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PAS 2 - Inventories - Accounting Standard that is useful in

understanding Financial Accounting Reporting
Bs. Accountancy (Aklan State University)

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PAS 2 INVENTORY

1. Which of the following items should be excluded from a company’s inventory at the balance sheet date?
a. Goods lost while in transit, which were purchased FOB shipping point.
b. Goods held by customers on approval or on trial
c. Goods out on consignment
d. Goods purchased FOB destination

2. The cost of inventories shall comprise all costs of purchase, cost of conversion and other costs incurred
in bringing the inventories to their present location and condition. Which of the following cost shall be
included in the cost of inventories?
a. Import duties and other taxes, transport, handling and other costs directly attributable to the acquisition
of finished goods, materials and services
b. Abnormal amounts of wasted materials, labor or other production costs.
c. Storage costs unnecessary in its production process.
d. Administrative overheads that do not contribute to brining inventories to their present location and
condition.

3. The valuation of inventories on prime cost basis

a. Is always achieved when standard costing is adopted
b. Would achieve the same results as direct costing
c. Would exclude all overhead from reported inventory costs.
d. Is always achieved when the LIFO flow assumption is adopted

4. A major advantage of the retail inventory method is that it

a. Permits companies which use it avoid taking annual inventory
b. Hides costs from customers and employees
c. Provides a method for inventory control and facilitates determination of the periodic inventory.
d. Gives a more accurate statement of inventory cost than other methods

5. Technically, the weighted average inventory cost flow method is applicable to which of the following
inventory system?
I. Perpetual II. Periodic
a. Both I and II b. I only c. II only d. Neither I nor II

6. The measurement basis ‘net realizable value’ is best described as:

a. unamortised historical cost;
b. an asset’s selling price or a liability’s settlement amount;
c. unadjusted initial cost;
d. time adjusted cash flow.

7. Inventories are assets

I. held for sale in the ordinary course of business
II. in the process of production for such sale
III. in the form of materials or supplies to be consumed in the production process or in the rendering of
services
a. I and II only b. I only c. I, II and III d. II and III only

8. Net realizable value is

a. estimated selling price in the ordinary course of business
b. estimated selling price in the ordinary course of business less the estimated costs of completion in the
case of finished goods and estimated costs necessary to make the sale in the case of work in process
c. estimated selling price in the ordinary course of business less the estimated costs of completion in the
and estimated costs necessary to make the sale.
d. is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable,
willing parties in an arm’s length transaction.

9. The weighted average inventory costing method is particularly suitable to inventory where:
a. dissimilar products are stored in separate locations;
b. the entity carries stocks of raw materials, work-in-progress and finished goods;
c. goods have distinct use-by dates and the goods produced first must be sold earliest;
d. homogeneous products are mixed together.

10. When an inventory costing formula is changed, the change is required to be applied:
a. prospectively and the adjustment taken through the current profit or loss;
b. retrospectively and the adjustment taken through the opening balance of accumulated profits;
c. prospectively and the current period adjustment recognized directly in equity;
d. retrospectively and the adjustment recognized as an extraordinary gain or loss.

11. The measurement rule for inventories, mandated by IAS 2 Inventories, is:
a. lower of fair value and selling price;
b. lower of cost and net realizable value;
c. higher of initial cost and realizable value;
d. higher of completion costs and replacement costs.

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12. ‘Net realisable value’ of inventory is defined as the net amount that an enterprise expects to realise
from the sale of the inventory:
a. in the ordinary course of operations less estimated costs of completion and costs necessary to make the
sale;
b. plus the estimated costs of completion plus the estimated costs necessary to make the sale;
c. in a forced sale;
d. plus the estimated costs of completion.

13. Net realisable value of inventories may fall below cost for a number of reasons including:
I. Product obsolescence.
II. Physical deterioration of inventories.
III. An increase in the expected replacement costs of the inventory,
IV. An increase in the estimated costs of completion.
a. I, II and IV only; b. I, III and IV only; c. II, III and IV only; d. I and II only.

14. When determining the net realisable value of inventory, estimates must be made of the following:
I. Estimated costs of completion.
II. Expected replacement cost.
III. Expected selling price.
IV. Estimated selling price.
a. I, II, III and IV; b. I, II and III only; c. II and IV only; d. I, III and IV only.

