IAS 2

International Accounting Standard 2: Inventories (IAS 2) is an international financial reporting standard issued by the International Accounting Standards Board (IASB) that governs the valuation and presentation of inventories.

Overview and Definitions

IAS 2 defines inventories as assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services.

The fundamental principle of IAS 2 is that inventories must be measured at the lower of cost and net realisable value (NRV). Cost comprises all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.

Conversion Costs and Overheads

Costs of conversion include costs directly related to the units of production (e.g., direct labour) and a systematic allocation of fixed and variable production overheads.

Variable production overheads: Those indirect costs of production that vary directly, or nearly directly, with the volume of production (e.g., indirect materials such as lubricants and indirect labour).
Fixed production overheads: Those indirect costs of production that remain relatively constant regardless of the volume of production (e.g., depreciation and maintenance of factory buildings and equipment, and the cost of factory management and administration).

The allocation of fixed production overheads to the costs of conversion is based on the normal capacity of the production facilities.

Booking Examples for IAS 2

1. Initial Recognition and Completion

Scenario: An entity purchases raw materials for $10,000. It incurs $2,000 in direct labour and $1,000 in production overheads (e.g., $400 variable lubricants and $600 fixed factory rent) to manufacture finished goods.

2. Write-down to Net Realisable Value (NRV)

Scenario: At year-end, the finished goods (cost $13,000) have a market value of $12,500. Estimated costs to complete the sale (shipping/commissions) are $1,000.

NRV Calculation: $12,500 - $1,000 = $11,500.
Write-down Amount: $13,000 (Cost) - $11,500 (NRV) = $1,500.

Disclosure Requirements

An entity must disclose specific information to allow users of financial statements to understand the valuation and impact of inventories. According to IAS 2.36, the following disclosures are required: