INVENTORIES

IAS 2
SCOPE

IAS 2 prescribes the accounting treatment for inventories. Inventories comprise the
following assets:
• Assets held for sale in the ordinary course of business (i.e. finished goods and
merchandise).
• Assets in the process of production for such sale (work in progress).
• Assets to be consumed in the production process or in the rendering of services (materials
and supplies).
MEASUREMENT

At recognition, inventories are measured at cost, which comprises

1. all costs of purchase,
2. costs of conversion, and
3. other costs incurred in bringing the inventories to their present location and
condition.
THE COSTS OF PURCHASE

Include the purchase price, import duties and other taxes that are not recoverable, and
transport, handling, and other costs directly attributable to the purchase. Trade discounts,
rebates, and other similar items are deducted in determining the costs of purchase.
When an arrangement contains a financing element (e.g. a difference between the purchase
price for normal credit terms and the amount paid), the element is not part of the costs of
purchase. It is instead recognized as interest expense over the period of the financing
COSTS OF CONVERSION

Comprise costs directly related to the units of production (i.e. direct labor and direct
materials). They also include a systematic allocation of fixed production overheads (e.g.
depreciation and the cost of factory management) and variable production overheads (e.g.
indirect materials and indirect labor).
COSTS OF CONVERSION-FIXED OVERHEAD

The amount of fixed overheads allocated to each unit of production is not increased as a
result of the actual level of production (i.e. the quantity produced or the time of production
during a period) in a period being significantly lower than normal capacity. Otherwise, the
carrying amount of a unit of production would increase while the actual level of production
decreases. By contrast, if the actual level of production significantly exceeds normal
capacity, fixed overheads allocated to each unit of production are decreased so that
inventories are not measured above cost. Variable overheads are allocated to each unit of
production on the basis of the actual use of the production facilities
OTHER COSTS

Are included in the costs of conversion to the extent that they are incurred in bringing
the inventories to their present location and condition.
For example, it may be appropriate to include non-production overheads or the costs of
designing products for specific customers in determining the cost of inventories. In limited
cases, which are identified in IAS 23, the costs of conversion also include borrowing costs
COSTS NOT INCLUDED

• The following are examples of costs not included in the costs of purchase or conversion:
• Abnormal amounts of wasted materials or labor.
• Storage costs (unless they are necessary in the production process before a further
production stage).
• Administrative overheads that do not contribute to bringing the inventories to their
present location and condition.
• Selling costs.
EXAMPLE

Entity E purchases merchandise on Nov 01, 01. Delivery takes place on the same day. In the
case of (normal) deferred settlement terms of one month, the purchase price would be AED
200. However, E and its supplier stipulate that payment has to be made on Nov 30, 02, but
at an amount of AED 212 (AED 200 plus interest of 6% for one year).
Required
Prepare any necessary entries in E's financial statements as at Dec 31, 01. Should it be
necessary to recognize interest expense, assume that E recognizes interest expense on a
straight-line basis due to materiality considerations?
SOLUTION

Interest for the period from Dec 01, 01 to Nov 30, 02 (length of the financing) must not be
capitalized. It is instead recognized as interest expense.
COST METHODS

The cost of inventories that are not ordinarily interchangeable and goods or services
produced and segregated for specific projects have to be assigned by using specific
identification of their individual costs. This means that each item is measured on the basis
of its individual costs of purchase or conversion. By contrast, the costs of purchase or
conversion of other inventories have to be assigned by using the FIFO (first in, first out) or
weighted average cost formula. In the latter case, the average may by calculated on a
periodic basis or as each additional shipment is received, depending upon the circumstances
of the entity
MEASUREMENT AFTER RECOGNITION

