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Inventories
IAS 2

Objective

► Objective of IAS 2 is to prescribe the accounting treatment for inventories

► IAS 2 provides guidance on:
► Cost determination

► Subsequent recognition as an expense

► Cost formulas used to assign costs to inventories

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What are ‘inventories’?

Inventories

Assets that are held for sale in the ordinary course of business

Assets that are in the process of production for such sale

Assets that are in the form of materials or supplies to be consumed in the production process or rendering of services

Initial recognition

Inventories are initially recognised at cost

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Subsequent measurement

Inventories are subsequently measured at lower of cost or Net Realisable Value

Net realisable value (NRV) is the estimated selling price in ordinary course of business less the estimated cost of
completion and estimated costs necessary to make the sale

Cost

Cost includes all costs involved in bringing the inventories to their present Deferred settlement terms
location and condition.
► Difference between purchase
price for normal credit terms
Cost and amount paid
► recognised as interest
expense over the period of
financing
Purchase costs Conversion Costs Other Costs

► Purchase price ► Direct production costs ► Only if incurred in

► Non-refundable import ► Systematic allocation of bringing inventories to
duties and taxes production overheads present location and
► Transport & handling ► Special consideration for condition
charges joint products and by- ► Borrowing costs in limited
► Other directly attributable products circumstances
costs (as per IAS 23)
► Deduct trade discounts/
rebates/ similar items

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Cost

Exclusions

► Abnormal amounts of wasted materials, labor and other production costs

► Storage costs unless necessary to the production process
► Administrative overheads*
► Selling costs

* that do not contribute to bringing inventories to their present location and condition

Cost formulas

Specific Identification
► Specific identification of individual costs is required for:
► Items not ordinarily interchangeable; and
► Goods/services produced and segregated for specific projects.

FIFO
► Assumes that items purchased (or manufactured) first are sold first.
► Therefore inventory at period end is most recently purchased or produced.

Weighted- Average Cost

► Weighted average cost is calculated from the cost of:
► Items at beginning of period; and
► Cost of similar items purchased/produced during the period.

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Consistency: different cost formulas for inventories

Different cost formula may be

Same cost formula for all inventories
justified for inventories with
having similar nature and use
different nature or use

Apply treatment consistently once chosen

Cost formulas

Example
► Inventories used in one operating segment may have a different use from the same type of inventories
used in another operating segment. However, a difference in geographical location of inventories (or in
the respective tax rules), by itself, is not sufficient to justify the use of different cost formulas

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Measurement techniques alternative to actual cost

Standard Cost Retail Method

► Takes into account normal levels of materials, labor, ► For inventories of large numbers of rapidly changing
efficiency and capacity utilisation items with similar margins (retail industry)

► It should be regularly reviewed and revised, ► Cost is determined by reducing the sales value
if necessary by appropriate percentage gross margin

These techniques may be used for convenience if the results approximate cost

Case study 1

ABC sells watches and its valuing its inventory at FIFO cost price
at 31st December.
Transactions held are given below:
► Purchases:
March 10 x $15 each = $150
May 20 x $20 each = $400
November 15 x $25 each = $375
► Sales:
April 8 x $30 each = $240
October 15 x $40 each = $600
Determine the value of closing inventory at 31st December 2014.

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Solution

Sales in April 8x15 = 120

Balance in April 2x15 = 30
Purchases in May 20x20 = 400
Balance in May 2x15 + 20x20 = 430

Sales in October:
From April Stock 2x15 = 30
From May Stock 13x20 = 260
Balance in October 7x20 = 140
Purchase in November 15x25 = 375
Balance in November 7x20 + 15x25 = 515

Net realisable value (‘NRV’)

► Estimates of net realisable value should also consider:

► fluctuations of price or cost directly relating to events after the period end to the extent such events confirm
conditions existing at period end
► purpose for which inventory is held

► A review of NRV of all inventories should be made in each period.

► Item by item review to be done for write-down to NRV

► appropriate to group similar/ related items in some circumstances

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Case study 2

► X Inc. has 100 switchboards in stock at the balance sheet date, 31st December 2014. The switchboards are valued
at net realisable value since their cost of manufacturing is very high.
► X Inc. had entered into an agreement on 28th December 2014 to sell 60 switchboards at $50 on
5th January 2015.
► Remaining 40 switchboards are expected to be sold in the following month when the price is expected to be at $48
each.
► The sale price of these switchboards as on 31st December 2014 was $45 each.
► Determine the value of stock at 31st December 2014.

Solution

► Value of 60 switchboards at $ 50 =$ 3000

► Value of 40 switchboards at $ 48 =$ 1920
► Value of stock at 31st December 2014 = $ 4,920

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Case study 4

► Company P, a cabinet manufacturer, has 100 units of raw material timber inventory on hand at 31December 2012
with a carrying amount of 100. The current market value of that timber is 95.
► P intends to use the timber to manufacture cabinets. P estimates costs to completion and sale of 50 and a selling
price for the cabinets of 160.

What is the Net realizable value of the inventory?

Solution

► Net realizable value of timber

= Sale price – cost to completion and sale

= 160 – 50
= 110
Carrying value = 100
No loss. Inventory will be kept at 100

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Recognition criteria

As an expense As an asset
► When inventories are sold, their carrying amount is ► Inventory allocated to other asset, e.g., self-constructed
recognised as an expense in the period in which related PPE is recognised as an expense during the useful life of
revenue is recognised. that asset

► Any write-down to NRV or reversal of write-down is ► Consignment inventory

recognised as an expense in the period in which they occur

Disclosure in financial statements

► Accounting policies adopted in measuring inventories, including the cost formula used
► Total carrying amount – in appropriate classifications
► Carrying amount at fair value less costs to sell
► Carrying amount of inventories pledged as security for liabilities
► The amount of inventories recognised as an expense
► The amount of any write-down or any reversal of write-down and events that led to reversal of write-
down

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Key differences

► No GAAP difference between IAS 2 and Ind AS 2

Key differences

Issue IAS 2 IGAAP

Purchase price under normal terms less The cost will be the purchase price under deferred credit
actual price paid under deferred terms is terms.
recognized as Interest expense.
Deferred Settlement terms

► Reversal is permitted if circumstances No specific guidance provided in AS 2 for reversal of write-

that previously caused inventories to be down of inventories.
Reversal of Write-down of written down no longer exist.
Inventory
► Reversal is limited to the amount of
original write-down.

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Thank You

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