Here are simplified notes on IAS 2 Inventories, drawing information from the provided documents:
Objective of IAS 2 Inventories
The primary objective of IAS 2 is to prescribe the accounting treatment for inventories.
A key issue addressed is the amount of cost to be recognised as an asset and carried
forward until related revenues are recognised.
The standard provides guidance on determining the cost of inventories, their subsequent
recognition as an expense, and any write-down to net realisable value.
It also gives guidance on the cost formulas used to assign costs to inventories.
Scope of IAS 2 Inventories
IAS 2 applies to all inventories.
Exceptions to its application include:
o Financial instruments (covered by IAS 32 and IFRS 9).
o Biological assets related to agricultural activity and agricultural produce at the point
of harvest (covered by IAS 41 Agriculture).
The standard does not apply to the measurement of inventories held by 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 in accordance
with well-established industry practices. Changes in this value are recognised in profit or
loss.
Key Definitions
Inventories are assets that are:
o Held for sale in the ordinary course of business.
o In the process of production for such sale.
o In the form of materials or supplies to be consumed in the production process or in
the rendering of services.
Net realisable value is defined as the estimated selling price in the ordinary course of
business less the estimated costs of completion and the estimated costs necessary to make
the sale.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date.
Measurement of Inventories
Inventories are to be measured at the lower of cost and net realisable value.
o Cost of Inventories:
Comprises all costs of purchase, costs of conversion, and other costs
incurred in bringing the inventories to their present location and condition.
Costs of purchase include the purchase price, import duties, other taxes (if
not recoverable), and transport, handling, and other costs directly
attributable to the acquisition. Trade discounts, rebates, and similar items
are deducted.
Costs that are excluded from the cost of inventories and recognised as
expenses include:
Abnormal amounts of wasted materials, labour, or other production
costs.
Storage costs, unless essential for the production process before a
further stage.
Administrative overheads that do not contribute to bringing
inventories to their present condition and location.
Selling costs.
If a purchase involves deferred settlement terms with a financing element,
that element is recognised as interest expense.
Inventories comprising agricultural produce harvested from biological
assets are initially measured at their fair value less costs to sell at the point
of harvest; this fair value then serves as their cost for applying IAS 2.
o Techniques for Measurement of Cost:
Techniques like the standard cost method or the retail method may be used
for convenience if their results approximate cost. Standard costs should be
regularly reviewed and revised.
o Net Realisable Value:
Inventories are usually written down to net realisable value item by item.
In some cases, similar or related items may be grouped for write-down, such
as items within the same product line with similar purposes, end uses, and
marketing areas, if impractical to evaluate separately. However, it's not
appropriate to write down inventories based on broad classifications (e.g.,
finished goods).
Estimates of net realisable value are based on the most reliable evidence
available at the time, considering price or cost fluctuations from events
occurring after the period-end that confirm existing conditions.
The purpose for which inventory is held is also considered; for firm sales
contracts, the contract price is used, while excess quantities are based on
general selling prices.
Recognition as an Expense
When inventories are sold, their carrying amount is recognised as an expense in the period
the related revenue is recognised.
Any write-down of inventories to net realisable value and all losses of inventories are
recognised as an expense in the period they occur.
Any reversal of a write-down (due to an increase in net realisable value) is recognised as a
reduction in the amount of inventories recognised as an expense in the period the reversal
occurs.
Inventories allocated to other asset accounts (e.g., for self-constructed property, plant or
equipment) are recognised as an expense over the useful life of that asset.
Disclosure Requirements
Financial statements must disclose:
o The accounting policies adopted for measuring inventories, including the cost
formula used.
o The total carrying amount of inventories and carrying amounts by appropriate
classifications.
o The carrying amount of inventories carried at fair value less costs to sell.
o The amount of inventories recognised as an expense during the period.
o The amount of any write-down recognised as an expense.
o The amount of any reversal of a write-down recognised as a reduction in expense.
o The circumstances or events that led to the reversal of a write-down.
Effective Date
IAS 2 (revised in 2003) became operative for annual periods beginning on or after 1 January
2005. Earlier application was encouraged.
Relationship with Conceptual Framework and IAS 8
IAS 2 should be read in the context of its objective, the Basis for Conclusions, the Preface to
IFRS Standards, and the Conceptual Framework for Financial Reporting.
IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors provides a basis for
selecting and applying accounting policies when explicit guidance is absent. When an entity
changes its assessment of an asset's useful life, this change is accounted for as a change in
an accounting estimate in accordance with IAS 8. Similarly, changes in an asset's residual
value are accounted for as a change in an accounting estimate in accordance with IAS 8.
Here are detailed notes on IAS 2 Inventories, based on the provided documents:
IAS 2 Inventories: Detailed Notes
1. Objective The primary objective of IAS 2 is to prescribe the accounting treatment for inventories.
A key issue it addresses is the amount of cost to be recognised as an asset and carried forward until
the related revenues are recognised. The Standard provides guidance on determining the cost of
inventories, their subsequent recognition as an expense, including any write-down to net realisable
value, and the cost formulas used to assign costs to inventories.
2. Scope IAS 2 applies to all inventories. However, it has specific exceptions for:
Financial instruments (which are covered by IAS 32 Financial Instruments: Presentation and
IFRS 9 Financial Instruments).
Biological assets related to agricultural activity and agricultural produce at the point of
harvest (which are covered by IAS 41 Agriculture). The Standard does not apply to the
measurement of inventories held by 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 in accordance with well-established industry
practices. Changes in this net realisable value are recognised in profit or loss in the period of
the change. Broker-traders, who buy or sell commodities for others or their own account
primarily to generate profit from price fluctuations or margins, measure their inventories at
fair value less costs to sell, and are excluded from only the measurement requirements of
IAS 2.
3. Key Definitions
Inventories are assets that are:
o Held for sale in the ordinary course of business.
o In the process of production for such sale.
o In the form of materials or supplies to be consumed in the production process or in
the rendering of services.
o Inventories include goods purchased for resale (e.g., merchandise by a retailer, or
land/property held for resale), finished goods produced, work in progress, and
materials and supplies awaiting use in production. Costs to fulfil a contract that do
not give rise to inventories or assets within other Standards' scope are accounted for
under IFRS 15 Revenue from Contracts with Customers.
Net realisable value is the estimated selling price in the ordinary course of business less the
estimated costs of completion and the estimated costs necessary to make the sale. It is an
entity-specific value.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in
an orderly transaction between market participants at the measurement date. Fair value
reflects the perspective of market participants in a market accessible to the entity. Net
realisable value for inventories may not equal fair value less costs to sell.
4. Measurement of Inventories Inventories are to be measured at the lower of cost and net
realisable value.
Cost of Inventories:
o Comprises all costs of purchase, costs of conversion, and other costs incurred in
bringing the inventories to their present location and condition.
o Costs of purchase include the purchase price, import duties, other taxes (unless
subsequently recoverable), and transport, handling, and other costs directly
attributable to the acquisition of finished goods, materials, and services. Trade
discounts, rebates, and similar items are deducted.
o Costs of conversion typically include costs directly related to the units produced,
such as direct labour, and systematic allocation of fixed and variable production
overheads incurred in converting materials into finished goods.
o Other costs are included only if they are incurred to bring the inventories to their
present location and condition (e.g., non-production overheads or costs of designing
products for specific customers).
o Excluded Costs (recognised as expenses in the period incurred) include:
Abnormal amounts of wasted materials, labour, or other production costs.
Storage costs, unless they are necessary in the production process before a
further production stage.
Administrative overheads that do not contribute to bringing inventories to
their present location and condition.
Selling costs.
o IAS 23 Borrowing Costs identifies limited circumstances where borrowing costs can
be included in the cost of inventories.
o If a purchase involves deferred settlement terms effectively containing a financing
element, that element is recognised as interest expense over the financing period.
o For inventories comprising agricultural produce harvested from biological assets,
their initial cost for IAS 2 application is their fair value less costs to sell at the point
of harvest, as per IAS 41 Agriculture.
Techniques for Measurement of Cost:
o Techniques like the standard cost method or the retail method can be used for
convenience if their results approximate actual cost. Standard costs should be
regularly reviewed and revised based on current conditions.
