Inventories

In April 2001 the International Accounting Standards Board (Board) adopted IAS 2
Inventories, which had originally been issued by the International Accounting Standards
Committee in December 1993. IAS 2 Inventories replaced IAS 2 Valuation and Presentation of
Inventories in the Context of the Historical Cost System (issued in October 1975).
In December 2003 the Board issued a revised IAS 2 as part of its initial agenda of
technical projects. The revised IAS 2 also incorporated the guidance contained in a
related Interpretation (SIC-1 Consistency—Different Cost Formulas for Inventories).
Other Standards have made minor consequential amendments to IAS 2. They include
IFRS 13 Fair Value Measurement (issued May 2011), IFRS 9 Financial Instruments (Hedge
Accounting and amendments to IFRS 9, IFRS 7 and IAS 39) (issued November 2013),
IFRS 15 Revenue from Contracts with Customers (issued May 2014), IFRS 9 Financial
Instruments (issued July 2014) and IFRS 16 Leases (issued January 2016).

International Accounting Standard 2 Inventories (IAS 2) is set out in paragraphs
1–42 and the Appendix. All the paragraphs have equal authority but retain the IASC
format of the Standard when it was adopted by the IASB. IAS 2 should be read in the
context of its objective and the Basis for Conclusions, the Preface to IFRS Standards and
the Conceptual Framework for Financial Reporting. IAS 8 Accounting Policies, Changes in
Accounting Estimates and Errors provides a basis for selecting and applying accounting
policies in the absence of explicit guidance.

International Accounting Standard 2
Inventories

Objective

The objective of this Standard is to prescribe the accounting treatment for
inventories. A primary 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. This Standard provides guidance on the
determination of cost and its subsequent recognition as an expense, including
any write-down to net realizable value. It also provides guidance on the cost
formulas that are used to assign costs to inventories.

Scope

This Standard applies to all inventories, except:
(a) [deleted]
(b) financial instruments (see IAS 32 Financial Instruments:
Presentation and IFRS 9 Financial Instruments); and
(c) biological assets related to agricultural activity and agricultural
produce at the point of harvest (see IAS 41 Agriculture).
This Standard does not apply to the measurement of inventories held by:
(a) producers of agricultural and forest products, agricultural produce
after harvest, and minerals and mineral products, to the extent that
they are measured at net realizable value in accordance with
well-established practices in those industries. When such
inventories are measured at net realizable value, changes in that
value are recognized in profit or loss in the period of the change.
(b) commodity broker-traders who measure their inventories at fair
value less costs to sell. When such inventories are measured at fair
value less costs to sell, changes in fair value less costs to sell are
recognized in profit or loss in the period of the change.
The inventories referred to in paragraph 3(a) are measured at net realizable
value at certain stages of production. This occurs, for example, when
agricultural crops have been harvested or minerals have been extracted and
sale is assured under a forward contract or a government guarantee, or when
an active market exists and there is a negligible risk of failure to sell. These
inventories are excluded from only the measurement requirements of this
Standard.
Broker-traders are those who buy or sell commodities for others or on their
own account. The inventories referred to in paragraph 3(b) are principally
acquired with the purpose of selling in the near future and generating a profit
from fluctuations in price or broker-traders’ margin. When these inventories are measured at fair value less costs to sell, they are excluded from only the
measurement requirements of this Standard.

Definitions

The following terms are used in this Standard with the meanings specified:
Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the
production process or in the rendering of services.
Net realizable value 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.
Fair value is the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date. (See IFRS 13 Fair Value Measurement.)
Net realizable value refers to the net amount that an entity expects to realize
from the sale of inventory in the ordinary course of business. Fair value
reflects the price at which an orderly transaction to sell the same inventory in
the principal (or most advantageous) market for that inventory would take
place between market participants at the measurement date. The former is an
entity-specific value; the latter is not. Net realizable value for inventories may
not equal fair value less costs to sell.
Inventories encompass goods purchased and held for resale including, for
example, merchandise purchased by a retailer and held for resale, or land and
other property held for resale. Inventories also encompass finished goods
produced, or work in progress being produced, by the entity and include
materials and supplies awaiting use in the production process. Costs incurred
to fulfil a contract with a customer that do not give rise to inventories (or
assets within the scope of another Standard) are accounted for in accordance
with IFRS 15 Revenue from Contracts with Customers.

