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IAS 2, "Inventories," is an International Financial
Reporting Standard (IFRS) that provides guidance
on accounting for inventories. Here’s a detailed
overview of the key principles and guidance
provided by IAS 2:
Key Principles of IAS 2
Measurement of Inventories
 Inventories should be measured at the lower of cost
and net realizable value (NRV).
Determining the Cost of Inventories
 Cost includes all costs of purchase, costs of
conversion, and other costs incurred in bringing the
inventories to their present location and condition.
 Components of Cost
Costs of Purchase:
 Purchase price
 Import duties and other taxes (excluding those subsequently
recoverable)
 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.
Costs of Conversion:
 Direct labor costs
 Systematic allocation of fixed and variable production overheads
incurred in converting materials into finished goods
 Fixed production overheads are allocated based on normal capacity
of the production facilities.
Other Costs:
 Costs incurred in bringing the inventories to their present location
and condition.
 Excludes abnormal amounts of wasted materials, labor, or other
production costs, storage costs, administrative overheads, and
selling costs.
 Cost Formulas

IAS 2 allows for different cost formulas to assign

costs to inventories:
Specific Identification:
 Used when items of inventory are not ordinarily
interchangeable.
 Assigned costs specifically to identified items of
inventory.
First-In, First-Out (FIFO):
 Assumes that the items of inventory that were
purchased or produced first are sold first.
Weighted Average Cost:
 Calculated by dividing the total cost of goods
available for sale by the total units available for sale.
 Net Realizable Value (NRV)

 NRV 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.
 Inventories are written down to NRV on
an item-by-item basis.
 Write-downs to NRV should be recognized
as an expense in the period in which the
write-down occurs.
 Recognition as an Expense
 When inventories are sold, the carrying
amount of those inventories is recognized
as an expense in the period in which the
related revenue is recognized.
 Any write-down to NRV and any loss of
inventories are recognized as an expense
when they occur.
 Reversals of write-downs, if NRV
increases, are recognized as a reduction
of the inventory expense in the period in
which the reversal occurs.
 Example: Calculation of
Inventory Cost
 Let's consider a company that incurs the
following costs for its inventories:
Purchase price: $10,000
Import duties: $500
Transport costs: $300
Trade discounts: $200
Direct labor: $2,000
Fixed production overheads: $1,500 (normal
capacity basis)
Variable production overheads: $1,000
Total cost of purchase:
Purchase price+Import duties+Transport costs−Trad
e discounts=10,000+500+300−200=$10,600
Total cost of conversion:
Direct labor+Fixed production overheads+Variable p
roduction overheads=2,000+1,500+1,000=$4,500
Total cost of inventories:
Total cost of purchase+Total cost of conversion=10,
600+4,500=$15,100
If the NRV of these inventories is determined to be
$14,000, the inventories should be measured at the
lower of cost and NRV:
Lower of cost and NRV=min(15,100,14,000)=$14,00
0
The inventory would be written down to $14,000, and
the write-down of $1,100 ($15,100 - $14,000) would
be recognized as an expense.
 Conclusion

