IAS 2 Notes

IAS 2 ‘INVENTORIES’
DEFINITION OF INVENTORY
The nature of inventories varies with the type of business. Inventories are:
‰ Assets held for sale in the ordinary course of business. For a retailer, these are items that the business sells – its stock-in trade. For a
manufacturer, assets held for sale are usually referred to as ‘finished goods’
‰ Assets in the process of production for sale (‘work-in-progress’ for a manufacturer)
‰ Assets in the form of materials or supplies to be used in the production process or in the rendering of services (‘raw materials’ in
the case of a manufacturer).
EXAMPLES OF INVENTORIES
1. Merchandise or goods purchased and held for resale
2. Consumables: Tangible items that are consumed in the production of goods or rendering of services.
3. Agricultural produce after harvest
4. Finished goods produced.
5. Work in progress being produced.
6. Raw materials
RECOGNITION OF INVENTORY
1. Inventory sold during the reporting period: The inventory sold during the reporting period should be recognized as an expense
(cost of sales) in the profit or loss at it carrying amount.
2. Unsold inventory as at the reporting date: The quantity of the unsold inventory should be recognized as an asset (current assets)
in the statement of financial position at the lower of cost value and net realizable value (NRV).
NB: Whenever cost value is higher than the net realizable value (NRV), it means that the inventory has impaired. The impairment on
inventory should be charged to cost of sales and also deducted from the inventory asset.
MEASUREMENT OF INVENTORY
a. At initial recognition: At as time of acquisition (or production), inventory should be initially measures at cost. This represents its
purchase price plus all directly attributable costs in getting the inventory ready for sale.
Cost of inventory: This is the cash or cash equivalents paid or the fair value of other consideration given to acquire or produce an
inventory.
Cost of inventories includes:
 Purchase costs
 Delivery costs
 Cost of conversion
 Import duties and other non-refundable taxes
 Transport, handling and any other directly attributable cost.
 Trade discount, rebates and any other similar cost should be deducted.
 Borrowing costs (when the inventory meets definition of a qualifying asset)
 Any other cost of bringing the asset to their present location and condition.
Costs that will not be included as part of inventory costs
 Storage costs (Unless it relates to cost of storing raw materials and work in progress before production is completed)
 Abnormal waste
 Administrative overheads
 Advertising costs
 Other selling expenses
b. At Subsequent measurement: After the initial recognition, inventory should be measured at lower of cost and net realizable
value. That is, the cost value should be compared with the net amount that would be realized from the sale of the inventory.
NET REALISABLE VALUE
Definition: Net realizable 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.
Net realizable value is the amount that can be obtained from selling the inventory in the normal course of business, less any
further costs that will be incurred in getting it ready for sale or disposal.
 Net realizable value is usually higher than cost. Inventory is therefore usually valued at cost.
 However, when inventory loses value, perhaps because it has been damaged or is now obsolete, net realizable value will be
lower than cost.
 The cost and net realizable value should be compared for each separately - identifiable item of inventory, or group of similar
inventories, rather than for inventory in total.
REASONS WHY NET REALIZABLE VALUE MAY BE LOWER THAN COST VALUE
Net realizable value might be lower than cost so that the cost of inventories may not be recoverable in the following circumstances:
 Inventories are damaged

 Inventories have become wholly or partially obsolete.
 Selling prices have declined.
 Company’s marketing strategy to sell at loss.
IMPAIRMENT ON INVENTORY
IAS 2 requires that inventory should be measure at lower of cost and net realizable value. This general requirement means that
inventory should always tested for impairment at each reporting date.
The excess of the cost value (Carry amount) over it net realizable value represents the amounts of impairment on inventory.
ACCOUNTING ENTRIES
Dr Cost of sales
Cr Inventory
METHODS OF MEASURING THE COST OF INVENTORY AFTER INITIAL RECOGNITION

IAS 2 recommends the following methods:
 Measurement techniques
 Specific actual costs
 Actual cost based on cost formular: IAS 2 recommends the following methods:
 Weighted average cost (WAC)
 First in first out (FIFO)

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IAS 2 ‘INVENTORIES’

 Inventories are damaged

METHODS OF MEASURING THE COST OF INVENTORY AFTER INITIAL RECOGNITION

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