IAS 2 : Inventory

Question 1

Under IFRS the relevant standard for inventories is IAS 2 – Inventories. The term ‘inventories’ includes raw materials, work-in-progress, finished goods and goods for resale, although the standard does not include all instances of these categories; some are covered by other standards, for example growing crops are covered by IAS 41 – Agriculture. This chapter deals only with the inventories within the scope of IAS 2.

Answer 1

Under IFRS the relevant standard for inventories is IAS 2 – Inventories. The term ‘inventories’ includes raw materials, work-in-progress, finished goods and goods for resale, although the standard does not include all instances of these categories; some are covered by other standards, for example growing crops are covered by IAS 41 – Agriculture. This chapter deals only with the inventories within the scope of IAS 2.

Question 2

Under the historical cost accounting system, costs of inventories comprise expenditure which has been incurred in the normal course of business in bringing the inventory to its present location and condition. All costs incurred in respect of inventories are charged as
period costs, except for those which relate to those unconsumed inventories which are expected to be of future benefit to the entity. These are carried forward as an asset, to be matched with the revenues that they will generate in the future. Inventories in the statement of financial position have characteristics similar to those of prepaid expenses or property, plant and equipment – they are effectively deferred costs.

Answer 2

Under the historical cost accounting system, costs of inventories comprise expenditure which has been incurred in the normal course of business in bringing the inventory to its present location and condition. All costs incurred in respect of inventories are charged as
period costs, except for those which relate to those unconsumed inventories which are expected to be of future benefit to the entity. These are carried forward as an asset, to be matched with the revenues that they will generate in the future. Inventories in the statement of financial position have characteristics similar to those of prepaid expenses or property, plant and equipment – they are effectively deferred costs.

Question 3

Objective

The objective of IAS 2 is to prescribe the accounting treatment for inventories. The standard notes that a primary issue in accounting for inventories is the cost to be recognised as an asset until the related revenues are recognised. The standard provides guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realisable value. Further to this, it provides guidance on the cost formulas that are used to assign costs to inventories. [IAS 2.1].

Answer 3

The objective of IAS 2 is to prescribe the accounting treatment for inventories. The standard notes that a primary issue in accounting for inventories is the cost to be recognised as an asset until the related revenues are recognised. The standard provides guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realisable value. Further to this, it provides guidance on the cost formulas that are used to assign costs to inventories. [IAS 2.1].

Question 4

Definitions 1

Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering
of services.

Answer 4

Inventories are assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering
of services.

Question 5

Definitions 2

Net realisable value is 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.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Answer 5

Net realisable value is 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.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.

Question 6

Scope 1

IAS 2 applies to all inventories in financial statements except:

• financial instruments; and
• biological assets related to agricultural activity and agricultural produce at the point
of harvest. [IAS 2.2].

Answer 6

IAS 2 applies to all inventories in financial statements except:

• financial instruments; and
• biological assets related to agricultural activity and agricultural produce at the point
of harvest. [IAS 2.2].

Question 7

Scope 2

Agricultural produce that has been harvested by the entity from its biological assets is in scope; it is initially recognised at its fair value less costs to sell at the point of harvest, as set out in IAS 41. This figure becomes the cost of inventories at that date for the purposes of IAS 2. [IAS 2.20].

Answer 7

Agricultural produce that has been harvested by the entity from its biological assets is in scope; it is initially recognised at its fair value less costs to sell at the point of harvest, as set out in IAS 41. This figure becomes the cost of inventories at that date for the purposes of IAS 2. [IAS 2.20].

Question 8

Scope 3a

The measurement provisions of IAS 2 do not apply to the measurement of inventories held by:

(a) producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are
measured at net realisable value in accordance with well-established practices in those industries. When such inventories are measured at net realisable value,
changes in that value are recognised in profit or loss in the period of the change. [IAS 2.3]. This occurs, for example, when agricultural crops have been harvested
or minerals have been extracted and sale is assured under a forward contract or a government guarantee, or when an active market exists and there is a
negligible risk of failure to sell. [IAS 2.4]. However, in practice this approach is not common; and

Answer 8

The measurement provisions of IAS 2 do not apply to the measurement of inventories held by:

(a) producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are
measured at net realisable value in accordance with well-established practices in those industries. When such inventories are measured at net realisable value,
changes in that value are recognised in profit or loss in the period of the change. [IAS 2.3]. This occurs, for example, when agricultural crops have been harvested
or minerals have been extracted and sale is assured under a forward contract or a government guarantee, or when an active market exists and there is a
negligible risk of failure to sell. [IAS 2.4]. However, in practice this approach is not common; and

Question 9

Scope 3b

(b) commodity broker-traders who measure their inventories at fair value less costs to sell. If these inventories are measured at fair value less costs to sell, the changes in fair value less costs to sell are recognised in profit or loss in the period of the
change. [IAS 2.3]. Broker-traders are those who buy or sell commodities for others or on their own account and these inventories are principally acquired with the
purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin. [IAS 2.5].

In both cases, the standard stresses that these inventories are only scoped out from the measurement requirements of IAS 2; the standard’s other requirements, such as disclosure, continue to apply.

Answer 9

(b) commodity broker-traders who measure their inventories at fair value less costs to sell. If these inventories are measured at fair value less costs to sell, the changes in fair value less costs to sell are recognised in profit or loss in the period of the
change. [IAS 2.3]. Broker-traders are those who buy or sell commodities for others or on their own account and these inventories are principally acquired with the
purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin. [IAS 2.5].

In both cases, the standard stresses that these inventories are only scoped out from the measurement requirements of IAS 2; the standard’s other requirements, such as disclosure, continue to apply.

Question 10

Scope 4

Collectibles, for example paintings or sculptures, acquired for short-term investment purposes and traded in the ordinary course of business could be within scope of IAS 2. Depending on the facts and circumstances, these could be either:
• inventories measured at the lower of cost and net realisable value; or
• commodities, measured at fair value less costs
to sell.

Answer 10

Collectibles, for example paintings or sculptures, acquired for short-term investment purposes and traded in the ordinary course of business could be within scope of IAS 2. Depending on the facts and circumstances, these could be either:
• inventories measured at the lower of cost and net realisable value; or
• commodities, measured at fair value less costs to sell.

Question 11

Scope - Core inventories and spare parts – IAS 2 or IAS 16

It is our view that an item of inventory that is not held for sale or consumed in a production process should be accounted for as an item of property, plant and equipment (PP&E) under IAS 16 – Property, Plant and Equipment – if it is necessary to the operation of a facility during more than one operating cycle AND its cost cannot be recouped through sale (or it is significantly impaired after it has been used to operate
the asset or obtain benefit from the asset). This applies even if the part of inventory that is deemed to be an item of PP&E cannot physically be separated from other inventory. By contrast, spare parts are classified as inventory unless they meet the definition of
PP&E.

Answer 11

It is our view that an item of inventory that is not held for sale or consumed in a production process should be accounted for as an item of property, plant and equipment (PP&E) under IAS 16 – Property, Plant and Equipment – if it is necessary to the operation of a facility during more than one operating cycle AND its cost cannot be recouped through sale (or it is significantly impaired after it has been used to operate the asset or obtain benefit from the asset). This applies even if the part of inventory that is deemed to be an item of PP&E cannot physically be separated from other inventory. By contrast, spare parts are classified as inventory unless they meet the definition of
PP&E.

Question 12

Scope - Broadcast rights – IAS 2 or IAS 38 .1

Broadcasters purchase programmes under a variety of different arrangements. Often they commit to purchasing programmes that are at a very early stage of development, perhaps merely being concepts. The broadcaster may have exclusive rights over the
programme or perhaps only have the rights to broadcast for a set period of time or on a set number of occasions. IFRS is not clear on how these rights should be classified and when they should
be recognised.

Answer 12

Broadcasters purchase programmes under a variety of different arrangements. Often they commit to purchasing programmes that are at a very early stage of development, perhaps merely being concepts. The broadcaster may have exclusive rights over the
programme or perhaps only have the rights to broadcast for a set period of time or on a set number of occasions. IFRS is not clear on how these rights should be classified and when they should be recognised.

Question 13

Scope - Broadcast rights – IAS 2 or IAS 38 .2

We believe that an entity may either treat these rights as intangible assets and classify them under IAS 38 – Intangible Assets, or classify them as inventory under IAS 2. Such rights would certainly seem to meet the definition of inventory under IAS 2. Given that the acquisition of these rights forms part of the cost
of the broadcaster’s programming schedule, they meet the general IAS 2 definition in that they are:

(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or
in the rendering of services. [IAS 2.6].

Answer 13

We believe that an entity may either treat these rights as intangible assets and classify them under IAS 38 – Intangible Assets, or classify them as inventory under IAS 2. Such rights would certainly seem to meet the definition of inventory under IAS 2. Given that the acquisition of these rights forms part of the cost
of the broadcaster’s programming schedule, they meet the general IAS 2 definition in that they are:

(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or
in the rendering of services. [IAS 2.6].

