IAS 2 – INVENTORIES

 OBJECTIVE

The objective of IAS 2 is to prescribe the accounting treatment for inventories.

 DEFINITIONS

Inventories are assets:

 Held for sale in the ordinary course of business

 In the process of production for such sale; or (work in progress, finished goods awaiting to be sold)

 In the form of materials or supplies to be consumed in the production process or in the rendering of
services
 Net Realizable Value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated cost necessary to make a 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.

 MEASUREMENT OF INVENTORIES

Inventory shall be measured at the lower of cost and net realizable value.

 COST OF INVENTORIES

The cost of inventories will comprise all costs of purchase, costs of conversion and other costs incurred in
bringing the inventories to their present location and condition.

Purchase cost comprise the;

 Purchase price plus;
 Import duties and other non –refundable taxes;
 Transport, handling and any other cost directly attributable to the acquisition of finished goods,
services and materials; less
 Trade discounts, rebates and other similar amounts

 COST OF CONVERSION:

 Costs directly related to the units of production (direct labor); and

 Systematic allocation of fixed and variable production overheads that are incurred in converting
materials into finished goods. (Factory rent, depreciation of machinery, supervisor salary, power
consumption)

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  The allocation of fixed overheads to the costs of conversion is based on the normal capacity of the
production facilities.
 Other cost incurred in bringing the inventories to their present location and condition (i.e. non
production overheads or costs of designing products for specific customers).

The Standard excludes the following from the cost of inventories

 The abnormal amount of wasted material, labor or other production cost;

 Storage costs unless necessary for production before the further production process/stage;
 Administrative overheads that do not contribute to bringing inventories to their present location and
condition; and
 Selling cost
 Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a
foreign currency
 Interest cost when inventories are purchased with deferred settlement terms

COSTS OF INVENTORIES OF A SERVICE PROVIDER

The cost of inventories of service providers includes primarily the labour and other cost of the personnel
directly engaged in providing the service including supervisory personnel and directly attributable overheads.

 COST FORMULAS

For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas.
The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.

 NET REALIZABLE VALUE

As a general rule assets should not be carried at amounts greater than those expected to be realized from
their sale or use. In case of inventories this amount could fall below cost when items are damaged or
become wholly or partially obsolete, or where the costs to completion have increased in order to make the
sale or the prices have declined. (Prudence Concept).

 The principal situations in which NRV is likely to be less than cost, i.e. where there has been:
 An increase in costs or a fall in selling price
 A physical deterioration in conditions of inventory
 Obsolescence of products
 A decision as part of the company’s marketing strategy to manufacture and sell products at a loss
 Errors in production or purchasing.

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  RULES:

 The write down of inventories would normally take place on an item-by-item basis but similar or
related items may be grouped together (in case of service provider each service will be treated as
item).

 The NRV should be based on the most reliable evidence available at the time of estimates are
made.

 Fluctuations after reporting date should also be taken into account to the extent they confirm the
conditions existing at the reporting date.

 The estimate of NRV should also take into account the purpose for which the inventory is held (firm
sale / purchase contracts).

 Materials or supplies held for use in the production process should not be written down below cost
if the finished products in which they will be incorporated are expected to be sold at or above cost.
Otherwise, when the decline in the value of materials indicates that the cost of finished goods
exceeds NRV, the materials should be written down to NRV.

 NRV should be reassessed at each reporting date and necessary adjustments such as further
reduction or increase in NRV should be made however, reversal of write down is limited to the
original write down of inventories.

 Material reductions should be disclosed separately.

 RECOGNITION AS EXPENSE

The following treatment is required, when inventories are sold.

 The carrying amount is recognized as an expense in the period in which the related revenue is
recognized (matching concept)

 The amount of any write down of inventories to NRV and all losses of inventories are recognized
as an expense in the period in which the related write down or loss occurred

 The amount of any reversal of any write down of inventories, arising from the increase in NRV is
recognized as a reduction in the amount of inventories recognized as an expense in the period in
which the reversal occurs.

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 QUESTION

On 30 September 20X9, Razor’s closing inventory was counted and valued at its cost of $1 million. Some
items of inventory which had cost $210,000 had been damaged in a flood (on 15 September 20X9) and are
not expected to achieve their normal selling price which is calculated to achieve a gross profit margin of 30%.
The sale of these goods will be handled by an agent who sells them at 80% of the normal selling price and
charges Razor a commission of 25%.

At what value will the closing inventory of Razor be reported in its statement of financial position as
at 30 September 20X9?

A. $1 million
B. $790,000
C. $180,000
D. $970,000

ANSWER

Option D
The normal selling price of damaged inventory is $300,000 (210/70%).

This will now sell for $240,000 (300,000 x 80%), and have a NRV of $180,000 (240 – (240 x 25%)). The
expected loss on the inventory is $30,000 (210 cost – 180 NRV) and therefore the inventory should be
valued at $970,000 (1,000 – 30).

The inventories allocated to other assets i.e. when the inventory becomes the part of cost of self-
constructed assets, the inventories are recognized as an expense over the useful life of those assets.

PAST EXAMS ANALYSIS

Topic Exam Attempt Question

IAS 2 Dec.14 MCQ.8

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