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  1. 1. IAS 2: Inventories Roshankumar S Pimpalkarroshankumar.2007@rediffmail.com
  2. 2. Scope:This standard generally applies to all inventories.Exception:This standard does not apply to Work in progress (WIP) arising under construction contract. This is covered in IAS 11: Construction contract. Financial instrument. This is covered by IAS 32 and IAS 39. Inventories of agricultural and forest products, mineral ores and agricultural produce to the extent they are measured at net realisable value in accordance with well established practices in certain industries. Biological assets related to agricultural activity. This is covered by IAS 41: Agriculture Commodity brokers who measure their inventories at fair value less cost to sell.Definition of InventoryInventory is an asset which is Held for sale in ordinary course of business (finished goods or merchandise) In the process of production for such sale (WIP) In the form of material or supplies to be consumed in the production process (Raw material).Measurement of Inventory Cost of inventory: cost capitalised as inventory includes all the costs incurred directly or indirectly to bring the inventory at its present condition and location. The following are the components of cost included in measuring the inventory a. Cost of purchase b. Cost of conversion c. Other costs i. Cost of purchase include all the costs incurred in initial acquisition of inventory such as purchase price, shipping cost any import duty and taxes. If there are subsequent adjustments to the cost of purchase, such as rebate or cash discount, these should be adjusted. ii. Cost of conversion includes costs directly related to the units of production as well as systematic allocation of fixed and variable overheads. iii. Other costs are capitalised if it meets the condition of bringing the inventory to its present condition and location. Such as cost of transporting inventory form factory to its retail location. Certain non-production overheads like portion of plant managers salary is also allocated to inventory. Certain inventories take substantial period of time to get ready for its intended use or sale, in such circumstances borrowing cost may also be included in inventory (IAS 23: Borrowing cost)When inventories are sold, the carrying amounts of those inventories are recorded as an expense inthe period in which the related revenue is recognised.Main forms of inventoryroshankumar.2007@rediffmail.com
  3. 3. Raw materials are the materials that are used in production process. Work in Progress is the inventory for which the production is not complete yet. Finished goods are type of goods that are complete and ready for sale. Merchandize is goods that are purchased and held for resale eg. By retailerAmounts allocated to inventory:It includes labour and other costs of personnel directly involved in manufacturing. In case of serviceproviders, such costs are capitalised as inventory to the extent that the related revenue has not beenrecognised. It can also include allocated overheads.Inventories of Service Providers:Services providers primarily derive revenue by providing services, as opposed to sale of products orgoods. The costs classified as inventory mainly consist of labour and other costs of personnel, as wellas other attributable overheads directly related to providing services. E.g. in case of TechnicalAdvisory service provider the costs of inventory includes consultant wages, consultant office space,consultant IT equipment.Any cost related to back office staff and selling expenses are classified as period costs are thereforerecognised as expenses in the period in which they are incurred.Treatment of Abnormal Waste:Under IAS 2 any excessive spoilage or abnormal waste is excluded from inventory. Abnormal wasteis to be expensed as period cost. It is not included in inventory because it does not have futureeconomic benefits and also it has not incurred in bringing the inventory to its present condition andlocation.Measuring InventoryIt depends on two factors The technique used The cost formula appliedApplication of above two factors generally depend on nature of inventoryTechnique 1. Standard Cost Method: it considers normal level of material and supplies, labour, efficiency and capacity utilisation. 2. Retail Cost Method: It is used in retail industry to measure rapidly changing high volume inventory having similar margin. Inventory cost is determined by reducing sale value by appropriate percentage of gross margin.Cost FormulaeOnce chosen the cost formula should be applied consistently to all inventories that have similar natureand use. 1. Specific Identification: it is generally used for unique inventory which is easily distinguishable and generally not interchangeable like rare jewellery. 2. Weighted Average: it represents weighted average cost of inventory units for a period of time associated with inventory on hand. It is determined from the weighted average of cost of similar items at the beginning of the period and the cost of similar items purchased orroshankumar.2007@rediffmail.com
  4. 4. produced during the period. This formula is used for inventory which is normally interchangeable. 3. FIFO: this method assumes the inventory purchased first is sold first. The remaining inventory at the end of the period is from the most recent purchase.IAS 2 states that the inventory should be measured at lower of Cost or Net Realisable Value (NRV).NRV is the estimated selling price in the ordinary course of business less the estimated cost ofcompletion and estimated cost necessary to make the sale.Assessing NRVAn assessment of NRV is made at each period to determine whether the write down of inventoryneeds to be recognised or reversed. There are three circumstances 1. Unrecoverable: if the circumstances cause the cost of the inventory to be unrecoverable (eg. Due to damage of obsolescence) a write down of inventory to the NRV is recognised as an expense. 2. Reversal: if the circumstances that caused the write down no longer exist or if there has been positive change in circumstances, then the previous write down is reversed. The new carrying amount is the lower of cost and revised net realisable value. 3. Selling above and below cost: if the specific component of inventory is selling below cost it may not be necessary to write it down if the finished product in which they will be incorporated is expected to sell at or above cost.For an accounting firm following are most likely to be classified directly as component of inventoryprior to revenue being recognised Salaries of client service accountant Travel cost to client location An allocation of salary costs of technology support staff assisting client service accountants with computer auditing techniques Cost of material used to prepare clients reportsCost of brochures distributed to clients will not be included in inventory as it is not directly related toservices provided.Inventories can be allocated to other assets account.roshankumar.2007@rediffmail.com