Question 14

Scope - Broadcast rights – IAS 2 or IAS 38 .3

When classified as inventory, the rights will need to be disclosed within current assets, even if the intention is not to consume them within 12 months. [IAS 1.68].
As with costs of other inventory the cash outflow from acquisition will be classified as an operating cash flow and the expense will be presented within cost of sales when the right is consumed.

Answer 14

When classified as inventory, the rights will need to be disclosed within current assets, even if the intention is not to consume them within 12 months. [IAS 1.68].
As with costs of other inventory the cash outflow from acquisition will be classified as an operating cash flow and the expense will be presented within cost of sales when the right is consumed.

Question 15

Scope - Broadcast rights – IAS 2 or IAS 38 .4

There is also the issue of the timing of recognition of these rights. In accordance with The Conceptual Framework for Financial Reporting an asset is a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. Hence it is necessary to determine when control is obtained.
Under IFRS, executory contracts where both parties are still to perform (such as purchase orders where neither payment nor delivery has taken place) do not generally result in the recognition of assets and liabilities. When a broadcaster initially contracts to
purchase a programme it will not usually result in immediate recognition of an asset relating to that programme. At this point there will not normally be an asset under the control of the broadcaster.

Answer 15

There is also the issue of the timing of recognition of these rights. In accordance with The Conceptual Framework for Financial Reporting an asset is a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity. Hence it is necessary to determine when control is obtained.
Under IFRS, executory contracts where both parties are still to perform (such as purchase orders where neither payment nor delivery has taken place) do not generally result in the recognition of assets and liabilities. When a broadcaster initially contracts to
purchase a programme it will not usually result in immediate recognition of an asset relating to that programme. At this point there will not normally be an asset under the control of the broadcaster.

Question 16

Scope - Broadcast rights – IAS 2 or IAS 38 .5

Factors that may be relevant in determining when
the entity controls an asset include whether:
• the underlying resource is sufficiently developed to be identifiable (e.g. whether the manuscript or screenplay has been written, and whether directors and actors have been hired);
• the entity has legal, exclusive rights to broadcast, which may be in respect of a defined period or geographic area;
• there is a penalty to the licensor for non-delivery of the content;
• it is probable that content will be delivered; and
• it is probable that economic benefits will flow to the entity.

Answer 16

Factors that may be relevant in determining when
the entity controls an asset include whether:
• the underlying resource is sufficiently developed to be identifiable (e.g. whether the manuscript or screenplay has been written, and whether directors and actors have been hired);
• the entity has legal, exclusive rights to broadcast, which may be in respect of a defined period or geographic area;
• there is a penalty to the licensor for non-delivery of the content;
• it is probable that content will be delivered; and
• it is probable that economic benefits will flow to the entity.

Question 17

Scope - Broadcast rights – IAS 2 or IAS 38 .6

Where there is difficulty in determining when control of the asset is obtained it may be helpful to assess at what point any liability arises, since a liability will generally indicate that an asset has been acquired. In practice an entity might recognise an asset and
liability for a specific broadcast right on the following trigger dates:
• when a screening certificate is obtained;
• when programming is available for exhibition;
• the beginning of the season;
• the beginning of the license period; or
• the date the event occurs (e.g. game-by-game basis)..

The issue of when a licensor recognises revenue under IFRS 15 on the sale of such broadcast rights is covered in Chapter 28.

Answer 17

Where there is difficulty in determining when control of the asset is obtained it may be helpful to assess at what point any liability arises, since a liability will generally indicate that an asset has been acquired. In practice an entity might recognise an asset and
liability for a specific broadcast right on the following trigger dates:
• when a screening certificate is obtained;
• when programming is available for exhibition;
• the beginning of the season;
• the beginning of the license period; or
• the date the event occurs (e.g. game-by-game basis).

The issue of when a licensor recognises revenue under IFRS 15 on the sale of such broadcast rights is covered in Chapter 28.

Question 18

Scope - Bitcoin and other crypto-currencies 1

In recent years, numerous crypto-currencies (e.g. Bitcoin) and crypto-tokens have been launched. Crypto-assets each have their own terms and conditions, and the purpose for holding them differs between holders. As a result, the holders of a crypto-asset will need to evaluate their own facts and circumstances in determining which IFRS recognition
and measurement requirements should be applied.

Answer 18

In recent years, numerous crypto-currencies (e.g. Bitcoin) and crypto-tokens have been launched. Crypto-assets each have their own terms and conditions, and the purpose for holding them differs between holders. As a result, the holders of a crypto-asset will need to evaluate their own facts and circumstances in determining which IFRS recognition and measurement requirements should be applied.

Question 19

Scope - Bitcoin and other crypto-currencies 2

Many crypto-assets would meet the relatively wide definition of an intangible asset. An intangible asset is defined by IAS 38 as an identifiable non-monetary asset without physical substance. [IAS 38.8].
However not all intangible assets are within the scope of IAS 38 as the standard is clear that it does not apply to items that are in the scope of another standard.
For example, IAS 38 excludes from its scope intangible assets held by an entity for sale in the ordinary course of business, which are within scope of IAS 2 [IAS 38.3(a)] and financial assets as defined in IAS 32 – Financial Instruments: Presentation. [IAS 38.3(e)].

Answer 19

Many crypto-assets would meet the relatively wide definition of an intangible asset. An intangible asset is defined by IAS 38 as an identifiable non-monetary asset without physical substance. [IAS 38.8].
However not all intangible assets are within the scope of IAS 38 as the standard is clear that it does not apply to items that are in the scope of another standard.
For example, IAS 38 excludes from its scope intangible assets held by an entity for sale in the ordinary course of business, which are within scope of IAS 2 [IAS 38.3(a)] and financial assets as defined in IAS 32 – Financial Instruments: Presentation. [IAS 38.3(e)].

Question 20

Scope - Bitcoin and other crypto-currencies 3

Although this is often assumed, IAS 2 does not require inventory to be tangible. IAS 2 defines inventory as assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or
in the rendering of services. [IAS 2.6].

Crypto-assets could be held for sale in the ordinary course of business, for example, by a commodity broker-trader. Whether crypto-assets are held for sale in the ordinary course of business would depend on the specific facts and circumstances of the holder.

Answer 20

Although this is often assumed, IAS 2 does not require inventory to be tangible. IAS 2 defines inventory as assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or
in the rendering of services. [IAS 2.6].

Crypto-assets could be held for sale in the ordinary course of business, for example, by a commodity broker-trader. Whether crypto-assets are held for sale in the ordinary course of business would depend on the specific facts and circumstances of the holder.

Question 21

Scope - Bitcoin and other crypto-currencies 4

In practice, crypto-assets are generally not used in the production of inventory and, thus, would not be considered materials and supplies to be consumed in the production process. However, in limited circumstances, a crypto-asset could be held for
consumption in the rendering of a service. For example, a crypto-asset, not readily convertible to cash, that only entitles the holder to a specific service (e.g. server capacity) could be considered inventory if the holder uses the underlying service to deliver its own services in the ordinary course of its business.

Answer 21

In practice, crypto-assets are generally not used in the production of inventory and, thus, would not be considered materials and supplies to be consumed in the production process. However, in limited circumstances, a crypto-asset could be held for
consumption in the rendering of a service. For example, a crypto-asset, not readily convertible to cash, that only entitles the holder to a specific service (e.g. server capacity) could be considered inventory if the holder uses the underlying service to deliver its own services in the ordinary course of its business.

Question 22

Scope - Bitcoin and other crypto-currencies 5

IAS 2 does not apply to financial instruments. [IAS 2.2(b)]. Thus, where a crypto-asset meets the definition of a financial instrument, it should be accounted for under IFRS 9 – Financial Instruments – rather than as inventory under IAS 2.

Answer 22

IAS 2 does not apply to financial instruments. [IAS 2.2(b)]. Thus, where a crypto-asset meets the definition of a financial instrument, it should be accounted for under IFRS 9 – Financial Instruments – rather than as inventory under IAS 2.

Question 23

Scope - Transfers of rental assets to inventory

An entity may, in the course of its ordinary activities, routinely sell items that had previously been held for rental and classified as property, plant and equipment. For example, car rental companies may acquire vehicles with the intention of holding them as rental cars for a limited period and then selling them. IAS 16 requires that when such items become held for sale rather than rental they be transferred to inventory at their carrying value. [IAS 16.68A]. Revenue from the subsequent sale is then recognised gross
rather than net.

Answer 23

An entity may, in the course of its ordinary activities, routinely sell items that had previously been held for rental and classified as property, plant and equipment. For example, car rental companies may acquire vehicles with the intention of holding them as rental cars for a limited period and then selling them. IAS 16 requires that when such items become held for sale rather than rental they be transferred to inventory at their carrying value. [IAS 16.68A]. Revenue from the subsequent sale is then recognised gross rather than net.

Question 24

Measurement - Intro 1

The standard’s basic rule is that inventories are measured at the lower of cost and net realisable value, apart from those inventories scoped out of its measurement requirements as explained at above.
[IAS 2.9].

