IAS 2 Inventories

 Inventories are assets:

1. Held for sale in the ordinary course of business
2. In the process of production for such sale
3. 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.

Inventories can include any of the following

1. Good purchased and held for resale (goods held for sale by a retailer, or land and buildings held for resale)
2. Finished goods produced
3. Work in progress being produced
4. Materials and supplies awaiting use in the production process (raw materials)

Measurement.

The cost of inventories will consist of all costs of:

+ Purchase. The cost of purchase will includes:
+ Purchased price
+ Import duties and other taxes
+ Transport, handling and any other cost directly attributable to the acquisition of finished goods, services and materials
less trade discounts, rebates and other similar amounts

+ Cost of conversions. Consist of two main parts:

+ Costs directly related to the units of production (direct materials, direct labour)
+ Fixed and variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic
basis

Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of
production (cost of the factory management and administration, depreciation, maintenance)
Variable production overheads are those indirect costs of production that vary directly or nearly directly with the volume of
production (indirect materials and labour)

+ Other costs incurred in bringing the inventories to their present location and condition. Other costs should be recognised only if they
are incurred in bringing the inventory to their present location and condition. For example costs of designing products for specific
customers

 Fixed production overheads must be allocated to items of inventory on the basis of the normal capacity of the production facilities.
This is an important point.
 Normal capacity is the expected achievable production based on the average over several periods or seasons, under normal
circumstances
 The above figure should take account of the capacity lost through planned maintenance
 If it approximates to the normal level of activity then the actual level of production can be used
 Low production or idle plant will not result in a higher fixed overhead allocation to each unit
 Unallocated overheads must be recognised as an expense in the period in which they are incurred
 When production is abdominal high, the fixed production overhead allocated to each unit will be reduced, so avoiding
inventories being stated at more than cost
 The allocation of variable production overheads to each unit is based on the actual use of production facilities

 Cost which would not be included in cost of inventories. Instead they should be recognised as an expense in the period they are
incurred
 Abnormal amounts of wasted materials, labour or other production costs
 Storage costs (except costs which are necessary in the production process before a further production stage)
 Administrative overheads not incurred to bring inventories to their present location and conditions
 Selling costs
 Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency

 An entity may purchase inventories on deferred settlement terms. When the arrangement effectively contains a financing element,
that element (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 formulae
 Where inventories consist of a large number of interchangeable (identical or very similar) items, the cost of inventories should be
assigned using Firs-In, First-Out (FIFO) or weighted average cost formulas. The LIFO (last in, first out) is not permitted by IAS
2.
 Where individual items of inventory are segregated for a specific project, specific costs should be attributed to those items of
inventory.
 An entity shall use the same cost formula for all inventories having similar nature and use to the entity.
 For inventories with a different nature or use, different cost formulas may be justified.
For example, inventories used in one operating segment may have a use to the entity different from the type of inventories used in
another operating 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.

Measurement
 Inventories should be measured at lower of cost and net realisable value (NRV).

 In the case of inventories NRV could fall below cost when items are damaged or become obsolete, or where the costs to completion
have increased in order to make the sale. The principal situations in which NRV is likely to be less than costs, where there has been:
1. An increase in costs or fall in selling price
2. A physical deterioration in the condition of inventory
3. Obsolescence of products
4. A decision as part of the company’s marketing strategy to manufacture and sell products at a loss
5. Errors in production or purchasing.

 A write-down of inventories would normally take place on an item by item basis but similar or related items may be grouped
together. This grouping together is acceptable for, say, items in the same product line, but it is not acceptable to write down
inventories based on a whole classification (finished goods) or a whole business.
 The assessment of NRV should take place at the same time as estimates are made of selling price, using the most reliable
information available. Fluctuations of price or cost should be taken into account if they relate directly to events after the reporting
period, which confirm conditions existing at the end of the period.
 The reasons why inventory is held must also be taken into account. Some inventory, for example may be held to satisfy a firm
contract and its NRV will therefore be the contract price. Any additional inventory of the same type held at the period end will, in
contrast, be assessed according to general sales prices when NRV is estimated.
 NRV must be reassessed at the end of each period and compared again with cost. If the NRV has risen for inventories held over the
end of more than one period, then the previous write down must be reversed to the extent that the inventory is then valued at the
lower of cost and the new NRV. This may be possible when selling prices have fallen in the past and then risen again.
 On occasion write down to NRV may be of such size, incidence or nature that is must be disclosed separately

Recognition as an expense. The following treatment is required when inventories are sold:
1. The carrying amount is recognised as an expense in the period in which the related revenues is recognised
2. The amount of any write-down of inventories to NRV and all losses of inventories are recognised as an expense in the period the
write-down or loss occurs
3. The amount of any reversal of any write-down of inventories, arising from an increase in NRV, is recognised as a reduction in the
amount of inventories recognised as an expense in the period in which the reversal occurs.

Required disclosures
1. Accounting policy for inventories
2. Carrying amount, generally classified as merchandise, supplies, materials, work in progress, and finished goods. The classifications
depend on what is appropriate for the entity
3. Carrying amount of any inventories carried at fair value less costs to sell
4. Carrying amount of inventories pledged as security for liabilities
5. Amount of any write-down of inventories recognised as an expense in the period
6. Amount of any reversal of a write-down to NRV and the circumstances that led to such reversal
7. Cost of inventories recognised as expense (cost of goods sold).