15. IAS 2 Inventories requires that when inventories are written down to net realisable value, they are
written-down:
a. on a class-by-class basis;
b. on the basis of industry segment;
c. on an item-by-item basis;
d. according to geographical segment within the entity.

16. Ming Company had the following items of inventory at reporting date:
Item Quantity Cost/unit P NRV/unit
Refrigerators 10 100 95
Stoves 20 80 85
The adjustment necessary at reporting date is:
a. DR Inventory P 50; c. CR Inventory P 50;
b. DR Inventory P100; d. CR Inventory P0.

17. If the selling price of inventory that has been written down to net realisable value in a prior period,
subsequently recovers, the:
a. previous amount of the write-down can be reversed;
b. carrying amount of the inventory cannot be adjusted;
c. value adjustment can be recognised immediately in equity;
d. adjustment must be recognised in a ‘provision for future inventory write-downs’ account.

18. Under IAS 2 Inventories, items of inventory that are used by business enterprise as components in a
self-constructed property asset are required to be:
a. aggregated into the ‘cost of goods sold’ expense in the period in which the items are used;
b. expensed directly into equity in the period in which the items are used;
c. capitalised and depreciated;
d. added to a ‘property construction’ provision account.

19. All of the following are common classifications for the disclosure of inventories in a set of financial
statements:
I. Raw materials
II. Finished goods
III. Work in progress
IV.Assets held for resale
a. I and II only b. I, II, III and IV c. II and III only d. II and IV only

20. Where the net realisable value of inventory falls below cost, IAS 2 Inventories, requires that:
a. the inventory continue to be carried in the balance sheet at cost;
b. the inventory be written down to net realisable value;
c. no adjustment be made, but the difference between net realisable value and cost be disclosed in the
notes to the financial statements;
d. the difference be added to the carrying amount of the inventory.

21. Which of the following items are comprised (added or deducted) in the cost of inventories according to
IAS 2, Inventories?
I. Storage costs for work in progress
II. Fixed administration overheads
III. Trade discount
IV. Storage costs relating to finished goods
V. Fixed production overheads

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a. I, II and V only b. I and V only c. I, III and V only d. all of the above
22. IAS 2 should be applied in financial statements prepared in accounting for inventories other than
which of the following?
a. Biological assets related to agricultural activity
b. Finished goods assets held for sale in a retail business
c. Raw material assets in the manufacturing process
d. Materials or supplies assets to be consumed in the rendering of services

23. Which of the terms listed below has this definition: The estimated selling price in the ordinary course
of business less the estimated costs of completion and the estimated costs necessary to make the sale
according to this Standard?
a. Write-down value b. Net realisable value c. Actual cost value d. Delayed inventory value

24. The costs that comprises the purchase price, import duties and other taxes (other than those
subsequently recoverable by the entity from the taxing authorities), and transport, handling and other
costs directly attributable to the acquisition of finished goods, materials and services
a. Costs of conversion c. Costs of purchase
b. Other costs d. All of these

25. Good Luck Company. produces gaskets. From the cost accounting, the following information is
available:
Direct material and labour cost per unit: 100; indirect material and labour cost per unit: 20; production
overheads per unit: 15; general administration overheads per unit: 10; selling costs per unit: 20.
Determine the cost of inventory per unit according to IAS 2, Inventories
a. 100 b. 120 c. 135 d. 165

26. An entity produces piston rings. The selling price of a piston ring amounts to 100. The cost of direct
and indirect material per unit is 100, general administration cost per unit is 15, and selling costs per unit
are 5. At which amount should each piston ring be accounted for in the balance sheet at 31 December
2007 according to IAS 2?
a. 95 b. 100 c. 115 d. 120

27. Which of the following types of inventories are excluded under the scope of IAS 2?
I. Commodities such as soybeans
II. Purchased subcomponents
III. Work in progress arising under construction contracts
IV. Copper that has been extracted
V. Stationary for administrative use
VI. Forest product produce after the point of harvest
a. I, IV and V only b. I, IV, V and VI only c. I, III, IV, V and VI only d. All of these

28. What methods are used to measure cost under IAS 2?

I. Standard costing system
II. Retail method
III. Specific identification method
IV. FIFO
V. Weighted average method
a. IV and V only b. III, IV and V only c. II, III, IV and V only d. all of these

