IAS 2 inventories: what your stock is really worth on your balance sheet

IAS 2 inventories are the stock your business holds to sell in the ordinary course of business: finished goods, work in progress, and the raw materials and supplies that will become those goods. That matters because unsold stock is an asset on your balance sheet, while sold stock becomes cost of sales. Get the value wrong and both statements are wrong. IAS 2 exists to keep that valuation honest and consistent.

IAS 2 inventories: what counts as inventory?

Under IAS 2, inventories are assets that meet one of three descriptions:

• Held for sale in the ordinary course of business — the finished goods a retailer or wholesaler holds for customers.
• In the process of production for such sale — work in progress: partly finished goods on a production line.
• Materials or supplies to be consumed in production or in rendering services — raw materials, components, packaging, and consumables that will go into what you sell.

A service business can hold inventories too: the costs of services for which the related revenue has not yet been recognised, such as unbilled work on a job still in progress. The test is whether you hold the item to sell, to finish and sell, or to consume in producing what you sell.

IAS 2 inventories: what goes into cost?

IAS 2 inventories are first recorded at cost: purchase costs, conversion costs, and other costs of bringing inventories to their present location and condition.

Costs of purchase cover the purchase price, non-recoverable import duties and taxes, and directly attributable transport and handling — less trade discounts, rebates, and similar deductions.

Costs of conversion apply to manufactured goods: direct labour plus a systematic allocation of fixed and variable production overheads. Fixed overheads — factory rent, machinery depreciation, factory management — are allocated on the basis of normal capacity: expected average production under normal circumstances. If production is unusually low, unallocated overhead is expensed in the period, not loaded onto the few units made. If production is abnormally high, the per-unit allocation is reduced so inventory is not carried above cost.

Excluded from cost: abnormal waste; storage, unless necessary in the production process before a further stage; administrative overheads that do not bring inventories to their present location and condition; and selling costs. Borrowing costs are normally expensed too — only inventory taking a substantial period to produce can qualify under IAS 23.

IAS 2 inventories: the lower of cost and net realisable value test

Cost is only the starting point. Under IAS 2 inventories are carried at the lower of cost and net realisable value (NRV).

Net realisable value is the estimated selling price in the ordinary course of business, less estimated costs of completion and estimated costs necessary to make the sale — a forward-looking, item-by-item test of what you could actually realise from this stock.

Suppose you bought 100 units at $10 each, the selling price falls to $8, and selling costs are $1 per unit. NRV is $7, so the $300 write-down is expensed in the period and the balance sheet shows the stock at $700, not the $1,000 paid.

Write-downs are recognised when identified — when goods are damaged, become obsolete, or selling prices decline — not deferred until the goods sell at a loss. If circumstances later change, the write-down is reversed, but only up to the original amount. Inventory is never carried above original cost because of a recovery.

Which cost formula: FIFO, weighted average, or specific identification?

When identical units were bought at different prices, IAS 2 needs a rule for which cost leaves inventory first:

• Specific identification is used for items that are not ordinarily interchangeable, and for goods segregated for specific projects — a custom-built machine, for example. Each item keeps its own actual cost.
• FIFO (first-in, first-out) assumes the oldest units are sold first, so remaining inventory is valued at the most recent costs.
• Weighted average recalculates an average cost per unit — after each purchase, or periodically — and applies that average to both sales and remaining stock.

The same cost formula must be used for inventories of similar nature and use. One formula is absent: LIFO (last-in, first-out) is not permitted under IFRS, so it cannot be used in IFRS financial statements even if software offers it.

When stock is sold, written down, or written back

The matching principle runs through IAS 2 inventories. When inventories are sold, their carrying amount is recognised as an expense in the same period as the related revenue. Write-downs are expensed in the period they occur, and reversals reduce expense in the period of reversal.

IAS 2 also requires disclosures: the accounting policies adopted, carrying amounts by classification (raw materials, work in progress, finished goods), the amount expensed in the period, write-downs and reversals, and inventories pledged as security for liabilities.

Why this matters even if nobody audits you

You may never prepare full IFRS statements, but the discipline is useful in any business: count stock at what it cost to get it sale-ready, test it honestly against what you can sell it for, write it down when that falls, and use one cost formula consistently instead of whichever flatters this month's profit.

Stock carried above realisable value is a loan from your future self — the loss appears later, all at once. A lower-of-cost-and-NRV check each period-end keeps the surprise small and the numbers believable.

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