IAS 2 Inventories

Overview
IAS 2 sets out the accounting treatment for inventories, including the determination of cost, the
subsequent recognition of an expense and any write-downs to net realisable value.

Scope
Applies to all inventories except:
- work in progress on construction and service contracts (IAS 11);
- financial instruments (IAS 32 and IFRS 9); and
- biological assets arising from agricultural activity (IAS 41).
Does not apply to the measurement of inventories held by:
- producers of agricultural and forest products, and minerals and mineral products, that are
measured at net realisable value in accordance with well-established practices in those
industries; and
- commodity broker-traders who measure their inventories at fair value less costs to sell.
Changes in the above inventory values are recognised in profit or loss in the period of the
change.

Definitions
Inventories – assets that are:
- held for sale in the ordinary course of business;
- in the process of production for such sale; or
- in the form of materials or supplies to be consumed in the production process or in the
rendering of services.
Net realisable value (NRV) - the estimated selling price less the estimated costs of completion
and the estimated costs necessary to make the sale.
Cost of inventories – all costs incurred in bringing the inventories to their present location and
condition, including the costs of purchase and conversion.
- Costs of purchase of inventories comprise the purchase price (less trade discounts, rebates
and similar items), irrecoverable taxes, and transport, handling and other costs directly
attributable to their acquisition.
- Costs of conversion include costs directly related to the units of production, such as direct
labour and systematically allocated fixed and variable production overheads incurred in
producing finished goods.
Fair value – the price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.
Measurement
 Inventories shall be stated at the lower of cost and net realisable value.
 To the extent that service providers have inventories, they measure them at the costs of
their production. These costs are primarily the costs of labour directly engaged in
providing the service, including supervisory personnel, and attributable overheads.
 The cost of inventories of items that are ordinarily interchangeable and have not been
produced and segregated for specific projects is determined by using the first-in, first-
out (FIFO) or weighted average cost formula. The same cost formula shall be adopted
for all inventories having a similar nature and use to the entity.
 Inventories are usually written down to NRV on an item by item basis, unless it is more
appropriate to group similar or related items.

Recognition as an expense
 When inventories are sold, the carrying amount of those inventories should be
recognised as an expense in the period in which the related revenue is recognised.
 Any losses of inventories and the amount of any write-down to net realisable value
shall be recognised as expense in the period in which the loss or write-down occurs.
 Any reversal of any write-down of inventories that resulted from an increase in the net
realisable value shall be recognised as a reduction in the inventory expense in the period
in which the reversal occurs.

Disclosure
The following shall be disclosed in the financial statements
- the accounting policies for inventories
- the total carrying amount of inventories and the carrying amount in classifications appropriate
to the entity
- the carrying amount of inventories carried at fair value less costs to sell
- the amount of inventories recognised as an expense during the period
- the amount of any write-down of inventories recognised as an expense
- the amount of any reversal of any write-down that is recognised as a reduction in the amount
of inventories recognised as an expense
- the circumstances or events that led to the reversal of a write-down of inventories
- the carrying amount of inventories pledged as security for liabilities.
Examples of costs excluded from the cost of inventories and recognized as an expense when they are
incurred:

Abnormal amounts of wasted materials, labour or other production costs;  Storage costs, unless those
costs are necessary in the production process before a further production stage;  Administrative
overheads that do not contribute to bringing inventories to their present location and condition; and 
Selling costs.
Example # 1 Lower of the cost or net realizable value (LCNRV)

