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IAS 2: INVENTORIES
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PRACTICAL GUIDE
IAS 2 Inventories
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The cost of inventories shall comprise all costs of purchase, costs of conversion and
other costs incurred in bringing the inventories to their present location and
condition.
The cost of inventories shall be assigned by using the first-in, first-out (FIFO) or
weighted average cost formula. An entity shall use the same cost formula for all
inventories having a similar nature and use to the entity. For inventories with a
different nature or use, different cost formulas may be justified. However, the cost of
inventories of items that are not ordinarily interchangeable and goods or services
produced and segregated for specific projects shall be assigned by using specific
identification of their individual costs.
When inventories are sold, the carrying amount of those inventories shall be
recognized as an expense in the period in which the related revenue is recognized.
The amount of any write-down of inventories to net realizable value and all losses of
inventories shall be recognized as an expense in the period the write-down or loss
occurs. The amount of any reversal of any write-down of inventories, arising from an
increase in net realizable value, shall be recognized as a reduction in the amount of
inventories recognized as an expense in the period in which the reversal occurs.
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Examples
Costs of purchase that should be included in purchase cost
PURCHASE COST
Purchase Price
discounts/rebates on purchase price
penalty charge for overdue payments
travel expenses of the purchasing department
Taxes
VAT
real property transfer tax
import duties
Transport
forwarding charges for external transport
transport insurance
storage rental fee charged for intermediate storage
internal storage costs after receiving materials
internal transport between stock locations
other costs
costs for a letter of reference (e.g. quality certificate for drugs)
costs for commission, brokerage
YES
X
X
NO
X
X
X
X
X
X
X
X
X
X
X
X
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YES
X
X
X
X
X
NO
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Camera B
Camera C
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8.3
Purcahes 20X1
Inventories at
Inventories at the
the year 20X1
year 20X0 end
end (before
(before discount
discount)
9.9
0.5
2.5
10.3
2.6
0.6
Solution
A rebate of 1.2 million euro from B should be considered as a separate asset, which is credited to
the income statement as deduction of selling costs. This rebate is driven by the sales of the period
and should therefore be considered in the net income of the period. As the rebate is sales related, it
is regarded as a deduction from selling costs. A rebate of 1.0 million euro from C should be
considered as a separate asset, which is credited to the cost of sales (0.75 million euro) as well as to
the cost of inventories (0.25 million euro). This rebate is driven by the purchases of the period and
should therefore be allocated to the cost of cameras purchased and sold within the period as well
as to cameras purchased, but not yet sold. As the rebate is purchase related, it is regarded as a
deduction from the cost of sales.
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Answer
Items (1), (3), (5), (7), (8), and (9) are permitted to be included in cost of inventory under IAS 2.
Salaries of accounting department, sales commission, and after-sales warranty costs are not
considered cost of inventory under IAS 2 and thus are not allowed to be included in cost of
inventory.
down an entire product line or group of inventories in a given geographical area that cannot be
practicably evaluated separately. Service contracts usually accumulate costs on a contract-bycontract basis and net realizable value must be considered on this basis [IAS 2.29].
Estimates of net realizable value must be based on the most reliable evidence available and take
into account fluctuations of price or cost after the end of the period if this is evidence of conditions
at the end of the period [IAS 2.30]. A loss realized on a sale of a product after the end of the period
may well provide evidence of the net realizable value of that product at the end of the period.
However if this product is, for example, an exchange traded commodity and the loss realized can be
attributed to a fall in prices on the exchange after the period end date then this loss would not, in
itself, provide evidence of the net realizable value at the period end date. Estimates of net
realizable value must also take into account the purpose for which the inventory is held. Therefore
inventory held for a particular contract has its net realizable value based on the contract price, and
only any excess inventory held would be based on general selling prices. If there is a firm contract to
sell and this is in excess of inventory quantities that the entity holds or is able to obtain under a firm
purchase contract, this may give rise to a provision that should be recognized in accordance with
IAS 37 - Provisions, Contingent Liabilities and Contingent Assets [IAS 2.31].
IAS 2 explains that materials and other supplies held for use in the production of inventories are not
written down below cost if the final product in which they are to be used is expected to be sold at
or above cost [IAS 2.32]. This is the case even if these materials in their present condition have a net
realizable value that is below cost and therefore would otherwise require write down. Thus, a
whisky distiller would not write down an inventory of grain because of a fall in the grain price, so
long as it expected to sell the whisky at a price which is sufficient to recover cost. If a decline in the
price of materials indicates that the cost of the final product will exceed net realizable value then a
write down is necessary and that their replacement cost may be the best measure of their net
realizable value [IAS 2.32]. If an entity writes down any of its finished goods, the carrying value of
any related raw materials must also be reviewed to see if they too need to be written down. Often
raw materials are used to make a number of different products. In these cases it is normally not
possible to arrive at a particular net realizable value for each item of raw material based on the
selling price of any one type of finished item. If the current replacement cost of raw materials is less
than their historical cost, a provision is only required to be made if the finished goods into which
they will be made are expected to be sold at a loss. No provision should be made just because the
anticipated profit will be less than normal. 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 net realizable value because of changed economic circumstances, the amount of the
write-down is reversed. The reversal cannot be greater than the amount of the original write-down,
so that the new carrying amount will always be the lower of the cost and the revised net realizable
value [IAS 2.33].
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The amount of inventory recognized as an expense in the period is normally included in cost of
sales; this category includes unallocated production overheads and abnormal costs as well as the
costs of inventory that has been sold. However, the circumstances of the entity may warrant the
inclusion of distribution or other costs into cost of sales [IAS 2.38]. Hence when a company presents
its profit or loss based upon this function of expense or cost of sales method it will normally be
disclosing costs that are greater than those that have been previously classified as inventory, but
this appears to be explicitly allowable by the standard.
Some entities adopt a format for profit or loss that results in amounts other than the cost of
inventories being disclosed as an expense during the period. This will happen if an entity presents
an analysis of expenses using a classification based on the nature of expenses. The entity then
discloses the costs recognized as an expense for raw materials and consumables, labor costs and
other costs together with the amount of the net change in inventories for the period [IAS 2.39].
This issue is addressed in the following example taken from International Airlines Group 2012
financial statements:
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Fair values are the appropriate measurement bases for broker-traders, because they have access to
ready markets. Net realizable value is appropriate for producers, because they may not have such
access.
Example Difference between net realizable value and fair value less costs to sell
An entity holds mineral inventories. It could sell the stock on the open market for $ 100 per ton
after selling costs. The entity is currently in a forward contract to sell the stock at $ 120 per ton. In
this situation, fair value less selling costs is $ 100 per ton, but net realizable value is $ 120 per ton.
Example Net realizable value and fair value less costs to sell may differ between producer and a
broker trader entity.
A producer in Brazil holds agricultural produce that it can sell locally for $ 100 per ton or to a broker
in Uruguay for $ 500 per ton. The broker can sell the produce in Uruguayans market at $ 800 per
ton. In this situation, to the extent that the producer will sell to the broker, both the fair value and
the net realizable value for the producer is $ 500 per ton. For the broker, the fair value and the net
realizable value is $ 800 per ton. In this situation, the values are different as between the producer
and the broker, because the producer does not have access to the market in Uruguay and must sell
either on the local market or to the broker.
The Technical summary has been prepared by IFRS Foundation staff and has not been approved by the IASB. For the requirements reference must be
made to International Financial Reporting Standard which can be obtained if pay the subscription to IASB www.ifrs.org
The examples included in this application guide have been prepared by ConsultasIFRS team. You are not allowed to copy, forward, edit, translate,
modify, use or copy any content.
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