Under IAS 2 inventory should be valued at the lower of Cost & Net Realisable value
Cost = all expenditure incurred in bringing the product to its present location and condition. This includes costs such as transport, import duties, production overheads etc. It excludes things like selling costs, abnormal waste, general expenses, storage costs.
NRV = the actual or estimated selling price less all further costs to completion and less all costs to be incurred in marketing, selling and distribution
Inventory should be valued in this way for separate items of inventory or for groups of similar items, i.e. on a line-by-line basis.
If stocks are going to be sold at less than cost we should recognise this loss immediately. This is why we reduce the value to NRV if we notice it’s less than the original cost price.
This complies with the need for financial information to be reliable as required by the IASB Conceptual Framework. The Framework explains that in order for information to be reliable, asset values must not be overstated. Therefore, by valuing stock at the lower value, the asset of stock is not overstated.
Keep an eye out for this in real life where something might go out of fashion or become obsolete. This may indicate the need to reduce its carrying value from cost to NRV.