After recognition (i.e. at the first balance sheet date after the purchase or conversion and
also at following balance sheet dates), inventories are measured at the lower amount of (a)
costs of purchase or conversion and (b) net realizable value.
This principle may lead to a write-down or to a reversal of a write-down.
NET REALIZABLE VALUE

is the estimated selling price in the ordinary course of business less the estimated costs
necessary to make the sale, less the estimated costs of completion. The estimated costs of
completion are relevant in the case of work in progress. They represent the costs of
conversion not incurred until the end of the reporting period. They comprise the same items
of cost that are included in measuring the costs of conversion and therefore also include
fixed costs.
WRITE DOWN THE INVENTORIES

Inventories are usually written down item by item. However, in some circumstances it may
be appropriate to group similar or related items. There is a certain degree of discretion in
determining the group. It may be appropriate to group similar or related items of inventory
if they relate to the same product line, have similar purposes or end uses, are produced and
marketed in the same geographical area, and cannot be practicably evaluated separately
from other items in that product line. However, it is not possible, for example, to regard all
finished goods or all inventories of a particular operating segment as a group. In the case of
services, each service is generally treated as a separate item.
WRITE DOWN THE INVENTORIES-CONT.

Materials and supplies are not written down below cost if the finished goods in which they
will be incorporated are expected to be sold at or above cost. However, when a decrease in
the price of materials indicates that the cost of the finished goods exceeds net realizable
value, the materials are written down. In such cases the replacement cost of the raw
materials will often be the best available measure of their net realizable value
EXAMPLE (A)

On Dec 31, 01, entity E owns 100 units of merchandise M. The purchase took place on Oct
15, 01. Settlement in cash and delivery took place on the same date. The costs of purchase
were CU 1 per unit. On Dec 31, 01, the net realizable value amounts to AED 0.9 per unit.
Required
Prepare any necessary entries in E's financial statements as at Dec 31, for year 01
SOLUTION (A)

On Dec 31, 01, the inventories have to be measured at the lower of cost (AED 100) and net
realizable value (AED 90) (IAS 2.9). This results in a write-down of AED 10:
EXAMPLE (B)

Based on the same example A above On Jul 10, 02, the company sold 90 units of M to a
customer for AED 95. Settlement in cash and delivery took place on the same date.
On Dec 31, 02 there are still 10 units of M in the warehouse of E which could not be sold
yet. At that date, net realizable value amounts to AED 1.1 per unit.
Required
Prepare any necessary entries in E's financial statements as at Dec 31, for the year 02.
SOLUTION (B)

The carrying amount of the 90 units sold is AED 81 (AED 0.9 · 90 units). The carrying
amount of the inventories that are sold is recognized as an expense in the period in which
the related revenue is recognized
SOLUTION (B)

Cost =1
NRV = 1.1
Lower is 1
Current carrying amount =0.9
1-0.9=0.1
0.1× 10 units=1 to be reversed
PRESENTATION AND DERECOGNITION

Inventories may be presented only as a single amount in the statement of financial position.
If so, it is usually necessary to explain the composition of the inventories (finished goods,
merchandise, materials and supplies, and work in progress) in the notes.
The presentation of changes in the carrying amount of inventories in profit or loss depends
on the form in which the analysis of expenses is presented: If the reporting entity presents
its expenses according to the function of expense method (= cost of sales method), the
following applies: The carrying amount of inventories that are sold is recognized as cost of
sales in the period in which the related revenue is recognized. A write-down increases cost
of sales, whereas a reversal of a write-down leads to a reduction in cost of sales.
PRESENTATION AND DERECOGNITION- CONT.

If the reporting entity presents its expenses according to the nature of expense method, the
following applies: The cost of the merchandise sold is recognized in the line item “cost of
merchandise sold.” The difference between the carrying amount of finished goods and work
in progress at the end of the reporting period and the corresponding amount at the end of the
previous period is presented in the line item “changes in inventories of finished goods and
work in progress.” A write-down and a reversal of a write-down are included in the
appropriate line item mentioned above.
REFERENCES

• Christian, D., & Lüdenbach, N. (2013). Ifrs essentials. Retrieved from https://
ebookcentral.proquest.com
• PKF, I. L. (2019). Wiley interpretation and application of ifrs standards. Retrieved from
https://ebookcentral.proquest.com