Inventory at the end of the period

Product A 10 Units of Rs. 100 Each = Rs. 1000

Product B 20 Units of Rs. 150 each = Rs. 3000

Product C 15 Units of Rs. 300 each = Rs. 4500

Rs.8500

Net Realizable Value = Market Price – Disposal Cost

Product A = Rs. 110 - Rs. 20 =Rs. 90

Product B = Rs. 170 - Rs. 10 =Rs. 160

Product C = Rs. 250 - Rs. 0 =Rs. 250

Lower of Cost or Net realizable value

Cost NRV LCNRV

Product A Rs. 100 Rs. 90 Rs. 90

Product B Rs. 150 Rs. 160 Rs. 150

Product C Rs. 300 Rs. 250 Rs. 250

Value of Inventory at LCNRV

Product A 10 Units of Rs. 90 Each = Rs. 900

Product B 20 Units of Rs. 150 each = Rs. 3000

Product C 15 Units of Rs. 250 each = Rs. 3750

Rs.7650

Reduction on Inventory = Rs.8500 -Rs. 7650 = Rs. 850

Accounting Treatment

Cost of Goods Sold (Dr.) Rs. 850 OR Loss in Inventory (Dr.) Rs. 850
Inventory (Cr.) Rs. 850 Allowance to reduce Inventory (Cr.) Rs. 850

Example 2

An entity has work in process inventory. Till now the cost of $70,000 has been spent on this inventory.
The estimated cost to convert the WIP inventory into finished goods is $48,000. The estimated selling
price of inventory if sold in its present condition is $70,500 and if sold after it has been converted to
finished goods is $120,000. The entity has to pay 2% commission to its distributors. The entity does not
sell the incomplete inventory.

Required: Calculate NRV and explain at which amount the inventories should appear in Statement of
Financial Position.
Solution:

Estimated selling price in ordinary course of business 120,000

Less: Estimated cost of completion (48,000)

Less: Estimated cost necessary to make the sale $120,000 x 2% (2,400)

NRV 69,600

Cost 70,000

The amount at which inventories should appear in SFP (lower) 69,600

Example 3

You have a contract to supply 100 barrels of oil at $25 per barrel. The price is fixed for the 6 months. At
the end of the 1st month the market price of oil is $30. (The fair value is $30.) You buy the 100 barrels at
the market price. Selling costs are $2 per barrel.

Required: What is the NRV of inventories?

Solution:

The NRV of inventories is $23 per unit (i.e. $25 - $2). The total NRV is $23 x 100 units = $2,300

Example 4

The following data relates to inventory of King Limited:

Particulars Cost NRV

Rs. Rs.

Material A 87,000 98,000

Material B 94,000 82,000

Total Raw Material Inventory 181,000 180,000

WIP AX 105,000 116,000

WIP BY 97,000 87,000

Total WIP Inventory 202,000 203,000

Product X 120,000 135,000

Product Y 105,000 102,000

Total Finished goods Inventory 225,000 237,000

Total Inventory 608,000 620,000

Required: Calculate the amount of write down to NRV, if required.

Solution:

Particulars Cost NRV Write down

Rs. Rs. Rs.

Material A 87,000 98,000 0

Material B 94,000 82,000 12000

Total Raw Material Inventory 181,000 180,000

WIP AX 105,000 116,000 0

WIP BY 97,000 87,000 10000

Total WIP Inventory 202,000 203,000

Product X 120,000 135,000 0

Product Y 105,000 102,000 3000

Total Finished goods Inventory 225,000 237,000 25000

Total Inventory 608,000 620,000

Example # 5

During the night of 15th December 2004, flood water entered in the warehouse of Fine Distributors and
destroyed the entire inventory. Certain information relating to the period from 1 st July to 14th
December, 2004 is however, available at the Sales Office of the company.

Rupees

Gross sales 9,625,000

Opening inventories 1,250,000

Gross purchases 8,250,000

Un-recorded sales 625,000

Sales return 1,250,000

Purchase return 375,000

Freight on purchase 1,250,000

Mark up on cost 20%

Required: Calculate the Cost of Inventories, for which the company should lodge an insurance claim.

Solution:

Opening stock 1,250,000

Purchases (Note-1) 9,125,000

Cost of sales (Note-2) (7,500,000)

Amount of insurance claim / loss caused by fire 2,875,000

Notes
1. Purchases 8,250,000 – 375,000 +1,250,000 = 9,125,000

2. Cost of sales (9,625,000 + 625,000 – 1,250,000) x 100/120 = 7,500,000

Example # 6

Aqeel Limited is engaged in the production of fountain pens. At the year end, the company owns the
following inventory.