Answer 24

The standard’s basic rule is that inventories are measured at the lower of cost and net realisable value, apart from those inventories scoped out of its measurement requirements as explained at above.
[IAS 2.9].

Question 25

Measurement - Intro 2

Net realisable value is ‘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’. [IAS 2.6].

This is different to fair value, which IAS 2 defines in accordance with IFRS 13 – Fair Value Measurement, as ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’. [IAS 2.6].

Answer 25

Net realisable value is ‘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’. [IAS 2.6].

This is different to fair value, which IAS 2 defines in accordance with IFRS 13 – Fair Value Measurement, as ‘the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date’. [IAS 2.6].

Question 26

Measurement - Intro 3

The standard points out that net realisable value is an entity-specific value, the amount that the entity actually expects to make from selling that particular inventory, while fair value is not. Fair value reflects the price at which an orderly transaction to sell the same
inventory in the principal (or most advantageous) market for that inventory would take place between market participants at the measurement date. Therefore, net realisable value may not be the same as fair value less costs to sell. [IAS 2.7].

Answer 26

The standard points out that net realisable value is an entity-specific value, the amount that the entity actually expects to make from selling that particular inventory, while fair value is not. Fair value reflects the price at which an orderly transaction to sell the same
inventory in the principal (or most advantageous) market for that inventory would take place between market participants at the measurement date. Therefore, net realisable value may not be the same as fair value less costs to sell. [IAS 2.7].

Question 27

Measurement - What may be included in cost?

The costs attributed to inventories under IAS 2 comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. [IAS 2.10]. This definition allows for significant interpretation of the costs to be included in inventory.

Answer 27

The costs attributed to inventories under IAS 2 comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. [IAS 2.10]. This definition allows for significant interpretation of the costs to be included in inventory.

Question 28

Measurement - Costs of purchase

Costs of purchase include import duties and unrecoverable taxes, transport, handling and other costs directly attributable to the inventories. [IAS 2.11].
Trade discounts and similar rebates should be deducted from the costs attributed to inventories.
[IAS 2.11]. For example a supplier may pay to its customer an upfront cash incentive when entering into a contract. This is a form of rebate and the incentive
should be accounted for as a liability by the customer until it receives the related inventory, which is then shown at cost net of this incentive.

Answer 28

Costs of purchase include import duties and unrecoverable taxes, transport, handling and other costs directly attributable to the inventories. [IAS 2.11].
Trade discounts and similar rebates should be deducted from the costs attributed to inventories. [IAS 2.11].
For example a supplier may pay to its customer an upfront cash incentive when entering into a contract. This is a form of rebate and the incentive should be accounted for as a liability by the customer until it receives the related inventory, which is then shown at cost net of this incentive.

Question 29

Measurement - Costs of conversion 1

Costs of conversion include direct costs such as direct labour and materials, as well as an allocation of fixed and variable production overheads. It must be remembered that the inclusion of overheads is not optional. Overheads may comprise indirect labour and
materials or other indirect costs of production. For the most part there are few problems over the inclusion of direct costs in inventories, although difficulties may arise over the inclusion of certain types of overheads and over the allocation of overheads into the
inventory valuation.

Answer 29

Costs of conversion include direct costs such as direct labour and materials, as well as an allocation of fixed and variable production overheads. It must be remembered that the inclusion of overheads is not optional. Overheads may comprise indirect labour and
materials or other indirect costs of production. For the most part there are few problems over the inclusion of direct costs in inventories, although difficulties may arise over the inclusion of certain types of overheads and over the allocation of overheads into the
inventory valuation.

Question 30

Measurement - Costs of conversion 2

Overhead costs must be apportioned using a ‘systematic allocation of fixed and variable production overheads that are incurred in converting materials
into finished goods’. [IAS 2.12]. Overheads should be allocated to the cost of inventory on a consistent basis from year to year, and should not be omitted in anticipation of a net realisable value problem.

Answer 30

Overhead costs must be apportioned using a ‘systematic allocation of fixed and variable production overheads that are incurred in converting materials into finished goods’. [IAS 2.12]. Overheads should be allocated to the cost of inventory on a consistent basis from year to year, and should not be omitted in anticipation of a net realisable value problem.

Question 31

Measurement - Costs of conversion 3

Variable production overheads are indirect costs that vary directly, or nearly directly, with the volume of production such as indirect material and indirect labour. [IAS 2.12]. Variable production overheads are allocated to each unit of production on the basis of
the actual use of the production facilities. [IAS 2.13].

Answer 31

Variable production overheads are indirect costs that vary directly, or nearly directly, with the volume of production such as indirect material and indirect labour. [IAS 2.12]. Variable production overheads are allocated to each unit of production on the basis of
the actual use of the production facilities. [IAS 2.13].

Question 32

Measurement - Costs of conversion 4

Fixed production overheads are indirect costs that remain relatively constant regardless of the volume of production, such as building and equipment maintenance and depreciation, and factory management expenses. The allocation of fixed production overheads is based on the normal capacity of the facilities. Normal capacity is defined as ‘the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance’. [IAS 2.13].

Answer 32

Fixed production overheads are indirect costs that remain relatively constant regardless of the volume of production, such as building and equipment maintenance and depreciation, and factory management expenses. The allocation of fixed production overheads is based on the normal capacity of the facilities. Normal capacity is defined as ‘the production expected to be achieved on average over a number of periods or seasons under normal circumstances, taking into account the loss of capacity resulting from planned maintenance’. [IAS 2.13].

Question 33

Measurement - Costs of conversion 5

While actual capacity may be used if it approximates to normal capacity, increased overheads may
not be allocated to production as a result of low output or idle capacity. In these cases the unallocated overheads must be expensed. Similarly, in periods of abnormally high production, the fixed overhead absorption must be reduced, as otherwise inventories
would be recorded at an amount in excess of cost.
[IAS 2.13].

Answer 33

While actual capacity may be used if it approximates to normal capacity, increased overheads may
not be allocated to production as a result of low output or idle capacity. In these cases the unallocated overheads must be expensed. Similarly, in periods of abnormally high production, the fixed overhead absorption must be reduced, as otherwise inventories
would be recorded at an amount in excess of cost.
[IAS 2.13].

Question 34

Measurement - Costs of conversion 6

In computing the costs to be allocated via the overhead recovery rate, costs such as distribution and selling must be excluded, together with the cost of storing raw materials and work in progress, unless it is necessary that storage costs be incurred prior to further processing, which may occasionally be the
case

Answer 34

In computing the costs to be allocated via the overhead recovery rate, costs such as distribution and selling must be excluded, together with the cost of storing raw materials and work in progress, unless it is necessary that storage costs be incurred prior to further processing, which may occasionally be the
case

Question 35

Measurement - Costs of conversion 7

IAS 2 mentions the treatment to be adopted when a production process results in the simultaneous production of more than one product, for example a main product and a by-product. If the costs of converting each product are not separately identifiable, they should be allocated between the products on a rational and consistent basis. For example, this might be the relative sales value of each of the products either at the stage in the production process when the products become separately identifiable, or at the completion of production. If the value of the by-product is immaterial, it may be measured at net realisable value and this value deducted from the cost of the main product.
[IAS 2.14].

Answer 35

IAS 2 mentions the treatment to be adopted when a production process results in the simultaneous production of more than one product, for example a main product and a by-product. If the costs of converting each product are not separately identifiable, they should be allocated between the products on a rational and consistent basis. For example, this might be the relative sales value of each of the products either at the stage in the production process when the products become separately identifiable, or at the completion of production. If the value of the by-product is immaterial, it may be measured at net realisable value and this value deducted from the cost of the main product. [IAS 2.14].

Question 36

Measurement - Other costs 1

Other costs are to be included in inventories only to the extent that they bring them into their present location and condition. Often judgement will be necessary to make this assessment. An example is given in IAS 2 of design costs for a special order for a
particular customer and the standard notes that it may be appropriate to include such costs or other non-production overheads. [IAS 2.15].

Answer 36

Other costs are to be included in inventories only to the extent that they bring them into their present location and condition. Often judgement will be necessary to make this assessment. An example is given in IAS 2 of design costs for a special order for a particular customer and the standard notes that it may be appropriate to include such costs or other non-production overheads. [IAS 2.15].

Question 37

Measurement - Other costs 2

However a number of examples are given of costs that are specifically disallowed. These are:

(a) abnormal amounts of wasted materials, labour, or other production costs;
(b) storage costs, unless those costs are necessary in the production process prior to a further production stage;
(c) administrative overheads that do not contribute to bringing inventories to their present location and condition; and
(d) selling costs. [IAS 2.16].

Answer 37

However a number of examples are given of costs that are specifically disallowed. These are:

(a) abnormal amounts of wasted materials, labour, or other production costs;
(b) storage costs, unless those costs are necessary in the production process prior to a further production stage;
(c) administrative overheads that do not contribute to bringing inventories to their present location and condition; and
(d) selling costs. [IAS 2.16].

