What are Inventories?
IAS 2 Inventories is the accounting standard governing the recognition, measurement and disclosures for inventories.
Inventories are assets:
- held for sale in the normal course of business. (e.g. a retailer will hold stock, a manufacturer will hold finished goods)
- in the process of production for sale (e.g. work in progress)
- materials or supplies to be used in the production process (e.g. raw materials)
IAS 2 Inventories states that inventories should be valued at the lower of:
- cost and
- net realisable value
How is inventory valued?
Inventory is valued at the lower of cost and net realisable value
- the purchase price and associated costs,
- plus costs of conversion and
- any other costs incurred in bringing the inventories to their present location and condition.
Costs of purchase includes:
- the cost of the item itself (minus any trade discounts or rebates)
- plus import duties, transport costs and other handling costs directly associated with the purchase of the item.
Costs of conversion are:
- the ‘internal costs’ incurred in getting the inventory into its current state, such as the company’s own costs incurred in producing finished goods.
- They include both direct costs (such as labour and expenses) plus a share of production overheads, where production overhead absorption rates are based on normal levels of activity.
Net realisable value (NRV) is the estimated selling price of the item minus estimated selling costs.
IAS 2 notes the practice of writing down inventories below cost to their net realisable value is consistent with the view that assets should not have a carrying value in the statement of financial position that exceeds the amount expected to be realised from their sale or use.
Inventory valuation methods
Under IAS 2, three methods are allowed for measuring the cost of inventories.
- Actual cost
- First-in, first-out (FIFO)
- Weighted average cost.
Actual cost is used where items can be individually identified. This is a common valuation method for high value items, e.g. cars, heavy machinery, jewelry.
If it is not possible to use the actual cost method of valuation, the entity may chose between the first in, first out method or the weighted average method.
Whatever method is chosen should be used consistently for each accounting period.
Inventory and Disclosures
The following disclosures are required for inventory under IAS 2:
- accounting policy used for measuring inventories, including the cost valuation method used.
- total carrying amount of inventories, classified appropriately. (eg raw materials, work-in-progress and finished goods for a manufacturer)
- amount of inventories carried at net realisable value
- amount of inventories written down in value (and loss expensed in period)
- Details of any circumstances that have led to the write-down of inventories to NRV.