IAS 2 INVENTORIES
.
IAS 2 Inventories prescribes the accounting treatment for inventories. The standard provides
guidance on the amount of cost to be recognised as an asset and carried forward until the
related revenues are generated. The standard also gives guidance on what constitutes cost and
how to write down the asset to net realisable value.
IAS 2 defines inventories as assets held for sale in the ordinary course of business (like items of
clothing in a retail clothing business) in the process of production for such sale (like cloth in a
clothing manufacturing business) or in a form of materials or supplies to be consumed in the
production process or in the rendering of services (like thread and buttons in a clothing
manufacturing business).
Measurement
The principle under IAS 2 is that inventories should be measured at the lower of cost and net
realisable value. Net realisable value is the estimated selling price in the normal course of
business less the estimated costs of completion and the estimated costs of making the sale.
Inventories are usually written down to net realisable value, item by item or groups of
similar items where it is not practical to evaluate separate items. Cost should comprise all
cost of purchase, costs of conversion (if manufacturing) and other costs incurred in bringing the
inventories to their present location and condition.
Determining cost
The cost according to IAS 2 can be determined as follows:
Cost of purchase: these include the purchase price, import duties and other taxes (to the extent
that they are not recoverable from the tax authority) handling cost and other cost directly
attributable to the acquisition.
Cost of conversion include costs directly related to the units being produced, for example, direct
labour costs. The costs also include an allocation of fixed and variable overhead that are incurred
in converting materials into finished goods.
Variable production overheads are those indirect costs of production that vary directly with the
volume being produced, for example indirect materials and indirect labour. Fixed production
overheads are those indirect costs of production that remain constant irrespective of the numbers
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of units produced, for example, depreciation of factory buildings and equipment and the cost of
factory management and administration. Financing cost if the requirement of IAS 23 borrowing
cost are satisfied.
Costs not included in cost of inventory
IAS 2 inventories exclude the following cost from being recognised as cost of inventories. The
must be written off in the income statement.
(a)
Abnormal amounts of wasted materials labour or other production costs
(b)
Storage costs, unless those costs are necessary in the production process before a
further production stage
(c)
Administrative overheads that do not contribute to bringing inventories to their
present location and condition
(d)
Selling and distribution costs.
Inventory valuation methods acceptable under IAS 2
The acceptable methods of inventory valuation under IAS 2 are First-in-first out (FIFO),
weighted average, standard costs and retail method. Last-in-first out (LIFO) is no longer
acceptable under IAS 2 inventories.
Example
CJ’s business sells three products X Y and Z. The following information was available at the
year end:
X
Y
Z
GH
GH
GH
2
Cost
7
10
19
Net realisable value
10
8
15
Units
100
200
300
What is the value of the closing inventory?
X
(7×100) = 700
Y
(8×200) = 1600
Z
(15×300) =4,500
TOTAL
GH₵6,800
Example:
Value the following items of inventory.
(a) Materials costing GH¢12,000 bought for processing and assembly for a profitable special
order. Since buying these items, the cost price has fallen to GH¢10,000
(b) Equipment constructed for a customer for an agreed price of GH¢18,000. This has
recently been completed at a cost of GH¢16,800. It has now been discovered that, in
order to meet certain regulations, estimated completion cost of GH¢4,200 will be
required. The customer has accepted partial responsibility and agreed to meet half the
extra cost.
Solution
(a) Value at GH¢12,000. The GH¢10,000 is irrelevant. The rule is lower of cost or NRV, not
lover of cost or replacement cost. Since the special order is known to be profitable, the
NRV will be above cost.
(b) Value at NRV, i.e. GH¢15,900 as this is below cost
(NRV=contract price of GH¢18,000-company’s share of modification cost of GH¢2,100
Example 2
Stores data for October 2011
Date
Receipts
purchase
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Issues
01/10/2011
05/10/2011
06/10/2011
12/10/2011
20/10/2011
Price
4.00
4.50
150 units
100 units
80 units
100 units
90 units
4.8
24/10/2011
80 units
FIFO METHOD
Receipts
Date
Qty
Issue
Unit price
Amt
1/10/10 150
GH¢4
5/10/10 100
4.50
Qty
Unit price
Balance
Amt
Qty
Unit price
Amt
600
150
GH¢4
600
450
100
4.50
450
90
4.8
432
4.8
384
6/10/10
80
4
320
12/10/10
70
4
280
30
4.5
135
20/10/10 90
4.8
432
70
4.5
315
10
4.8
48
80
WEIGHTED AVERAGE METHOD
Receipts
Date
Issue
Qty
Unit price
Amt
1/10/10 150
GH¢4
5/10/10 100
4.50
Balance
Qty
Unit price
Qty
Unit price
Amt
600
150
GH¢4
600
450
100
4.50
450
250
4.2
1050
4.2
1050
6/10/10
Amt
250
80
4.2
336 (80)
170
4
4.2
4.2
(336)
714
12/10/10
20/10/10 90
100
4.8
4.2
420
432
80
4.57
384
170
4.2
714
(100)
4.2
(420)
70
4.2
294
70
4.2
294
90
4.8
432
160
4.57 726
160
4.57
726
(80)
4.57
(384)
80
4.23 342
Disclosure of inventories
The financial statement should disclose the following:
(a)
The accounting policies adopted in measuring inventories
(b)
The total amount of inventories in classifications appropriate to the business
(c)
The carrying amount of inventories carried at net realisable value.
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