IAS 2

Inventories
 IAS 2 - Overview

• Objective and scope

• Measurement
• Expense recognition
• Disclosure

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 IAS 2 - Objective
• The objective of this Standard is to prescribe
the accounting treatment for inventories.

• Standards for what costs are recognized as

inventory costs and when these costs are
transferred to the SOPL as expense

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 IAS 2 - Scope
IAS 2 applies to all inventories, except:
a) Work in progress arising under construction
contracts, including directly related service contracts
(see IAS 11 Construction Contracts)

b) Financial instruments (IAS 39 Financial Instruments)

c) Biological assets related to agricultural activity and

agricultural produce at the point of harvest (IAS 41
Agriculture)

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 IAS 2 - Definition
Inventories are assets:
(a) Held for sale in the ordinary course of
business
(b) In the process of production for such sale, or
(c) In the form of materials or supplies to be
consumed in the production process or in the
rendering of services

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IAS 2 - Measurement
• Inventories are measured at the lower of cost and
net realizable value (LC and NRV)
• Net Realizable Value: is the estimated selling
price less the estimated cost of completion and
sale.
• Need to know:
- what costs are included
- what cost formulas are permitted
- how net realizable value is determined
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 IAS 2 - Measurement
• Costs include:

1. Purchase costs
2. Conversion costs
3. Other inventorable costs

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 IAS 2 - Measurement
• Purchase costs
– purchase price and all costs directly attributable to their
acquisition such as non-refundable taxes, transportation
and handling, reduced by volume discounts and rebates
– if purchase arrangement effectively contains an unstated
financing element, for eg. a difference between the
purchase price for normal credit terms and the deferred
settlement amount, the difference is recognised as
interest expense over the period of the financing (ie it is
not added to the cost of the inventories)

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 Example
• If purchased and paid today, price = Br 10,000

• If purchased today and paid a year after, price =

Br 11,000

• The difference Br 1,000 is not part of the cost of

inventory, it is interest expense.

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 IAS 2 – Measurement – Conversion cost
 Includes: Direct labor, variable and fixed production
overhead costs.
 Variable production overhead: allocate to inventory based on
actual usage.
 Fixed production overhead: allocate to production based on
normal operating capacity (except when abnormally high
production)

• 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.
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 IAS 2 - Measurement
• Allocate fixed production overheads on
– normal capacity if low or normal production
– actual production (units) if abnormally high
production (so that inventory is not measured above
cost)
Note: unallocated overheads are expensed when
incurred
• Allocate variable production overheads on actual production

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 Example
• Fixed production (FP) overheads = CU900,000
Normal capacity = 250,000 units.
Actual Units Produced = 200,000.

Allocation rate:
= CU900,000 ÷ 250,000 units normal capacity
= CU3.6 per unit produced.
Allocate to inventories:
= CU3.6 × 200,000 units = CU720,000.
Unallocated overheads:
= CU900,000-CU720,000
= CU180,000 (Treated as expense)

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 Example
• Same as previous Example except 300,000 units
produced actually.
• Normal capacity = 250,000 units.
Allocation rate:
= CU900,000 ÷ 300,000 units
= CU3 per unit.
Allocate to inventories:
= CU3 × 300,000 units
= CU900,000

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 Example - Wastage
• Total costs of a production run = CU100,000
(including a cost of normal wastage of CU2,000).
• The weakening of operating controls while the
owner-manager was in hospital caused the wastage
of raw materials to increase to CU7,000 per
production run.
• The abnormal wastage cost:
= CU7,000 – CU2,000
= CU5,000 (Treated as expense)

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 Joint products
- Allocate joint costs between products on a
rational basis such as relative sales value of
products when they become separable

- If minor in value (ie. byproduct), do not allocate:

measure by-product at net realizable value and
deduct this amount from main product costs

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 Example
• A production process costs CU100,000 (including
allocated overheads). It mixes base chemicals to
produce:
– 5,000 litres of product A (sales value = CU250,000); and
– 1,000 litres of by-product C (sales value = CU2,000).
• Cost to be allocated to A = 100,000-2000
= 98,000
• Cost per litre of A:
= CU98,000/5,000 litres
= CU19.60

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Example
• Same as in the previous Example except, instead of
byproduct ‘C’ there is a joint product ‘B’.
• Total costs = CU300,000 to produce:
– 5,000 litres of A (sales value = CU250,000); and
– 4,000 litres of B (sales value = CU400,000).
• Allocate joint process costs on relative sales values.

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Total Cost of A:
= (CU250,000 ÷ CU650,000) x CU300,000
= CU115,385
Cost per litres of A = CU115,385 ÷ 5,000 litres = CU23.08.

Total Cost of A:
= (CU400,000 ÷ CU650,000) × CU300,000
= CU184,615
Cost per litre of B = CU184,615 ÷ 4,000 litres = CU46.15.

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 Other Inventoriable Costs

– limited to costs to bring the inventories to their present

location and condition

– borrowing costs included if for a qualifying inventory

item.

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 Do not add to inventory cost:
• Costs of abnormal waste
• Storage or warehousing costs unless necessary for next
stage of production
• Administrative overheads not associated with production
• Selling costs
• Financing charges above purchase price for normal credit
terms
• Exchange rate differences arising directly on the recent
acquisition of inventories invoiced in a foreign currency

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 Cost formulas permitted should:
- Assign recent costs to ending inventory
- Correspond closely with the actual physical flow of the
goods and services
- Three permitted: Specific identification, First-in, first-
out, and weighted average
- The Standard does not permit the use of the last-in,
first-out (LIFO) formula to measure the cost of
inventories.

