Financial Reporting (F7/FR) Masters’ Academy of professional studies +923215040978Page 1 IAS 2 Inventory 1.Inventories are 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. 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: para. 6) 3.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. Measurement of inventories The standard states that 'Inventories should be measured at the lower of cost and net realizable value. Cost of inventories The cost of inventories will consist of all costs of: 1.Purchase 2.Costs of conversion 3.Other costs incurred in bringing the inventories to their present location and condition Costs of purchase The standard lists the following as comprising the costs of purchase of inventories. 1.Purchase price PLUS 2.Import duties and other taxes PLUS 3.Transport, handling and any other cost directly attributable to the acquisition of finished goods, services and materials LESS 4.Trade discounts, rebates and other similar amounts Costs of conversion Costs of conversion of inventories consist of two main parts. (a)Costs directly related to the units of production, eg direct materials, direct labour
Financial Reporting (F7/FR) Masters’ Academy of professional studies +923215040978Page 2 (b)(b) Fixed and variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic basis. The standard emphasises that fixed production overheads must be allocated to items of inventory on the basis of the normal capacity of the production facilities. This is an important point. (a) Normal capacity is the expected achievable production based on the average over several periods/seasons, under normal circumstances. (b) The above figure should take account of the capacity lost through planned maintenance. (c) If it approximates to the normal level of activity then the actual level of production can be used. (d) Low production or idle plant will not result in a higher fixed overhead allocation to each unit. (e) Unallocated overheads must be recognised as an expense in the period in which they were incurred. (f) When production is abnormally high, the fixed production overhead allocated to each unit will be reduced, so avoiding inventories being stated at more than cost. (g) The allocation of variable production overheads to each unit is based on the actual use of production facilities.