRV calculations for items near expiry
• Basis for probability of sale estimates
• Historical loss analysis
• Movement in provisions during the year
• Comparison of provisions to actual write-offs

Common Client Pushbacks (And How to Address Them)

"We'll sell it all before it expires"

Response: "What's the historical evidence? Let's look at last year's near-expiry stock and what actually happened."

"We return expired stock to suppliers"

Response: "Show me the return policy documentation. What's the actual return acceptance rate? What's the timeline for credit notes?"

"Expiry dates are conservative—products are good for longer"

Response: "Legally, products cannot be sold past expiry date regardless of actual condition. NRV for expired products is zero or negative."

"We discount everything and it sells"

Response: "At what discount? If you sell at 50% discount, the NRV is 50% of MRP, not cost. Show me discounted sales data."

"The provision is immaterial"

Response: "Let's calculate. X% of inventory is within 90 days of expiry, average provision needed is Y%, total provision should be Z. Is Z material?"

Disclosure Requirements

Ind AS 2 paragraph 36 requires disclosure of:

(a) Accounting policies for inventories

(b) Total carrying amount, classified appropriately

(c) Amount of write-down to NRV recognized as expense

(d) Amount of reversal of any write-down

(e) Carrying amount of inventories pledged as security

For businesses with significant expiry risk:

Additional disclosure recommended:

• Provision for slow-moving and near-expiry inventory
• Movement in provision during the year
• Methodology for NRV estimation
• Key assumptions and sensitivities

Tax Implications

For income tax purposes:

• **Write-off of expired stock:**
• Deductible as business loss under Section 28
• Documentation required: destruction certificate, inventory records
• Physical destruction often required for deduction

• **Provision for anticipated expiry:**
• Generally not allowed as deduction until actual loss
• Disallowance creates timing difference
• Deferred tax asset recognition considerations

• **GST considerations:**
• No ITC reversal required for expired goods (natural loss)
• But if expired goods are "written off," ITC reversal may apply under Section 17(5)(h)
• Interpretation varies; professional judgment required

Tax-audit report implications:

Form 3CD requires disclosure of stock valuation method. If method differs from consistent past practice or doesn't follow proper NRV approach, it should be reported.

Industry-Specific Considerations

Pharmaceuticals:

• Schedule H/H1/X drugs have regulatory requirements
• Expired medicines cannot be returned to trade
• Destruction requires specific protocols
• Higher scrutiny on valuation given health implications

FMCG and retail:

• High SKU count makes comprehensive review difficult
• Automated aging reports essential
• Sampling strategy based on value and days to expiry
• Return policies with distributors affect NRV

Dairy and perishables:

• Very short shelf life (days, not months)
• Daily/weekly valuation adjustments may be needed
• Significant judgment in probability estimates
• Material provisions likely

Restaurants and food service:

• Raw materials and prepared inventory
• Very short life for prepared items
• End-of-day disposal common
• Systematic waste tracking needed

Technology and Audit Efficiency

When clients have inventory management systems:

• Extract aging reports directly from system
• Verify system captures expiry dates accurately
• Test system calculations against manual recalculation
• Use data analytics for full population analysis

Audit data analytics:

• Plot distribution of days-to-expiry across inventory
• Identify outliers (very near expiry, high value)
• Compare expiry profile to prior year
• Analyze velocity (days of stock on hand vs. days to expiry)

When clients lack systems:

• Manual sampling becomes necessary
• Higher sample sizes for higher risk
• Consider qualified opinion if documentation inadequate
• Recommend system implementation for future periods

The Qualified Opinion Risk

Circumstances leading to qualification:

• Unable to obtain sufficient evidence about NRV
• Client refuses to make appropriate provisions
• Expired inventory included in valuation
• Expiry tracking systems inadequate for audit

Example qualification language:

"We were unable to obtain sufficient appropriate audit evidence about the net realizable value of inventories amounting to ₹X as at March 31, 20XX, because the company does not maintain records of expiry dates at item level. Consequently, we were unable to determine whether any adjustments to this amount were necessary."

Management Letter Points

Common recommendations:

• Implement batch-level inventory tracking with expiry dates
• Generate monthly aging reports for management review
• Establish systematic provision policy based on days to expiry
• Create protocol for handling and disposing expired stock
• Document return policies with suppliers
• Train staff on FEFO procedures
• Consider inventory management software investment

ROI argument for clients:

"A ₹50,000/year inventory system that properly tracks expiry will likely pay for itself through:

• Reduced write-offs (better visibility)
• Successful return claims (documentation)
• Audit efficiency (lower audit fees)
• Better working capital management
• Regulatory compliance (FSSAI, drugs)"

The Bottom Line

For CAs auditing clients with perishable inventory, expiry-based valuation isn't optional—it's required under Ind AS 2. Stock approaching expiry date has declining NRV, and proper accounting requires writing down to that lower value.

The audit challenge is getting sufficient evidence. Clients with expiry tracking systems provide clean, analyzable data. Clients without systems create audit risk that may require qualification.

Your advisory role includes helping clients understand that proper inventory management isn't just operational efficiency—it's financial statement accuracy.

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