IAS 2: Inventories
Inventory at the lower of cost and net realisable value: what goes into cost, FIFO and weighted average, and write-downs.
ACCA exams this helps with: FR Financial Reporting SBR Strategic Business Reporting See the ACCA map
New to this topic?
What it is: The rules for valuing goods a business holds to sell, is making, or will use in making things.
The key idea: inventory is shown at the lower of cost and net realisable value (NRV), item by item. If you can’t sell it for at least what it cost, write it down.
Example. A sofa cost £1,200. It can now be sold for £1,300, but needs £150 of repairs to sell. NRV = 1,300 − 150 = £1,150, so it is shown at £1,150 and £50 is written off.
Key words
- Inventories
- Assets held for sale in the ordinary course of business, in production for sale, or as materials to be used in production or services.Example: Finished goods, work in progress, raw materials.
- Cost
- All costs of purchase, costs of conversion and other costs incurred to bring the inventory to its present location and condition.Example: Purchase price + import duty + delivery in.
- Net realisable value (NRV)
- Estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs to make the sale.Example: Selling price 1,300 − selling costs 150 = 1,150.
- FIFO
- First in, first out: the items bought first are assumed to be sold first, so closing inventory is the most recent purchases.Example: Closing inventory valued at the latest prices.
- Weighted average cost
- Each item is valued at the average cost of similar items available during the period.Example: Total cost 5,000 ÷ 1,000 units = £5 each.
Learn
Measurement
Inventory is measured at the lower of cost and net realisable value. The comparison is normally done item by item (or for groups of similar items), not for the total.
What goes into cost
| Include | Exclude (expense as incurred) |
|---|---|
| Purchase price, import duties, non-recoverable taxes | Recoverable taxes such as VAT |
| Transport and handling to get the goods in | Selling and distribution costs |
| Less trade discounts and rebates | Abnormal waste of materials, labour or overheads |
| Direct labour and direct materials | Storage costs (unless needed between production stages) |
| Production overheads, fixed and variable | Administrative overheads that don’t help bring the inventory to its present location and condition |
Fixed production overheads are allocated using the normal capacity of the production facilities. If output is unusually low, the overhead per unit is not increased: the unallocated overhead is an expense. If output is unusually high, the overhead per unit is reduced so inventory is not measured above cost.
Cost formulas
- Specific identification for items that are not ordinarily interchangeable (for example custom-made goods).
- Otherwise FIFO or weighted average cost, used consistently for inventories of a similar nature and use.
- LIFO is not allowed under IFRS.
Write-downs
A write-down to NRV is an expense in the period it happens. If the circumstances that caused it no longer exist, it is reversed, but only up to the original write-down (so the new carrying amount is still the lower of cost and revised NRV). When inventory is sold, its carrying amount becomes cost of sales.
Worked example
Three items at the year end:
| Item | Cost £ | Selling price £ | Costs to complete and sell £ | NRV £ | Value at £ |
|---|---|---|---|---|---|
| A | 1,200 | 1,300 | 150 | 1,150 | 1,150 |
| B | 800 | 1,500 | 100 | 1,400 | 800 |
| C | 500 | 450 | 30 | 420 | 420 |
| Total | 2,500 | 2,370 |
Compared item by item, inventory is £2,370 and the write-down is 2,500 − 2,370 = £130 (50 on A and 80 on C). The profit on B can’t be used to cover the losses on A and C.
Fixed overheads. Fixed production overheads are £50,000 and normal capacity is 10,000 units, so £5 is added to each unit. This year only 8,000 units were made. Each unit still carries £5 (£40,000 in inventory and cost of sales), and the other £10,000 is an expense of the period.
Practice questions
Type or choose your answers, then press Check answer. Questions with a New numbers button can be repeated with different figures.