Question 38

Measurement - Other costs : Storage and distribution costs 1

Storage costs are not permitted as part of the cost of inventory unless those costs are necessary in the production process prior to a further production stage. [IAS 2.16(b)]. This appears to prohibit including the costs of the warehouse and the overheads of a retail outlet as part of inventory, as neither of these
is a prelude to a further production stage.

Answer 38

Storage costs are not permitted as part of the cost of inventory unless those costs are necessary in the production process prior to a further production stage. [IAS 2.16(b)]. This appears to prohibit including the costs of the warehouse and the overheads of a retail outlet as part of inventory, as neither of these
is a prelude to a further production stage.

Question 39

Measurement - Other costs : Storage and distribution costs 2

Where it is necessary to store raw materials or work in progress prior to a further processing or manufacturing stage, the costs of such storage should be included in production overheads. For example, it would appear reasonable to allow the costs of storing maturing stocks, such as cheese, wine or whisky, in the cost of production. Although distribution costs are obviously a cost of bringing an item to its present location, the question arises as to whether costs of transporting inventory from one location to another are eligible.

Answer 39

Where it is necessary to store raw materials or work in progress prior to a further processing or manufacturing stage, the costs of such storage should be included in production overheads. For example, it would appear reasonable to allow the costs of storing maturing stocks, such as cheese, wine or whisky, in the cost of production. Although distribution costs are obviously a cost of bringing an item to its present location, the question arises as to whether costs of transporting inventory from one location to another are eligible.

Question 40

Measurement - Other costs : Storage and distribution costs 3

Costs of distribution to the customer are not allowed as they are selling costs, which are prohibited by the standard from being included in the carrying value of inventory. [IAS 2.16(d)]. It therefore seems probable that distribution costs of inventory whose production process is complete should not normally be included in its carrying value. If the inventory is transferred from one of the entity’s storage facilities to another and the
condition of the inventory is not changed at either location, none of the warehousing costs may be included in inventory costs. It follows that transportation costs between the two storage facilities should not be included in the carrying value of inventory.

Answer 40

Costs of distribution to the customer are not allowed as they are selling costs, which are prohibited by the standard from being included in the carrying value of inventory. [IAS 2.16(d)]. It therefore seems probable that distribution costs of inventory whose production process is complete should not normally be included in its carrying value. If the inventory is transferred from one of the entity’s storage facilities to another and the
condition of the inventory is not changed at either location, none of the warehousing costs may be included in inventory costs. It follows that transportation costs between the two storage facilities should not be included in the carrying value of inventory.

Question 41

Measurement - Other costs : Storage and distribution costs 4

A question arises about the meaning of ‘production’ in the context of large retailers with distribution centres, for example supermarkets. As the transport and logistics involved are essential to their ability to put goods on sale at a particular location in an appropriate
condition, it seems reasonable to conclude that such costs are an essential part of the production process and can be included in the cost of inventory. The circumstances of the entity may warrant the inclusion of distribution or other costs into cost of sales even though they have been excluded from the cost of inventory. [IAS 2.38].

Answer 41

A question arises about the meaning of ‘production’ in the context of large retailers with distribution centres, for example supermarkets. As the transport and logistics involved are essential to their ability to put goods on sale at a particular location in an appropriate
condition, it seems reasonable to conclude that such costs are an essential part of the production process and can be included in the cost of inventory. The circumstances of the entity may warrant the inclusion of distribution or other costs into cost of sales even though they have been excluded from the cost of inventory.
[IAS 2.38].

Question 42

Measurement - Other costs : General and administrative overheads 1

IAS 2 specifically disallows administrative overheads that do not contribute to bringing inventories to their present location and condition. [IAS 2.16(c)]. Other costs and overheads that do contribute are allowable as costs of production. There is a judgement to be made about such matters, as under a very broad interpretation any department could be considered
to make a contribution.

Answer 42

IAS 2 specifically disallows administrative overheads that do not contribute to bringing inventories to their present location and condition. [IAS 2.16(c)]. Other costs and overheads that do contribute are allowable as costs of production. There is a judgement to be made about such matters, as under a very broad interpretation any department could be considered
to make a contribution.

Question 43

Measurement - Other costs : General and administrative overheads 2

For example, the accounts department will normally support the following functions:

(a) production – by paying direct and indirect production wages and salaries, by controlling purchases and related payments, and by preparing periodic financial statements for the production units;
(b) marketing and distribution – by analysing sales and by controlling the sales ledger; and
(c) general administration – by preparing management accounts and annual financial statements and budgets, by controlling cash resources and by planning investments.

Answer 43

For example, the accounts department will normally support the following functions:

(a) production – by paying direct and indirect production wages and salaries, by controlling purchases and related payments, and by preparing periodic financial statements for the production units;
(b) marketing and distribution – by analysing sales and by controlling the sales ledger; and
(c) general administration – by preparing management accounts and annual financial statements and budgets, by controlling cash resources and by planning investments.

Question 44

Measurement - Other costs : General and administrative overheads 3

Only those costs of the accounts department that can be allocated to the production function can be included in the cost of conversion. Part of the management and overhead costs of a large retailer’s logistical department may be included in cost if it can be related to bringing the inventory to its present location and condition. These types of cost are unlikely to be material in the context of the inventory total held by organisations. An entity wishing to include a material amount of overhead of a borderline nature must ensure it can sensibly justify its inclusion under the provisions of IAS 2 by presenting an analysis of the function and its contribution to the production process similar to the above.

Answer 44

Only those costs of the accounts department that can be allocated to the production function can be included in the cost of conversion. Part of the management and
overhead costs of a large retailer’s logistical department may be included in cost if it can be related to bringing the inventory to its present location and condition. These types of cost are unlikely to be material in the context of the inventory total held by organisations. An entity wishing to include a material amount of overhead of a borderline nature must ensure it can sensibly justify its inclusion under the provisions of IAS 2 by presenting an analysis of the function and its contribution to the production process similar to the above.

Question 45

Measurement of cost 1

IAS 2 specifically allows the use of the standard cost method, or of the retail method, provided that the chosen method gives a result which approximates to cost. Standard costs should take into account normal levels of materials and supplies, labour, efficiency
and capacity utilisation. They must be regularly reviewed and revised where necessary.
[IAS 2.21]. Normal levels of activity are discussed in above.

Answer 45

IAS 2 specifically allows the use of the standard cost method, or of the retail method, provided that the chosen method gives a result which approximates to cost. Standard costs should take into account normal levels of materials and supplies, labour, efficiency
and capacity utilisation. They must be regularly reviewed and revised where necessary.
[IAS 2.21]. Normal levels of activity are discussed in above.

Question 46

Measurement of cost 2

The retail method is often used in the retail industry for measuring inventories with high volumes of rapidly changing items with similar margins. [IAS 2.22]. It may be unnecessarily time-consuming to determine the cost of the period-end inventory on a conventional
basis. Consequently, the most practical method of determining period-end inventory may be to record inventory on hand at selling prices, and then convert it to cost by adjusting for a normal margin

Answer 46

The retail method is often used in the retail industry for measuring inventories with high volumes of rapidly changing items with similar margins. [IAS 2.22]. It may be unnecessarily time-consuming to determine the cost of the period-end inventory on a conventional basis. Consequently, the most practical method of determining period-end inventory may be to record inventory on hand at selling prices, and then convert it to cost by adjusting for a normal margin

Question 47

Measurement of cost 3

Judgement is applied in the retail method in determining the margin to be removed from the selling price of inventory in order to convert it back to cost. The percentage has to take account of circumstances in which inventories have been marked down to below
original selling price. Adjustments have to be made to eliminate the effect of these markdowns so as to prevent any item of inventory being valued at less than both its cost and its net realisable value. In practice, however, entities that use the retail method apply a gross profit margin computed on an average basis appropriate for departments and/or ranges, rather than applying specific mark-up percentages. This practice is, in fact, acknowledged by IAS 2, which states that, ‘an average percentage for each retail department is often used’. [IAS 2.22].

Answer 47

Judgement is applied in the retail method in determining the margin to be removed from the selling price of inventory in order to convert it back to cost. The percentage has to take account of circumstances in which inventories have been marked down to below
original selling price. Adjustments have to be made to eliminate the effect of these markdowns so as to prevent any item of inventory being valued at less than both its cost and its net realisable value. In practice, however, entities that use the retail method apply a gross profit margin computed on an average basis appropriate for departments and/or ranges, rather than applying specific mark-up percentages. This practice is, in fact, acknowledged by IAS 2, which states that, ‘an average percentage for each retail department is often used’. [IAS 2.22].

Question 48

Measurement of cost - Cost formulas 1

Items that are not interchangeable and goods or services produced for specific projects should have their costs specifically identified and these costs will be matched with the goods physically sold. [IAS 2.23]. In practice this is a relatively unusual method of
valuation, as the clerical effort required does not make it feasible unless there are relatively few high value items being bought or produced. Consequently, it would normally be used where the inventory comprised items such as antiques, jewellery and automobiles in the hands of dealers. This method is inappropriate where there are large numbers of items that are interchangeable, as specific identification of costs could distort the profit or loss arising from these inventories through the method applied to selecting items that remain in inventories. [IAS 2.24].

