Inventories (International Accounting Standard 2)
to exchange financial assets or financial
Objective
The objective of this Standard is to prescribe the accounting
treatment for inventories.
A primary issue in accounting for inventories is the amount
of cost to be recognised as an asset and carried forward
until the related revenues are recognised.
This Standard provides guidance on the determination of
cost and its subsequent recognition as an expense,
including any write-down to net realisable value.
It also provides guidance on the cost formulas that are used
to assign costs to inventories.
Scope
This Standard applies to all inventories, except:
a) financial instruments (see IAS 32 Financial Instruments:
Presentation and IFRS 9 Financial Instruments); and
b) biological assets related to agricultural activity and
agricultural produce at the point of harvest (see IAS 41
Agriculture).
A financial instrument is any contract that gives rise to a
financial asset of one entity and a financial liability or equity
instrument of another entity (IAS 32).
(IAS 32) A financial asset is any asset that is:
a) cash;
b) an equity instrument of another entity;
c) a contractual right:
i. to receive cash or another financial asset from
another entity; or
ii. to exchange financial assets or financial
liabilities with another entity under conditions that
are potentially favourable to the entity (derivative,
call or put options); or
d) a contract that will or may be settled in the entity’s own
equity instruments (derivative).
Examples of financial assets
a) Cash and cash equivalents
b) Receivables
c) Investment in equity or debt instruments
d) Sinking fund
(IAS 32) A financial liability is any liability that is:
a) a contractual obligation:
i. to deliver cash or another financial asset to
another entity; or
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ii.
liabilities with another entity under conditions that
are potentially unfavourable to the entity
(derivative); or
b) a contract that will or may be settled in the entity’s own
equity instruments (derivative
Examples of financial liabilities
a) Payables
b) Lease liabilities
c) Held for trading liabilities
d) Derivative liabilities
e) Redeemable preference shares issued
f) Returnable deposits
An equity instrument is any contract that evidences a
residual interest in the assets of an entity after deducting
all of its liabilities (IAS 32).
A biological asset is a living animal or plant.
Agricultural activity is the management by an entity of the
biological transformation and harvest of biological assets
for sale or for conversion into agricultural produce or into
additional biological assets.
Agricultural produce is the harvested produce of the entity’s
biological assets. (Source: IAS 41)
This Standard does not apply to the measurement (lower
of cost and net realisable value) of inventories held by:
a) producers of agricultural and forest products,
agricultural produce after harvest, and minerals and
mineral products, to the extent that they are measured at
net realisable value in accordance with well-established
practices in those industries.
b) commodity (gold, electricity, rice) broker-traders who
measure their inventories at fair value less costs to sell.
Note: Broker-traders are those who buy or sell
commodities for others or on their own account.
Definitions
Inventories are assets:
a) held for sale in the ordinary course of business;
b) in the process of production for such sale; or
c) in the form of materials or supplies to be consumed in
the production process or in the rendering of services.
Net realisable value is the estimated selling price in the
ordinary course of business less the estimated costs of
completion and the estimated costs (to sell) necessary to
make the sale.
Fair value is the price that would be received to sell an asset
or paid to transfer a liability in an orderly transaction
between market participants at the measurement date.
(See IFRS 13 Fair Value Measurement.)
Note: Net realisable value for inventories may not
equal fair value less costs to sell.
Measurement of inventories
Inventories shall be measured at the lower of cost and net
realisable value.
Cost of inventories
The cost of inventories shall comprise all costs of purchase,
costs of conversion and other costs incurred in bringing the
inventories to their present location and condition
Costs of purchase
The costs of purchase of inventories comprise the purchase
price, import duties and other taxes (other than those
subsequently recoverable by the entity from the taxing
authorities, e.g., VAT), and transport, handling and other
costs directly attributable to the acquisition of finished
goods, materials and services. Trade discounts, rebates
and other similar items are deducted in determining the
costs of purchase
Import duty is a tax collected on imports and some exports
by a country's customs authorities.
A handling fee is an amount charged to a customer on top
of the order subtotal and shipping cost to cover any
additional expenses related to order fulfillment.
Handling costs are costs implied on consumer other than
selling price of product. It can be different for different
industries. For e-commerce it can include warehouse
storage costs, shipment cost, and packaging cost. For
Insurance industry it can mean processing and
administration costs of insurance claims.
Costs of conversion
The costs of conversion of inventories include costs directly
related to the units of production, such as direct labour.
