IAS 2 Inventories was issued by the International Accounting Standards Board (IASB) in 1993, with its first adoption in 2001, effectively replacing IAS 2 Valuation and Presentation of Inventories in the context of the historical cost system (1975). The standard was revised by the IASB in December 2003 to incorporate guidance on SIC-1 Consistency – Different Cost Formulas for Inventories and applies to annual periods starting on or after 1 January 2005.
The Standard which is effective today incorporates minor amendments as a result of newer International Financial Reporting Standards, including IFRS 13 Fair Value Measurement (May 2011), IFRS 9 Financial Instruments (July 2014), IFRS 15 Revenue from Contracts (May 2014) and IFRS 16 Leases (January 2016).
Scope of IAS 2
IAS 2 applies to all inventories except for financial instruments falling under IFRS 9 Financial Instruments and biological assets related to the agricultural activity under IAS 41 Agriculture.
Definition of inventories
The standard specifies that inventories are assets which are:
- Held for sale in the ordinary course of the business;
- In the process of production for such sale; and
- Materials or supplies to be consumed in the production process or in the rendering of services.
Measurement of inventory
All inventories under IAS 2 are to be measured at the lower of cost or net realisable value (NRV). IAS 2 provides three tranches of costs that should be included in the total cost of bringing the inventories to their present condition and location:
- Cost of purchase;
- Cost of conversion; and
- Other costs.
The cost of purchase includes the purchase price, import duties and taxes (not including those recoverable by the organisation from the taxing authorities), transport, handling and other directly attributable costs. Trade discounts are deducted when determining the cost of inventory.
The cost of conversion of inventories includes any costs which are directly attributable to the production of the inventory, such as direct wages and an allocation of fixed and variable overheads which are incurred in converting raw materials into finished goods.
Other costs relate to costs which are incurred in bringing the inventories to their present condition, such as non-production overheads incurred in designing products for specific customers.
IAS 2 allows other techniques for the measurement of the cost of inventories, where, for convenience, such techniques give a result approximate of the cost. The standard cost method can be applied by producers of large amounts of small items where materials, labour, efficiency and capacity utilisation are taken into account. These cost pools are regularly reviewed and revised, if necessary.
Another measurement technique, often used in the retail industry, is the retail method. Retailers use this method for measuring inventories of large numbers of rapidly changing items in which other methods are rendered impracticable. In the retail method, the cost is calculated by reducing the percentage gross margin from the sales value of the inventory.
Cost formulas for inventories
Items which are not interchangeable and goods or services which are produced for specific projects shall have a specific cost attributed to those items of inventory, regardless of the manner in which they have been procured.
For other items which are easily interchangeable, the first-in, first-out (FIFO) or weighted average cost formula is to be used. These inventories have a similar nature and use to the entity. The use of the last-in, first-out (LIFO) formula is no longer permissible under the revised IAS 2.
Net realisable value
In the case where inventories have been damaged or become obsolete, such that the costs incurred in making a sale exceed the selling price of the item, the inventory must be written down to its net realisable value. The net realisable value is the estimated selling price in the ordinary course of business less any costs of completion and other estimated costs necessary to make the sale.
Recognition of the cost of inventory in the Income Statement
The cost of the inventory is recognised as an expense in the income statement in the period in which the related revenue is recognised. Any write-downs to the inventories’ net realisable value are to be expensed in the period in which the write-down or loss occurs. Any reversals due to an increase in the net realisable value shall be recognised as a reduction in the amount of inventory expensed in the period in which the reversal occurs.
Disclosure of inventory in the Financial Statements
IAS 2 requires the following to be disclosed in the financial statements:
The accounting policies and cost formula adopted in measuring inventories;
The total carrying amount of inventories, generally classified as materials, work in progress, finished goods, etc.;
The carrying amount of any inventories carried at fair value less cost to sell; and
Amount of any write-downs of inventories recognised as an expense and any reversals thereof, including the circumstances that led to such event.
References: Ifrs.org (2003), IAS 2 Inventories
Available at: https://www.ifrs.org/issued-standards/list-of-standards/ias-2-inventories/
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