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 Specific identification:
 IASB requires in cases where inventories are not ordinarily
interchangeable or for goods and services produced or segregated
for specific projects.
 Cost of goods sold includes costs of the specific items sold.
 Used when handling a relatively small number of costly, easily
distinguishable items.
 Matches actual costs against actual revenue.
 Cost flow matches the physical flow of the goods.

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 Example: Specific identification:
- An entity has produced 10 items (e.g., exclusive single family homes),
- At the end of the reporting period, 3 items (first, sixth, and eighth homes
were on hand/not sold)
1. What will be the value of Ending inventory that will appear in
the Statement of financial position?
2. What will be the amount of cost of goods sols that will appear
on profit & loss statement ?
Solution:
1. The cost of ending inventory for an entity:
the actual production cost of the 3homes still on hand on the reporting date.
2. Cost of goods sold = the actual production cost of the sold homes.
 FIFO and weighted average:
• FIFO – cost of latest purchases ends up in cost of ending inventory,
cost of earliest purchases are in cost of goods sold

• Weighted average – weighted average cost of all goods available

for sale ends up in both ending inventory and cost of goods sold

• An entity shall use the same cost formula for all inventories having
a similar nature and use to the entity.

• For inventories with a different nature or use, different cost

formulas may be justified.

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IAS 2 - Measurement

• Inventories reported at the Lower of Cost and Net

Realizable Value
• Why?
– Because inventory not reported at more than the future cash
flows into the company from their sale
• NRV = the estimated selling price in the ordinary
course of business less the estimated costs of
completion and the estimated costs to make the sale

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Example:
• Cost (FIFO) Br. 80
• Selling price Br. 84
• Cost to complete Br. 5
• Cost to sell 10% of SP =8.4
What is the NRV?
NRV:
= Br.84 - Br.5 - Br.8.40
= Br.70.60
LC and NRV = Br.70.60

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 IAS 2 – Measurement – Write downs and
write ups

• Write-downs are recognized in profit or loss

• Subsequent write-ups permitted to maximum of prior
write-downs if:
- changed economic circumstances and NRV has
increased, prior situation no longer exists
• Reversals also taken to profit or loss

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IAS 2 – Expense Recognition – Up on sale
 Carrying amount of inventory sold is expense in same
period as the related revenue
 Inventory adjustments (losses, write-downs to lower
of cost and NRV, write-down reversals, etc.) are
recognized as an adjustment to the expense (cost of
sales) recognized in the period or may be treated
separately as expense.

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Illustration of LCNRV: JF Foods computes its inventory
at LCNRV (amounts in thousands).

LO 1
Methods of Applying LCNRV

LO 1
Methods of Applying LCNRV

 In most situations, companies price inventory on an item-by-item

basis.
 Tax rules in some countries require that companies use an
individual-item basis.
 Individual-item approach gives the lowest valuation for statement
of financial position purposes.
 Method should be applied consistently from one period to another.

LO 1
Illustration: Data for Ricardo Company

Cost of goods sold (before adj. to NRV) €108,000

Ending inventory (cost) 82,000
Ending inventory (at NRV) 70,000

Loss
Loss Loss Due to Decline to NRV 12,000
Method
Method Inventory (€82,000 - €70,000)

12,000
COGS
COGS Cost of Goods Sold 12,000
Method
Method Inventory

12,000 LO 1
 Partial Statement of Financial Position

Loss COGS
Method Method
Current assets:
Inventory € 70,000 € 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000

LO 1
Recording Net Realizable Value
Loss COGS
Income Statement Method Method
Sales € 200,000 € 200,000
Cost of goods sold 108,000 120,000
Gross profit 92,000 80,000
Operating expenses:
Selling 45,000 45,000
General and administrative 20,000 20,000
Total operating expenses 65,000 65,000
Other income and expense:
Loss due to decline of inventory to NRV 12,000 -
Interest income 5,000 5,000
Total other (7,000) 5,000
Income from operations 20,000 20,000
Income tax expense 6,000 6,000
Net income € 14,000 € 14,000
LCNRV

Use of an Allowance
Instead of crediting the Inventory account for net realizable
value adjustments, companies generally use an allowance
account.

Loss
Loss Method
Method

Loss Due to Decline to NRV 12,000

Allowance to Reduce Inventory to NRV 12,000

LO 1
 Partial Statement of Financial Position
No
Allowance Allowance
Current assets:
Inventory € 70,000 € 82,000
Allowance to reduce inventory (12,000)
Inventory at NRV 70,000
Prepaids 20,000 20,000
Accounts receivable 350,000 350,000
Cash 100,000 100,000
Total current assets 540,000 540,000

LO 1
 Recovery of Inventory Loss
 Amount of write-down is reversed.
 Reversal limited to amount of original write-down.

Continuing the Ricardo example, assume the net realizable value

increases to €74,000 (an increase of €4,000). Ricardo makes the
following entry, using the loss method.

Allowance to Reduce Inventory to NRV 4,000

Recovery of Inventory Loss 4,000

LO 1
 Disclosure
• Accounting policy adopted in measuring inventories, including
cost formulas
• Carrying amount of inventories under major headings (e.g. raw
materials, WIP and finished goods)
• Carrying amount of inventories at fair value less costs to sell 
• Amount expended in the period 
• Amount of any write downs of inventories 
• Amount of any reversal of write downs
• Cause of write downs
• Carrying amount of inventories pledged as security

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 Thank you!!!

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