The International Accounting Standards Board issued the revised version of the International Accounting Standard 2, Inventories. This article presents a closer look of standard (objective, scope, definitions, measurement and disclosures.International Accounting Standard; Inventories; IASC; IASB

Muthupandian, K S

English

Research Papers in Economics

IAS 2, 
 
Inventories – 
 
A Closer Look 
 
K.S.Muthupandian* 
 
 
In September 1974, the International Accounting Standards Committee (IASC) issued the 
Exposure  Draft  E2,  Valuation  and  Presentation  of  Inventories  in  the  Context  of  the 
Historical  Cost  System.  In  October  1975,  the  IASC  issued  IAS  2,  Valuation  and 
Presentation of Inventories in the Context of the Historical Cost System. In August 1991, 
the IASC issued the Exposure Draft E38, Inventories as part of the „Comparability of 
Financial Statements‟ project started in 1987. In December 1993, the IASC issued IAS 2, 
Inventories. The effective date was fixed as 1 January 1995. On 18 December 2003, the 
International Accounting Standards Board (IASB) issued the revised version of IAS 2 
and is applicable for annual periods beginning on or after 1 January 2005. 
 
Objective   
The objective of IAS 2 is to prescribe the accounting treatment for inventories. A primary 
issue in accounting for inventories is the amount of cost to be recognised as an asset and 
carried forward until the related revenues are recognised. IAS 2 provides guidance for 
determining  the  cost  of  inventories  and  for  subsequently  recognising  an  expense, 
including any write-down to net realisable value (NRV). It establishes the guidelines for 
the  recording  and  presentation  of  inventories.  It  also  provides  guidance  on  the  cost 
formulas that are used to assign costs to inventories.  
_______________________________________________________________________ 
*M.Com.,  AICWA  and  Member  of  Tamil  Nadu  State  Treasuries  and  Accounts 
Service, presently working as Treasury Officer, Ramanathapuram District, Tamil 
Nadu. Email: ksmuthupandian@yahoo.co.in 
   2 
 
IAS 2 provides guidance on the following in respect of the accounting for inventories: 
• The amount of cost to be recognised as an asset and carried forward until the related 
revenue is recognised. 
• Guidance on determining cost and the subsequent recognition as an expense, including 
any write-downs to NRV. 
• Guidance on 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).  
The revision to IAS 2 has introduced 2 types of exclusions, those that are entirely outside 
the scope and those that are outside the scope of measurement only.  
 
The following inventories are excluded entirely: 
  Work in process arising under construction contracts, including directly related 
service contracts (IAS 11, Construction Contracts); 
  Financial instruments (IAS 39, Financial Instruments); and 
  Biological assets related to agricultural activity and agricultural produce at the 
point of harvest or collection point (IAS 41, Agriculture).  
The  following  are  within  the  scope  of  the  standard,  IAS  2  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 NRV 
(above  or  below  cost)  in  accordance  with  well-established  practices  in  those 
industries. When such inventories are measured at NRV, changes in that value are 
recognised in profit or loss in the period of the change.  
  Commodity broker-traders who measure their inventories at fair value (FV) less 
costs to sell. When such inventories are measured at FV less costs to sell, changes 
in FV less costs to sell are recognised in profit or loss in the period of the change. 
Commodity broker-traders are defined as those who “buy or sell commodities for 
others or on their own account”. 
 
 
 
 
   3 
Definition of Inventories 
 
Inventories are assets: 
(a) owned to be sold in the normal course of operation; 
(b) in the process of production in connection with said sale; or 
(c) in the form of materials or supplies, to be consumed in the production process or in 
the provision of services. 
 
 
Definitions of NRV and FV 
 
NRV is the estimated sale price of an asset in the normal course of operation less the 
costs estimated to complete their production and those necessary to make the sale. This 
value is entity-specific.  
 
FV is the amount for which an asset can be exchanged or a liability written off, among 
knowledgeable, interested and duly informed parties performing a transaction at arms-
length. This value is not entity-specific. 
 
NRV for inventories may not equal FV less costs to sell. 
 
Measurement of Inventories  
Inventories shall be measured at the lower of cost and the NRV.  
Inclusions 
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.   
Costs of purchase 
  
•means  purchase price,  non-recoverable import duties  and other taxes (which are not 
subsequently recoverable from the tax authorities), transportation, storage, handling and 
other costs directly attributable to the acquisition of merchandise, materials or services. 
 
•trade discounts, rebates etc should be deducted. 
 
•foreign exchange differences should not be included. 
 