 IAS 2 ensures that inventories are

accurately measured and reflected in
financial statements, promoting
transparency and consistency in financial
reporting. By providing clear guidance on
determining costs and recognizing
expenses, IAS 2 helps stakeholders make
informed decisions based on the true
economic value of a company’s
inventories.
 The accounting treatment for
inventories
 It is governed by several key principles
and standards, most notably the
International Financial Reporting
Standards (IFRS) and Generally Accepted
Accounting Principles (GAAP). Here’s a
comprehensive guide to the accounting
treatment for inventories:
1. Definition of Inventory
 IFRS (IAS 2): Inventories are assets held for sale in
the ordinary course of business, in the process of
production for such sale, or in the form of materials
or supplies to be consumed in the production
process or in the rendering of services.
 GAAP (ASC 330): Similar to IFRS, inventories
include goods that are ready for sale, work in
progress, and raw materials.
2. Initial Recognition
 Measurement: Inventories should be initially
recognized at cost. Cost includes all expenditures
directly attributable to bringing the inventory to its
present location and condition. This includes
purchase price, import duties, transport, handling,
and other costs directly attributable to the
acquisition.
3. Subsequent Measurement
 Cost Formulas: The cost of inventories should be assigned by using
either:
 First-In, First-Out (FIFO)
 Weighted Average Cost
 Specific Identification (for items that are not ordinarily interchangeable and
goods or services produced and segregated for specific projects).
 Lower of Cost and Net Realizable Value (NRV):
 IFRS (IAS 2): Inventories should be measured at the lower of cost and NRV.
NRV 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.
 GAAP (ASC 330): Similar to IFRS, inventories are measured at the lower of
cost or market, where market generally means current replacement cost, but
it should not exceed the NRV or be less than NRV minus a normal profit
margin.
4. Inventory Write-Downs
 IFRS (IAS 2): If the cost of inventories exceeds NRV, the inventory is
written down to NRV. The write-down should be recognized as an
expense in the period in which it occurs.
 GAAP (ASC 330): Similar to IFRS, inventory is written down to
market (replacement cost) if lower than cost, with constraints applied
to market value to prevent overstatement or understatement.
5. Reversal of Write-Downs
 IFRS (IAS 2): If there is a subsequent increase in
the NRV of inventories previously written down,
the amount of the write-down is reversed. The
reversal is limited to the amount of the original
write-down and is recognized as a reduction in
the cost of sales.
 GAAP (ASC 330): Generally, under GAAP,
reversals of inventory write-downs are prohibited.
6. Cost of Goods Sold (COGS)
 When inventory is sold, its carrying amount is
recognized as an expense in the period in which
the related revenue is recognized. This expense is
commonly referred to as the cost of goods sold
(COGS).
7. Disclosure Requirements
 IFRS (IAS 2): Requires the following disclosures:
 The accounting policies adopted in measuring inventories.
 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 recognized as
a reduction in the amount of inventories recognized as an expense
in the period.
 The circumstances or events that led to the reversal of a write-
down.
 GAAP (ASC 330): Requires disclosures including:
 Major inventory classifications.
 Basis of stating inventories (e.g., lower of cost or market).
 Costing methods employed (e.g., FIFO, LIFO, average cost).
 Practical Considerations