29. Read the situation below and then decide which technique you should use for measuring cost.
At Pacquiao Company, the many items that compose inventories are made up of various subcomponent
parts, some purchased from outside vendors and some manufactured in-house. It is difficult to trace the
items sold, and the items remaining in inventory, to the specific purchased items. Which technique for
measuring inventories should Pacquiao use?
a. Standard costing b. Retail method c. FIFO d. LIFO

30. IAS 2 provides practical guidance in the case of a service provider. Inventories include the costs of the
service, as described in paragraph 16 of IAS 2, but exclude which of the following?
I. Labour and other costs relating to sales
II. Attributable overheads
III. Supervisory personnel costs
IV. General administrative personnel
a. I and II only b. III and IV only c. I and IV only d. all of these

31. You are a manufacturer whose finished product normally sells for 100. It costs you 150 to build plus 20
to make the sale. For purposes of inventory definitions under IAS 2, which amount would you account for?
a. 80 b. 100 c. 150 d. 120

32. The costs of conversion of inventories include all of the following, except
a. Costs directly related to the units of production, such as direct labor
b. Systematic allocation of fixed production overhead
c. Systematic allocation of variable production overhead
d. Systematic allocation of administrative overhead

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33. When agricultural crops have been harvested or mineral ores have been extracted and a sale is
assured under a forward contract or government guarantee, such inventories are measured at
a. Net realizable value b. Cost c. Standard cost d. Relative sales price

34. This is defined as “ those who buys or sell commodities for others or on their own account”
a. Brokers b. Traders c. Commission agents d. Broker-traders

35. Commodities of broker-traders are measured at

a. Fair value b. Fair value less cost to sell c. Cost d. Net realizable value

36. Which of the items listed below are comprised in determining the cost of inventories according to IAS
2?
a. General administrative overheads, trade discounts, and recoverable purchase taxes
b. Variable production overheads, fixed production overheads, and general administrative overheads
c. Storage costs of work in progress, variable production overheads, and fixed production overheads
d. Import duties on shipping of inventory inwards, trade discounts received on purchase of inventory, and
recoverable purchase taxes

37. In measuring the costs of purchase, you have noted that an entity bought inventory on deferred credit
terms, thus paying a price higher than it would have been under normal credit terms. How is the excess
amount treated under IAS 2?
a. The excess is included in the cost of the inventory
b. The excess is recognised as interest expense over the period of the financing
c. A percentage of the excess is recognised as directly attributable to the acquisition of the inventory
d. The excess is recognsed directly to equity

38. Complete the following statement When measuring fixed production overheads, if an entity has
abnormally high production in excess of normal capacity, it is necessary to:
a. Expense unallocated overheads in the period
b. Increase the amount of overheads allocated to each unit of production
c. Reduce the rate of overhead absorption in order to avoid carrying the inventory at more than actual cost
d. Allocated to units produced on the basis of actual use of the production facilities

39. In valuing raw materials inventory at lower of cost or market, what is the meaning of the term
“market”?
a. Net realizable value
b. Net realizable value less a normal profit margin
c. Current replacement cost
d. Discounted present value

40. The use of a Discounts Lost account implies that the recorded cost of a purchased inventory item is its
a. Invoice price
b. Invoice price plus the purchase discount lost
c. Invoice price less the purchase discount taken
d. Invoice price less the purchase discount allowable whether taken or not

41. Valuing assets at their liquidation values rather than their cost is inconsistent with the
a. Periodicity assumption c. Materiality constraint
b. Matching constraint d. Historical cost principle

42. If the inventory account at the end of the year is understated, the effect will be to
a. Overstate the gross profit on sales
b. Understate the net purchases
c. Overstate the cost of goods sold
d. Overstate the goods available for sale

43. Heroes Co. received merchandise on consignment. As of March 31, Heroes had recorded the
transaction as a purchase and included the goods in inventory. The effect of this on its financial
statements for March 31 would be
a. No effect
b. Net income was correct and current assets and current liabilities were overstated
c. Net income, current assets, and current liabilities were overstated
d. Net income and current liabilities were overstated

44. A large manufacturer of cosmetics sells merchandise to a retailer, which in turns sells the goods to the
public at large through its chain of retail outlets. The retailer purchases merchandise from the
manufacturer under a consignment contract. When should revenue from the sale of merchandise to the
retailer be recognized by the manufacturer?
a. When goods are delivered to the retailer.
b. When goods are sold by the retailer
c. It will depend on the terms of delivery of the merchandise by (i.e., CIF cost, insurance, and freight or
FOR).
d. It will depend on the terms of payment (i.e., cash or credit).

