SLAS 5 (REVISED 2005)

SRI LANKA
ACCOUNTING STANDARD

INVENTORIES

THE INSTITUTE OF
CHARTERED ACCOUNTANTS OF
SRI LANKA
 SLAS 5 (REVISED 2005)

SRI LANKA
ACCOUNTING STANDARD

INVENTORIES

The Institute of
Chartered Accountants
of Sri Lanka
SLAS 5

Contents
Sri Lanka Accounting Standard SLAS 5 (Revised 2005)
Inventories
paragraphs
OBJECTIVE 1
SCOPE 2-5
DEFINITIONS 6-8
MEASUREMENT OF INVENTORIES 9-33
Cost of Inventories 10-22
Costs of Purchase 11
Costs of Conversion 12-14
Other Costs 15-18
Cost of Inventories of a Service Provider 19
Cost of Agricultural Produce Harvested from
Biological Assets 20
Techniques for the Measurement of Cost 21-22
Cost Formulas 23-27
Net Realisable Value 28-33
RECOGNITION AS AN EXPENSE 34-35
DISCLOSURE 36-39

2
 SLAS 5

COMPLIANCE WITH INTERNATIONAL

ACCOUNTING STANDARDS 40
EFFECTIVE DATE 41
WITHDRAWAL OF SLAS 5 42

3
SLAS 5

Sri Lanka Accounting Standard SLAS 5 (Revised 2005)

Inventories
Sri Lanka Accounting Standard SLAS 5 Inventories (Revised 2005) is set out in
paragraph 1-42. All the paragraphs have equal authority. SLAS 5 (Revised
2005) should be read in the context of its objective, the Preface to Sri Lanka
Accounting Standards and the Framework for the Preparation and Presentation
of Financial Statements. SLAS 10 Accounting Policies, Changes in Accounting
Estimates and Errors (Revised 2005) provides a basis for selecting and applying
accounting policies in the absence of explicit guidance.

Objective
1. The objective of this Standard is to prescribe the accounting treatment
for inventories. A primary issue in accounting for inventories is the
amount of cost to be recognised as an asset and carried forward until the
related revenues are recognised. This Standard provides guidance on the
determination of cost and its subsequent recognition as an expense,
including any write-down to net realisable value. It also provides
guidance on the cost formulas that are used to assign costs to inventories.

Scope
2. This Standard applies to all inventories, except:

(a) work in progress arising under construction contracts,

including directly related service contracts (see SLAS 13
Construction Contracts);

(b) financial instruments; and

4
 SLAS 5

(c) biological assets related to agricultural activity and

agricultural produce at the point of harvest.

3. This Standard does not apply to the measurement of inventories held

by:

(a) producers of agricultural and forest products, agricultural

produce after harvest, and minerals and mineral products, to
the extent that they are measured at net realisable value in
accordance with well-established practices in those industries.
When such inventories are measured at net realisable value,
changes in that value are recognised in profit or loss in the
period of the change.

(b) commodity broker-traders who measure their inventories at

fair value less costs to sell. When such inventories are
measured at fair value less costs to sell, changes in fair value
less costs to sell are recognised in profit or loss in the period of
the change.

4. The inventories referred to in paragraph 3(a) are measured at net

realisable value at certain stages of production. This occurs, for example,
when agricultural crops have been harvested or minerals have been
extracted and sale is assured under a forward contract or a government
guarantee, or when an active market exists and there is a negligible risk
of failure to sell. These inventories are excluded from only the
measurement requirements of this Standard.

5. Broker-traders are those who buy or sell commodities for others or on

their own account. The inventories referred to in paragraph 3(b) are
principally acquired with the purpose of selling in the near future and
generating a profit from fluctuations in price or broker-traders’ margin.
When these inventories are measured at fair value less costs to sell, they
are excluded from only the measurement requirements of this Standard.

5
SLAS 5

Definitions
6. The following terms are used in this Standard with the meanings
specified:

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.

Net realisable 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.

Fair value is the amount for which an asset could be exchanged, or a

liability settled, between knowledgeable, willing parties in an arm’s
length transaction.

7. Net realisable value refers to the net amount that an entity expects to
realise from the sale of inventory in the ordinary course of business. Fair
value reflects the amount for which the same inventory could be
exchanged between knowledgeable and willing buyers and sellers in the
marketplace. The former is an entity-specific value; the latter is not. Net
realisable value for inventories may not equal fair value less costs to sell.

8. Inventories encompass goods purchased and held for resale including,

for example, merchandise purchased by a retailer and held for resale, or
land and other property held for resale. Inventories also encompass
finished goods produced, or work in progress being produced, by the
entity and include materials and supplies awaiting use in the production
process. In the case of a service provider, inventories include the costs of
6
 SLAS 5

the service, as described in paragraph 19 for which the entity has not yet
recognised the related revenue (see Sri Lanka Accounting Standard
SLAS 29 Revenue).

Measurement of Inventories
9. Inventories shall be measured at the lower of cost and net realisable
value.

Cost of Inventories
10. The cost of inventories shall comprise all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their
present location and condition.