Cost Formulas:
o For items that are not ordinarily interchangeable and goods/services produced for
specific projects, specific identification of their individual costs must be used. This is
appropriate when items are segregated for a specific project, regardless of whether
they were bought or produced. However, it is inappropriate for large numbers of
ordinarily interchangeable items as it could be used to manipulate profit or loss.
o For all other inventories, the first-in, first-out (FIFO) or weighted average cost
formula must be used. An entity must use the same cost formula for all inventories
having a similar nature and use. Different formulas may be justified for inventories
with a different nature or use. A difference in geographical location or tax rules
alone is not sufficient to justify different cost formulas.
Net Realisable Value (NRV):
o The cost of inventories may not be recoverable if they are damaged, obsolete, or if
selling prices, completion costs, or selling costs have changed adversely. Writing
inventories down to NRV is consistent with the principle that assets should not be
carried in excess of expected realisable amounts.
o Inventories are usually written down to net realisable value item by item.
o In some circumstances, it may be appropriate to group similar or related items for
write-down, such as items in the same product line with similar purposes, end uses,
and marketing in the same geographical area, if separate evaluation is impractical. It
is not appropriate to write down inventories based on broad classifications (e.g.,
all finished goods).
o Estimates of NRV are based on the most reliable evidence available at the time,
considering price or cost fluctuations after the period-end that confirm conditions
existing at the end of the period.
o The purpose for which the inventory is held is considered. For firm sales contracts,
the contract price is used. For quantities exceeding sales contracts, general selling
prices are used.
o Materials and other supplies for production are not written down below cost if the
finished products are expected to be sold at or above cost. However, if material
price declines indicate that finished product cost exceeds NRV, the materials are
written down to NRV, with replacement cost potentially being the best measure.
o A new assessment of NRV is made in each subsequent period. A reversal of a
write-down occurs when the circumstances that caused the original write-down no
longer exist or when there is clear evidence of an increase in NRV due to changed
economic circumstances. The reversal is limited to the amount of the original write-
down, ensuring the new carrying amount is the lower of cost and revised NRV.
5. Recognition as an Expense
When inventories are sold, their carrying amount is recognised as an expense in the period
the related revenue is recognised.
Any write-down of inventories to net realisable value and all losses of inventories are
recognised as an expense in the period they occur.
Any reversal of a write-down (due to an increase in NRV) is recognised as a reduction in the
amount of inventories recognised as an expense in the period the reversal occurs.
Inventories allocated to other asset accounts (e.g., as a component of self-constructed
property, plant, or equipment) are recognised as an expense over the useful life of that
asset.
The amount of inventories recognised as an expense during the period (often called cost of
sales) includes costs previously in inventory, unallocated production overheads, and
abnormal production costs. Other amounts like distribution costs may also be included
depending on entity circumstances.
6. Disclosure Requirements Financial statements must disclose:
The accounting policies adopted for measuring inventories, including the cost formula used
[135(a)].
The total carrying amount of inventories and carrying amounts by appropriate
classifications (e.g., merchandise, production supplies, materials, work in progress, finished
goods) [135(b), 136].
The carrying amount of inventories carried at fair value less costs to sell [135(c)].
The amount of inventories recognised as an expense during the period [135(d)].
The amount of any write-down of inventories recognised as an expense [135(e)].
The amount of any reversal of any write-down recognised as a reduction in expense
[135(f)].
The circumstances or events that led to the reversal of a write-down [135(g)].
The carrying amount of inventories pledged as security for liabilities [136(h)].
7. Effective Date The revised IAS 2 (issued in December 2003) became operative for annual periods
beginning on or after 1 January 2005. Earlier application was encouraged.
8. Relationship with Other IFRS Standards and Conceptual Framework IAS 2 should be read in the
context of its objective, the Basis for Conclusions, the Preface to IFRS Standards, and the Conceptual
Framework for Financial Reporting. IAS 8 Accounting Policies, Changes in Accounting Estimates and
Errors provides a basis for selecting and applying accounting policies when explicit guidance is
absent. Changes in estimates, such as an asset's useful life or residual value, are accounted for as a
change in an accounting estimate in accordance with IAS 8.