Measurement of inventories

Inventories shall be measured at the lower of cost and net realizable value.

Cost of inventories

The cost of inventories shall comprise all costs of purchase, costs of
conversion and other costs incurred in bringing the inventories to their
present location and condition.

Costs of purchase

The costs of purchase of inventories comprise the purchase price, import
duties and other taxes (other than those subsequently recoverable by the
entity from the taxing authorities), and 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

The costs of conversion of inventories include costs directly related to the
units of production, such as direct labor. They also include a systematic
allocation of fixed and variable production overheads that are incurred in
converting materials into finished goods. Fixed production overheads are
those indirect costs of production that remain relatively constant regardless of
the volume of production, such as depreciation and maintenance of factory
buildings, equipment and right-of-use assets used in the production process,
and the cost of factory management and administration. Variable production
overheads are those indirect costs of production that vary directly, or nearly
directly, with the volume of production, such as indirect materials and
indirect labor.
The allocation of fixed production overheads to the costs of conversion is
based on the normal capacity of the production facilities. Normal capacity is
the production expected to be achieved on average over a number of periods
or seasons under normal circumstances, taking into account the loss of
capacity resulting from planned maintenance. The actual level of production
may be used if it approximates normal capacity. The amount of fixed
overhead allocated to each unit of production is not increased as a
consequence of low production or idle plant. Unallocated overheads are
recognized as an expense in the period in which they are incurred. In periods
of abnormally high production, the amount of fixed overhead allocated to
each unit of production is decreased so that inventories are not measured
above cost. Variable production overheads are allocated to each unit of
production on the basis of the actual use of the production facilities.
A production process may result in more than one product being produced
simultaneously. This is the case, for example, when joint products are
produced or when there is a main product and a by-product. When the costs
of conversion of each product are not separately identifiable, they are
allocated between the products on a rational and consistent basis. The
allocation may be based, for example, on the relative sales value of each
product either at the stage in the production process when the products
become separately identifiable, or at the completion of production. Most
by-products, by their nature, are immaterial. When this is the case, they are
often measured at net realizable value and this value is deducted from the cost
of the main product. As a result, the carrying amount of the main product is
not materially different from its cost.

Other costs

Other costs are included in the cost of inventories only to the extent that they
are incurred in bringing the inventories to their present location and
condition. For example, it may be appropriate to include non-production
overheads or the costs of designing products for specific customers in the cost
of inventories.
Examples of costs excluded from the cost of inventories and recognized as
expenses in the period in which they are incurred are:
(a) abnormal amounts of wasted materials, labor or other production
costs;
(b) storage costs, unless those costs are necessary in the production
process before a further production stage;
(c) administrative overheads that do not contribute to bringing
inventories to their present location and condition; and
(d) selling costs.
IAS 23 Borrowing Costs identifies limited circumstances where borrowing costs
are included in the cost of inventories.
An entity may purchase inventories on deferred settlement terms. When the
arrangement effectively contains a financing element, that element, for
example a difference between the purchase price for normal credit terms and
the amount paid, is recognized as interest expense over the period of the
financing.
[Deleted]

Cost of agricultural produce harvested from biological assets

In accordance with IAS 41 Agriculture inventories comprising agricultural
produce that an entity has harvested from its biological assets are measured
on initial recognition at their fair value less costs to sell at the point of
harvest. This is the cost of the inventories at that date for application of this
Standard.