They also include a systematic allocation of fixed and
variable production overheads that are incurred in
converting materials into finished goods. Fixed production
overheads are those indirect costs of production that
remain relatively constant regardless of the volume of
production, such as depreciation and maintenance of
factory buildings, equipment and right-of-use assets used
in the production process, and the cost of factory
management and administration. Variable production
overheads are those indirect costs of production that vary
directly, or nearly directly, with the volume of production,
such as indirect materials and indirect labour.
Other costs (included in cost of inventories)
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Other costs are included in the cost of inventories only to
the extent that they are incurred in bringing the inventories
to their present location and condition.
For example, it may be appropriate to include non-
production overheads or the costs of designing products for
specific customers in the cost of inventories.
IAS 23 Borrowing Costs identifies limited circumstances
where borrowing costs are included in the cost of
inventories.
Exclusions (cost of inventories)
An entity may purchase inventories on deferred settlement
terms. When the arrangement effectively contains a
financing element, that element, for example a difference
between the purchase price for normal credit terms and the
amount paid, is recognised as interest expense over the
period of the financing.
Cost of agricultural produce harvested from biological
assets
In accordance with IAS 41 Agriculture inventories
comprising agricultural produce that an entity has
harvested from its biological assets are measured on initial
recognition at their fair value less costs to sell at the point
of harvest. This is the cost of the inventories at that date
for application of this Standard.
Cost formulas
The cost of inventories of items that are not ordinarily
interchangeable (individually unique) and goods or services
produced and segregated for specific projects shall be
assigned by using specific identification of their individual
costs.
The cost of inventories, other than those dealt with using
specific identification, shall be assigned by using the first-
in, first-out (FIFO) or weighted average cost formula. An
entity shall use the same cost formula for all inventories
having a similar nature and use to the entity. For
inventories with a different nature or use, different cost
formulas may be justified. For example, inventories used in
one operating segment may have a use to the entity
different from the same type of inventories used in another
operating segment.
A difference in geographical location of inventories (or in
the respective tax rules), by itself, is not sufficient to justify
the use of different cost formulas.
The FIFO formula assumes that the items of inventory that
were purchased or produced first are sold first, and
consequently the items remaining in inventory at the end
of the period are those most recently purchased or
produced.
Under the weighted average cost formula, the cost of each
item is determined from the weighted average of the cost
of similar items at the beginning of a period and the cost of
similar items purchased or produced during the period. The
average may be calculated on a periodic basis, or as each
additional shipment is received, depending upon the
circumstances of the entity.
Net realisable value
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.
The cost of inventories may also not be recoverable if the
estimated costs of completion or the estimated costs to be
incurred to make the sale have increased.
The practice of writing inventories down below cost to net
realisable value is consistent with the view that assets
should not be carried in excess of amounts expected to be
realised from their sale or use.
Inventories are usually written down to net realisable value
item by item (damaged).
In some circumstances, however, it may be appropriate to
group similar or related items (obsolete). This may be the
case with items of inventory relating to the same product
line that have similar purposes or end uses, are produced
and marketed in the same geographical area, and cannot
be practicably evaluated separately from other items in that
product line.
It is not appropriate to write inventories down on the basis
of a classification of inventory, for example, finished goods,
or all the inventories in a particular operating segment.
A new assessment is made of net realisable value in each
subsequent period. When the circumstances that previously
caused inventories to be written down below cost no longer
exist or when there is clear evidence of an increase in net
realisable value because of changed economic
circumstances, the amount of the write-down is reversed
(ie the reversal is limited to the amount of the original
write-down) so that the new carrying amount is the lower
of the cost and the revised net realisable value. This occurs,
for example, when an item of inventory that is carried at
net realisable value, because its selling price has declined,
is still on hand in a subsequent period and its selling price
has increased.
Recognition as an expense
When inventories are sold, the carrying amount of those
inventories shall be recognised as an expense in the period
in which the related revenue is recognised.
The amount of any write-down of inventories to net
realisable value and all losses of inventories shall be
recognised as an expense (“loss on inventory writedown”,
as part of “other expenses”) in the period the write-down
or loss occurs.
The amount of any reversal of any write-down of
inventories, arising from an increase in net realisable value,
shall be recognised as a reduction in (cost of sales) the
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amount of inventories recognised as an expense in the
period in which the reversal occurs.
