International Accounting Standard 2

Inventories

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Objective:

• The objective of IAS 2 is to prescribe the accounting treatment for inventories.
• It provides guidance for determining the cost of inventories and for subsequently recognizing an expense, including any write-down to net realizable value.
• It also provides guidance on the cost formulas that are used to assign costs to inventories.

Scope:
The standard is applicable to inventories other than the following:

• Work in progress arising under construction contracts, including directly related service contracts.
• Financial instruments.
• Biological assets related to agricultural activity and agricultural produce at the point of harvest (to be measured at their net realizable value)

Definition:

The following terms are used in this Standard with the meanings specified:

Inventories are assets:

• Held for sale in the ordinary course of business
• In the process of production for such sale
• In the form of materials or supplies to be  consumed in the production process or in the rendering of services.

Net realisable value:

It is the estimated selling price less the cost to complete and sell.

Fair value:

Fair value is the amount for which an asset could be exchanged, or a liability settled, between
knowledgeable, willing parties in an arm’s length transaction.
Measurement of inventories:
Inventories shall be measured at the lower of cost and net realisable value.
Cost of inventories:

• Costs of purchase (including taxes, transport, and handling) net of trade discounts received.
• Costs of conversion (including fixed and variable manufacturing overheads).
• Other costs incurred in bringing the inventories to their present location and condition.

Costs not to be included in the inventory cost:

• Abnormal losses of material, labour etc.
• Storage costs unless these are necessary in the production process.
• Administrative overheads that are not to bring the inventories at present location or condition.
• Selling costs.

Cost of inventories of service providers:

Only the labor cost and the cost of personnel directly involved in providing services.

Cost of agriculture produce:

Agricultural produce harvested from the biological assets is measured as fair value less estimated point of sale cost at the point of harvest.

Techniques of measurement of cost:

• Standard cost method
• Retail method

Cost Formulas:

• Items which are not ordinarily interchangeable should be valued at individual cost basis.
• For interchangeable items, FIFO (First In First Out) and WACO (Weighted Average Cost)are benchmark treatment.

Write-Down to Net Realisable Value:

• NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale.
• Any write-down to NRV should be recognized as an expense in the period in which the write-down occurs.
• Any reversal should be recognized in the income statement in the period in which the reversal occurs.

Recognition as an expense:

The inventory cost should be recognized as an expense in the period in which their revenue is recognized  (IAS 18).