Techniques for the measurement of cost

Techniques for the measurement of the cost of inventories, such as the
standard cost method or the retail method, may be used for convenience if the
results approximate cost. Standard costs take into account normal levels of
materials and supplies, labor, efficiency and capacity utilization. They are
regularly reviewed and, if necessary, revised in the light of current conditions.
The retail method is often used in the retail industry for measuring
inventories of large numbers of rapidly changing items with similar margins
for which it is impracticable to use other costing methods. The cost of the
inventory is determined by reducing the sales value of the inventory by the
appropriate percentage gross margin. The percentage used takes into consideration inventory that has been marked down to below its original
selling price. An average percentage for each retail department is often used.

Cost formulas

The cost of inventories of items that are not ordinarily interchangeable and
goods or services produced and segregated for specific projects shall be
assigned by using specific identification of their individual costs.
Specific identification of cost means that specific costs are attributed to
identified items of inventory. This is the appropriate treatment for items that
are segregated for a specific project, regardless of whether they have been
bought or produced. However, specific identification of costs is inappropriate
when there are large numbers of items of inventory that are ordinarily
interchangeable. In such circumstances, the method of selecting those items
that remain in inventories could be used to obtain predetermined effects on
profit or loss.
The cost of inventories, other than those dealt with in paragraph 23, shall
be assigned by using the first-in, first-out (FIFO) or weighted average cost
formula. An entity shall use the same cost formula for all inventories
having a similar nature and use to the entity. For inventories with a
different nature or use, different cost formulas may be justified.
For example, inventories used in one operating segment may have a use to the
entity different 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.
The FIFO formula assumes that the items of inventory that were purchased or
produced first are sold first, and consequently the items remaining in
inventory at the end of the period are those most recently purchased or
produced. Under the weighted average cost formula, the cost of each item is
determined from the weighted average of the cost of similar items at the
beginning of a period and the cost of similar items purchased or produced
during the period. The average may be calculated on a periodic basis, or as
each additional shipment is received, depending upon the circumstances of
the entity.

Net realizable value

The cost of inventories may not be recoverable if those inventories are
damaged, if they have become wholly or partially obsolete, or if their selling
prices have declined. The cost of inventories may also not be recoverable if the
estimated costs of completion or the estimated costs to be incurred to make
the sale have increased. The practice of writing inventories down below cost to
net realizable value is consistent with the view that assets should not be
carried in excess of amounts expected to be realized from their sale or use.

Inventories are usually written down to net realizable value item by item. In
some circumstances, however, it may be appropriate to group similar or
related items. This may be the case with items of inventory relating to the
same product line that have similar purposes or end uses, are produced and
marketed in the same geographical area, and cannot be practicably evaluated
separately from other items in that product line. It is not appropriate to write
inventories down on the basis of a classification of inventory, for example,
finished goods, or all the inventories in a particular operating segment.
Estimates of net realizable value are based on the most reliable evidence
available at the time the estimates are made, of the amount the inventories
are expected to realize. These estimates take into consideration fluctuations of
price or cost directly relating to events occurring after the end of the period to
the extent that such events confirm conditions existing at the end of the
period.
Estimates of net realizable value also take into consideration the purpose for
which the inventory is held. For example, the net realizable value of the
quantity of inventory held to satisfy firm sales or service contracts is based on
the contract price. If the sales contracts are for less than the inventory
quantities held, the net realizable value of the excess is based on general
selling prices. Provisions may arise from firm sales contracts in excess of
inventory quantities held or from firm purchase contracts. Such provisions
are dealt with under IAS 37 Provisions, Contingent Liabilities and Contingent Assets.
Materials and other supplies held for use in the production of inventories are
not written down below cost if the finished products in which they will be
incorporated are expected to be sold at or above cost. However, when a decline
in the price of materials indicates that the cost of the finished products
exceeds net realizable value, the materials are written down to net realizable
value. In such circumstances, the replacement cost of the materials may be
the best available measure of their net realizable value.
A new assessment is made of net realizable value in each subsequent period.
When the circumstances that previously caused inventories to be written
down below cost no longer exist or when there is clear evidence of an increase
in net realizable value because of changed economic circumstances, the
amount of the write-down is reversed (ie the reversal is limited to the amount
of the original write-down) so that the new carrying amount is the lower of
the cost and the revised net realizable value. This occurs, for example, when
an item of inventory that is carried at net realizable value, because its selling
price has declined, is still on hand in a subsequent period and its selling price
has increased.