Some inventories may be allocated to other asset accounts,
for example, inventory used as a component of self-
constructed property, plant or equipment. Inventories
allocated to another asset in this way are recognised as an
expense during the useful life of that asset.
Disclosure
The financial statements shall disclose:
a) the accounting policies adopted in measuring
inventories, including the cost formula used;
b) the total carrying amount of inventories and the carrying
amount in classifications appropriate to the entity;
c) the carrying amount of inventories carried at fair value
less costs to sell; d) the amount of inventories recognised
as an expense during the period;
e) the amount of any write-down of inventories recognised
as an expense in the period;
f) the amount of any reversal of any write-down that is
recognised as a reduction in the amount of inventories
recognised as expense in the period;
g) the circumstances or events that led to the reversal of a
write-down of inventories; and
h) the carrying amount of inventories pledged as security
for liabilities.
Financial Instruments: Presentation
International Accounting Standard 32
Objective
The objective of this Standard is to establish principles for
presenting financial instruments as liabilities or equity and
for offsetting financial assets and financial liabilities. It
applies to the classification of financial instruments, from
the perspective of the issuer, into financial assets, financial
liabilities and equity instruments; the classification of
related interest, dividends, losses and gains; and the
circumstances in which financial assets and financial
liabilities should be offset. (IAS 32 par. 2)
The principles in this Standard complement the principles
for recognising and measuring financial assets and financial
liabilities in IFRS 9 Financial Instruments, and for disclosing
information about them in IFRS 7 Financial Instruments:
Disclosures. (IAS 32 par. 3)
A financial instrument is any contract that gives rise to a
financial asset of one entity and a financial liability or equity
instrument of another entity. (IAS 32 par. 11)
Examples of financial instrument
1. Cash in the form of notes and coins
2. Cash in the form of checks
3. Cash in bank
4. Trade accounts
5. Note and loan
6. Debt security
7. Equity security
Financial asset
A financial asset is any asset that is:
1. cash;
2. an equity instrument of another entity;
3. a contractual right: a. to receive cash or another financial
asset from another entity; or b. to exchange financial
assets or financial liabilities with another entity under
conditions that are potentially favourable to the entity
(derivatives, e.g., call or put options); or
4. a contract that will or may be settled in the entity’s own
equity instruments ... (derivatives). (IAS 32 par. 11)
Financial liability
A financial liability is any liability that is:
1. a contractual obligation:
a. to deliver cash or another financial asset to
another entity; or b. to exchange financial assets
or financial liabilities with another entity under
conditions that are potentially unfavourable to the
entity (derivatives); or
2. a contract that will or may be settled in the entity’s own
equity instruments … (derivatives). (IAS 32 par. 11)
Nonfinancial assets and liabilities
Physical assets (such as inventories, property, plant and
equipment), right-of-use assets and intangible assets (such
as patents and trademarks) are not financial assets. Control
of such physical assets, right-of-use assets and intangible
assets creates an opportunity to generate an inflow of cash
or another financial asset, but it does not give rise to a
present right to receive cash or another financial asset.
(IAS 32 par. AG10)
Assets (such as prepaid expenses) for which the future
economic benefit is the receipt of goods or services, rather
than the right to receive cash or another financial asset, are
not financial assets. Similarly, items such as deferred
revenue and most warranty obligations are not financial
liabilities because the outflow of economic benefits
associated with them is the delivery of goods and services
rather than a contractual obligation to pay cash or another
financial asset. (IAS 32 par. AG11)
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Liabilities or assets that are not contractual (such as income
taxes that are created as a result of statutory requirements
imposed by governments) are not financial liabilities or
financial assets. Accounting for income taxes is dealt with
in IAS 12. Similarly, constructive obligations, as defined in
IAS 37 Provisions, Contingent Liabilities and Contingent
Assets, do not arise from contracts and are not financial
liabilities. (IAS 32 par. AG12)
A constructive obligation is an obligation that derives from
an entity’s actions where: (a) by an established pattern of
past practice, published policies or a sufficiently specific
current statement, the entity has indicated to other parties
that it will accept certain responsibilities; and (b) as a
result, the entity has created a valid expectation on the part
of those other parties that it will discharge those
responsibilities. (IAS 37 par. 10)
Equity instrument
An equity instrument is any contract that evidences a
residual interest in the assets of an entity after deducting
all of its liabilities. (IAS 32 par. 11)
Equity instruments include ordinary share capital,
preference share capital, and warrants or option.
