IAS 2 Inventories

DEFINITIONS

are assets:
(a) held for sale in the ordinary course of business (finished goods);
Inventories (b) in the process of production for such sale (WIP); or
(c) in the form of materials or supplies to be consumed in the production process or in
the rendering of services (raw materials and other supplies).
is the estimated selling price in the ordinary course of business less the
NRV estimated costs of completion and the estimated costs necessary to make the
sale.
The price that would be received to sell an asset or paid to transfer a liability in orderly
FV
transaction between market participants at the measurement date.

EXAMPLE 1

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 SFP.

EXAMPLE 2

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?

WAQAS YOUNAS ACMA 1

COST OF INVENTORIES: GENERAL

The costs of inventories shall comprise:

(a) all costs of purchase,
(b) costs of conversion,
Costs of
(c) other costs incurred in bringing the inventories into their present location and
Inventories
condition. For example, it may be appropriate to include non-POH or the costs of
designing products for specific customers in the cost of inventories.

Purchase price XX
Non-refundable/adjustable import duties and taxes XX
Costs of Transport and handling costs XX
Purchase Other costs directly attributable to acquisition XX
Trade discounts and rebates (X)
XX
These include:
Costs of (a) costs directly related to the units of production, such as direct labour
Conversion (b) a systematic allocation of fixed and variable POH that are incurred in converting
materials into finished goods.
The conversion costs are included in inventory on the basis of following level of
productions:
Level of • Direct labour etc ➔ actual level of production
Production
• Variable POH ➔ actual level of production
• Fixed POH ➔ normal or actual, whichever is higher
Examples of costs excluded from the cost of inventories and recognized as expenses in the
period in which they are incurred are:
Costs to be (a) abnormal amounts and wastages;
excluded (b) storage costs, unless necessary for the production process;
(c) administrative overheads; and
(d) selling costs.
Deferred amount paid – purchase price for normal credit terms = interest expense
Settlement
Terms
EXAMPLE 3

ABC Limited purchased material worth cash price of $5,000 but they had to pay $5,600 in total as they
were allowed by the supplier to take two months extra credit period on ABC Limited specific request.
Required:
Record the journal entries.

WAQAS YOUNAS ACMA 2

MEASUREMENT TECHNIQUES

When to use Techniques for the measurement of the cost of inventories, such as the standard cost
these method or the retail method, may be used for convenience if the results approximate cost.
techniques?
Standard costs take into account normal levels of materials and supplies, labour, efficiency
Standard
and capacity utilization. They are regularly reviewed and, if necessary, revised in the light
Costs Method
of current conditions.
It is often used in the retail industry having of large numbers of rapidly changing items
with similar margins for which it is impracticable to use other methods. The cost is
determined by reducing the sales value of the inventory by the appropriate percentage
Retail Method
gross margin. The percentage used takes into consideration inventory marked down to
below its original selling price. An average percentage for each department is often used.

COST FORMULAS

An entity shall use the same cost formula for all inventories having a similar nature and use
Consistency
to the entity.
Different For inventories with a different nature or use, different cost formulas may be justified.
formulas
The FIFO formula assumes that the items of inventory that were purchased or produced first
FIFO are sold first, and consequently the items remaining in inventory at the end of the period are
those most recently purchased or produced.
Under the weighted average cost formula, the cost of each item is determined from the
weighted average of the cost of similar items at the beginning of a period and the cost of
Weighted
similar items purchased or produced during the period. The average may be calculated on a
Average
periodic basis, or as each additional shipment is received, depending upon the circumstances
of the entity.

WAQAS YOUNAS ACMA 3

NRV

The practice of writing inventories down below cost to NRV is consistent with the view that
Rationale assets should not be carried in excess of amounts expected to be realised from their sale or
use.
Inventories are usually written down to NRV item by item. It is not appropriate to write
Item by Item inventories down on the basis of a classification of inventory, for example, finished goods,
or all the inventories in a particular operating segment.
Estimates of NRV are based on the most reliable evidence available at the time the estimates
Estimate
are made, of the amount the inventories are expected to realise.
NRV of Materials and other supplies held for use in the production of inventories are not written down
Raw below cost if the finished products in which they will be incorporated are expected to be sold
Material at or above cost.
A new assessment is made of NRV in each subsequent period. When the circumstances that
previously caused inventories to be written down below cost no longer exist or when there is
clear evidence of an increase in NRV because of changed economic circumstances, the
Reversal of amount of the write-down is reversed (i.e. the reversal is limited to the amount of the original
write down write-down) so that the new carrying amount is the lower of the cost and the revised NRV.
This occurs, for example, when an item of inventory that is carried at NRV, because its selling
price has declined, is still on hand in a subsequent period and its selling price has increased.

RECOGNITION AS AN EXPENSE

When
The carrying amount of those inventories shall be recognized as an expense in the period
Inventories are
in which the related revenue is recognized.
sold
Write down and
losses Recognized as an expense in the period the write-down or loss occurs.
Reversal of write Recognized as a reduction in the amount of inventories recognized as an expense in the
down period in which the reversal occurs.
Allocation to Some inventories may be allocated to other asset accounts, for example, inventory used as
other assets a component of self-constructed property, plant or equipment.

WAQAS YOUNAS ACMA 4

 ANSWER 1

$
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% NRV (2,400)
69,600

Cost 70,000
The amount at which inventories should appear in SFP (lower) 69,600

ANSWER 2

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

ANSWER 3

Dr. Cr.
Inventories (purchases) SFP 5,000

Supplier SFP 5,000

Purchase of Inventories

Supplier SFP 5,000

Interest exp PL 600

Bank SFP 5,600

Payment for Inventories

WAQAS YOUNAS ACMA 5

WAQAS YOUNAS ACMA 6