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F3_Module 7: Inventory
Inventories are assets
held for sale in the ordinary course of the business, i.e. finished goods
in the production of progress, i.e. work in progress
in the form of materials or suppliers, i.e. raw materials
Inventory = Quantity x Valuation
Quantity
continuous inventory records: each time inventory is received into
the warehouse or leaves the warehouse, the inventory records are
updated
inventory count - period end inventory records: at the end of the
period, the inventory is counted by warehouse staff in an inventory
count
Valuation measured at the lower of **
Cost: all costs to get item to current location in current condition
Actual cost
Deemed cost
Inventories consist of a large number of interchangeable
(identical or very similar) items ⇒ impossible to determine
costs on an indi item basis). IAS 2 allows FIFO and AVCO for
cost estimation techniques
FIFO
Average cost
NRV
Selling price X
Less: completion costs (X)

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 Less: selling costs (X)
If the inventory is expected to be sold at a profit:
• Value at cost
• Do not anticipate profit
If the inventory is expected to be sold at a loss:
• Value at net realisable value
• Do provide for the future loss (record the unexpected loss even if it
has not happened yet ⇒ being prudent and avoid overstating the assets

💡 **This is an example of prudence in presenting financial info.

Assets should not be carried at amounts greater than those
expected to be realised from their sale or use.

Scenarios in which NRV (Net realisable value) is likely to be less than

cost are:
An increase in costs or a fall in selling price
a physical deterioration in the condition of inv
Obsolescence of products
marketing strategy to manufacture or sell products at a loss
errors in production or purchasing
Cost of inventories will consist of all the following costs
purchases
purchase price (carriage inwards included)
import duties and other taxes
transport and handling or costs related to the acquisition of
finished goods, services and materials
Note: less any trade discounts, rebates(refunds) and other similar
amounts
costs of conversion

F3_Module 7: Inventory 2
 The cost of conversion includes all the costs directly and
indirectly involved in turning raw materials into finished goods.
Costs directly related to the units of production, eg direct
materials, direct labor
fixed (e.g. the cost of factory management and admin) and
variable production overheads (e.g. indirect materials and labor)
that are incurred in converting materials into finished goods,
allocated on a systematic basis (IAS 2)
Carriage outwards (selling exp) are not included in the costs of
of inventories

Any other costs should be recognised if they are incurred in

bringing the inventories to their present location and condition. The
standard lists types of cost which would not be included in cost of
inventories, instead, they should be recognised as an expense:

F3_Module 7: Inventory 3
 abnormal amount of wasted materials, labor or other
production costs
storage costs, unless those costs are necessary in the
production process before a further production stage)
Administration overheads that do not contribute to bringing
inventories to their present location and condition
selling costs/expenses

Determining cost
1. Standard Costs (IAS 2, para. 21)
✅ What it is:
An estimate of what inventory should cost under normal
conditions (normal usage of materials, labor, and efficiency).
Based on expected costs rather than actual invoices.
✅ When used:
Common in manufacturing businesses
When tracking actual cost of every item is too complex or time-
consuming
📌 Important:
These standard costs must be reviewed and updated regularly
to ensure they’re still realistic.
The goal is that standard costs approximate actual costs
closely.
🛍️ 2. Retail Method (IAS 2, para. 22)
✅ What it is:
A shortcut method used mainly in the retail industry.
It works by:
🔸 Taking the total retail value of inventory (what it would sell
for)
🔸 Then reducing it by the average gross margin %

F3_Module 7: Inventory 4
 → That gives an estimated cost

✅ When used:
When a business holds many rapidly changing, similar items
(e.g., supermarkets, clothing stores)
When it’s impractical to track exact cost per unit
🧠 Example:
You have $100,000 of inventory at retail price
Your average gross margin is 25%
So cost of inventory = $100,000 × (1 – 25%) = $75,000

F3_Module 7: Inventory 5
 💡 NOTE: NO NETTING OFF

Theoretical methods of estimating cost

F3_Module 7: Inventory 6
 Various batches of inventories purchased at different times during the
year and at different prices ⇒ impossible to determine precisely which
items are still held at the year end and what the actual purchase cost of
the goods was ⇒ two methods to approximate the cost of its inventories
FIFO (considered more realistic)
first goods purchased/produced will be the first to be sold
remaining inv are from the most recent purchases/production
Average cost
Periodic (or simple) average cost: cost of all
purchases/production during the year divided by the total number
of units purchased
continuous weighted average cost: WAC is recalculated each
time a new item is purchased/produced during the period.
Alternatively, WAC is calculated periodically, at the end of each
month i.e.

F3_Module 7: Inventory 7