Objective
IAS 2 prescribes the accounting treatment for inventories, focusing on:
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Measurement
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Cost determination
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Expense recognition
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Write-downs to net realizable value (NRV)
1. Definition
Inventories are assets:
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Held for sale in the ordinary course of business;
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In the process of production for such sale;
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In the form of materials or supplies to be consumed in the production process or in rendering services.
🧾 Examples:
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Finished goods (ready for sale)
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Work in progress (partially completed goods)
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Raw materials (inputs for production)
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Spare parts or supplies used in manufacturing
2. Measurement
Inventories are measured at the lower of:
Cost and Net Realizable Value (NRV)
Cost includes:
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Cost of purchase
– Purchase price
– Import duties and taxes (excluding recoverable VAT)
– Transportation, handling, and other costs
– Less: trade discounts or rebates -
Cost of conversion
– Direct labor
– Direct material
– Production overheads (fixed and variable) -
Other costs incurred to bring inventories to their present location and condition.
Example 1: Measuring Inventory
A company purchased 1,000 units of material for $10 each.
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Purchase cost = $10,000
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Freight cost = $1,000
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Discount = $500
Total cost = $10,000 + $1,000 – $500 = $10,500
If NRV (expected selling price – cost to sell) = $9,800
→ Inventory is recorded at $9,800 (lower of cost or NRV)
3. Net Realizable Value (NRV)
NRV = Estimated selling price – Cost to complete and sell
Inventories are written down when NRV < cost.
A write-down is reversed if circumstances improve later.
Example 2: Write-Down and Reversal
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Original cost = $15,000
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NRV at year-end = $13,000 → Write down = $2,000
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Next year, NRV rises to $14,500
→ Reverse write-down = $1,500 (cannot exceed original cost)
4. Cost Formulas
When inventories are interchangeable:
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FIFO (First-In, First-Out)
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Weighted Average Cost
When specific items are not interchangeable:
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Specific identification method (e.g., luxury cars)
Example 3: FIFO vs Weighted Average
| Date | Units | Unit Cost | Total Cost |
|---|---|---|---|
| Jan 1 | 100 | $10 | $1,000 |
| Jan 10 | 100 | $12 | $1,200 |
| Total | 200 | $2,200 |
If 120 units are sold:
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FIFO: 100 @$10 + 20 @$12 = $1,000 + $240 = $1,240 (COGS)
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Weighted Average: $2,200 / 200 = $11 per unit
→ 120 × $11 = $1,320 (COGS)
5. Recognition as Expense
When inventories are sold, their carrying amount becomes an expense (Cost of Goods Sold) in the period in which related revenue is recognized.
6. Disclosure Requirements
Entities must disclose:
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Accounting policies (cost formula used)
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Carrying amount of inventories by category
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Amount of inventories recognized as expense
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Write-downs and reversals recognized
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Inventories pledged as security
Example 4: Disclosure
In the financial statements:
“Inventories are measured at the lower of cost (using FIFO) and net realizable value.
At year-end, total inventories amounted to $500,000, including $20,000 of goods pledged as loan security.”
✅ Key Points Summary Table
| Concept | Treatment |
|---|---|
| Measurement | Lower of cost and NRV |
| Cost includes | Purchase, conversion, other costs |
| Excluded costs | Abnormal waste, storage (unless necessary), selling costs, interest |
| Cost formula | FIFO or Weighted Average |
| Write-down | When NRV < cost |
| Reversal | Allowed if NRV increases |
| Disclosure | Methods, values, write-downs, pledged inventory |