IAS 2 Inventories requires inventories to be measured at the lower of cost and net realisable value (NRV), so that inventory is never carried in the financial statements at more than the amount actually expected to be realised from its sale.
What Qualifies as Inventory Under IAS 2?
The Standard defines inventories as assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services. Net realisable value is defined as 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.
The Core Measurement Rule: Lower of Cost and NRV
The Standard states expressly that inventories shall be measured at the lower of cost and net realisable value. This rule rests on the principle that assets should not be carried in the financial statements at an amount exceeding what is expected to be realised from their sale or use.
What Does the Cost of Inventories Include?
The Standard provides that 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 comprise the purchase price, import duties and other taxes, other than those subsequently recoverable by the entity from the taxing authorities.
- They also include 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.
When Is the Cost of Inventories Not Recoverable?
The Standard notes that 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. In such cases, the carrying amount is written down to net realisable value if that value is lower than cost.
Can a Write-Down of Inventories Be Reversed Later?
Yes. 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 realisable value because of changed economic circumstances, the amount of the write-down is reversed, 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 realisable value.
Illustrative example (assumed figures): Assume an entity purchased a batch of goods at a cost of 100 monetary units, and its expected selling price fell to 90 units, with estimated costs necessary to complete the sale (such as marketing and shipping) of 5. Net realisable value would then be 90 − 5 = 85. Since 85 is lower than the cost of 100, the inventory is written down to 85, and the difference of 15 is recognised as a write-down loss in that period.
Legal References
- IAS 2 — Inventories, paragraph 6 (definitions of inventories and net realisable value)
- IAS 2 — Inventories, paragraph 9 (lower of cost and NRV rule)
- IAS 2 — Inventories, paragraphs 10 and 11 (components of the cost of inventories)
- IAS 2 — Inventories, paragraph 28 (reasons the cost may not be recoverable)
- IAS 2 — Inventories, paragraph 33 (reversal of a write-down)
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