IAS 2 INVENTORIES - NBAA · This Accounting Standard is aimed to streamline the accounting methods for inventories. The foremost concern in Inventory accounting is that the cost would

IAS 2 INVENTORIES

Overview

This Accounting Standard is aimed tostreamline the accounting methods forinventories.

The foremost concern in Inventoryaccounting is that the cost would beconsidered as asset which gets carriedfurther until the other relevant revenuesare recorded.

Overview

This provides guidance for determiningthe cost and its consecutive records asexpense. It includes all written down tothe net value which is realizable.

Added to this it provides guidelines oncost formulas employed to assign costsfor inventories.

Objectives

The objective of IAS 2 is to set outthe accounting treatment forinventories. It provides guidance ondetermining cost and its subsequentrecognition as an expense includingany write down to net realizablevalue. [IAS 2 para 1].

Objectives

A primary issue in accounting forinventories is the amount of cost to berecognized as an asset and carriedforward until the related revenues arerecognised

Objectives

It also provides guidance on the cost formulas that are used to assign costs to inventories.“Inventories shall be measured at the lower of cost and net realizable value”

Scope

Applicable to all the inventories, except• work in progress on construction

contracts and service contracts.• financial instruments (IAS 32 &

IFRS 9).• biological assets arising from

agricultural activity at the point ofharvest (IAS 41).

Scope

The Standard is also not applicable totheproducers of agricultural and forest

products after harvest,mineral and mineral products andcommodity broker-traders who

measure their inventories at fairvalue less costs to sell

Scope

The improvements to IFRSs amendedIAS 41, ‘Agriculture’, which resulted inan amendment to IAS 2. Agricultureinventories comprising agriculturalproduce that an entity has harvestedfrom its biological assets are nowmeasured on initial recognition at theirfair value less costs to sell at the pointof harvest.

Definitions

Inventories are assets:• held for sale in the ordinary course of

business;• in the process of production for sale,

or• in the form of materials or supplies to

be consumed in production or inrendering services. [IAS 2 para 6].

Definitions

Definitions

Net Realizable Value: is the estimatedselling price in the ordinary course ofbusiness less the estimated cost ofcompletion and the estimated costsnecessary to make the sale.

Definitions

Fair Value: is the amount for which anasset could be exchanged, or a liabilitysettled, between knowledgeable, willingparties in an arm’s length transaction.

Recognition

An entity should initially recogniseinventory when it has control of theinventory, expects it to provide futureeconomic benefits and the cost of theinventory can be measured reliably.[Framework paras 49(a), 89].

Recognition

Assets held in an entity’s premises maynot qualify as inventories if they areheld on consignment (that is, on behalfof another entity and where no liabilityto pay for the goods exists unless theyare sold).

Measurement

Initial measurement of inventories is atcost. The cost of inventories includes allcosts of purchase, costs of conversionand all other costs incurred in bringingthe inventories to their present locationand condition.

Measurement

The costs of purchase include thepurchase price, import duties andother taxes (not recoverable from thetaxing authorities), transport andhandling costs and other costsdirectly attributable to the acquisitionof the inventory. Reductions aremade for trade discounts, rebatesand other similar items. [IAS 2 para 9

Measurement

Agricultural produce, such as wool, logsand grapes is the harvested product ofbiological assets and is recognised asinventory. [IAS 2 para 20]. The cost ofagricultural produce at initialrecognition is its fair value less costs tosell at the point of harvest. [IAS 41 para13].

Measurement

Costs of acquisition, manufacture,exchange and other expenses areincluded in the inventories that havemade it be in the current position.• Purchase costs include;• purchase price,• Transport costs,• import duties,

Measurement

• handling taxes and• other expenses that have direct

impact on the procurement ofproducts.

Measurement

Costs not included in the valuation ofinventories but treated as expenseswhen they occur include;• Abnormal wastage of materials, labor

and other production costs• Storage costs not essential for the

production process• Selling and distribution costs• Administrative costs

Measurement

Measurement

Measurement

Example 1Tuntufye Trading Company purchasesmotorbikes from several countries andsells them to Northern regions. Duringthe current year, the company hasincurred following expenses:1. Trade discounts on purchase2. Handling costs relating to imports.Cont ….

