IAS 2 Inventories: Measurement, Cost Formulas and Common Issues
IAS 2 governs how inventories are measured in financial statements. This guide covers the cost of inventories, permitted cost formulas, net realisable value, and write-down requirements.
What Does IAS 2 Cover?
IAS 2 Inventories establishes accounting for goods held for sale, work in progress, and materials to be consumed in production or service delivery. Its key requirements are the measurement of inventory at the lower of cost and net realisable value, and the permitted methods for determining cost.
What Is Included in Inventory Cost?
The cost of inventories includes: costs of purchase (purchase price, import duties, transport, handling costs, less trade discounts and rebates); costs of conversion (direct labour, direct materials, and systematically allocated fixed and variable production overhead); and other costs incurred in bringing inventories to their present location and condition. Abnormal waste, storage costs (unless necessary before further processing), administrative overheads, and selling costs are excluded from inventory cost.
Cost Formulas
IAS 2 permits two cost formulas for assigning costs to inventories: FIFO (First-In, First-Out): assumes oldest inventory is sold first — closing inventory reflects the most recent purchase prices. Weighted Average Cost (AVCO): assigns an average cost to all units, recalculated each time a new purchase is made. IAS 2 prohibits LIFO (Last-In, First-Out), unlike US GAAP. Items that are not interchangeable must use specific identification — their actual cost is tracked individually.
Net Realisable Value
Inventories must be measured at the lower of cost and net realisable value (NRV). NRV = estimated selling price in the ordinary course of business, less estimated costs of completion and estimated costs necessary to make the sale. Where NRV falls below cost, inventory is written down to NRV and the loss recognised in profit or loss. Write-downs are reviewed each period — if circumstances change and NRV recovers, the write-down is reversed (up to the original write-down amount).
Exam Context
IAS 2 is examined in ACCA FA and FR and is particularly important for finance professionals in manufacturing, retail, and distribution businesses where inventory is a significant balance sheet item.
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