IAS 2 — Inventories

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Overview
IAS 2 Inventories contains the requirements on how to account for most types of inventory. The
standard requires inventories to be measured at the lower of cost and net realisable value
(NRV) and outlines acceptable methods of determining cost, including specific identification (in
some cases), first-in first-out (FIFO) and weighted average cost.
A revised version of IAS 2 was issued in December 2003 and applies to annual periods
beginning on or after 1 January 2005.

History of IAS 2

Date Development Comments

September 1974 Exposure Draft E2 Valuation and Presen-

tation of Inventories in the Context of the
Historical Cost Systempublished

October 1975 IAS 2 Valuation and Presentation of In-

ventories in the Context of the Historical
Cost System issued

August 1991 Exposure Draft E38 Inventoriespublished

December 1993 IAS 9 (1993) Inventories issued Operative for annual financial
statements covering periods
beginning on or after 1 January
1995

18 December 2003 IAS 2 Inventories issued Effective for annual periods

beginning on or after 1 January
2005

Related Interpretations

o IFRIC 20 Stripping Costs in the Production Phase of a Surface Mine

o SIC-1 Consistency - Different Cost Formulas for Inventories. SIC-1 was superseded by
and incorporated into IAS 2 (Revised 2003).

Summary of IAS 2

Objective of IAS 2
The objective of IAS 2 is to prescribe the accounting treatment for inventories. It provides
guidance for determining the cost of inventories and for subsequently recognising an expense,
 including any write-down to net realisable value. It also provides guidance on the cost formulas
that are used to assign costs to inventories.

Scope
Inventories include assets held for sale in the ordinary course of business (finished goods),
assets in the production process for sale in the ordinary course of business (work in process),
and materials and supplies that are consumed in production (raw materials). [IAS 2.6]
However, IAS 2 excludes certain inventories from its scope: [IAS 2.2]
o work in process arising under construction contracts (see IAS 11 Construction Contracts)
o financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement)
o biological assets related to agricultural activity and agricultural produce at the point of
harvest (see IAS 41 Agriculture).
Also, while the following are within the scope of the standard, IAS 2 does not apply to the mea-
surement of inventories held by: [IAS 2.3]
o producers of agricultural and forest products, agricultural produce after harvest, and
minerals and mineral products, to the extent that they are measured at net realisable value
(above or below cost) in accordance with well-established practices in those industries.
When such inventories are measured at net realisable value, changes in that value are
recognised in profit or loss in the period of the change
o commodity brokers and dealers who measure their inventories at fair value less costs to
sell. When such inventories are measured at fair value less costs to sell, changes in fair
value less costs to sell are recognised in profit or loss in the period of the change.

Fundamental principle of IAS 2

Inventories are required to be stated at the lower of cost and net realisable value (NRV). [IAS
2.9]

Measurement of inventories
Cost should include all: [IAS 2.10]
o costs of purchase (including taxes, transport, and handling) net of trade discounts received
o costs of conversion (including fixed and variable manufacturing overheads) and
o other costs incurred in bringing the inventories to their present location and condition
IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs (interest)
can be included in cost of inventories that meet the definition of a qualifying asset. [IAS 2.17 and
IAS 23.4]
Inventory cost should not include: [IAS 2.16 and 2.18]
o abnormal waste
o storage costs
o administrative overheads unrelated to production
o selling costs
o foreign exchange differences arising directly on the recent acquisition of inventories
invoiced in a foreign currency
o interest cost when inventories are purchased with deferred settlement terms.
The standard cost and retail methods may be used for the measurement of cost, provided that
the results approximate actual cost. [IAS 2.21-22]
For inventory items that are not interchangeable, specific costs are attributed to the specific indi-
vidual items of inventory. [IAS 2.23]
For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas.
[IAS 2.25] The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no
longer allowed.
The same cost formula should be used for all inventories with similar characteristics as to their
nature and use to the entity. For groups of inventories that have different characteristics,
different cost formulas may be justified. [IAS 2.25]

Write-down to net realisable value

NRV is the estimated selling price in the ordinary course of business, less the estimated cost of
completion and the estimated costs necessary to make the sale. [IAS 2.6] Any write-down to
NRV should be recognised as an expense in the period in which the write-down occurs. Any
reversal should be recognised in the income statement in the period in which the reversal
occurs. [IAS 2.34]

Expense recognition
IAS 18 Revenue addresses revenue recognition for the sale of goods. When inventories are
sold and revenue is recognised, the carrying amount of those inventories is recognised as an
expense (often called cost-of-goods-sold). Any write-down to NRV and any inventory losses are
also recognised as an expense when they occur. [IAS 2.34]

Disclosure
Required disclosures: [IAS 2.36]
o accounting policy for inventories
o carrying amount, generally classified as merchandise, supplies, materials, work in progress,
and finished goods. The classifications depend on what is appropriate for the entity
o carrying amount of any inventories carried at fair value less costs to sell
o amount of any write-down of inventories recognised as an expense in the period
o amount of any reversal of a write-down to NRV and the circumstances that led to such
reversal
o carrying amount of inventories pledged as security for liabilities
o cost of inventories recognised as expense (cost of goods sold).
IAS 2 acknowledges that some enterprises classify income statement expenses by nature
(materials, labour, and so on) rather than by function (cost of goods sold, selling expense, and
so on). Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an
entity to disclose operating costs recognised during the period by nature of the cost (raw
materials and consumables, labour costs, other operating costs) and the amount of the net
change in inventories for the period). [IAS 2.39] This is consistent with IAS 1 Presentation of
Financial Statements, which allows presentation of expenses by function or nature.