IAS 2 | Inventories

1

Objective

The Standard prescribes the accounting treatment for inventories, focusing on the determination of cost and its subsequent recognition as an expense, including write-downs to net realisable value.

2

Scope

The Standard applies to all inventories except financial instruments (IAS 32/IFRS 9) and biological assets related to agricultural activity (IAS 41).

3

Measurement Exemptions

The Standard does not apply to the measurement of inventories held by: (a) Producers of agricultural/forest products and minerals if measured at net realisable value (NRV). (b) Commodity broker-traders who measure at fair value less costs to sell.

4

Exemption Clarification (Producers)

Inventories mentioned in Para 3(a) are measured at NRV at certain production stages (e.g., harvest) when sale is assured. These are excluded only from the measurement requirements of IAS 2.

5

Exemption Clarification (Brokers)

Broker-traders buy/sell for others or on their own account to profit from price fluctuations. Their inventories, if measured at fair value less costs to sell, are excluded only from measurement requirements.

6

Definition: Inventories

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/supplies to be consumed in production or rendering services.

7

NRV vs Fair Value

Net Realisable Value (NRV) is the estimated selling price less estimated costs to complete and sell. Fair Value is the price to sell an asset in an orderly transaction between market participants. NRV is an entity-specific value; Fair Value is not.

8

Inventory Categories

Inventories encompass goods purchased for resale (retailer merchandise, land), finished goods produced, work in progress, and materials/supplies awaiting use.

9

Measurement Principle

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

10

Cost of Inventories

Cost comprises all costs of purchase, costs of conversion, and other costs incurred in bringing inventories to their present location and condition.

11

Costs of Purchase

Includes purchase price, import duties, non-recoverable taxes, transport, and handling. Trade discounts and rebates are deducted from the cost.

12

Costs of Conversion

Includes costs directly related to units of production (e.g., direct labour) and a systematic allocation of fixed and variable production overheads.

13

Overhead Allocation

Fixed overheads (e.g., depreciation, factory management) are allocated based on normal capacity. Unallocated overheads due to low production are expensed immediately. In periods of abnormally high production, the allocation rate is decreased to avoid carrying inventory above cost.

14

Joint & By-Products

When conversion costs are not separately identifiable (joint products), they are allocated on a rational basis (e.g., relative sales value). Immaterial by-products are measured at NRV and deducted from the cost of the main product.

15

Other Costs

Other costs are included only if incurred to bring inventories to their present location and condition (e.g., design costs for a specific customer).

16

Excluded Costs

The following are excluded from inventory cost and recognised as expenses: (a) Abnormal waste of materials/labour; (b) Storage costs (unless necessary for the production process); (c) Administrative overheads not contributing to bringing inventory to its state; (d) Selling costs.

17

Borrowing Costs

IAS 23 Borrowing Costs identifies limited circumstances where borrowing costs are included in inventory cost.

18

Deferred Settlement

If inventories are purchased on deferred terms containing a financing element, the difference between the purchase price and the amount paid is recognised as interest expense over the financing period.

20

Agricultural Produce

Produce harvested from biological assets is initially measured at fair value less costs to sell at the point of harvest (per IAS 41). This value becomes the 'cost' for applying IAS 2 thereafter.

21

Measurement Techniques

Techniques like the standard cost method or retail method may be used for convenience if the results approximate cost.

22

Retail Method

Used in retail for large numbers of rapidly changing items with similar margins. Cost is determined by reducing the sales value by the appropriate percentage gross margin.

23

Specific Identification

Cost of items that are not ordinarily interchangeable or are segregated for specific projects must be assigned by specific identification of their individual costs.

24

Specific Identification Logic

This attributes specific costs to identified items. It is inappropriate for large numbers of interchangeable items, as it could allow manipulation of profit by selecting specific low/high-cost items for sale.

25

Cost Formulas (FIFO/Weighted Average)

For inventories not covered by Para 23, cost shall be assigned using First-In, First-Out (FIFO) or Weighted Average cost formulas.

26

Consistency

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

27

Geographical Location

A difference in geographical location or tax rules is not sufficient justification to use different cost formulas for the same type of inventory.

28

Net Realisable Value (NRV)

Cost may not be recoverable if items are damaged, obsolete, or selling prices decline. Writing down to NRV ensures assets are not carried in excess of amounts expected to be realised.

29

Grouping for NRV

Write-downs are usually item by item. Grouping is only appropriate for items in the same product line with similar purposes, produced/marketed in the same area, which cannot be evaluated separately.

30

Estimating NRV

Estimates are based on the most reliable evidence available at the time, considering price fluctuations after the period end if they confirm conditions existing at the end of the period.

31

NRV & Contracts

NRV depends on the purpose of holding the inventory. For firm sales contracts, NRV is based on the contract price. Provisions for onerous contracts are dealt with under IAS 37.

32

Raw Materials Write-Down

Materials are not written down below cost if the finished goods they are incorporated into are expected to be sold at or above cost. If finished goods will sell below cost, materials are written down, often using replacement cost as the best measure.

33

Reversal of Write-Down

A new assessment of NRV is made in each subsequent period. If the reason for the write-down ceases to exist, the write-down is reversed (limited to the original write-down amount).

34

Expense Recognition

When inventory is sold, the carrying amount is recognised as an expense in the period the revenue is recognised. Write-downs and losses are expensed in the period they occur.

35

Allocation to Assets

Some inventory may be allocated to other assets (e.g., self-constructed property, plant, and equipment). These are expensed via depreciation over the asset's useful life.

36

Disclosure

Financial statements must disclose: (a) Accounting policies/cost formulas; (b) Total carrying amount and by classification; (c) Amounts carried at fair value less costs to sell; (d) Inventory recognised as expense; (e) Write-downs recognised as expense; (f) Reversals of write-downs; (g) Circumstances leading to reversals; (h) Inventory pledged as security.

37

Classifications

Common classifications include merchandise, production supplies, materials, work in progress, and finished goods.

38

Cost of Sales

The amount recognised as an expense (often "cost of sales") includes costs previously included in inventory measurement, unallocated overheads, and abnormal production costs.

39

Expense by Nature

If an entity classifies expenses by nature, it discloses costs recognised as expense for raw materials, consumables, etc., alongside the net change in inventories for the period.

40

Effective Date

The Standard applies for annual periods beginning on or after 1 January 2005. (Subsequent paragraphs 40C-40H detail amendments by other IFRS standards).

41

Supersession

This Standard supersedes IAS 2 (revised 1993).

42

Supersession of SIC

This Standard supersedes SIC-1 regarding consistency of cost formulas.