Answer 48

Items that are not interchangeable and goods or services produced for specific projects should have their costs specifically identified and these costs will be matched with the goods physically sold. [IAS 2.23]. In practice this is a relatively unusual method of
valuation, as the clerical effort required does not make it feasible unless there are relatively few high value items being bought or produced. Consequently, it would normally be used where the inventory comprised items such as antiques, jewellery and automobiles in the hands of dealers. This method is inappropriate where there are large numbers of items that are interchangeable, as specific identification of costs could distort the profit or loss arising from these inventories through the method applied to selecting items that remain in inventories. [IAS 2.24].

Question 49

Measurement of cost - Cost formulas 2

Where it is necessary to use a cost-flow assumption (i.e. when there are large numbers of ordinarily interchangeable items), IAS 2 allows either a FIFO (first-in, first-out) or a weighted average cost formula to be used. [IAS 2.25].

Answer 49

Where it is necessary to use a cost-flow assumption (i.e. when there are large numbers of ordinarily interchangeable items), IAS 2 allows either a FIFO (first-in, first-out) or a weighted average cost formula to be used. [IAS 2.25].

Question 50

Measurement of cost - Cost formulas 3

The standard makes it clear that the same cost formula should be used for all inventories having a similar nature and use to the entity, although items with a different nature and use may justify the use of a different cost formula. [IAS 2.25]. For example the standard acknowledges that inventories used in one operating segment may have a use to the entity different from the same type of inventories used in another operating segment. However, a difference in geographical location of inventories (or in their respective tax rules) is not sufficient, by itself, to justify the use of different cost formulas. [IAS 2.26].

Answer 50

The standard makes it clear that the same cost formula should be used for all inventories having a similar nature and use to the entity, although items with a different nature and use may justify the use of a different cost formula. [IAS 2.25]. For example the standard acknowledges that inventories used in one operating segment may have a use to the entity different from the same type of inventories used in another operating segment. However, a difference in geographical location of inventories (or in their respective tax rules) is not sufficient, by itself, to justify the use of different cost formulas. [IAS 2.26].

Question 51

Measurement of cost - Cost formulas 4

An entity may choose, as a result of particular facts and circumstances, to change its cost formula, for instance, from a FIFO-based cost formula to a weighted average cost formula. The change in a cost formula represents a change in the basis on which the value of the inventory has been determined, rather than a change in valuation of the inputs used to determine the cost of the inventory. An accounting policy is defined in IAS 8 as including specific bases applied by an entity in preparing and presenting financial statements. Therefore a change in the cost formula represents a change in accounting policy which should only be made if it results in the financial statements providing reliable and more relevant information. [IAS 8.14]. If material, the change in accounting policy will have to be dealt with as a prior period adjustment in accordance with IAS 8

Answer 51

An entity may choose, as a result of particular facts and circumstances, to change its cost formula, for instance, from a FIFO-based cost formula to a weighted average cost formula. The change in a cost formula represents a change in the basis on which the value of the inventory has been determined, rather than a change in valuation of the inputs used to determine the cost of the inventory. An accounting policy is defined in IAS 8 as including specific bases applied by an entity in preparing and presenting financial statements. Therefore a change in the cost formula represents a change in accounting policy which should only be made if it results in the financial statements providing reliable and more relevant information. [IAS 8.14]. If material, the change in accounting policy will have to be dealt with as a prior period adjustment in accordance with IAS 8

Question 52

Measurement of cost - Cost formulas :
First-in, first-out (FIFO) 1

In the vast majority of businesses it will not be practicable to keep track of the cost of identical items of inventory on an individual unit basis; nevertheless, it is desirable to approximate to the actual physical flows as far as possible. The FIFO method probably gives the closest approximation to actual cost flows, since it is assumed that when inventories are sold or used in a production process, the oldest are sold or used first.
Consequently the balance of inventory on hand at any point represents the most recent purchases or production. [IAS 2.27].

Answer 52

In the vast majority of businesses it will not be practicable to keep track of the cost of identical items of inventory on an individual unit basis; nevertheless, it is desirable to approximate to the actual physical flows as far as possible. The FIFO method probably gives the closest approximation to actual cost flows, since it is assumed that when inventories are sold or used in a production process, the oldest are sold or used first.
Consequently the balance of inventory on hand at any point represents the most recent purchases or production. [IAS 2.27].

Question 53

Measurement of cost - Cost formulas :
First-in, first-out (FIFO) 2

This can best be illustrated in the context of a
business which deals in perishable goods (e.g. food retailers) since clearly such a business will use the first goods received earliest. The FIFO method, by allocating the earliest costs incurred against revenue, matches actual cost flows with the physical flow
of goods reasonably accurately. In any event, even in the case of businesses which do not deal in perishable goods, this would reflect what would probably be a sound management policy. In practice, the FIFO method is generally used where it is not possible to value inventory on an actual cost basis.

Answer 53

This can best be illustrated in the context of a
business which deals in perishable goods (e.g. food retailers) since clearly such a business will use the first goods received earliest. The FIFO method, by allocating the earliest costs incurred against revenue, matches actual cost flows with the physical flow of goods reasonably accurately. In any event, even in the case of businesses which do not deal in perishable goods, this would reflect what would probably be a sound management policy. In practice, the FIFO method is generally used where it is not possible to value inventory on an actual cost basis.

Question 54

Measurement of cost - Cost formulas :
Weighted average cost

The weighted average method, which like FIFO is suitable where inventory units are identical or nearly identical, involves the computation of an average unit cost by dividing the total cost of units by the number of units. The average unit cost then has to be revised with every receipt of inventory, or alternatively at the end of predetermined periods. [IAS 2.27]. In practice, weighted average systems are widely used in packaged inventory systems that are computer controlled, although its results are not very different from FIFO in times of relatively low inflation, or where inventory turnover is relatively quick.

Answer 54

The weighted average method, which like FIFO is suitable where inventory units are identical or nearly identical, involves the computation of an average unit cost by dividing the total cost of units by the number of units. The average unit cost then has to be revised with every receipt of inventory, or alternatively at the end of predetermined periods. [IAS 2.27]. In practice, weighted average systems are widely used in packaged
inventory systems that are computer controlled, although its results are not very different from FIFO in times of relatively low inflation, or where inventory turnover is relatively quick.

Question 55

Measurement of cost - Cost formulas :
Last-in, first-out (LIFO)

LIFO, as its name suggests, is the opposite of FIFO and assumes that the most recent purchases or production are used first. In certain cases this could represent the
physical flow of inventory (e.g. if a store is filled and emptied from the top). However it is not an acceptable method under IAS 2. LIFO is an attempt to match current costs with current revenues so that profit or loss excludes the effects of holding gains or losses. Essentially, therefore, LIFO is an attempt to achieve something closer to replacement cost accounting for the statement of profit or loss, whilst disregarding
the statement of financial position. Consequently, the period-end balance of inventory on hand represents the earliest purchases of the item, resulting in
inventories being stated in the statement of financial position at amounts which may bear little relationship to recent cost levels

Answer 55

LIFO, as its name suggests, is the opposite of FIFO and assumes that the most recent purchases or production are used first. In certain cases this could represent the
physical flow of inventory (e.g. if a store is filled and emptied from the top). However it is not an acceptable method under IAS 2. LIFO is an attempt to match current costs with current revenues so that profit or loss excludes the effects of holding gains or losses. Essentially, therefore, LIFO is an attempt to achieve something closer to replacement cost accounting for the statement of profit or loss, whilst disregarding the statement of financial position. Consequently, the period-end balance of inventory on hand represents the earliest purchases of the item, resulting in inventories being stated in the statement of financial position at amounts which may bear little relationship to recent cost levels

Question 56

Net realisable value 1

IAS 2 carries substantial guidance on the estimation of net realisable value. When this is below cost, inventory must be written down. The cost of inventory may have to be reduced to its net realisable value if the inventory has become damaged, is wholly or partly obsolete, or if its selling price has declined. The costs of inventory may not be recovered from sale because of increases in the costs to complete, or the estimated selling costs. [IAS 2.28]. However the costs to consider in making this assessment should only comprise direct costs to complete and sell the inventory.

Answer 56

IAS 2 carries substantial guidance on the estimation of net realisable value. When this is below cost, inventory must be written down. The cost of inventory may have to be reduced to its net realisable value if the inventory
has become damaged, is wholly or partly obsolete, or if its selling price has declined. The costs of inventory may not be recovered from sale because of increases in the costs to complete, or the estimated selling costs. [IAS 2.28]. However the costs to consider in making
this assessment should only comprise direct costs to complete and sell the inventory.