Share warrants
In finance, a warrant is a security that entitles the holder
to buy the underlying stock of the issuing company at a
fixed price called exercise price until the expiry date.
Warrants and options are similar in that the two contractual
financial instruments allow the holder special rights to buy
securities. Wikipedia
Share option
a benefit in the form of an option given by a company to an
employee to buy a share in the company at a discount or
at a stated fixed price.
Liabilities and equity
The issuer of a financial instrument shall classify the
instrument, or its component parts, on initial recognition as
a financial liability, a financial asset or an equity instrument
in accordance with the substance of the contractual
arrangement and the definitions of a financial liability, a
financial asset and an equity instrument. (IAS 32 par. 15)
To determine whether a financial instrument is an equity
instrument rather than a financial liability, the instrument
is an equity instrument if the instrument includes no
contractual obligation to deliver cash or another financial
asset ... (IAS 32 par. 16)
Redeemable preference share
The substance of a financial instrument, rather than its
legal form, governs its classification in the entity’s
statement of financial position. Substance and legal form
are commonly consistent, but not always. Some financial
instruments take the legal form of equity but are liabilities
in substance and others may combine features associated
with equity instruments and features associated with
financial liabilities.
For example: a preference share that provides for
mandatory redemption by the issuer for a fixed or
determinable amount at a fixed or determinable future
date, or gives the holder the right to require the issuer to
redeem the instrument at or after a particular date for a
fixed or determinable amount, is a financial liability. (IAS
32 par. 18)
Interest, dividends, losses and gains
Interest, dividends (e.g., paid to holders), losses and gains
relating to a financial instrument or a component that is a
financial liability (e.g., mandatorily redeemable preference
shares) shall be recognised as income or expense (e.g.,
interest expense) in profit or loss. Distributions to holders
of an equity instrument shall be recognised by the entity
directly in equity. Transaction costs of an equity transaction
shall be accounted for as a deduction from equity. (IAS 32
par. 35)
Compound financial instruments
The issuer of a non-derivative financial instrument shall
evaluate the terms of the financial instrument to determine
whether it contains both a liability and an equity
component. Such components shall be classified separately
as financial liabilities, financial assets or equity
instruments. (IAS 32 par. 28)
Paragraph 28 applies only to issuers of non-derivative
compound financial instruments. Paragraph 28 does not
deal with compound financial instruments from the
perspective of holders. IFRS 9 deals with the classification
and measurement of financial assets that are compound
financial instruments from the holder’s perspective. (IAS 32
par. AG30)
An entity recognises separately the components of a
financial instrument that (a) creates a financial liability of
the entity and (b) grants an option to the holder of the
instrument to convert it into an equity instrument of the
entity. For example, a bond or similar instrument
convertible by the holder into a fixed number of ordinary
shares of the entity (“convertible bonds”) is a compound
financial instrument. From the perspective of the entity,
such an instrument comprises two components: a financial
liability (a contractual arrangement to deliver cash or
another financial asset) and an equity instrument (a call
option granting the holder the right, for a specified period
of time, to convert it into a fixed number of ordinary shares
of the entity). The economic effect of issuing such an
instrument is substantially the same as issuing
simultaneously a debt instrument with an early settlement
provision and warrants to purchase ordinary shares (e.g.,
“bonds issued with share warrants”), or issuing a debt
instrument with detachable share purchase warrants.
Accordingly, in all cases, the entity presents the liability and
equity components separately in its statement of financial
position. (IAS 32 par. 29)
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IFRS 9 deals with the measurement of financial assets and
financial liabilities. Equity instruments are instruments that
evidence a residual interest in the assets of an entity after
deducting all of its liabilities. Therefore, when the initial
carrying amount of a compound financial instrument is
allocated to its equity and liability components, the equity
component is assigned the residual amount after deducting
from the fair value of the instrument as a whole the amount
separately determined for the liability component. The sum
of the carrying amounts assigned to the liability and equity
components on initial recognition is always equal to the fair
value that would be ascribed to the instrument as a whole.