Costs of Purchase

11. The costs of purchase of inventories comprise the purchase price, import
duties and other taxes (other than those subsequently recoverable by the
entity from the taxing authorities), and transport, handling and other
costs directly attributable to the acquisition of finished goods, materials
and services. Trade discounts, rebates and other similar items are
deducted in determining the costs of purchase.

Costs of Conversion

12. The costs of conversion of inventories include costs directly related to

the units of production, such as direct labour. They also include a
systematic allocation of fixed and variable production overheads that are
incurred in converting materials into finished goods. Fixed production
overheads are those indirect costs of production that remain relatively
constant regardless of the volume of production, such as depreciation
and maintenance of factory buildings and equipment, and the cost of
factory management and administration. Variable production overheads
7
SLAS 5

are those indirect costs of production that vary directly, or nearly

directly, with the volume of production, such as indirect materials and
indirect labour.

13. 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
actual level of production may be used if it approximates normal
capacity. 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 recognised 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. Variable
production overheads are allocated to each unit of production on the
basis of the actual use of the production facilities.

14. A production process may result in more than one product being
produced simultaneously. This is the case, for example, when joint
products are produced or when there is a main product and a by-product.
When the costs of conversion of each product are not separately
identifiable, they are allocated between the products on a rational and
consistent basis. The allocation may be based, for example, on the
relative sales value of each product either at the stage in the production
process when the products become separately identifiable, or at the
completion of production. Most by-products, by their nature, are
immaterial. When this is the case, they are often measured at net
realisable value and this value is deducted from the cost of the main
product. As a result, the carrying amount of the main product is not
materially different from its cost.

8
 SLAS 5

Other Costs

15. Other costs are included in the cost of inventories only 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
the cost of inventories.

16. Examples of costs excluded from the cost of inventories and recognised
as expenses in the period in which they are incurred are:

(a) abnormal amounts of wasted materials, labour or other

production costs;

(b) storage costs, unless those costs are necessary in the production
process before a further production stage;

(c) administrative overheads that do not contribute to bringing

inventories to their present location and condition; and

(d) selling costs.

17. SLAS 20 Borrowing Costs identifies limited circumstances where

borrowing costs are included in the cost of inventories.

18. 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 recognised as interest expense over the
period of the financing.

Cost of Inventories of a Service Provider

19. To the extent that service providers have inventories, they measure them
at the costs of their production. These costs consist primarily of the
9
SLAS 5

labour and other costs of personnel directly engaged in providing the

service, including supervisory personnel, and attributable overheads.
Labour and other costs relating to sales and general administrative
personnel are not included but are recognised as expenses in the period
in which they are incurred. The cost of inventories of a service provider
does not include profit margins or non-attributable overheads that are
often factored into prices charged by service providers.

Cost of Agricultural Produce Harvested from Biological Assets

20. Inventories comprising agricultural produce that an entity has harvested

from its biological assets are measured on initial recognition at their fair
value less estimated point-of-sale costs at the point of harvest. This is the
cost of the inventories at that date for application of this Standard.

Techniques for the Measurement of Cost

21. Techniques for the measurement of the cost of inventories, such as the
standard cost method or the retail method, may be used for convenience
if the results approximate cost. Standard costs take into account normal
levels of materials and supplies, labour, efficiency and capacity
utilisation. They are regularly reviewed and, if necessary, revised in the
light of current conditions.

22. The retail method is often used in the retail industry for measuring
inventories of large numbers of rapidly changing items with similar
margins for which it is impracticable to use other costing methods. The
cost of the inventory is determined by reducing the sales value of the
inventory by the appropriate percentage gross margin. The percentage
used takes into consideration inventory that has been marked down to
below its original selling price. An average percentage for each retail
department is often used.

10
 SLAS 5

Cost Formulas
23. The cost of inventories of items that are not ordinarily interchangeable
and goods or services produced and segregated for specific projects
shall be assigned by using specific identification of their individual
costs.

24. Specific identification of cost means that specific costs are attributed to
identified items of inventory. This is the appropriate treatment for items
that are segregated for a specific project, regardless of whether they have
been bought or produced. However, specific identification of costs is
inappropriate when there are large numbers of items of inventory that are
ordinarily interchangeable. In such circumstances, the method of
selecting those items that remain in inventories could be used to obtain
predetermined effects on profit or loss.

25. The cost of inventories, other than those dealt with in paragraph 23,
shall be assigned by using the first-in, first-out (FIFO) or weighted
average cost formula. 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.

26. For example, inventories used in one business segment may have a use
to the entity different from the same type of inventories used in another
business segment. However, a difference in geographical location of
inventories (or in the respective tax rules), by itself, is not sufficient to
justify the use of different cost formulas.

27. The FIFO formula assumes that the items of inventory that 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. Under the weighted average cost formula, 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
11
SLAS 5

purchased or produced during the period. The average may be calculated

on a periodic basis, or as each additional shipment is received,
depending upon the circumstances of the entity.

