FACR – ICMAP ML2 (F-21) Ch # 03 – IAS 02
IAS 02 – INVENTORIES
OBJECTIVE:
Key issue in accounting for inventories is the amount of cost to be recognized as an asset and carried
forward until the related revenues are recognized.
SCOPE:
The following items are not covered under IAS 02.
a) Work in progress under long-term constructions contracts – IFRS 15.
b) Financial instruments (i.e. shares, bonds) – IFRS 09.
c) Biological assets (agricultural produce / livestock) – IAS 41.
INVENTORY DEFINED:
Inventories are assets:
FINISHED GOODS WORK – IN – PROCESS RAW MATERIALS
In the form of materials or
Held for sale in the ordinary In the process of production for supplies to be consumed in the
course of business; such sale; or production process or in the
rendering of services.
Purpose of holding defines the treatment of item: same item can be inventory or PP&E.
INITIAL RECOGNITION:
Inventory is initially measured at “cost”. Capitalized cost is the sum of the following:
a) Purchase Price / list price net of trade discounts and rebates. (Trade discount is allowed at the time
of transaction and cash discount (settlement) discount is allowed at the time of payment.)
b) Cost of conversion. (e.g. direct labor, direct expenses and FOH based on normal capacity)
c) Other – desired location and condition for sale (e.g. freight-in, borrowing costs as per IAS 23 and
non-refundable taxes, insurance in-transit)
Following items are excluded:
• Abnormal loss. • Selling, marketing and administrative expenses.
• Post production storage expenses. • Settlement discounts.
• Refundable taxes. • Fire insurance.
EXERCISE # 01: COST OF INVENTORIES
J Ltd incurred the following costs in relation to inventories during 2019:
Raw material Rs.56,000, Direct Labor Rs.40,000, Cost of wasted material Rs.6,000, transportation cost
of raw material to factory Rs.10,000, transportation cost of factory to showroom Rs.1,000, transportation
cost of showroom to customer premises Rs.2,000.
Required:
Calculate the cost of inventories to be capitalized.
[Answer: Rs.106,000/-]
EXERCISE # 02: COST OF INVENTORIES
Mario has incurred the following costs in relation to a unit of inventory:
Raw materials cost 1.50, Import duties 0.40, Direct labour 0.50, Subcontracted labour costs 0.80,
Recoverable sales tax 0.20, Storage costs 0.05, Production overheads (per unit) 0.25, There was a
problem with the first batch of items produced, so abnormal wastage costs of Rs.0.10 per unit have also
been incurred by Mario.
Required:
At what cost should Mario value this inventory in its financial statements?
[Answer: Rs.3.45 per unit]
Prepared by: M. Umar Munir (Gold Medalist), FCMA, MS Finance
FACR – ICMAP ML2 (F-21) Ch # 03 – IAS 02
SUBSEQUENT MEASUREMENT:
Due to the application of prudence concept, inventory is valued as LOWER of (a) cost and (b) NRV.
NOTES:
• Inventories are usually written down to net realizable value item by item.
• Re-assess at the end of each reporting period.
• Reversal of write-down is possible.
CIRCUMSTANCES WHEN NRV COULD BE LOWER THAN COST:
EXERCISE # 03: COST VS. NRV
On 31 December 2015, a company has partly-completed inventory with a cost to date of Rs.26,300. It is
expected that further costs of Rs.8,900 will be incurred in order to complete the inventory. It will then be
sold for Rs.47,500. Selling costs will be Rs.2,000.
Required:
Calculate the cost and the net realisable value of this inventory at 31 December 2015.
[Answer: NRV Rs.36,600]
EXERCISE # 04: COST VS. NRV
At the end of an accounting period, the cost of a company's inventory is Rs.450,000. This includes
damaged items with a cost of Rs.25,000 which are expected to be sold for only Rs.10,000 (less selling
expenses of 5%). All other items of inventory have a net realisable value which exceeds cost.
Required:
Calculate the amount of inventory that is to be reported at the end of financial period.
[Answer: Rs.434,500]
EXERCISE # 05: COST VS. NRV
On 30 September 20X4 Razor’s closing inventory was counted and valued at its cost of Rs.1 million. This
included some items of inventory which had cost Rs.210,000 and had been damaged in a flood on 15
September 20X4. These are not expected to achieve their normal selling price which is calculated to
achieve a gross profit margin of 30%. The sale of these goods will be handled by an agent who sells them
at 80% of the normal selling price and charges Razor a commission of 25%.
Required:
At what value will the closing inventory of Razor be reported in its statement of financial position as at 30
September 20X4?
[Answer: Rs.970,000]
Prepared by: M. Umar Munir (Gold Medalist), FCMA, MS Finance
FACR – ICMAP ML2 (F-21) Ch # 03 – IAS 02
EXERCISE # 06: COST OF INVENTORY TO BE REPORTED
ABC Co. has the following items in inventory:
1) Goods purchased for resale at a cost of Rs.40,000. The recent downturn in the economy has meant
that these goods will now sell for Rs.42,000 with costs to sell of Rs.2,500.
2) Materials purchased at a cost of Rs.30,000 per tonne which will be sold at a profit. The manufacturer
of the materials has just announced that from now on they will sell these materials to you at a lower
price of Rs.28,000 per tonne.
3) Plant constructed for a specific customer at a cost of Rs.50,000 and an agreed price to the customer
of Rs.60,000. New health and safety requirements mean that the plant will need to be modified at a
cost to ABC Co. of Rs.4,000 before it can be delivered to the customer.
Required:
At what value should each of the above be included in the inventory of ABC Co.
[Answer:1) Rs.39,500, 2) Rs.30,000, 3) Rs.50,000]
COST FORMULAS:
Interchangeable Goods Non-Interchangeable Goods
FIFO or Weighted Average (LIFO is not allowed) Specific Identification Methods
EXERCISE # 07: INVENTORY LOSSES WRITE DOWN
Component A1 was carried at a cost of Rs.8,000 but its NRV was estimated to be Rs.7,300.
Required:
Record the write down of the losses under each case separately:
a) Perpetual inventory system is used.
b) Periodic inventory system is used.
[Answer: DIY]
CONSISTENCY IN APPLICATION:
IAS 2 provides that an entity should use the same cost formula for all inventories having similar nature
and use to the entity.
RECOGNITION AS AN EXPENSE:
• When inventories are sold, the carrying amount of those inventories shall be recognized as an
expense in the period in which the related revenue is recognized.
• The amount of any write-down of inventories to net realizable value and all losses of inventories shall
be recognized 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
realizable value, shall be recognized as a reduction in the amount of inventories recognized as an
expense in the period in which the reversal occurs.
DISCLOSURES:
The financial statements shall disclose:
a) the accounting policies adopted in measuring inventories, including the cost formula used;
b) the total carrying amount of inventories and the carrying amount in classifications appropriate to the
entity;
c) the carrying amount of inventories carried at fair value less costs to sell;
d) the amount of inventories recognized as an expense during the period;
e) the amount of any write-down of inventories recognised as an expense in the period.
f) the amount of any reversal of any write-down that is recognized as a reduction in the amount of
inventories recognised as expense in the period.
g) the circumstances or events that led to the reversal of a write-down of inventories.
h) the carrying amount of inventories pledged as security for liabilities.
Prepared by: M. Umar Munir (Gold Medalist), FCMA, MS Finance
