PAS 2: INVENTORIES

Scope of PAS 2
Applies to all inventories except:
• work in progress arising under
construction contracts;
• financial instruments; and
• biological assets related to
agricultural activity.
Scope of PAS 2
Does not apply to the measurement of
inventories held by:
• producers of agricultural and forest
products, agricultural produce after
harvest, and minerals and mineral
products,

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Scope of PAS 2
• to the extent that these are
measured at net realizable value in
accordance with well-established
practices in those industries.
• commodity broker-traders who
measure their inventories at fair
value less costs to sell.

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 Nature of Inventories
 Inventories are assets:
 held for sale in the ordinary course
of business (finished goods);
 in the process of production for
such sale (work in process); or
 in the form of materials or supplies
to be consumed in the production
process or in the rendering of
services (raw mat.)
 RECOGNITION
 Requisites for recording:
Probable future economic
benefits will flow into the
Measurement Reliability

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Measurement of Inventories
INITIAL

Inventories should be
measured at cost
 Cost of Inventories
• Cost is the total expenditure that
has been incurred in bringing the
product or service to its present
location and condition.
Items of Inventory Cost
• General categories of expenditure
considered as cost:
• Costs of purchase
• Costs of conversion
• Other costs incurred in bringing the
inventories to their present location
and condition

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 Costs of Purchase
• purchase price
• 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.
 Conversion Costs
• Allocation of overhead needs to
be based on the enterprise’s
normal capacity.
• When there is a main product
and a by-product and the costs
of conversion of each product
are not separately identifiable,
they are allocated between the
products on a rational and
consistent basis.
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 Costs of By-Products
• Most by-products are immaterial.
Thus, they are often measured at
net realizable value and this
value is deducted from the cost
of the main product.

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Other Incidental Inventory Cost
 Other costs are included only to
the extent incurred in bringing the
inventories to their present location
and condition.
Items treated as expenses:
 Items treated as period costs
(expenses)
• abnormal amounts of wasted
material, labor or other
production cost,
• storage costs (unless necessary
in the production process prior to
a further production stage),
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Items treated as expenses:
 Items treated as period costs
(expenses)
• administrative overheads that do
not contribute to bringing
inventories to their present
location and condition, and
• selling costs.
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Other Inventory Costs
• PAS 23 Borrowing Costs, identifies
the limited circumstances where
borrowing costs are included in the
cost of inventories.
Deferred Payment Purchases
• 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
the period of the financing.
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SUBSEQUENT MEASUREMENT
 Inventories should be presented
at the lower of cost and net
realizable value.

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Cost Measurement Techniques
 Techniques for the measurement of
the cost of inventories may be used
for convenience if the results
approximate cost, these are:
– Standard cost method
– Retail method
– Gross profit method

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Cost Measurement Techniques
 Standard Cost Method
• 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.
Cost Measurement Techniques
 Retail Method
• Cost of the inventory is determined
by reducing the sales value of the
inventory by the appropriate
percentage gross margin.

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Retail Inventory Method
COST RETAIL
Beginning Inventory P xx P xx
Purchases P xx P xx
Purchases Returns ( xx) ( xx )
Freight in xx
Net markups xx
Net markdowns (xx)
Net purchases xx xx
MAFS xx xx

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Cost Measurement Techniques
 Gross Profit Method
• Cost of the inventory is determined
by deducting the estimated cost of
sales from the cost of goods
available for sale computed based
on average gross profit rate on
previous years.
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Cost Flow Assumptions
Some of the principal cost bases are as follows:
1. Specific identification – 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.
2. FIFO or Weighted Average – for all other
inventories, PAS 2 permits the cost of
inventories to be assigned using either first-in,
first-out (FIFO) or weighted average.
FIFO and Weighted Average Method
FIFO
• assumes that the items of inventory which were
purchased or produced first are sold first, and
consequently the items remaining in inventory at
the end of the period are those most recently
purchased or produced.
Weighted average method
• 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.
 Net realizable value
• Net realizable 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.
• Estimates of net realizable value
– are based on the most reliable evidence
available at the time the estimates are made,
and
– takes into consideration the purpose for which
the inventory is held.
Writing down of Inventories
The practice of writing inventories
down below cost to net realizable value
is consistent with the view that assets
should not be carried in excess of
amounts expected to be realized from
their sale or use.
Writing down of Inventories
Inventories may not be recoverable if:
– those inventories are damaged,
– they have become wholly or partially
obsolete,
– their selling prices have declined, or
– the estimated costs of completion or
estimated costs to be incurred to
make the sale have increased.
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 Writing down of Inventories
• Inventories are written down to net
realizable value:
–on an item by item basis, or
–group of similar or related items.
Recognition as Expense
• Inventories are sold are recognized as
an expense in the period in which the
related revenue is recognized.
• Write-down of inventories to net
realizable value and all losses of
inventories are recognized as an
expense in the period the write-down
or loss occurs.
Recognition as Expense
• Reversal of any write-down of inventories,
arising from an increase in net realizable
value, are recognized as a reduction in the
amount of inventories recognized as an
expense in the period in which the reversal
occurs.
• Inventories allocated to other asset
accounts, such as self-constructed property,
plant or equipment are recognized as an
expense during the useful life of that asset.
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Required Disclosures:
The financial statements shall
disclose, among others:
 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;
Required Disclosures:
The financial statements shall disclose,
among others:
 the carrying amount of inventories
carried at fair value less costs to sell;
 the amount of inventories recognised
as an expense during the period;
 the amount of any write-down of
inventories recognised as an expense
in the period;
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 Required Disclosures
The financial statements shall
disclose, among others:
 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;
 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.34
ANSWERS TO MCQ

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