Net Realisable Value

28. 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. The cost of inventories may also not be
recoverable if the estimated costs of completion or the estimated costs to
be incurred to make the sale have increased. The practice of writing
inventories down below cost to net realisable value is consistent with the
view that assets should not be carried in excess of amounts expected to
be realised from their sale or use.

29. Inventories are usually written down to net realisable value item by item.
In some circumstances, however, it may be appropriate to group similar
or related items. This may be the case with items of inventory relating to
the same product line that 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. It
is not appropriate to write inventories down on the basis of a
classification of inventory, for example, finished goods, or all the
inventories in a particular industry or geographical segment. Service
providers generally accumulate costs in respect of each service for which
a separate selling price is charged. Therefore, each such service is treated
as a separate item.

30. Estimates of net realisable value are based on the most reliable evidence
available at the time the estimates are made, of the amount the
inventories are expected to realise. These estimates take into
consideration fluctuations of price or cost directly relating to events
occurring after the end of the period to the extent that such events
confirm conditions existing at the end of the period.

12
 SLAS 5

31. Estimates of net realisable value also take into consideration the purpose
for which the inventory is held. For example, the net realisable value of
the quantity of inventory held to satisfy firm sales or service contracts is
based on the contract price. If the sales contracts are for less than the
inventory quantities held, the net realisable value of the excess is based
on general selling prices. Provisions may arise from firm sales contracts
in excess of inventory quantities held or from firm purchase contracts.
Such provisions are dealt with under SLAS 36, Provisions, Contingent
Liabilities and Contingent Assets.

32. Materials and other supplies held for use in the production of inventories
are not written down below cost if the finished products in which they
will be incorporated are expected to be sold at or above cost. However,
when a decline in the price of materials indicates that the cost of the
finished products exceeds net realisable value, the materials are written
down to net realisable value. In such circumstances, the replacement cost
of the materials may be the best available measure of their net realisable
value.

33. A new assessment is made of net realisable value in each subsequent

period. When the circumstances that previously caused inventories to be
written down below cost no longer exist or when there is clear evidence
of an increase in net realisable value because of changed economic
circumstances, the amount of the write-down is reversed (i e the reversal
is limited to the amount of the original write-down) so that the new
carrying amount is the lower of the cost and the revised net realisable
value. This occurs, for example, when an item of inventory that is
carried at net realisable value, because its selling price has declined, is
still on hand in a subsequent period and its selling price has increased.

Recognition as an Expense
34. When inventories are sold, the carrying amount of those inventories
shall be recognised as an expense in the period in which the related
revenue is recognised. The amount of any write-down of inventories to
13
SLAS 5

net realisable value and all losses of inventories shall be recognised as

an expense in the period the write-down or loss occurs. The amount of
any reversal of any write-down of inventories, arising from an increase
in net realisable value, shall be recognised as a reduction in the
amount of inventories recognised as an expense in the period in which
the reversal occurs.

35. Some inventories may be allocated to other asset accounts, for example,
inventory used as a component of self-constructed property, plant or
equipment. Inventories allocated to another asset in this way are
recognised as an expense during the useful life of that asset.

Disclosure
36. The financial statements shall disclose:

(a) the accounting policies adopted in measuring inventories,

including the cost formula used;

(b) the total carrying amount of inventories and the carrying

amount in classifications appropriate to the entity;

(c) the carrying amount of inventories carried at fair value less costs
to sell;

(d) the amount of inventories recognised as an expense during the

period;

(e) the amount of any write-down of inventories recognised as an

expense in the period in accordance with paragraph 34;

(f) 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 in accordance with paragraph 34;

14
 SLAS 5

(g) the circumstances or events that led to the reversal of a write-

down of inventories in accordance with paragraph 34; and

(h) the carrying amount of inventories pledged as security for

liabilities.

37. 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. Common classifications of inventories are
merchandise, production supplies, materials, work in progress and
finished goods. The inventories of a service provider may be described
as work in progress.

38. The amount of inventories recognised as an expense during the period,

which is often referred to as cost of sales, consists of those costs
previously included in the measurement of inventory that has now been
sold and unallocated production overheads and abnormal amounts of
production costs of inventories. The circumstances of the entity may also
warrant the inclusion of other amounts, such as distribution costs.

39. Some entities adopt a format for profit or loss that results in amounts
being disclosed other than the cost of inventories recognised as an
expense during the period. Under this format, an entity presents an
analysis of expenses using a classification based on the nature of
expenses. In this case, the entity discloses the costs recognised as an
expense for raw materials and consumables, labour costs and other costs
together with the amount of the net change in inventories for the period.

Compliance with International Accounting Standards

40. Compliance with this SLAS ensures compliance in all material respects
with International Accounting Standard IAS 2, Inventories.

15
SLAS 5

Effective Date
41. An entity shall apply this Standard for annual periods beginning on or
after 1 January 2006. Earlier application is encouraged. If an entity
applies this Standard for a period beginning before 1 January 2006, it
shall disclose that fact.

Withdrawal of SLAS 5
42. This Standard supersedes SLAS 5 Inventories.

16