IAS 2 - Inventories

IAS 2, "Inventories," is an International Financial Reporting Standard (IFRS) issued by the International Accounting Standards Board (IASB). It provides guidance on accounting for inventories and is applicable to all entities except those specifically excluded, such as financial instruments and biological assets related to agricultural activity. 

Here's an explanation of the key aspects of IAS 2:

Scope

IAS 2 applies to all inventories, which include assets:

• Held for sale in the ordinary course of business (finished goods).
• In the process of production for such sale (work in progress).
• In the form of materials or supplies to be consumed in the production process or in the rendering of services (raw materials).

Measurement

Inventories should be measured at the lower of cost and net realizable value (NRV).

Cost of Inventories

The cost of inventories includes:

• Costs of Purchase: Purchase price, import duties, transportation, handling, and other costs directly attributable to the acquisition.
• Costs of Conversion: Costs directly related to production, such as direct labor and a systematic allocation of fixed and variable production overheads.
• Other Costs: Costs incurred in bringing the inventories to their present location and condition.

Methods to determine the cost of inventories include:

• First-In, First-Out (FIFO)
• Weighted Average Cost

Net Realizable Value (NRV)

NRV 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. When the NRV is lower than the cost, the inventory should be written down to NRV.

Recognition as an Expense

When inventories are sold, the carrying amount of those inventories should be recognized as an expense in the period in which the related revenue is recognized. Any write-down to NRV and any loss of inventories should be recognized as an expense when the write-down or loss occurs.

Reversal of Write-Downs

If the NRV of a previously written-down inventory increases, the amount of the write-down can be reversed, limited to the original write-down amount. This reversal is recognized as a reduction in the amount of inventories recognized as an expense in the period the reversal occurs.

Disclosure Requirements

Entities must disclose:

• The accounting policies adopted for inventories.
• The total carrying amount of inventories and their classification.
• The amount of inventories recognized as an expense during the period.
• The amount of any write-down of inventories recognized as an expense.
• The amount of any reversal of any write-down recognized as a reduction in the amount of inventories recognized as an expense.
• The carrying amount of inventories pledged as security for liabilities.

Practical Application

1. Inventory Valuation: Ensuring that inventories are correctly valued using the lower of cost and NRV method helps in accurate financial reporting.
2. Cost Formulas: Choosing the appropriate cost formula (FIFO or weighted average) that best reflects the flow of inventory.
3. Impairment Consideration: Regular assessment of NRV to identify and write down impaired inventories ensures that financial statements reflect the true economic value of the inventories.

By adhering to IAS 2, entities ensure consistency and comparability in financial reporting related to inventories, which is crucial for investors, regulators, and other stakeholders who rely on financial statements for decision-making.