International

Accounting Standards
IAS 2 Inventories Revised
1993
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Preview
Inventories should be measured at the lower
of cost and net realizable value.
SIC-1 requires an enterprise to use the same
cost formula for all inventories having a
similar nature and use to the enterprise.

Objective

To explain how an enterprise accounts for

inventories in the context of a historical cost
system.

Scope
IAS 2 should be applied in accounting for inventories
under an historical cost system. IAS 2 does not
apply to:
work in progress arising under construction
contracts;
financial instruments; or
inventories such as livestock, agricultural and
forest products and mineral ores to the extent
that they are measured at net realizable value in
accordance with established industry practices.
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Inventories
Inventories are assets:
held for sale in the ordinary course of business;
in the process of production for such sale; or
in the form of materials or supplies to be consumed
in the production process or in rendering services.
The matching concept requires that the cost of
unsold or unconsumed stocks and work in
progress inventories are carried forward to
match future sales.
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Continued-Inventories
Depending on the nature of the company, inventories
can consist of:
- Trading companies: goods purchased for resale
- Manufacturing companies: Inventories can be subdivided
into:
Finished goods ready for sale to customers.
Work-in-progress in the process of production for subsequent sale
Raw materials in the form of materials and supplies to be consumed
in the production process

All goods to which the enterprise has legal title at inventory

date, regardless of their location at that time, should be
included in the inventory.

Definitions
Expense represents a decrease in assets or increase
in liabilities which results in a decrease in equity,
other than those relating to distributions to equity
participants.
Net realizable value represents the estimated selling
price less the cost to complete and dispose of an
item.
Measurement of Inventories
Inventories should be measured at the lower of cost
and net realizable value.
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Revenue recognition rule

According to IAS 18 Revenue, revenue from the sale
of goods should be recognized when all the
following conditions have been satisfied:
the enterprise had transferred to the buyer the significant risks
and rewards of ownership of the goods,
the enterprise retains neither continuing managerial
involvement to the degree usually associated with ownership
nor effective control over the goods sold,
the amount of revenue can be measured reliably,
it is probable that the economic benefits associated with the
transaction will flow to the enterprise, and
the costs incurred or to be incurred in respect of the
transaction can be measured reliably.

Continued-Revenue
Generally, it is only at the point of sale that
the conditions of revenue recognition are
met for inventories.
Except for some established practices such as
the construction industry, inventory should
not be reported at estimated selling price
when such amount exceeds cost.
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Recognition as expense

When inventories are sold, the carrying amount

should be recognized as an expense in the same
period.
In the case of write-downs to net realizable value
or all other losses of inventories, the expenses
should be recognized in the period they occur.
In case of reversals of write-downs, they should be
recognized in the period in which the reversals
occurs as a reduction in the amounts of inventories
recognized as an expense.
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Cost of Inventories
Cost is the total expenditure that has been incurred
in bringing the product or service to its present
location and condition.
The general categories of expenditure considered as
cost are:
Purchase cost
Production cost/costs of conversion
Other costs incurred in bringing the inventories to
their present location and condition
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Continued-Cost of Inventories
Purchase costs: includes

purchase price of materials,

purchase price of outside manufacturing,
other expenses of obtaining material,
import duties and other taxes,
transport and handling costs,
other costs directly attributable to the acquisition of
finished goods, materials and services.

Discounts, rebates and other similar items are

deducted.
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Continued-Cost of Inventories
In a manufacturing company the production
costs/conversion costs include:

Direct labor cost

Direct material
Other direct costs
Overhead

The allocation of overhead needs to be based

on the enterprises normal level of activity.
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Continued-Cost of Inventories
Some expenses should not be included in costs of
production:
abnormal amounts of wasted material, labor or
other production cost,
storage costs (unless necessary in the production
process prior to a further production stage),
administrative overhead that does not contribute to
bringing inventories to their present location and
condition and
selling costs.
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Continued-Cost of Inventories
Interest may be capitalized as part of the historical
cost of assets for which a period of time is
required to get them ready for their intended use.
- Examples of so-called qualifying assets are:
assets that are produced for an enterprises own use,
assets intended for sale that are produced as discrete
projects (for example ships, real estate
developments), and
assets which require a maturation process in order to
bring them into a saleable condition (eg, whisky).
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Continued-Cost of Inventories
If an enterprise chooses to capitalize interest, that
treatment should be applied consistently to all
borrowing costs that are directly attributable to the
acquisition, construction or production of all
qualifying assets of the enterprise.
(SIC-2 Consistency Capitalization of Borrowing
Costs).

