INVENTORIES

IAS 2
 Definition
2

 Inventories can take a number of different

from which include:
 Assets purchased and held for resale in the
ordinary course of business
 Raw materials, partly processed assets and
finished goods that have undergone the full
production process
 Other materials or supplies to be consumed in
the production process or in the rendering of
services

IAS 2 - Inventory/IAI-DipIFR
 Not apply to
3

 Work in progress arising under construction contracts,

including directly related service contract (IAS 11 –
construction contracts);
 Financial instruments (IAS 32 Financial Instruments:
Presentation and IAS 39 Financial Instruments:
Recognition and Disclosures);
 Biological assets related to agricultural activity and
agricultural produce at the point of harvest (IAS 41
Agriculture);
 Commodity broker-traders who measure their
inventories at fair value (FV) less cost to sell (C2S).
Changes in FV less C2S are recognized in profit or loss in
the period of the change.
IAS 2 - Inventory/IAI-DipIFR
 Inventories
4

 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 the
rendering of services

IAS 2 - Inventory/IAI-DipIFR
 Measurement
5

 Inventories should be measured at the lower of

cost and net realizable value (NRV)
 NRV is selling price expected to be achieved
less an estimate of cost to complete the
production of the finished goods and of the cost
to be incurred in making the sale
 Valuing inventory at the lower of cost and NRV
ensure that any profit be earned on their sale is
not recognized before the sale takes place
although any loss is recognized as soon as it is
identified.
IAS 2 - Inventory/IAI-DipIFR
 Cost of inventories
6

 Cost of purchase
 Cost of conversion
 Other costs incurred in bringing the
inventories to their present location and
condition

IAS 2 - Inventory/IAI-DipIFR
 Cost of purchase
7

 Cost of inventory is expenditure incurred in bringing

items to their location and condition. Such cost
include:
 The purchase price of goods acquired for resale or the raw
materials that are to be used in a production process
 Any discount or rebates that have been received should be
deducted from the cost
 It is only the costs that are directly attributable to
bringing the goods to their current state which should
be included. These may include:
 Import duties,
 Transport, and
 Other handling costs.

IAS 2 - Inventory/IAI-DipIFR
 Cost of Conversion
8

 Cost of conversion include cost directly

related to the units of production, such as:
 direct manufacturing
 direct labor costs
 a systematic allocation of
 ‒fixed overhead
 ‒variable overhead

IAS 2 - Inventory/IAI-DipIFR
 Include in cost
9

 Supplier’s gross price for raw materials

 Quantity discounts allowed by supplier (deduct from
cost)
 Costs of transporting materials to the business premises
 Labor costs directly incurred in the processing of raw
materials
 Variable costs, such as power, incurred in the processing
of raw materials
 Fixed production costs/overheads, such as rent for the
processing factory
 Depreciation charges on the plant used in the processing

IAS 2 - Inventory/IAI-DipIFR
 Expensed as incurred
10

 Costs of transporting goods to customers on sale

 Non-recoverable purchase taxes charged to customers on sale
 Non-recoverable sales taxes
 Commission payable to salesmen on the sale of the goods
 Provisions for bad and doubtful debts in relation to trade
receivables
 Costs of the accounts department
 Head office costs relating to the overall management of the
business
 Storage cost unless those cost are necessary in the production
process
 Administrative overhead cost that do not contribute to bringing
inventories to their present location and condition;
 Selling costs.

IAS 2 - Inventory/IAI-DipIFR
 Fixed overhead
11

 Fixed overheads should be allocated to each

production process on a systematic basis.
 It will generally be appropriate to allocate an
element of fixed overheads based on normal levels
of production.
 It is not appropriate to allocate to inventory
abnormal costs or administrative costs that do not
contribute to bringing the inventory to their current
state; instead such amounts should be recognized in
profit or loss in the period in which they are
incurred.

IAS 2 - Inventory/IAI-DipIFR
 Allocation of fixed overhead
12

 The allocation of fixed production overheads to the costs of

conversion is based on the normal capacity of the production
facilities.
 Normal capacity is the production expected to be achieved on average
over a number of periods or seasons under normal circumstances,
taking into account the loss of capacity resulting from planned
maintenance.
 The amount of fixed overhead allocated to each unit of
production is not increased as a consequence of low production
or idle plant. Unallocated overheads are recognized as an
expense in the period in which they are incurred.
 In periods of abnormally high production, the amount of fixed
overhead allocated to each unit of production is decreased so
that inventories are not measured above cost.

IAS 2 - Inventory/IAI-DipIFR
 Example: abnormal cost
13

 A business plans for fixed production overheads of

CU50,000 and annual production is estimated at
100,000 items in its financial year. The planned
overhead recovery rate is CU0.50 per item
(CU50,000 per 100,000 items).
 A fire at the factory results in production being only
75,000 units although there is no saving in the level
of fixed production overheads.
 Inventory should still be valued on the basis of
CU0.50 per item, leading to a recovery of
CU37,500 of overheads with the balance of
CU12,500 being expensed directly in the year

IAS 2 - Inventory/IAI-DipIFR
 Borrowing cost
14

 IAS 23 Borrowing Costs identifies limited

circumstances where borrowing costs are
included in the 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 recognized as interest
expense over IAS
the period of the financing.
2 - Inventory/IAI-DipIFR
 Cost formula
15

 Two cost formulas are allowed.

 First-in, first-out, known as FIFO: this method assumes a
physical flow of items whereby those purchased or
produced earliest are the first to be sold. The items
purchased or produced most recently are the ones in
inventory, to be valued at the most recent cost; and
 Weighted average costs: this method calculates an
average cost of purchase or production (calculated either
on a periodic basis or after each shipment has been
received or new batch has been produced), and values
inventory at that average cost.
 An entity shall use the same cost formula for all
inventories of a similar nature.
IAS 2 - Inventory/IAI-DipIFR
 NRV
16

 The key points to note with regard to NRV are:

 in the case of incomplete items, NRV takes account of the
costs to complete;
 in making the assessment of whether NRV is lower than cost
of inventory it may be appropriate to group items together.
However, items should only be grouped together when the
individual items cannot be valued separately. It is not
appropriate to treat a whole class of inventory, for example
all goods held for sale, as a group. in the absence of a
contractually agreed selling price, the best estimate is the
likely selling price, less appropriate deductions; and
 materials to be incorporated into a finished good should only
be written down if the eventual finished good will be sold for
less than the total cost.

IAS 2 - Inventory/IAI-DipIFR
 Disclosure
17
 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 entity;
 the carrying amount of inventories carried at fair value less costs to
sell;
 the amount of inventories recognized as an expense during the period;
 the amount of any write-down of inventories recognized as an expense
in the period
 the amount of any reversal of any write-down that is recognized as a
reduction in the amount of inventories recognized as expense in the
period
 the circumstances or events that led to the reversal of a write-down of
inventories
 the carrying amount of inventories pledged as security for liabilities

IAS 2 - Inventory/IAI-DipIFR