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45. When using the installment sales method

a. Gross profit is deferred until all cash is received, but revenue and costs are recognized in proportion to
the cash collected from the sale
b. Gross profit is recognized only after the amount of cash collected exceeds the cost of the item sold.
c. Revenue, costs, and gross profit are recognized proportionally as the cash is received from the sale of
product.
d. Total revenue and costs are recognized at the point of sale, but gross profit is deferred in proportion to
the cash that is uncollected from the sale.

46. The gross profit method of inventory valuation is not valid when
a. There is substantial increase in the quantity of inventory during the year.
b. There is substantial increase in the cost of inventory during the year
c. The gross margin percentage changes significantly during the year
d. All ending inventory is destroyed by fire before it can be counted

47. An example of an inventory accounting policy that should be disclosed is the

a. Effect of inventory profit caused by inflation
b. Classification of inventory into raw materials, work in process and finished goods
c. Identification of major suppliers.
d. Method used for inventory costing.

48. Merchandise shipped FOB shipping point on the last day of the year should ordinarily be included in
a. The buyer’s inventory balance
b. The seller’s inventory balance
c. Neither the buyer’s nor seller’s inventory balance
d. Both the buyer’s and the seller’s inventory balances

49. An entry debiting inventory and crediting cost of goods sold would be made when
a. Merchandise is sold and the periodic inventory method is used
b. Merchandise is sold and the perpetual inventory method is used
c. Merchandise is returned and the perpetual inventory method is used
d. Merchandise is returned and the periodic inventory method is used

50. An entity uses a periodic inventory system and neglected to record a purchase of merchandise on
account at year-end. This merchandise was omitted from the year-end physical count. How will these errors
affect the entity’s assets, liabilities, and shareholders’ equity at year-end and net earnings from the year?
Assets Liabilities Equity Net earnings
a. Understate Understate No effect No effect
b. Understate No effect Understate Understate
c. No effect Understate Overstate Overstate
d. No effect Overstate Understate Understate

51. Factory overhead includes

a. All manufacturing costs
b. All manufacturing costs which may be variable or fixed, except direct materials and direct labor
c. Indirect materials but not indirect labor
d. Indirect labor but not indirect materials

ANSWER KEY:
1. A
2. A
3. A
4. A
5. A
6. B
7. C
8. C
9. D
10. B
11. B
12. A
13. A
14. D
15. C
16. C
17. A
18. C
19. B
20. B
21. C Storage costs for work in progress and fixed production overheads are added in determining the
cost of inventories and trade discounts are deducted
22. A Biological assets related to agricultural activity are considered out of scope for IAS 2
23. B Net realisable value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale.

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24. C
25. C The cost of inventories shall comprise all cost of purchase, costs of conversion, and other costs
incurred in bringing the inventories to their present location and condition, i.e., direct costs of material and
labour, indirect material and labour cost, and production related overhead. General administration
overhead and selling costs are excluded from the cost of inventories
26. A Inventories should be measured at the lower of cost and net realisable value. Net realisable value
per unit is determined as selling price per unit (100) minus selling costs per unit (5), i.e., 95. The cost of
inventories per unit is 100. General administration costs are not included in the cost of inventories.

IAS 2 inventory includes:

I. Raw material assets in the manufacturing process
II. Purchased subcomponents
III. Work in process
IV. Finished goods assets held for sale in a retail business
V. Unaltered goods held by a trader for resale
VI. Materials or supplies assets to be consumed in the rendering of services
IAS 2’s exclusions are fairly limited and relate mostly to particular industries. IAS 2 does not apply to:
• Work in progress arising under construction contracts, including directly related service
contracts. This type of inventory is covered by IAS 11 and will be discussed later in this course.
• Financial instruments. These are covered by IAS 32, Financial Instruments: Disclosure and
Presentation, and IAS 39, Financial Instruments: Recognition and Measurement.
• Biological assets. Biological assets related to agricultural activity and agricultural produce at the
point of harvest are addressed by IAS 41.