Inventory Counts: Regular physical inventory counts are

essential to verify the accuracy of inventory records.
Perpetual vs. Periodic Systems: Companies can use
perpetual inventory systems, which continuously update
inventory records, or periodic systems, which update
inventory records at specific intervals.
Internal Controls: Effective internal controls over
inventory management are critical to prevent theft, loss,
and errors.
By adhering to these principles and standards, companies
can ensure accurate and consistent accounting for
inventories, providing valuable information for financial
statement users.
To guide in determining the cost of inventories and for
subsequently recognizing an expense, including any write-
down to net realizable value, we refer to the accounting
principles and standards provided by the International
Financial Reporting Standards (IFRS) and Generally Accepted
Accounting Principles (GAAP). Here are the key steps and
principles:
Determining the Cost of Inventories
Cost Components:
Purchase Costs: Includes the purchase price, import duties, and
other taxes (excluding those subsequently recoverable by
the entity from the taxing authorities), transport, handling,
and other costs directly attributable to the acquisition of
finished goods, materials, and services.
Conversion Costs: Includes costs directly related to the units of
production, such as direct labor, and a systematic allocation
of fixed and variable production overheads.
Other Costs: Any other costs incurred in bringing the
inventories to their present location and condition
 Cost Formulas:
Specific Identification: Used for items that are not
ordinarily interchangeable or goods produced and
segregated for specific projects.
First-In, First-Out (FIFO): Assumes that the oldest
inventory items are sold first.
Weighted Average Cost: Calculates the cost of
inventory based on the average cost of all similar
goods available during the period.
Recognizing Expense
 Expense Recognition: Inventories should be
recognized as an expense in the period in which the
related revenue is recognized. This typically
happens when the goods are sold.
Write-Down to Net Realizable Value:
 Net Realizable Value (NRV): 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.
 Inventories must be written down to NRV when the
cost is no longer recoverable. This can occur due to
damage, obsolescence, or declining selling prices.
Reversal of Write-Downs:
 If the circumstances that caused the write-down no
longer exist or if there is clear evidence of an increase in
net realizable value because of changed economic
circumstances, the amount of the write-down should be
reversed. The reversal is limited to the amount of the
original write-down.
 Example of Inventory Write-
Down Calculation
Cost of Inventory: $100,000
 Estimated Selling Price: $90,000
 Estimated Costs to Complete and Sell: $10,000
 Net Realizable Value (NRV): $90,000 - $10,000 = $80,000
 Write-Down Amount: $100,000 - $80,000 = $20,000
 The inventory would be written down by $20,000, and this
write-down would be recognized as an expense in the
period it occurs.
Compliance with Standards
 IFRS (IAS 2 – Inventories): Provides comprehensive
guidance on the determination of inventory costs, expense
recognition, and write-down to NRV.
 GAAP (ASC 330 – Inventory): Similar guidance is provided
under GAAP, with specific requirements and methodologies.
EXAMPLES
 Weighted Average Cost (WAC)
Inventory Method
Detailed Example
The Weighted Average Cost (WAC) method calculates the
cost of inventory by averaging the cost of all similar
goods available during the period. This method
smooths out price fluctuations over the period.
Example Scenario:
Company: ABC Retailers
Inventory Transactions:
1. Beginning Inventory: 100 units @ $10 each
2. Purchases During the Period:
Purchase 1: 200 units @ $12 each
Purchase 2: 150 units @ $15 each
3. Sales During the Period:
Sale 1: 250 units
Sale 2: 100 units
 Steps to Calculate Weighted
Average Cost:
1. Calculate the Total Cost and Total Units Available:
Beginning Inventory: 100 units @ $10 each =
$1,000
First Purchase: 200 units @ $12 each = $2,400
Second Purchase: 150 units @ $15 each = $2,250
Total Units Available:
100 (beginning) + 200 (first purchase) + 150
(second purchase) = 450 units Total Cost of
Inventory: $1,000 (beginning) + $2,400 (first
purchase) + $2,250 (second purchase) = $5,650
 Applying WAC to Sales:
Sale 1: 250 units
Cost of Goods Sold (COGS) for Sale 1 = 250
units * $12.56/unit = $3,140
Sale 2: 100 units
Cost of Goods Sold (COGS) for Sale 2 = 100
units * $12.56/unit = $1,256
Summary of Costs:
Total Cost of Goods Sold (COGS) for the Period:
COGS for Sale 1: $3,140
COGS for Sale 2: $1,256
Total COGS: $3,140 + $1,256 = $4,396
Remaining Inventory Calculation:

Units Remaining After Sales:

Total Units Available: 450 units
Total Units Sold: 250 + 100 = 350 units
Units Remaining: 450 - 350 = 100 units

Cost of Remaining Inventory:

Remaining Units: 100 units
Weighted Average Cost Per Unit: $12.56
Total Cost of Remaining Inventory: 100 units
* $12.56/unit = $1,256
Visual Representation of WAC
Process
Initial Inventory and Purchases:
 Explanation:
The Weighted Average Cost method
distributes the cost evenly across all
units, making it less susceptible to price
fluctuations.
This method ensures that all units carry the
same cost, which simplifies accounting
and provides a consistent value for
inventory and COGS.
It is particularly useful in industries where
inventory items are indistinguishable
from each other and where prices
fluctuate frequently.