Types of Inventories
IAS 2 classifies inventories into three main categories:
- Finished Goods: Completed products ready for sale.
- Work-in-Progress (WIP): Partially completed goods that are still in the production process.
- Raw Materials and Supplies: Items used in the production of finished goods.
Main Discussion
Measurement of Inventories
Under IAS 2, inventories are measured at the lower of cost and net realizable value (NRV):
- Cost includes all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.
- Net Realizable Value (NRV) is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the costs necessary to make the sale.
Cost Formulas
IAS 2 permits the following cost formulas to allocate inventory costs:
- First-In, First-Out (FIFO): Assumes that the earliest goods purchased are the first to be sold.
- Weighted Average Cost: Calculates an average cost for all inventory items and applies it uniformly.
Note: The Last-In, First-Out (LIFO) method is explicitly prohibited under IAS 2.
Exclusions from Cost of Inventory
Certain costs are excluded from the cost of inventory:
- Abnormal waste.
- Storage costs (unless necessary in the production process).
- Administrative overheads not related to production.
- Selling costs.
Recognition as 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.
Disclosure Requirements
IAS 2 mandates disclosure of:
- Accounting policies adopted for measuring inventories.
- Carrying amounts of inventories, classified appropriately.
- The amount of inventories recognized as an expense during the period.
- Any write-downs to NRV or reversals.
Real-Life Example
A manufacturing company, XYZ Ltd., produces and sells furniture. As of December 31, 2023, its inventory includes:
- Raw materials (wood, nails): BDT 500,000.
- Work-in-progress (partially assembled chairs): BDT 300,000.
- Finished goods (tables and chairs ready for sale): BDT 700,000.
XYZ Ltd. calculates its inventory cost using the FIFO method and reports its inventory at the lower of cost or NRV. During 2023, an inventory write-down of BDT 50,000 was recognized due to damage to some finished goods, which was disclosed in its financial statements.
Conclusion
IAS 2 plays a critical role in ensuring that inventory is accurately valued and fairly presented in financial statements. By adhering to its principles, organizations provide stakeholders with transparent and reliable information. Proper implementation of IAS 2 supports better decision-making and enhances trust in the financial reporting process.