Question 57

Net realisable value 2

IAS 2 requires that selling costs are excluded from the cost of inventory and are expensed as incurred.
[IAS 2.16]. Selling costs include direct costs that are only incurred when the item is sold, e.g. sales commissions, and indirect costs, which are those overheads that enable sales to take place, including sales administration and the costs of retail activities. Of course, the selling price of inventory takes account of the expected costs of sale. If inventory is not impaired then the distinction between direct and indirect selling costs is not relevant as both are excluded from the cost of inventory. [IAS 2.16].

Answer 57

IAS 2 requires that selling costs are excluded from the cost of inventory and are expensed as incurred. [IAS 2.16]. Selling costs include direct costs that are only incurred when the item is sold, e.g. sales commissions, and indirect costs, which are those overheads that enable sales to take place, including sales administration and the costs of retail activities. Of course, the selling price of inventory takes account of the expected costs of sale. If inventory is not impaired then the distinction between direct and indirect selling costs is not relevant as both are excluded from the cost of inventory. [IAS 2.16].

Question 58

Net realisable value 3

Writing inventory down to net realisable value should normally be done on an item-by item basis. IAS 2 specifically states that it may be appropriate to group similar or related items but it is not appropriate to write down an entire class of inventory, such as finished goods, or all the inventory of a particular segment. However, it may be necessary to write down an entire product line or group of inventories in a given geographical area if the items cannot be practicably evaluated separately. [IAS 2.29].

Answer 58

Writing inventory down to net realisable value should normally be done on an item-byitem basis. IAS 2 specifically states that it may be appropriate to group similar or related items but it is not appropriate to write down an entire class of inventory, such as finished goods, or all the inventory of a particular segment. However, it may be necessary to write down an entire product line or group of inventories in a given geographical area if the items cannot be practicably evaluated separately. [IAS 2.29].

Question 59

Net realisable value 4

Estimates of net realisable value must be based on the most reliable evidence available and take into account fluctuations of price or cost after the end of the period if this is evidence of conditions existing at the end of the period. [IAS 2.30]. A loss realised on a sale of a product after the end of the period may well provide evidence of the net realisable value of that product at the end of the period. However if this product is, for example, an exchange traded commodity, and the loss realised can be attributed to a fall in prices on the exchange after the period end date, then this loss would not, in itself, provide evidence of the net realisable value at the period end date.

Answer 59

Estimates of net realisable value must be based on the most reliable evidence available and take into account fluctuations of price or cost after the end of the period if this is evidence of conditions existing at the end of the period. [IAS 2.30]. A loss realised on a sale of a product after the end of the period may well provide evidence of the net realisable value of that product at the end of the period. However if this product is, for example, an exchange traded commodity, and the loss realised can be attributed to a fall in prices on the exchange after the period end date, then this loss would not, in itself, provide evidence of the net realisable value at the period end date.

Question 60

Net realisable value 5

Estimates of net realisable value must also take into account the purpose for which the inventory is held. Therefore inventory held for a particular contract has its net realisable value based on the contract price, and only any excess inventory held would be based on current market prices. If there is a firm contract to sell quantities in excess of inventory quantities that the entity holds or is able to obtain under a firm purchase contract, this may give rise to an onerous contract liability that should be provided for in accordance with IAS 37 – Provisions, Contingent Liabilities and Contingent Assets. [IAS 2.31]. For inventory such as unused office supplies that are held for internal use and not sale to third parties, the replacement cost is the best available measure of their net realisable value.

Answer 60

Estimates of net realisable value must also take into account the purpose for which the inventory is held. Therefore inventory held for a particular contract has its net realisable value based on the contract price, and only any excess inventory held would be based on current market prices. If there is a firm contract to sell quantities in excess of inventory quantities that the entity holds or is able to obtain under a firm purchase contract, this may give rise to an onerous contract liability that should be provided for in accordance with IAS 37 – Provisions, Contingent Liabilities and Contingent Assets. [IAS 2.31]. For inventory such as unused office supplies that are held for internal use and not sale to third parties, the replacement cost is the best available measure of their net realisable value.

Question 61

Net realisable value 6

IAS 2 explains that materials and other supplies held for use in the production of inventories are not written down below cost if the final product in which they are to be used is expected to be sold at or above cost. [IAS 2.32]. This is the case even if these materials in their present condition have a net realisable value that is below cost and would therefore otherwise require write down. Thus, a whisky distiller would not write down an inventory of grain because of a fall in the grain price, so long as it expected to sell the whisky at a price which is sufficient to recover cost. If a decline in the price of materials indicates that the cost of the final product will exceed net realisable value then a write down is necessary and the replacement cost of those materials may be the best measure of their net realisable value. [IAS 2.32]. If an entity writes down any of its finished goods, the carrying value of any related raw materials should also be reviewed to see if they too need to be written down.

Answer 61

IAS 2 explains that materials and other supplies held for use in the production of inventories are not written down below cost if the final product in which they are to be used is expected to be sold at or above cost. [IAS 2.32]. This is the case even if these materials in their present condition have a net realisable value that is below cost and would therefore otherwise require write down. Thus, a whisky distiller would not write down an inventory of grain because of a fall in the grain price, so long as it expected to sell the whisky at a price which is sufficient to recover cost. If a decline in the price of materials indicates that the cost of the final product will exceed net realisable value then a write down is necessary and the replacement cost of those materials may be the best measure of their net realisable value. [IAS 2.32]. If an entity writes down any of its finished goods, the carrying value of any related raw materials should also be reviewed to see if they too need to be written down.

Question 62

Net realisable value 7

Often raw materials are used to make a number of different products. In these cases it is normally not possible to arrive at a particular net realisable value for each item of raw material based on the selling price of any one type of finished item. If the current replacement cost of those raw materials is less than their historical cost, a provision is only required to be made if the finished goods into which they will be made are expected to be sold at a loss. No provision should be made just because the anticipated profit will be less than normal.

Answer 62

Often raw materials are used to make a number of different products. In these cases it is normally not possible to arrive at a particular net realisable value for each item of raw material based on the selling price of any one type of finished item. If the current replacement cost of those raw materials is less than their historical cost, a provision is only required to be made if the finished goods into which they will be made are expected to be sold at a loss. No provision should be made just because the anticipated profit will be less than normal.

Question 63

Net realisable value 8

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. The reversal cannot be greater than the amount of the original write-down, so that the new carrying amount will always be the lower of the cost and the revised net realisable value. [IAS 2.33].

Answer 63

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. The reversal cannot be greater than the amount of the original write-down, so that the new carrying amount will always be the lower of the cost and the revised net realisable value. [IAS 2.33].

Question 64

Measurement of crypto-assets in scope of IAS 2 .1

As discussed above, crypto-assets each have their own terms and conditions and, as a result, the holders of a crypto-asset will need to evaluate these terms and
conditions to determine which IFRS recognition and measurement requirements should be applied. In
some cases, crypto-assets may meet the definition of inventory.

Answer 64

As discussed above, crypto-assets each have their own terms and conditions and, as a result, the holders of a crypto-asset will need to evaluate these terms and
conditions to determine which IFRS recognition and measurement requirements should be applied. In
some cases, crypto-assets may meet the definition of inventory.

Question 65

Measurement of crypto-assets in scope of IAS 2 .2

Generally, IAS 2 requires inventory to be measured at the lower of cost and net realisable value. [IAS 2.9]. However, commodity broker-traders have the choice to measure their inventories, if these are considered to be commodities, at fair value less costs to sell.
[IAS 2.3(b)].

Answer 65

Generally, IAS 2 requires inventory to be measured at the lower of cost and net realisable value. [IAS 2.9]. However, commodity broker-traders have the choice to
measure their inventories, if these are considered to be commodities, at fair value less costs to sell.
[IAS 2.3(b)].

Question 66

Measurement of Crypto-assets: Cost or lower net realisable value 1

The costs of purchased crypto-asset inventories would typically comprise the purchase price, irrecoverable taxes and other costs directly attributable to the acquisition of the inventory (e.g. blockchain processing fees). The cost of inventory excludes anticipated selling costs as well as storage expenses [IAS 2.16] (e.g. costs of holding a wallet or other crypto-account).

Answer 66

The costs of purchased crypto-asset inventories would typically comprise the purchase price, irrecoverable taxes and other costs directly attributable to the acquisition of the inventory (e.g. blockchain processing fees). The cost of inventory excludes anticipated selling costs as well as storage expenses [IAS 2.16] (e.g. costs of holding a wallet or other crypto-account).

Question 67

Measurement of Crypto-assets: Cost or lower net realisable value 2

The cost of crypto-assets recorded as inventory may not be recoverable if those cryptoassets have become wholly or partially obsolete (decline in interest or application) or if their selling prices have declined. Similarly, the cost of crypto-asset inventory may not be fully recoverable if the estimated costs to sell them have increased.

Answer 67

The cost of crypto-assets recorded as inventory may not be recoverable if those cryptoassets have become wholly or partially obsolete (decline in interest or application) or if their selling prices have declined. Similarly, the cost of crypto-asset inventory may not be fully recoverable if the estimated costs to sell them have increased.