Measurement

3. Salaries of accounting department4. Sales commission paid to sales agents5. Import duties6. After sales warrant costs7. Costs of purchases (supplier’s invoices)8. Freight expensecont ….

Measurement

9. Insurance of purchases10. Brokerage commission paid toindenting agentsTuntufye Trading Company seeks youradvice on which costs are allowed byIAS 2 for inclusion in the cost ofinventory. Advice

Measurement

Solution:Items 1, 2, 5, 7, 8, 9, 10 are allowed by IAS

2 for the calculation of cost ofinventories.Salaries of accounts department, sales

commission, and after sales warrantycosts are not considered to be the cost ofinventory therefore they are not allowedby IAS 2 for inclusion in cost of inventory

Measurement

Subsequent to initial recognition,entities should measure inventories atthe lower of cost or net realisablevalue (defined as the estimatedselling price in the ordinary course ofbusiness less the estimated costs ofcompletion and the estimated sellingcosts). [IAS 2 paras 9, 6].

Measurement

Cost should be determined based onspecific identification for goods notordinarily interchangeable or thosesegregated for specific projects. Specificidentification costing is not appropriate forinventories of homogeneous products,such as raw materials to be used inproduction. FIFO or weighted averagemethods may be used to determine the

Measurement

Example 2 Hapa kazi Plc manufactures mechanicalparts, which trade under the name ‘Faru’.In the year ended 31 December 2015,10,000 Faru were manufactured and therelated costs were:• Materials

3,000,000• Labour

4 000 000

Measurement

• Sundry factory expenses 2,000,000

• Production storage costs 1,000,000

• Selling expenses 2,000,000

• Expenses at head office 4,000,000

At 31 December 2015, there were 1,000Faru in inventory Assuming that these

Measurement

Solution•Materials

3,000,000•Labour 4,000,000•Depreciation of machinery

2,000,000•Factory rates

1,000,000•Sundry factory expenses

2 000 000 cont

Measurement

•Production storage costs 1,000,000

•Total cost 13,000,000

•Units manufactured 10,000

•Unit cost 1,300Number of units at year end 1,000Value of closing inventory

MeasurementIAS 2 does not permit exchangedifferences arising directly on therecent acquisition of inventoriesinvoiced in a foreign currency to beincluded in the costs of purchase ofinventories.

MeasurementIAS 2 does not permit exchangedifferences arising directly on therecent acquisition of inventoriesinvoiced in a foreign currency to beincluded in the costs of purchase ofinventories.

Measurement

Net realizable valueThe estimated selling price in theordinary course of business less theestimated costs of completion and lessthe estimated costs necessary to makethe sale

Provision for inventory impairment

The cost of inventories may not berecoverable if those inventories aredamaged, if they have become whollyor partially obsolete, or if their sellingprices have declined.

The cost of inventories may also not berecoverable if the estimated costs ofcompletion or the estimated costs to beincurred to make the sale have increased.The practice of writing inventories downbelow cost to net realisable value isconsistent with the view that assets shouldnot be carried in excess of amountsexpected to be realized from their sale oruse.

DerecognitionInventory is derecognised when it is sold.It is recognised as an expense in thesame period as the revenue from its saleis recognised. An entity should alsoderecognise inventory when it has nofuture economic value, for example,obsolete inventory.The point at which to derecogniseinventory is not always straightforward,example where an entity supplies goodsunder sale and repurchase agreements,the entity may retain the risks andrewards of ownership and should

Derecognition

Disclosure• Accounting policy adopted in measuring

inventories, including cost formulas• Carrying amount of inventories under major

headings (e.g. raw materials, WIP and finished goods)

• Carrying amount of inventories at fair value less costs to sell

• Amount expended in the period• Amount of any write downs of inventories• Amount of any reversal of write downs• Cause of write downs• Carrying amount of inventories pledged as

it

End

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