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International Accounting Standard 2: Inventories (IAS 2) is an international financial reporting standard issued by the International Accounting Standards Board (IASB) that governs the valuation and presentation of inventories. [1]
IAS 2 defines inventories as assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services. [2]
The fundamental principle of IAS 2 is that inventories must be measured at the lower of cost and net realisable value (NRV). [3] Cost comprises all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition. [4]
Costs of conversion include costs directly related to the units of production (e.g., direct labour) and a systematic allocation of fixed and variable production overheads. [5]
The allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities. [8]
Scenario: An entity purchases raw materials for $10,000. It incurs $2,000 in direct labour and $1,000 in production overheads (e.g., $400 variable lubricants and $600 fixed factory rent) to manufacture finished goods.
| Event | Debit | Credit | Amount | Rationale |
|---|---|---|---|---|
| Purchase of materials | Raw Materials (Asset) | Cash / Accounts Payable | $10,000 | Recognition at purchase price. [9] |
| Conversion costs | Work in Progress (Asset) | Cash / Accrued Wages | $3,000 | Inclusion of labour and allocated overheads. [10] |
| Completion of goods | Finished Goods (Asset) | Raw Materials / WIP | $13,000 | Transfer of all capitalized costs to final stock. [11] |
| Balance Dec 31 | Finished Goods (SoFP) | $13,000 | Total carrying amount before NRV assessment. |
Scenario: At year-end, the finished goods (cost $13,000) have a market value of $12,500. Estimated costs to complete the sale (shipping/commissions) are $1,000.
| Event | Debit | Credit | Amount | Rationale |
|---|---|---|---|---|
| Recognize loss | Cost of Sales / Inventory Loss | Finished Goods (Asset) | $1,500 | Write-down to lower of cost or NRV. [12] |
| Final Balance | Finished Goods (SoFP) | $11,500 | Adjusted value reported on the Balance Sheet. [13] |
An entity must disclose specific information to allow users of financial statements to understand the valuation and impact of inventories. According to IAS 2.36, the following disclosures are required: [14]
| Paragraph | Category | Disclosure Requirement | Description / Examples |
|---|---|---|---|
| IAS 2.36(a) | Accounting Policies | Cost Formulas adopted | Disclose whether the group uses FIFO or Weighted Average Cost. (Note: LIFO is prohibited). |
| IAS 2.36(b) | Carrying Amounts | Total Carrying Amount | The total value of inventories as reported on the Consolidated Statement of Financial Position. |
| IAS 2.36(b) | Classification (Sub-categories) | Breakdown of inventories appropriate to the entity, typically: Raw Materials, Work in Progress (WIP), and Finished Goods. | |
| IAS 2.36(c) | Fair Value less Costs to Sell | The carrying amount of inventories carried at fair value less costs to sell (common for commodity broker-traders). | |
| IAS 2.36(d) | Income Statement Impact | Expense Recognition | The amount of inventories recognized as an expense during the period (typically the "Cost of Sales"). |
| IAS 2.36(e) | Write-downs | The amount of any write-down of inventories to Net Realizable Value (NRV) recognized as an expense in the period. | |
| IAS 2.36(f) | Reversals of Write-downs | The amount of any reversal of a previous write-down that is recognized as a reduction in the inventory expense. | |
| IAS 2.36(g) | Circumstances for Reversals | A description of the events or circumstances that led to the reversal of a write-down (e.g., an increase in selling price). | |
| IAS 2.36(h) | Encumbrances | Pledged as Security | The carrying amount of inventories pledged as security for liabilities (e.g., collateral for a bank loan). |