IAS 2 Inventories

By. Vicky Xu
Definition

Inventories are assets:

• Held for sale in ordinary course of business;
• In the process of production for such sale;
• In the form of materials or supplies to be consumed in the
production process or in the rendering of services.
Recognition

The cost of an item of inventory shall be recognised as an asset if,

and only if:
(a) it is probable that future economic benefits associated with the
item will flow to the entity; and
(b) the cost of the item can be measured reliably.
 Initial measurement
Cost includes:
• Costs of purchase, including non-recoverable taxes, transport and
handling;
• Costs of conversion;
• Other costs to bring inventory into its present condition and location.
 Initial measurement
Excludes:
• Abnormal waste;
• Storage costs (unless necessary for the production process);
• Admin overheads not related to production;
• Selling costs;
• Interest cost (where settlement is deferred);
• IAS 23 Borrowing Costs identifies rare circumstances where
borrowing costs can be included.
Initial measurement
Cost Formulas:
For non-interchangeable items:
• Specific identification

For interchangeable items, either:

• FIFO
• Weighted average cost
Subsequent measurement

Inventories are measured at the lower of cost and net realisable

value (NRV)
(This is an implicit impairment test, thus inventories are excluded
from the scope of IAS 36 impairment of assets)

NRV is the estimated selling price in the ordinary course of

business, less the estimated costs of completion and the estimated
costs to make the sale.
Subsequent measurement

Any write-down to NRV should be recognized as an expense in the

period in which the write-down occurs.

A new assessment is made of net realizable 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 realizable value because
of changed economic circumstances, the amount of the write-down
is reversed. The reversal is limited to the amount of the original
write-down.
Disclosure

• The total carrying amount of inventories by category

• Details of inventories carried at net realisable value
2018/12 Q3a Fill
Fill is a coal mining company and sells its coal on the spot and futures
markets. On the spot market, the commodity is traded for immediate
delivery and, on the forward market, the commodity is traded for future
delivery. The inventory is divided into different grades of coal. One of
the categories included in inventories at 30 November 20X6 is coal with
a low carbon content which is of a low quality. Fill will not process this
low quality coal until all of the other coal has been extracted from the
mine, which is likely to be in three years’ time. Based on market
information, Fill has calculated that the three-year forecast price of coal
will be 20% lower than the current spot price.
2018/12 Q3a Fill

The directors of Fill would like advice on two matters:

(i) whether the Conceptual Framework affects the valuation of
inventories;
(ii) how to calculate the net realisable value of the coal inventory,
including the low quality coal. (7 marks)
2018/12 Q3a Fill

Suggested answer:
(i) The Framework acknowledges a variety of measurement bases
including historical cost, current cost, net realisable value (NRV)
and present value. It refers to NRV as a settlement value which will
be determined by a future transaction. Thus in order to determine
NRV, the directors would need to refer to IAS 2 Inventories for the
definition and IAS 10 Events after the Reporting Date. The
directors should consider any adjusting events which provide
evidence of conditions which existed at the end of the reporting
period in order to determine NRV.
2018/12 Q3a Fill

IAS 2 defines NRV as the estimated selling price in the ordinary

course of business less the costs of completion and costs of sale. In
this case, the NRV will be determined on the basis of conditions
which existed at the date of the statement of financial position.
IFRS 13 does not apply to IAS 2 as regards NRV even though the
measurement method is very similar. Any future price movements
will be considered if they provide information about the conditions
at the date of the statement of financial position but normally these
movements would reflect changes in the market conditions after
that date and therefore would not affect the calculation of NRV.
2018/12 Q3a Fill

The NRV will be based upon the most reliable estimate of the
amounts which will be realised for the coal. The year-end spot price
will provide good evidence of the realisable value of the inventories
and where the company has an executory contract to sell coal at a
future date, then the use of the forward contract price may be
appropriate. However, if the contract is not executory but is a
financial instrument under IFRS 9 Financial Instruments or an
onerous contract recognised as a provision under IAS 37 Provisions,
Contingent Liabilities and Contingent Assets, it is unlikely to be
used to calculate NRV.
2018/12 Q3a Fill

(ii) Fill should calculate the NRV of the low carbon coal using the
forecast market price based upon when the inventory is expected to
be processed and realised. Future changes in the forecast market
price or the processing and sale of the low carbon coal may result in
adjustments to the NRV. As these adjustments are changes in
estimates, IAS 8 Accounting Policies, Changes in Accounting
Estimates and Errors will apply with the result that such gains and
losses will be recognised in the statement of profit or loss in the
period in which they arise.
Thank You
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