IAS 2-Inventories ( summary with examples )

Objective

IAS 2 prescribes the accounting treatment for inventories, focusing on:

• Measurement

• Cost determination

• Expense recognition

• Write-downs to net realizable value (NRV)

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1. Definition

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 rendering services.

🧾 Examples:

• Finished goods (ready for sale)

• Work in progress (partially completed goods)

• Raw materials (inputs for production)

• Spare parts or supplies used in manufacturing

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2. Measurement

Inventories are measured at the lower of:

Cost and Net Realizable Value (NRV)

Cost includes:

1. Cost of purchase
   – Purchase price
   – Import duties and taxes (excluding recoverable VAT)
   – Transportation, handling, and other costs
   – Less: trade discounts or rebates

2. Cost of conversion
   – Direct labor
   – Direct material
   – Production overheads (fixed and variable)

3. Other costs incurred to bring inventories to their present location and condition.

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Example 1: Measuring Inventory

A company purchased 1,000 units of material for $10 each.

• Purchase cost = $10,000

• Freight cost = $1,000

• 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)

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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.

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Example 2: Write-Down and Reversal

• Original cost = $15,000

• NRV at year-end = $13,000 → Write down = $2,000

• Next year, NRV rises to $14,500
  → Reverse write-down = $1,500 (cannot exceed original cost)

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4. Cost Formulas

When inventories are interchangeable:

• FIFO (First-In, First-Out)

• Weighted Average Cost

When specific items are not interchangeable:

• Specific identification method (e.g., luxury cars)

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Example 3: FIFO vs Weighted Average

If 120 units are sold:

• FIFO: 100 @$10 + 20 @$12 = $1,000 + $240 = $1,240 (COGS)

• Weighted Average: $2,200 / 200 = $11 per unit
  → 120 × $11 = $1,320 (COGS)

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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.

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6. Disclosure Requirements

Entities must disclose:

• Accounting policies (cost formula used)

• Carrying amount of inventories by category

• Amount of inventories recognized as expense

• Write-downs and reversals recognized

• Inventories pledged as security

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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.”

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✅ Key Points Summary Table