Question 68

Measurement of Crypto-assets: Cost or lower net realisable value 3

An entity holding crypto-asset inventory will need to estimate the net realisable value at each reporting period. For crypto-assets quoted on a crypto-asset exchange, the net realisable value would typically comprise the current quoted price less the estimated
selling costs. These selling costs can fluctuate significantly depending on the current demand for processing on the particular blockchain. Where net realisable value is below cost, the inventory should be written down to its net realisable value with the write down being recorded in profit or loss. [IAS 2.34]. A previous write-down of inventory is reversed when circumstances have improved, but the reversal is limited to the amount previously written down so that the carrying amount never exceeds the original cost.
[IAS 2.33].

Answer 68

An entity holding crypto-asset inventory will need to estimate the net realisable value at each reporting period. For crypto-assets quoted on a crypto-asset exchange, the net realisable value would typically comprise the current quoted price less the estimated
selling costs. These selling costs can fluctuate significantly depending on the current demand for processing on the particular blockchain. Where net realisable value is below cost, the inventory should be written down to its net realisable value with the write down being recorded in profit or loss. [IAS 2.34]. A previous write-down of inventory is reversed when circumstances have improved, but the reversal is limited to the amount previously written down so that the carrying amount never exceeds the original cost.
[IAS 2.33].

Question 69

Measurement of Crypto-assets : Fair value less costs to sell 1

As noted at above, commodity broker-traders may measure their commodity inventories at fair value less costs to sell. [IAS 2.3(b)]. Broker-traders buy or sell
commodities for others or on their own account. When these commodities are principally acquired for the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin, they can be classified as commodity inventory at fair value less costs to sell.

Answer 69

As noted at above, commodity broker-traders may measure their commodity inventories at fair value less costs to sell. [IAS 2.3(b)]. Broker-traders buy or sell
commodities for others or on their own account. When these commodities are principally acquired for the purpose of selling in the near future and generating a profit from fluctuations in price or broker-traders’ margin, they can be classified as commodity inventory at fair value less costs to sell.

Question 70

Measurement of Crypto-assets : Fair value less costs to sell 2

While there is no definition of a commodity under IFRS, crypto-assets that are fungible (mutually interchangeable) and immediately marketable at quoted prices could potentially be considered commodities if they were held by broker-traders. However, judgement should be exercised in
determining whether a particular crypto-asset can be regarded as a commodity.

Answer 70

While there is no definition of a commodity under IFRS, crypto-assets that are fungible (mutually interchangeable) and immediately marketable at quoted prices could potentially be considered commodities if they were held by broker-traders. However, judgement should be exercised in
determining whether a particular crypto-asset can be regarded as a commodity.

Question 71

Measurement of Crypto-assets : Fair value less costs to sell 3

The quoted prices of crypto-assets may vary considerably between exchanges. A broker-trader measuring crypto-assets at fair value less costs to sell will need to determine the principal (or most advantageous) market for those assets, and whether they could enter into a transaction for the crypto-asset at the price in that market at the measurement date.

Answer 71

The quoted prices of crypto-assets may vary considerably between exchanges. A broker-trader measuring crypto-assets at fair value less costs to sell will need to determine the principal (or most advantageous) market for those assets, and whether they could enter into a transaction for the crypto-asset at the price in that market at the measurement date.

Question 72

Measurement of Crypto-assets : Fair value less costs to sell 4

When a broker-trader measures its inventory at fair value less costs to sell, any changes in the recognised amount should be included in profit or loss for the period. [IAS 2.3(b)]. A broker-trader holder of a crypto-asset will need to estimate the costs to sell the
crypto-asset at each reporting date, taking into consideration the transaction cost on the relevant blockchain and other fees required in order to convert the crypto-asset into cash. These fees could fluctuate significantly from period to period depending on the current demand for processing on the relevant blockchain.

Answer 72

When a broker-trader measures its inventory at fair value less costs to sell, any changes in the recognised amount should be included in profit or loss for the period. [IAS 2.3(b)]. A broker-trader holder of a crypto-asset will need to estimate the costs to sell the
crypto-asset at each reporting date, taking into consideration the transaction cost on the relevant blockchain and other fees required in order to convert the crypto-asset into cash. These fees could fluctuate significantly from period to period depending on the current demand for processing on the relevant blockchain.

Question 73

Real Estate Inventory - Classification of real estate as inventory 1

Many real estate businesses develop and construct residential properties for sale, and these developments often consist of several units. The strategy is to make a profit from the development and construction of the property rather than to make a profit in the long term from general price increases in the property market. The intention is to sell the property units as soon as possible following their construction and the sale is therefore in the ordinary course of the entity’s business.

Answer 73

Many real estate businesses develop and construct residential properties for sale, and these developments often consist of several units. The strategy is to make a profit from the development and construction of the property rather than to make a profit in the long term from general price increases in the property market. The intention is to sell the property units as soon as possible following their construction and the sale is therefore in the ordinary course of the entity’s business.

Question 74

Real Estate Inventory - Classification of real estate as inventory 2

When construction is complete it is not uncommon for individual property units to be leased at market rates to earn revenues to partly cover expenses such as interest, management fees, and real estate taxes. Large-scale buyers of commercial property, such as insurance companies, are often reluctant to buy unless a property has been let, as this assures immediate cash flows from the investment.

Answer 74

When construction is complete it is not uncommon for individual property units to be leased at market rates to earn revenues to partly cover expenses such as interest, management fees, and real estate taxes. Large-scale buyers of commercial property, such as insurance companies, are often reluctant to buy unless a property has been let, as this assures immediate cash flows from the investment.

Question 75

Real Estate Inventory - Classification of real estate as inventory 3

It is our view that if it is in the entity’s ordinary course of business (supported by its strategy) to hold property for short-term sale rather than for long-term capital appreciation or rental income, the entire property (including the leased units) should be accounted for and presented as inventory. This will continue to be the case as long as it remains the intention to sell the property in the short term. Rent received should be included in other income as it does not represent a reduction in the cost of inventory.

Answer 75

It is our view that if it is in the entity’s ordinary course of business (supported by its strategy) to hold property for short-term sale rather than for long-term capital appreciation or rental income, the entire property (including the leased units) should be accounted for and presented as inventory. This will continue to be the case as long as it remains the intention to sell the property in the short term. Rent received should be included in other income as it does not represent a reduction in the cost of inventory.

Question 76

Real Estate Inventory - Classification of real estate as inventory 4

Investment property is defined in IAS 40 as ‘property … held … to earn rentals or for capital appreciation or both, rather than for … use in the production or supply of goods or services or for administrative purposes; or … sale in the ordinary course of business’. [IAS 40.5]. Therefore in the case outlined above, the property does not meet the definition of investment property. Properties intended for sale in the ordinary course of business, no matter whether leased out or not, are outside the scope of IAS 40. However, if a property is not intended for sale, IAS 40 requires it to be transferred from inventory to investment property when there is a change in use. The change can be evidenced by the commencement of an operating lease to another party

Answer 76

Investment property is defined in IAS 40 as ‘property … held … to earn rentals or for capital appreciation or both, rather than for … use in the production or supply of goods or services or for administrative purposes; or … sale in the ordinary course of business’. [IAS 40.5]. Therefore in the case outlined above, the property does not meet the definition of investment property. Properties intended for sale in the ordinary course of business, no matter whether leased out or not, are outside the scope of IAS 40. However, if a property is not intended for sale, IAS 40 requires it to be transferred from inventory to investment property when there is a change in use. The change can be evidenced by the commencement of an operating lease to
another party

Question 77

Real Estate Inventory - Costs of real estate inventory :
Allocation of costs to individual units in multi-unit developments 1

A real estate developer of a multi-unit complex will be able to track and record various costs that are specific to individual units, such as individual fit out costs. However there will also be various costs that are incurred which are not specific to any individual unit, such as the costs of land and any shared facilities, and a methodology will be required to allocate these costs to the individual units. This will of course impact the profit that is recognised on the sale of each
individual unit.

Answer 77

A real estate developer of a multi-unit complex will be able to track and record various costs that are specific to individual units, such as individual fit out costs. However there will also be various costs that are incurred which are not specific to any individual unit, such as the costs of land and any shared facilities, and a methodology will be required to allocate these costs to the individual units. This will of course impact the profit that is recognised on the sale of each individual unit.

