IAS 2 – INVENTORIES
The objective of IAS 2 is to set the accounting treatment for inventories. A primary issue in accounting for inventories is the amount of cost to be recognized as an asset and carried forward until the related revenues are recognised. This Standard provides guidance on the determination of cost and its ensuing recognition as an expense, as well as any write-down to net realisable value. It likewise provides regulation on the cost formulas that are used to allocate costs to inventories.
Under IAS 2, inventories shall be measured at the lower of:
- cost; or
- net realisable value.
COST OF INVENTORIES
The cost of inventories shall comprise all
- costs of purchase – encompass the purchase price, import duties and other taxes, and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services less trade discounts and like items.
- costs of conversion – consist of 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 used in converting materials into finished goods.
- other costs incurred in bringing the inventories to their present location and condition.
Cost of agricultural produce harvested from biological assets
In accordance with IAS 41 Agriculture, inventories comprising agricultural produce that an entity has harvested from its biological assets are measured on initial recognition at their fair value less costs to sell at the point of harvest.
COST EXCLUDED FROM INVENTORY
There are certain costs that are excluded from the cost of inventories and recognized as expenses in the period in which they are incurred. Examples of costs excluded from inventories are as follows:
(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.
- Specific Identification – costs are attributed to specific items of inventory. This is the suitable treatment for items that are keep apart for a specific project, irrespective of whether they have been bought or produced. Take note that specific identification of costs is unsuitable if there are large numbers of items of inventory that are ordinarily interchangeable.
- First-in First-out Method – The FIFO method 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.
- Weighted Average Method – Under the weighted average cost method, the cost of every item is determined from the weighted average of the cost of similar items at the start of a period and the cost of similar items purchased or produced during the period.
NET REALIZABLE VALUE
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 realizable 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.
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 realize. 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.
RECOGNITION AS AN EXPENSE
Once inventories are sold, the carrying amount of those inventories shall be recognized as an expense in the period in which the related revenue is recognized. The amount of any write-down of inventories to net realizable value and all losses of inventories shall be recognized 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 realizable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.
According to IAS 2, some inventories can 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.
Under IAS 2, 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;
(f) the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognized as expense in the period
(g) the circumstances or events that led to the reversal of a write-down of inventories; and
(h) the carrying amount of inventories pledged as security for liabilities.