Item # Units Cost per unit (Rs.) NRV per unit (Rs.)
K300i 300 100 80
K500i 200 5000 6000
K700i 100 4500 4000
J200i 400 300 400
C100 400 400 410
C110 900 600 500
C200 1000 50 55
N500 50 100 95
N600 200 50 40

Required: You are required to calculate the amount of inventory by aggregate by category basis.

Solution:

Items # Units Cost Per NRV per Total Cost Total NRV Lower of
Unit unit Rs. Rs. Cost & NRV
Rs. Rs. Rs.
K300i 300 100 80 30,000 24,000
K500i 200 5000 6000 1,000,000 1,200,000
K700i 100 4500 4000 450,000 400,000
1,480,000 1,624,000 1,480,000
J200i 400 300 400 120,000 160,000 120,000

C100 400 400 410 160,000 164,000

C110 900 600 500 540,000 450,000
C200 1000 50 55 50,000 55,000
750,000 669,000 669,000
N500 50 100 95 5,000 4,750
N600 200 50 40 10,000 8,000
15,000 12,750 12,750
Value of Inventory 2,281,750
 Practice Problems:

Problem 1

From the data given below, compute the value of inventory in hand (800 units) in accordance with the
requirements of IAS 2.

Rs.

Invoice price (including sales tax) - 1000 units 11,150

Cost of material 8,250

Income Tax paid at import stage 800

Custom duty 600

Sales Tax (refundable) 2,000

Transport charges 500

Material handling charges 400

Store rent 300

Discounts allowed 250

Indirect labour 200

Variable overhead 130

Depreciation 520

Selling expenses 220

Maintenance of factory equipment 300

Designing charges 550

Material wasted 250

Problem 2

Azhar and Company are importers of a particular item. Accountant of the company has prepared the
Profit and Loss Account following average method for valuation of closing inventory. Following are the
details of transactions during the year:

Date Quantity Amount in Rupees

Opening inventory 1,000

Purchases 05-07-2002 5,000 3,250,000

10-09-2002 14,000 8,750,000

26-12-2002 9,500 6,650,000

24-03-2003 18,600 13,857,000

05-04-2003 15,600 11,310,000

31-05-2003 10,100 6,969,000

Sales 57,000
Closing inventory 16,800

The Profit and Loss Account prepared by the Accountant on average method of valuation of closing
inventory is as follows:

Profit and loss Account

Rs. Rs.

Sales 41,325,000

Cost of sales

Opening inventory 560,000

Purchases 50,786,000

51,346,000

Less: Closing inventory 11,688,250

39,657,480

Gross Profit 1,667,520

Operating and selling expenses 1,525,900

Net profit 141,620

Required: Prepare a revised Profit & Loss Account based on FIFO method for valuation of closing
inventory at cost or net realizable value whichever is lower. The selling expenses are 2% of sales.

Problem 3:

Kidz Party & Co. (KPC) manufactures and sells toys. Following information is available regarding four of
its inventory items as on 31 December 2017:

Items Units Cost per unit (Rs.) Normal selling price

per unit (Rs.)
Toy cars 10,000 1,250 1,200
Doll houses 5,000 1,800 2,700
Stuffed toys 1,850 1,200 1,900
Minion costumes 870 1,500 2,500

Following information is also available:

(i) A sales order for 3,000 toy cars @ Rs. 1,100 per unit is in hand. The remaining units can be
sold at normal selling price after incurring selling cost of Rs. 150 per unit.
(ii) Doll houses include 1,000 defective units with no scrap value. 20% of the remaining doll
houses are damaged and can be sold at 50% of cost.
(iii) Stuffed toys costing Rs. 420,000 were accidentally damaged and are beyond repair. KPC
plans to sell these toys as scrap. Proceeds from such sale are estimated at Rs. 175,000 and
the sale would require transportation cost of Rs. 6,300.
(iv) All minion costumes have manufacturing faults and can be sold in present condition at Rs.
1,350 per unit. However, 60% of the units can be rectified at a cost of Rs. 200 per unit after
which they can be sold at Rs. 1,600 per unit.

Required: Calculate the amount at which above inventory items should be carried as on 31
December 2017 in accordance with IAS 2 ‘Inventories’.