Question 78

Real Estate Inventory - Costs of real estate inventory :
Allocation of costs to individual units in multi-unit developments 2

There are two general approaches to this allocation, both of which we believe are acceptable under IAS 2. The first approach is to allocate these non-unit specific costs based on some relative cost basis. A reasonable proxy of relative cost is likely to be the size of each unit and hence an appropriate methodology would be to allocate the nonunit specific cost per square metre to the individual units based upon the floor area of
each unit. Another proxy of (total) relative cost may be the use of the specific cost of each unit. Marking up the specific cost that is attributable to each unit by a fixed percentage so as to cover and account for the non-unit specific costs would also seem reasonable. This relative cost approach is consistent with the guidance under IAS 2 in respect of allocation of overheads which requires a ‘systematic allocation of fixed and variable production overheads’. [IAS 2.12]

Answer 78

There are two general approaches to this allocation, both of which we believe are acceptable under IAS 2. The first approach is to allocate these non-unit specific costs based on some relative cost basis. A reasonable proxy of relative cost is likely to be the size of each unit and hence an appropriate methodology would be to allocate the nonunit specific cost per square metre to the individual units based upon the floor area of each unit. Another proxy of (total) relative cost may be the use of the specific cost of each unit. Marking up the specific cost that is attributable to each unit by a fixed percentage so as to cover and account for the non-unit specific costs would also seem reasonable. This relative cost approach is consistent with the guidance under IAS 2 in respect of allocation of overheads which requires a ‘systematic allocation of fixed and variable production overheads’. [IAS 2.12]

Question 79

Real Estate Inventory - Costs of real estate inventory :
Allocation of costs to individual units in multi-unit developments 3

The second approach would be to allocate these non-unit specific costs based on the relative sales value of each unit. This methodology is specifically referred to by the standard in the context of a production process that results in more than one product being produced simultaneously. [IAS 2.14]. Whichever approach is adopted it must be used consistently. In addition the developer should initially, as far as is practicable, segregate the non-unit specific costs between any commercial, retail and residential components before applying these methodologies.

Answer 79

The second approach would be to allocate these non-unit specific costs based on the relative sales value of each unit. This methodology is specifically referred to by the standard in the context of a production process that results in more than one product being produced simultaneously. [IAS 2.14]. Whichever approach is adopted it must be used consistently. In addition the developer should initially, as far as is practicable, segregate the non-unit specific costs between any commercial, retail and residential components before applying these methodologies.

Question 80

Real Estate Inventory - Costs of real estate inventory : Property demolition and operating lease costs 1

During the course of a property redevelopment project, an existing building may need to be demolished in order for the new development to take place. Should the cost of the building to be demolished be capitalised as part of the construction cost for the new building or should the cost
be charged to profit or loss?

Answer 80

During the course of a property redevelopment project, an existing building may need to be demolished in order for the new development to take place. Should the cost of the building to be demolished be capitalised as part of the construction cost for the new building or should the cost be charged to profit or loss?

Question 81

Real Estate Inventory - Costs of real estate inventory : Property demolition and operating lease costs 2

In all such cases an entity will need to exercise judgement in assessing the facts and circumstances. There are three distinct scenarios to consider:

(a) the entity is the owner-occupier, in which case the matter falls under IAS 16;
(b) the entity holds the property to earn rentals, in which case the matter falls under IAS 40;
(c) the entity sells such properties in its normal course of business.

Answer 81

In all such cases an entity will need to exercise judgement in assessing the facts and circumstances. There are three distinct scenarios to consider:

(a) the entity is the owner-occupier, in which case the matter falls under IAS 16;
(b) the entity holds the property to earn rentals, in which case the matter falls under IAS 40;
(c) the entity sells such properties in its normal course of business.

Question 82

Real Estate Inventory - Costs of real estate inventory : Property demolition and operating lease costs 3

IAS 2 defines inventories as assets (a) held for sale in the ordinary course of business; or (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. [IAS 2.6]. The cost of inventories must comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.
[IAS 2.10].

Answer 82

IAS 2 defines inventories as assets (a) held for sale in the ordinary course of business; or (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. [IAS 2.6]. The cost of inventories must comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.
[IAS 2.10].

Question 83

Real Estate Inventory - Costs of real estate inventory : Property demolition and operating lease costs 4

If it is the strategy of the developer to sell the developed property after construction, the new development falls within the scope of IAS 2, as it would be considered held for sale in the normal course of business by the developer. The cost of the old building as well as demolition costs and costs of developing the new one would be treated as inventory, but must still be subject to the normal ‘lower of cost and net realisable value’ requirements.

Answer 83

If it is the strategy of the developer to sell the developed property after construction, the new development falls within the scope of IAS 2, as it would be considered held for sale in the normal course of business by the developer. The cost of the old building as well as demolition costs and costs of developing the new one would be treated as inventory, but must still be subject to the normal ‘lower of cost and net realisable value’ requirements.

Question 84

Recognition in Profit or Loss 1

IAS 2 specifies that when inventory is sold, the carrying amount of the inventory must be recognised as an expense in the period in which the revenue is recognised. [IAS 2.34].

Answer 84

IAS 2 specifies that when inventory is sold, the carrying amount of the inventory must be recognised as an expense in the period in which the revenue is recognised. [IAS 2.34].

Question 85

Recognition in Profit or Loss 2

Judging when to recognise revenue, and therefore to charge the inventory expense, is one of the more complex accounting issues that can arise, particularly in the context of extended payment arrangements and manufacturer financing of sales to customers. In some industries, for example automobile manufacturing and retailing, aircraft manufacturing, railway carriage manufacturing and maintenance, and mobile phone handset retailing, it is customary for the goods concerned to be subject to extended and complex delivery, sales and settlement arrangements. For these types of transactions, the accounting problem that arises principally concerns when to recognise revenue, the consequent derecognition of inventory being driven by the revenue recognition
judgement

Answer 85

Judging when to recognise revenue, and therefore to charge the inventory expense, is one of the more complex accounting issues that can arise, particularly in the context of extended payment arrangements and manufacturer financing of sales to customers. In some industries, for example automobile manufacturing and retailing, aircraft manufacturing, railway carriage manufacturing and maintenance, and mobile phone handset retailing, it is customary for the goods concerned to be subject to extended and complex delivery, sales and settlement arrangements. For these types of transactions, the accounting problem that arises principally concerns when to recognise revenue, the consequent derecognition of inventory being driven by the revenue recognition
judgement

Question 86

Recognition in Profit or Loss 3

Inventory that goes into the creation of another asset, for instance into a selfconstructed item of property, plant or equipment, would form part of the cost of that
asset. Subsequently these costs are expensed through the depreciation of that item of property, plant and equipment during its useful life. [IAS 2.35].

Answer 86

Inventory that goes into the creation of another asset, for instance into a selfconstructed item of property, plant or equipment, would form part of the cost of that
asset. Subsequently these costs are expensed through the depreciation of that item of property, plant and equipment during its useful life. [IAS 2.35].

Question 87

Recognition in Profit or Loss 4

Any write-downs or losses of inventory must be recognised as an expense when the write-down or loss occurs. An inventory write down will reduce the value of the closing inventory. We tend not to process a journal for it and instead just record a smaller closing inventory figure when we CR Inventory (SFP) DR Closing inventory (C’o’S – SPL)????, so the impact on COGS is done via the closing inventory journal. No double entry. Reversals of previous write-downs are recognised as a reduction in the inventory expense recognised in the period in which the reversal occurs. [IAS 2.34].

Answer 87

Any write-downs or losses of inventory must be recognised as an expense when the write-down or loss occurs. An inventory write down will reduce the value of the closing inventory. We tend not to process a journal for it and instead just record a smaller closing inventory figure when we CR Inventory (SFP) DR Closing inventory (C’o’S – SPL)???, so the impact on COGS is done via the closing inventory journal. No double entry. Reversals of previous write-downs are recognised as a reduction in the inventory expense recognised in the period in which the reversal occurs. [IAS 2.34].

Question 88

Disclosure Requirements 1

The financial statements should disclose:

(a) the accounting policies adopted in measuring inventories, including the cost formula used;
(b) the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity;
(c) the carrying amount of inventories carried at fair value less costs to sell;
(d) the amount of inventories recognised as an expense during the period;

Answer 88

The financial statements should disclose:

(a) the accounting policies adopted in measuring inventories, including the cost formula used;
(b) the total carrying amount of inventories and the carrying amount in classifications appropriate to the entity;
(c) the carrying amount of inventories carried at fair value less costs to sell;
(d) the amount of inventories recognised as an expense during the period;

Question 89

Disclosure Requirements 2

(e) the amount of any write-down of inventories recognised as an expense in the period;
(f) the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense in the period;
(g) the circumstances or events that led to the reversal of a write-down of inventories; and
(h) the carrying amount of inventories pledged as security for liabilities. [IAS 2.36].

Answer 89

(e) the amount of any write-down of inventories recognised as an expense in the period;
(f) the amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense in the period;
(g) the circumstances or events that led to the reversal of a write-down of inventories; and
(h) the carrying amount of inventories pledged as security for liabilities. [IAS 2.36].

Question 90

Disclosure Requirements 3

IAS 2 does not specify the precise classifications that must be used to comply with (b) above. However it states that ‘information about the carrying amounts held in different classifications of inventories and the extent of the changes in these assets is useful to
financial statement users’, and suggests suitable examples of common classifications such as merchandise, production supplies, materials, work-in-progress, and finished goods. [IAS 2.37]

Answer 90

IAS 2 does not specify the precise classifications that must be used to comply with (b) above. However it states that ‘information about the carrying amounts held in different classifications of inventories and the extent of the changes in these assets is useful to
financial statement users’, and suggests suitable examples of common classifications such as merchandise, production supplies, materials, work-in-progress, and finished goods. [IAS 2.37]