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.
Some inventories may be allocated to other asset accounts, for example,
inventory used as a component of self-constructed property, plant or
equipment. Inventories allocated to another asset in this way are recognized as
an expense during the useful life of that asset.

Disclosure

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 recognized as an
expense in the period in accordance with paragraph 34;
(f) the amount of any reversal of any write-down that is recognized as a
reduction in the amount of inventories recognized as expense in the
period in accordance with paragraph 34;
(g) the circumstances or events that led to the reversal of a write-down
of inventories in accordance with paragraph 34; and
(h) the carrying amount of inventories pledged as security for
liabilities.
Information about the carrying amounts held in different classifications of
inventories and the extent of the changes in these assets is useful to financial
statement users. Common classifications of inventories are merchandise,
production supplies, materials, work in progress and finished goods.
The amount of inventories recognized as an expense during the period, which
is often referred to as cost of sales, consists of those costs previously included
in the measurement of inventory that has now been sold and unallocated
production overheads and abnormal amounts of production costs of
inventories. The circumstances of the entity may also warrant the inclusion of
other amounts, such as distribution costs.
Some entities adopt a format for profit or loss that results in amounts being
disclosed other than the cost of inventories recognized as an expense during
the period. Under this format, an entity presents an analysis of expenses using
a classification based on the nature of expenses. In this case, the entity
discloses the costs recognized as an expense for raw materials and consumables, labor costs and other costs together with the amount of the
net change in inventories for the period.

Effective date

An entity shall apply this Standard for annual periods beginning on or after
1 January 2005. Earlier application is encouraged. If an entity applies this
Standard for a period beginning before 1 January 2005, it shall disclose that
fact.
[Deleted]
[Deleted]
IFRS 13, issued in May 2011, amended the definition of fair value in
paragraph 6 and amended paragraph 7. An entity shall apply those
amendments when it applies IFRS 13.
[Deleted]
IFRS 15 Revenue from Contracts with Customers, issued in May 2014, amended
paragraphs 2, 8, 29 and 37 and deleted paragraph 19. An entity shall apply
those amendments when it applies IFRS 15.
IFRS 9, as issued in July 2014, amended paragraphs 2 and deleted
paragraphs 40A, 40B and 40D. An entity shall apply those amendments when
it applies IFRS 9.
IFRS 16 Leases, issued in January 2016, amended paragraph 12. An entity shall
apply that amendment when it applies IFRS 16.

Withdrawal of other pronouncements

This Standard supersedes IAS 2 Inventories (revised in 1993).
This Standard supersedes SIC-1 Consistency—Different Cost Formulas for Inventories.

Appendix
Amendments to other pronouncements

The amendments in this appendix shall be applied for annual periods beginning on or after 1 January
2005. If an entity applies this Standard for an earlier period, these amendments shall be applied for
that earlier period.

* * * * *

The amendments contained in this appendix when this Standard was revised in 2003 have been
incorporated into the relevant pronouncements published in this volume.

Approval by the Board of IAS 2 issued in December 2003

International Accounting Standard 2 Inventories (as revised in 2003) was approved for issue
by the fourteen members of the International Accounting Standards Board.
Sir David Tweedie Chairman
Thomas E Jones Vice-Chairman
Mary E Barth
Hans-Georg Bruns
Anthony T Cope
Robert P Garnett
Gilbert Gélard
James J Leisenring
Warren J McGregor
Patricia L O’Malley
Harry K Schmid
John T Smith
Geoffrey Whittington
Tatsumi Yamada