IAS 2 – Inventories

Excerpt: IAS 2 Inventories explains how inventories should be measured, valued, and disclosed in financial statements. This article breaks down key principles, cost formulas, and provides sample exam questions with answers.

IAS 2 Inventories – Accounting Treatment, Measurement & Exam Questions

IAS 2 Inventories is one of the fundamental IFRS standards, guiding how inventories are valued and presented in financial statements. It prescribes the accounting treatment for inventories, including their measurement, cost components, cost formulas, and write-downs to Net Realisable Value (NRV).

Before you dive in, make sure to check our detailed guide on IAS 1 Presentation of Financial Statements, which explains the structure and disclosure framework of IFRS-compliant financial statements.

Overview of IAS 2 Inventories

IAS 2 provides guidance on the determination of inventory cost and its subsequent recognition as an expense. It ensures that inventories are properly valued and prevents overstated assets by requiring measurement at the lower of cost and net realisable value (NRV).

Definition of Inventories

  • Held for sale in the ordinary course of business
  • In the process of production for such sale
  • In the form of materials or supplies to be consumed in production or service delivery

Scope of IAS 2

IAS 2 applies to all inventories except for:

  • Construction contracts (IAS 11)
  • Financial instruments (IAS 32 & IAS 39)
  • Biological assets (IAS 41 Agriculture)

It also does not apply to inventories held by:

  • Producers of agricultural or forest products measured at NRV
  • Mineral producers measured at NRV
  • Commodity brokers who measure inventories at fair value less costs to sell

Measurement of Inventories

Inventories are measured at the lower of cost and net realisable value (NRV). This serves as an implicit impairment test — hence, inventories are excluded from the scope of IAS 36 Impairment of Assets.

Cost of Inventories Includes:

  • Cost of purchase (including import duties, transport, and handling)
  • Costs of conversion (labour and overheads)
  • Other costs to bring inventory to its present condition and location

Cost Excludes:

  • Abnormal waste
  • Storage costs (unless part of production)
  • Administrative overheads not related to production
  • Selling and distribution costs
  • Interest and financing costs (except in rare cases under IAS 23 Borrowing Costs)

Cost Formulas

IAS 2 allows specific methods for assigning costs to inventories:

  • Specific Identification: Used for non-interchangeable items (e.g., luxury vehicles).
  • FIFO (First-In, First-Out): Assumes oldest inventory items are sold first.
  • Weighted Average Cost: Calculates cost based on average of all similar items.

LIFO (Last-In, First-Out) is not permitted under IFRS.

Measurement Techniques

  • Standard Cost Method: Uses normal levels of materials, labour, and efficiency. Reviewed periodically for accuracy.
  • Retail Method: Commonly used by retailers with many similar items. Determines cost by deducting average gross margin from sales value.

Net Realisable Value (NRV)

NRV is the estimated selling price in the ordinary course of business, less costs of completion and selling. If NRV falls below cost, the inventory must be written down, and the loss is recognized as an expense.

Disclosure Requirements under IAS 2

  • Accounting policies adopted for inventories
  • Total carrying amount and classification (raw materials, WIP, finished goods)
  • Amount of inventories recognized as an expense (cost of sales)
  • Amount of write-downs recognized or reversed
  • Carrying amount of inventories pledged as security

Exam Practice Questions on IAS 2 (with Solutions)

Question 1

ABC Ltd purchased inventory for GHS 50,000. Due to market decline, the selling price is estimated at GHS 48,000, with completion and selling costs of GHS 2,500. At what value should inventory be measured?

Solution:
NRV = GHS 48,000 – GHS 2,500 = GHS 45,500
Lower of cost (50,000) and NRV (45,500) = GHS 45,500.
→ Inventory should be written down by GHS 4,500.

Question 2

XYZ Manufacturing Ltd applies the FIFO method. At the year-end, it had 500 units purchased at GHS 8 and 400 units at GHS 10. If 600 units are sold, what is the cost of goods sold (COGS)?

Solution:
First 500 units @ GHS 8 = GHS 4,000
Next 100 units @ GHS 10 = GHS 1,000
→ COGS = GHS 5,000.
Remaining inventory = 300 units @ GHS 10 = GHS 3,000.

Question 3

State two reasons why inventories should be measured at the lower of cost and NRV.

  • To prevent overstatement of assets on the statement of financial position.
  • To ensure compliance with prudence and faithful representation principles.

Conclusion

IAS 2 ensures that inventory values reflect their true economic worth and prevents overstatement of profits. It is essential for students and professionals preparing for ICAG, ACCA, or CITG exams to master this standard alongside IAS 1 Presentation of Financial Statements and IAS 7 Statement of Cash Flows.

Stay tuned for our next post on IAS 7 – Statement of Cash Flows, where we’ll explore classification of cash flows and key exam scenarios.

Comments are closed.