Summary of IAS 2 Inventories

INTRODUCTION:
                                                International accounting standards 2 inventories ( IAS 2 ) revised in 1993, should be applied for annual periods beginning on or after 1 january 2005. The early application was encouraged.

REASONS FOR REVISING IAS 2:
                                                                                     The International Accounting Standards Board developed this revised IAS 2 as a part of its project on improvements to International Accounting Standards. Project was taken in the light of queries & criticisms raised by securities regulators, professional accountants & other interested parties.
The objectives of the project were:

• To reduce or eliminate alternatives
• Redundancies & conflicts within the Standards
• To deal with some convergence issues
• To make other improvement

SCOPE:
               Inventories includes:

• Assets held for sale in the ordinary course of business (finished goods)
• Assets in the production process for sale in the ordinary course of business (work in process) 
• Materials & supplies that are consumed in production (raw material)

IAS excludes certain inventories from its scope: (IAS 2.2)

• Work in process arising under construction contracts (IAS 11)
• Financial instruments (IAS 39)
• Biological assets related to agricultural activity & agricultural produce at the point of harvest (IAS 41)

The standard clarifies that some types of inventories are outside its scope while certain other types of inventories are exempted only from the measurement requirements in the Standard.


FUNDAMENTAL PRINCIPLE OF IAS 2:

                                                                                                            Inventories are required to be stated   at the lower cost and net realisable value (NRV).

                                 NRV = Estimated selling price - cost to sell in company

MEASUREMENT OF INVENTORIES:

                                                                    Cost should include all:

• Costs of purchase (including taxes, transports and handling) net of trade discounts received
• Costs of conversion (including fixed and variable manufacturing overheads)
• Other costs incurred in bringing the inventories to their present location and condition 

    IAS 23 Borrowing costs identifies some limited circumstances where borrowing costs (interest) can be included in cost of inventories that meet the definition of a qualifying asset.

Inventory cost should not include:

• Abnormal waste
• Storage costs
• Administrative overheads unrelated to production 
• Selling costs
• Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency
• Interest cost when inventories are purchased with deferred settlements terms

Cost formulas allowed: 
IAS 2 allows the FIFO or Weighted average cost formulas.
Cost formulas not allowed:
The LIFO formula, which had been allowed prior to 2003 revision of IAS 2 is no longer allowed.

                                                           The same cost formula should be used for all inventories with similar characteristics as to their nature & use to the entity. For groups of inventories that have different characteristics, different cost formulas may be justified (IAS 2.25)

WRITE-DOWN TO NET REALISABLE VALUE:
                                                                                                                                NRV is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale (IAS 2.6). Any write-down to NRV should be recognised as an expense in the period in which the write-down occurs. Any reversal should be recognised in the income statement in the period in which the reversal occurs.

RECOGNITION AS AN EXPENSE:
                                                                                           IAS 18 Revenue, addresses revenue recognition for the sale of goods. When inventories are sold & revenue is recognised, the carrying amount of those inventories is recognised as an expense (often called cost-of-goods-sold). Any write-down to NRV & any inventory losses are also recognised as an expense when they occur (IAS 2.34).

DISCLOSURE:
                                         The Standard requires the following disclosures:

1. Accounting policy for inventories
2. Carrying amount, generally classified as merchandise, supplies, materials, work in progress & finished goods. The classification depends on what is appropriate for the entity.
3. Carrying amount of any inventories carried at fair value less costs to sell 
4. Amount of any write-down of inventories recognised as an expense in the period
5. Amount of any reversal of a write-down to NRV and the circumstances that led to such reversal
6. Carrying amount of inventories pledged as security for liabilities
7. Cost of inventories recognised as expense (cost of goods sold).

APPROVAL OF IAS 2 BY THE BOARD:
                                                                                                          International Accounting Standard 2 Inventories was approved for issue by the fourteen members of the International Accounting Standards Board.