Objectives
The primary objectives of IAS 2 are:
- To provide the accounting treatment for inventories.
- To ensure that inventory costs are recognized as an Asset and carried forward until the related revenues are recognized (Inventory cost to be in line with revenue recognition principles).
- To provide guidance on the determination of cost and its subsequent recognition as an expense, including any write‑down to net realizable value
Scope
This Standard applies to all inventories, except:
- Financial instruments, and
- Biological assets related to agricultural activity and agricultural produce at the time of harvest.
(Investment held for sale and livestock is not covered)
Key Definitions
- Inventories are assets
- held for sale in the ordinary course of business
- In the process of production for such sale: or
- In production, or consumption during service delivery.
- In the form of materials or supplies to be consumed in the production process or in the rendering of services.
Net realizable value
It is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.
Net realizable value refers to the net amount that an entity expects to realize from the sale of inventory in the ordinary course of business
Fair value
It is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (See IFRS 13 Fair Value Measurement).
Fair value reflects the price at which an orderly transaction to sell the same inventory in the principal (or most advantageous) market for that inventory would take place between market participants at the measurement date.
Measurement of Inventories
IAS 2 requires inventories to be measured at the lower of Cost and NRV, ensuring they are not overstated in financial statements.
Components of cost of Inventory
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.
- Purchase Costs: - It comprises
- purchase price,
- import duties and other taxes (other than those whose ITC is allowed by the tax authorities), and
- Transport, handling and other costs directly attributable to the acquisition of finished goods, materials and services.
- Trade discounts, rebates and other similar items are deducted in determining the costs of purchase
- Conversion Costs: -The costs of conversion of inventories include costs directly related to the units of production, including
- Direct labor expenses.
- Fixed and variable overheads systematically allocated to inventory.
Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, such as
- depreciation and maintenance of factory buildings, equipment and right-of-use assets used in the production process, and
- the cost of factory management and administration.
Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as
- indirect materials and
- indirect labour.
Allocation of Fixed Production overhead
The allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities.
Normal capacity
- It is the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance.
- The actual level of production may be used if it approximates normal capacity.
- The amount of fixed overhead allocated to each unit of production is not increased as a consequence of low production or idle plant.
- Unallocated overheads are recognized as an expense in the period in which they are incurred.
- Variable production overheads are allocated to each unit of production on the basis of the actual use of the production facilities.
- when joint products are produced or when there is a main product and a by-product. When the costs of conversion of each product are not separately identifiable, they are allocated between the products on a rational and consistent basis.
- Other Costs
- Incidental expenses necessary to bring inventory to its current condition and location.
Costs excluded from the cost of inventories and recognised as expenses in the period in which they are incurred are:
- Abnormal loss amounts of materials, labour or other production costs;
- storage costs, unless those costs are necessary in the production process before a further production stage;
- administrative overheads that do not contribute to bringing inventories to their present location and condition; and
- selling costs
IAS 23 Borrowing Costs identifies limited circumstances where borrowing costs are included in the cost of inventories.
An entity may purchase inventories on deferred settlement terms. When inventory cost contains a financing element, that element (difference between the purchase price for normal credit terms and the amount paid including financing amount), is recognised as interest expense
Cost of agricultural produce harvested from biological assets
Agricultural produce that an entity has harvested from its biological assets are measured on initial recognition at their fair value less costs to sell at the point of harvest. This is the cost of the inventories at that date for application of this Standard.
Cost measurement techniques
Standard costs
It take into account normal levels of materials and supplies, labor, efficiency and capacity utilization. They are regularly reviewed and, if necessary, revised in the light of current conditions.
Retail method
It is used in the retail industry for measuring inventories of large numbers of rapidly changing items with similar margins for which it is impracticable to use other costing methods.
The cost of the inventory is determined by reducing the gross margin from sales value.
Cost formulas
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 there are large numbers of items of inventory that are ordinarily interchangeable this method will not be appropriate and the method of selecting those items that remain in inventories could be used to obtain predetermined effects on profit or loss.
Specific identification of cost means that specific costs are attributed to identified items of inventory.
The cost of inventories other than above shall be assign by using
- FIFO (First-In, First-Out):
- Assumes that the oldest inventory items are sold first.
- Closing inventory consists of the most recently purchased items.
- Weighted Average Cost:
- Uses a weighted average to assign costs evenly across inventory items. Suitable for interchangeable goods.
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.
Net Realizable Value (NRV)
The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined and if the estimated costs of completion or the estimated costs to be incurred to make the sale have increased.
So that assets should not be carried in excess of amounts expected to be realised from their sale or use.
Inventories are usually written down to net realisable value item by item.
In some circumstances, however, it may be appropriate to group similar or related items.
This may be the case with items of inventory relating to the same product line that have similar purposes or end uses, are produced and marketed in the same geographical area, and cannot be practicably evaluated separately from other items in that product line.
Estimates of net realisable value are based on the most reliable evidence available at the time the estimates are made, of the amount the inventories are expected to realise. And these estimates take into consideration fluctuations of price or cost directly relating to events occurring after the end of the period to the extent that such events confirm conditions existing at the end of the period.
Materials and other supplies held for use in the production of inventories are valued at cost only except
When a decline in the price of materials indicates that the cost of the finished products exceeds net realisable value, the materials are written down to net realisable value.
In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value.
A new assessment is made of net realisable value in each subsequent period.
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 realisable value because of changed economic circumstances, the amount of the write-down is reversed (ie the reversal is limited to the amount of the original write-down) so that the new carrying amount is the lower of the cost and the revised net realisable value.
Recognition as an expense
When inventories are sold, the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised.
The amount of any write-down of inventories to net realisable value and all losses of inventories shall be recognised 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 realisable value, shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.
Disclosures
The financial statements shall disclose:
- the accounting policies adopted in measuring inventories, including the cost formula used;
- the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity;
- the carrying amount of inventories carried at fair value less costs to sell;
- the amount of inventories recognized as an expense during the period;
- the amount of any write-down of inventories recognized as an expense in the period;
- the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense in the period.
- the circumstances or events that led to the reversal of a write-down of; and
- the carrying amount of inventories pledged as security for liabilities.
Add comment
Comments