Steel prices move. A trader who bought HR coil across three months at three different rates is holding one pile of physically identical material with three different costs attached to it. When the year closes, somebody has to decide what that pile is worth — and that decision changes reported profit, and the tax on it.
This is not an accounting technicality for a business where stock is most of the balance sheet. In a volatile market, the valuation method can move the margin you report by more than a season of good trading did.
You have two methods to choose from, not three
Indian standards are narrower than most traders assume. Under AS 2, Ind AS 2 and ICDS-II, the permitted cost formulas are:
- Specific identification, for items that are not ordinarily interchangeable or are segregated for a specific project.
- FIFO (first-in, first-out).
- Weighted average cost.
LIFO is not permitted under any of them. If someone is still valuing closing stock last-in-first-out because it was the convention years ago, that is a problem to raise with your auditor rather than a preference.
The distinction that matters for steel is interchangeability. A named coil with its own number, heat number and mill certificate is a strong candidate for specific identification — you know exactly which one you sold. A pile of 12 mm TMT of one brand and grade is interchangeable, so FIFO or weighted average applies.
What counts as cost
Cost is more than the rate on the mill invoice. It comprises the purchase price including duties and taxes that are not recoverable, freight inwards and other costs directly attributable to bringing the goods to their present location and condition, less trade discounts and rebates.
Excluded from cost, and therefore charged to the period instead:
- Abnormal waste of material, labour or other production costs.
- Selling and distribution expenses.
- Administrative overheads that do not contribute to bringing inventory to its present location and condition.
For a steel trader the practical consequence is freight inwards. Carrying it as a separate expense rather than into stock cost understates closing stock and overstates the current period’s cost — a distortion that grows with the distance from the mill.
Lower of cost and net realisable value
Whichever formula you use, inventory is measured at the lower of cost and net realisable value. NRV is the estimated selling price less the estimated costs necessary to make the sale.
In a falling market this rule bites. Material bought at a high rate and still unsold when prices drop must be written down to what it will actually fetch. The loss belongs to the period in which the price fell, not to the future period in which you eventually sell it.
An illustration
Illustrative figures, not a real customer’s. Say you bought the same grade three times and sold 150 tonnes:
| Purchase | Quantity | Rate | Value |
|---|---|---|---|
| Lot 1 | 100 t | ₹52,000/t | ₹52,00,000 |
| Lot 2 | 100 t | ₹56,000/t | ₹56,00,000 |
| Lot 3 | 100 t | ₹60,000/t | ₹60,00,000 |
| Total | 300 t | — | ₹1,68,00,000 |
Under FIFO, the 150 tonnes sold are the first 150 — all of Lot 1 and half of Lot 2 — costing ₹80,00,000, leaving closing stock of ₹88,00,000. Under weighted average, the average is ₹56,000 a tonne, so the same 150 tonnes cost ₹84,00,000 and closing stock is ₹84,00,000.
A ₹4,00,000 difference in reported cost of sales, on identical physical facts, from the choice of formula alone. In a rising market FIFO reports the higher profit; in a falling one it reports the lower.
Choosing, and then staying chosen
There is no universally correct answer, but there are sensible defaults. Weighted average suits fast-moving, homogeneous lines — standard TMT sizes, common pipe classes — and smooths the effect of price swings. FIFO suits material that genuinely moves in order and is easier to explain to a lender reading your accounts. Specific identification suits coil, where each one is a distinct, traceable object with its own weight and certificate.
The stronger rule is consistency. Switching formula between years changes your profit without anything real having changed, and it is the first thing an auditor asks about. Choose deliberately, apply the same formula to inventories of similar nature and use, and document why.
Where software fits, and where it does not. SteelERP is not your accounting ledger and does not compute your closing-stock valuation or your tax position — that is your accountant’s work, in your books.
What it holds is the layer every valuation depends on: what is actually in each yard, what each coil weighs, what was received against which purchase, and what left on which challan. A valuation formula applied to quantities that are wrong produces a number that is wrong with more confidence.
Sources
Permitted cost formulas, the prohibition on LIFO, the components of cost and the lower of cost and net realisable value — AS 2 Valuation of Inventories (ClearTax), Ind AS 2 Inventories (ClearTax) and Understanding Ind AS 2: Inventory Valuation (TaxGuru). This article is general information, not accounting or tax advice; your auditor decides what applies to your books.