No gain or loss arises from initially recognising the
components of the instrument separately. (IAS 32 par. 31)
Financial Instruments IFRS 9
Objective
The objective of this Standard is to establish principles for
the financial reporting of financial assets and financial
liabilities that will present relevant and useful information
to users of financial statements for their assessment of the
amounts, timing and uncertainty of an entity’s future cash
flows. (IFRS 9 par. 1.1)
Classification of financial assets
Unless paragraph 4.1.5 applies, an entity shall classify
financial assets as:
a. subsequently measured at amortised cost,
b. subsequently measured at fair value through other
comprehensive income; or
c. subsequently measured at fair value through profit or
loss on the basis of both:
a. the entity’s business model for managing the
financial assets and
b. the contractual cash flow characteristics of the
financial asset. (IFRS 9 par. 4.1.1)
Option to designate a financial asset at fair value through
profit or loss
An entity may, at initial recognition, irrevocably designate
a financial asset as measured at fair value through profit or
loss if doing so eliminates or significantly reduces a
measurement or recognition inconsistency (sometimes
referred to as an ‘accounting mismatch’) that would
otherwise arise from measuring assets or liabilities or
recognising the gains and losses on them on different
bases. (IFRS 9 par. 4.1.5)
A financial asset shall be measured at amortised cost if both
of the following conditions are met:
a. the financial asset is held within a business model whose
objective is to hold financial assets in order to collect
contractual cash flows and
b. the contractual terms of the financial asset give rise on
specified dates to cash flows that are solely payments of
principal and interest on the principal amount outstanding.
A financial asset shall be measured at fair value through
other comprehensive income if both of the following
conditions are met:
a. the financial asset is held within a business model whose
objective is achieved by both collecting contractual cash
flows and selling financial assets and
b. the contractual terms of the financial asset give rise on
specified dates to cash flows that are solely payments of
principal and interest on the principal amount outstanding.
A financial asset shall be measured at fair value through
profit or loss unless it is measured at amortised cost or at
fair value through other comprehensive income. However
an entity may make an irrevocable election at initial
recognition for particular investments in equity instruments
that would otherwise be measured at fair value through
profit or loss to present subsequent changes in fair value in
other comprehensive income.
At initial recognition, an entity may make an irrevocable
election to present in other comprehensive income
subsequent changes in the fair value of an investment in
an equity instrument within the scope of this Standard that
is neither held for trading nor contingent consideration
recognised by an acquirer in a business combination to
which IFRS 3 applies. (IFRS 9 par. 5.7.5)
Financial assets at fair value through profit or loss
1. Financial assets held for trading (or “trading securities”)
2. Quoted equity instruments not measured at fair value
through other comprehensive income.
3. Debt investments that are irrevocably designated on
initial recognition as at fair value through profit or loss.
4. Debt investments that do not satisfy the requirements
for measurement at amortized cost and at fair value
through other comprehensive income.
Measurement
Initial measurement
Except for trade receivables within the scope of paragraph
5.1.3, at initial recognition, an entity shall measure a
financial asset or financial liability at its fair value plus or
minus, in the case of a financial asset or financial liability
not at fair value through profit or loss, (fair value plus)
transaction costs that are directly attributable to the
acquisition or issue of the financial asset or financial
liability. (IFRS 9 par. 5.1.1)
Financial assets subsequently measured:
a. at amortised cost (fair value plus direct transaction
costs)
b. at fair value through other comprehensive income (fair
value plus direct transaction costs)
c. at fair value through profit or loss (fair value, direct
transaction costs are expensed outright)
Despite the requirement in paragraph 5.1.1, at initial
recognition, an entity shall measure trade receivables at
their transaction price (as defined in IFRS 15) if the trade
receivables do not contain a significant financing
component in accordance with IFRS 15. (IFRS 9 par. 5.1.3)
Subsequent measurement
After initial recognition, an entity shall measure a financial
asset at:
a. amortised cost;
b. fair value through other comprehensive income; or
c. fair value through profit or loss. (IFRS 9 par. 5.2.1)
Gains and losses
A gain or loss on a financial asset or financial liability that
is measured at fair value shall be recognised in profit or
loss unless:
a. ...
b. it is an investment in an equity instrument and the entity
has elected to present gains and losses on that investment
in other comprehensive income;
c. ...
d. it is a financial asset measured at fair value through
other comprehensive income and the entity is required to
recognise some changes in fair value in other
comprehensive income. (IFRS 9 par. 5.7.1)
Account titles
1. Financial asset - FVPL
2. Trading securities
3. Commission expense (an example of direct transaction
cost)
4. Unrealized gain/loss - TS
5. Gain/loss on sale of trading securities
6. Financial asset - FVOCI
7. Unrealized gain/loss - OCI
8. Retained earnings (both “Financial asset - FVOCI” and
“Unrealized gain/loss - OCI” are derecognized)