Costs of conversion  
• means direct labour plus an allocation of fixed and variable production overheads that 
are incurred in converting materials to finished goods.   4 
• such costs should be allocated using the normal capacity of the production facilities. 
Actual production level can only be used if it approximates normal capacity. 
• expense unallocated overheads. 
Other costs  
• only to the extent they are incurred in bringing inventories to their present location and 
condition. 
 
•  does  not  include  abnormal  wastage,  storage  costs  (unless  necessary  during  the 
production process before the next production stage), administrative overheads that do 
not contribute to brining inventories to their present location and condition or selling 
costs. 
 
• can include borrowing costs in circumstances identified in IAS 23, Borrowing Costs. 
 
•  if  settlement  terms  for  the  purchase  of  inventory  are  deferred,  there  is  a  financing 
element that should be recognised as an interest expense if the amount paid is different 
from that paid for normal credit terms. 
Exclusions 
Inventory cost should not include:   
  abnormal waste  
  storage costs  
  administrative overheads unrelated to production  
  selling costs  
  foreign  exchange  differences  arising  directly  on  the  recent  acquisition  of 
inventories invoiced in a foreign currency  
  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.   
 
 
Cost formulas 
 
The cost of inventories of those products that are not usually interchangeable, as well as 
of  the  goods  and  services  produced  and  segregated  for  specific  projects  shall  be 
determined through the method of specific identification of their individual costs.  
 
 
   5 
The cost of inventories of those products that are interchangeable shall be determined 
using the first-in first-out (FIFO) or the weighted average cost formula. The last-in first-
out (LIFO) formula, which had been allowed prior to the 2003 revision of IAS 2, is no 
longer allowed. 
 
The entity shall use the same cost formula for all inventories having a similar nature and 
use  within  the  same.  For  group  of  inventories  with  a  different  nature  or  use,  the 
utilization of cost formulas that are also different may be justified. 
 
Joint and by-products 
 
If costs are not separately identifiable, they should be allocated between joint products on 
a  rational  and  consistent  basis  e.g.  relative  sales  value  (at  stage  when  the  products 
become separately identifiable or on completion of production). 
 
Immaterial by-products should be measured at NRV and deducted from the cost of the 
main product. 
 
Determining NRV 
 
It is important to consider the most reliable evidence at the time estimates are made. This 
should include price / cost fluctuations directly relating to events after balance sheet date 
but only to the extent that they confirm conditions existing at balance sheet date. 
 
Write-Down to NRV  
The amount of any write-down of inventories to NRV and all losses of inventories should 
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, should be recognized as a reduction in the amount of inventories recognized as an 
expense in the income statement in the period in which the reversal occurs. 
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.  
When inventories are sold, the carrying amount of those inventories should be recognized 
as an expense in the period in which the related ordinary revenue is recognized.  
 
The cost  of some inventories  may be allocated to  other asset  accounts, for  example, 
inventory used as a component of self-constructed tangible fixed assets.   6 
 
The value of inventories allocated to other assets in this way should be recognized as an 
expense during the useful life of the former. 
 
Disclosure Requirements 
 
Financial statements shall disclose the following information: 
(a) The accounting policies adopted in valuating inventories, including the cost valuation 
formula that may have been used; 
(b) The total carrying amount of inventories generally classified as merchandise, 
supplies, materials, work in progress, and finished goods and partial (split) amounts 
according to the classification that may be appropriate for the entity; 
(c) The carrying amount of the inventories that may be accounted for based on their 
reasonable value less the sale costs; 
(d) The amount of inventories recognized as an expense during the period (cost of goods 
sold); 
(e) The amount of inventory write-downs that may have been recognized as an expense in 
the year; 
(f) The amount of reversals in previous value write-downs, which may have been 
recognized as a reduction in the amount of the expense (offset) on account of inventories 
in the period; 
(g) The circumstances or events that led to the reversal of write-downs; and 
(h) The carrying amount of inventories pledged as a guarantee for the payment of debts. 
 
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 enterprise 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. This is consistent with IAS 1, 
Presentation of Financial Statements, which allows presentation of expenses by function 
or nature.  
Conclusion 
IAS 2 stipulates how the asset considered as an inventory is measured, which concepts 
make up the cost and when it should be recognized as an expense and which information 
should be disclosed in the financial statements. But, the inventories concept established in 
IAS 2 fails to indicate that the assets held by a company may be kept as an investment or 
used as an internationally accepted means of payment. 
 
 
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IAS 2, Inventories - A Closer Look

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