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Cost of Formula
Some of the principal cost bases are as
follows:
1.

2.

Specific identification- is appropriate when

inventories are not ordinarily interchangeable, are
segregated for specific projects or are not comprised
of a large number of homogenous items that are
ordinarily interchangeable.
Cost flow assumptions For all other inventories,
IAS 2 permits the cost of inventories to be assigned
using either a benchmark or an allowed alternative
treatment.
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Continued-Cost of Formula
Benchmark Treatment the cost of inventories
can be assigned using either the first-in, firstout (FIFO) or the weighted average cost
formula.
Allowed Alternative the cost of inventories can
be assigned using the last-in, first-out (LIFO)
cost formula.
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Continued-Cost of Formula
Retail inventory method:
may be used for convenience.
the cost of the inventory is determined by
reducing the sales value of the inventory by the
appropriate percentage gross margin.

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Continued-Cost of Formula
Standard cost method:
may be used for convenience.
the standard cost is the pre-determined sum that
is obtained by costing the manufacturing
specification of the product at pre-determined
rates for the material, labor and overhead
expenses entering the manufacturing process.

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Continued-Cost of Formula
FIFO (First-in, First-out)
benchmark treatment,
assumes that the items of inventory which were
purchased first are sold first, and consequently
the items remaining in inventory at the end of
the period are those most recently purchased or
produced.

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Continued-Cost of Formula
Weighted average method
benchmark treatment.
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.

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Continued-Cost of Formula
LIFO (Last-in, First-out)
alternative treatment.
assumes that the items of inventory that were
purchased or produced last are sold first, and
consequently the items remaining in inventory
at the end of the period are those first purchased
or produced.
in periods of rising prices, FIFO results in the
highest and LIFO in the lowest valuation.
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SIC-1: Consistency: Different

Cost Formulas for Inventories.
Use the same cost formula for all
inventories having similar nature and use to
the enterprise.
For inventories with different nature or use,
different cost formulas may be justified.
A difference in geographical location of
inventories, by itself, is not sufficient to
justify the use of different cost formulas.

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Net realizable value

should be applied when 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.

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Continued-Net realizable value

Inventories are usually written down to net

realizable value on an item by item basis.
However, in some cases it may be appropriate
to group similar or related items.
It is not appropriate to write down inventories
based on a classification of inventory.
o Example: finished goods, or all the inventories in a
particular industry or geographical segment.

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Continued-Net realizable value

Estimates of net realizable value
are based on the most reliable evidence
available at the time the estimates are made.
take into consideration the purpose for which
the inventory is held

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Disclosure
The financial statements should disclose:
the accounting policies adopted in measuring
inventories, including the cost formula used;
the total carrying amount of inventories and the carrying
amount in classifications appropriate to the enterprise;
the carrying amount of inventories carried at net
realizable value;
the amount of any reversal of any write-down that is
recognized as income in the period;
the circumstances or events that led to the reversal of a
write-down of inventories; and
the carrying amount of inventories pledged as security
for liabilities.

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Continued-Disclosure
Information about the carrying amounts held in different
classifications of inventories and the extent of the
changes in these assets is useful to financial statement
users.
When the cost of inventories is determined using the LIFO
formula(allowed alternative treatment), the financial
statements should disclose the difference between the
amount of inventories as shown in the balance sheet and
either:
the lower of the amount arrived at and net realizable value;
or
the lower of current cost at the balance sheet date and net
realizable value.

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Continued-Disclosure
The financial statements should also disclose either:
the cost of inventories recognized as an expense during
the period; or
the operating costs, applicable to revenues, recognized
as an expense during the period, classified by their
nature.

Costs can classified based on

the nature of expenses, or
the function within the enterprise
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Continued-Disclosure
Costs of inventories recognized as an expense.
referred to as the function of expense or cost of sales
method and
classifies expenses according to their function as part of
cost of sales, distribution or administrative activities.
the cost of inventories recognized as an expense during
the period consists of those costs previously included in
the measurement of the items of inventory sold and
unallocated production overheads and abnormal
amounts of production costs of inventories.
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Continued-Disclosure
Operating costs applicable to revenue, classified by
their nature. Nature of expense method
an enterprise discloses the amounts of operating costs,
applicable to revenues for the period, classified by their
nature.
expenses are aggregated in the income statement
according to their nature, (for example depreciation,
purchases of materials, transport costs, wages and
salaries, advertising costs), and are not reallocated
among various functions within the enterprise.
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the end

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