IAS 2 also excludes certain other inventories from its measurement rules, although it includes them for the
other requirements of the standard. These exemptions relate to inventories that, in accordance with
accepted practices in particular industries, are “marked to market.” In other words, all movements in their
value (both up and down) while the inventories are held are taken straight to income, even though they
are not realised by a sale. These inventories, referred to in paragraph 3(a) of IAS 2, are measured at net
realisable value at certain stages of production.
Examples include:
• Agricultural and forest products
• Agricultural produce at harvest
The detailed conditions that apply for these types of excluded inventories are discussed in paragraphs 3–5
of IAS 2.

Commodities held by commodity brokers/traders are excluded from IAS 2 in certain circumstances. Broker-
traders buy or
sell commodities for others or on their own account. These inventories are generally acquired with the
purpose of selling in the near future and generating a profit from price fluctuations or broker-traders’
margins. They are excluded from the measurement requirements of IAS 2 when they are measured at fair
value less costs to sell. The changes in this value are
recognised in profit or loss in the period of change.

Examples of commodities typically held by traders include:

• Oil
• Natural gas
• Gold
• Coffee
• Wheat
• Feedstuffs

27. C These items are excluded inventories according to IAS 2

28. D

There are a number of possible causes of the inventory cost becoming not recoverable:
a. Physical damage
b. Obsolescence
c. Fall in selling price
d. Rise in completion costs

1. In principle, the lower of cost and net realisable value test should generally be applied on an item-by-
item basis, unless items are sold only in combination with other items, in which case they should be
considered together.
2. In some circumstances, however, it may be appropriate to group similar or related items. 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. A broad-brush approach that looks at inventories in large
categories would not meet the requirements of IAS 2, because losses in value of individual items of
inventory would be masked by unrealised gains on others.
3. In applying the cost vs. net realisable value test, it is relevant to consider the form in which the
inventories will be sold. This means that materials and other supplies held for use in the production of

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inventories are not written down below cost if the finished products in which they will be incorporated are
expected to be sold at or above cost.
4. As with raw materials, it is not necessary to consider the net realisable value of work in progress in its
existing state, but rather to look at the eventual selling price of the completed product less the conversion
cost to complete it and the estimated costs to sell it.

5. If a decline in the price of materials indicates that the cost of the finished products will exceed net
realisable value, the finished products are written down.
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 (i.e., 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. Any write-down to
net realisable value is reversible; the lower of cost and net realisable value test should be recalculated at
each balance sheet date.

Disclosure requirements:
a. The financial statements shall disclose the accounting policies adopted in measuring inventories,
including the cost formula used
b. The financial statements shall disclose the total carrying amount of inventories, analysed into
appropriate categories
For a manufacturing entity, appropriate categories for the classification of inventories could be:
● Raw materials
● Production supplies and merchandise
● Work in progress
● Finished goods
However, each entity should determine what is relevant to its own business.
c. the amount of inventories recognised as an expense in the period. To achieve this, cost of sales needs to
be disclosed.
d. Other important disclosures are the amount of any write-down of inventories recognised as an expense
in the period,
e. 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,
f. the circumstances or events that led to the reversal of a writedown of inventories.

In either of these situations, we assume that the entity can easily determine (1) exactly what inventory has
been written down to net realisable value, and (2) at the next balance sheet date, which of the items that
were previously written down are still held and are now stated at a higher amount. However, it may not
always be possible to do this in practice.

g. An entity shall also disclose the carrying amount of inventories pledged as security for liabilities.

h. And finally, entities must disclose the carrying amount of inventories carried at fair value less costs to
sell. But this applies only to certain agricultural produce and commodities as referred to in paragraphs 3–5
of IAS 2.

29. C Because both the items sold and those in Pacquiao’s inventory are difficult to trace to the specific
purchased items, the FIFO method is an appropriate way to measure the cost of inventories. Weighted
averages would also be a method allowed under IAS 2.

30. C The cost of inventories of a service provider consists primarily of the direct labour and other direct
costs, costs of supervisory personnel, and attributable overheads. Labour and other costs relating to sales
and general administrative personnel are not included but are recognised as expenses in the period in
which they are incurred.

31. A

32. D

33. A

34. D

35. B

36. C

37. B

38. C

39. A
40. D

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41. D
42. C
43. B
44. B
45. D
46. C
47. D
48. A
49. C
50. A
51. B
52.

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