Intermediate Accounting

University of San Carlos

PAS 2 INVENTORIES

Definition:
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

Recognition:
● Recognized only when it is probable that the future economic benefits will flow to the
entity and the inventories has a cost or value that can be measured reliably

Measurement:
● LCNRV - Lower of cost or net realizable value
○ Net Realizable Value (NRV) - it 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
■ Is NRV similar to FV? No. NRV is entity-specific; while FV is not.
● NRV for inventories may not equal FV less costs to sell

Scope of PAS 2:
● Applies to all inventories, except:
● Working in progress arising under construction contracts, including directly
related service contracts (PAS 11 Construction Contracts)
● Financial instruments (PAS 32 Financial Instruments: Presentation, PAS 39
Financial Instruments: Recognition and Measurement and PFRS 9 Financial
Instruments); and
● Biological assets related to agricultural activity and agricultural produce at the
point of harvest (PAS 41 Agriculture)
● Does not apply to the measurement of inventories held by:
● Producers of agricultural and forest products, agricultural produce after harvest,
and minerals and mineral products, to the extent that they are measured at net
realizable value in accordance with well-established practices in those industries
● Commodity broker-traders who measure their inventories at fair value less cost
to sell

Classification of inventories:
● Common:
○ Merchandise
○ Production supplies
○ Materials
○ Work in progress
○ Finished goods
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University of San Carlos

● Inventories of a service provider may be described as work in progress

Cost of inventories:
● Shall comprise:
● Costs of purchase
● Costs of conversion, and
● Other costs incurred in bringing the inventories to their present location and
condition

Costs of purchase ● Purchase price

● Import duties
● Other taxes (other than those subsequently
recoverable by the entity from the taxing
authorities)
● Transport, handling and other costs directly
attributable to the acquisition of finished goods,
materials and services

Trade discounts, rebates and other similar items are

deducted in determining the costs of purchase

Costs of conversion ● Costs directly related to the units of production,

such as direct labor
● A systematic allocation of fixed and variable
production overheads that are incurred in
converting materials into finished goods

Other costs incurred in ● Non-production overheads

bringing the inventories to ● The costs of designing products for specific
their present location and customers
condition ● Borrowing costs (PAS 23)

Examples of costs excluded from the cost of inventories:

● Abnormal amounts of wasted materials, labor or other production costs
● Storage costs, unless necessary in the production process before a further production
stage
○ Storage cost on GIP/WIP is capitalized
○ Storage cost on FG is not capitalized
● Administrative overheads that do not contribute to bringing inventories to their present
condition and location
● Selling costs
● Financing element when inventories are purchased on deferred settlement terms

Cost of inventories of a service provider

● Measured at the cost of their production, consisting of:
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University of San Carlos

● Labor and other costs of personnel directly engaged in providing the service,
including supervisory personnel
● Attributable overheads

Cost of agricultural produce harvested from biological assets

● PAS 41, Agriculture, their cost is at fair value less costs to sell at the point of harvest

Techniques for the measurement of cost

● Standard Cost Method
● Retails Method

Cost Formulas
● An entity shall use the same cost formula for all inventories having a similar nature and
use to the entity. For inventories with a different nature or use, different cost formulas
may be justified
● Specific identification - inventories of items that are not ordinarily interchangeable and
goods or services produced and segregated for specific projects
● FIFO or weighted average cost

NRV Measurement
● Estimates of NRV are based on the most reliable evidence available at the time the
estimates are made of the amount the inventories are expected to realize
● Inventories are usually written down to NRV item by item
● It is not appropriate to write inventories down on the basis of a classification of inventory
(ex. FG, or all the inventories in a particular operating segment)
● Materials and other supply shield for use in the production of inventories are not written
down below cost if the finished products in which they will be incorporated are expected
to be sold at or above cost
● When a decline in the price of materials indicates that the cost of the finished products
exceeds NRV, the materials are written down to NRV - replacement cost of the
materials may be the best available measure of their NRV

Subsequent Measurement
● Still at lower of cost or net realizable value (LCNRV)
● The amount of any write-down of inventories to NRV and all losses of inventories shall
be recognized as an expense in the period the write-down or loss occurs
● The amount of any reversal of any write-down of inventories, arising from an increase in
NRV, shall be recognized as a reduction in the amount of inventories recognized as an
expense in the period in which the reversal occurs

Use of inventories
● When inventories are sold, the carrying amount (CA) of those inventories shall be
recognized as an expense in the period in which the related revenue is recognized
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University of San Carlos

● Some inventories may be allocated to other asset accounts, for example, inventory used
as a component of self-constructed PPE
○ Inventories allocated to another asset in this way are recognized as an expense
during useful life of that asset

Disclosures
● Accounting policies, including the cost formula used
● The total CA of inventories and the CA in classification appropriate to the entity
● The CA of inventories carried at FV less costs to sell
● The amount of inventories recognized as an expense during the period
● The amount of any write-down of inventories recognized as an expense in the period
● The amount of any reversal of any write-down that is recognized as a reduction in the
amount of inventories recognized as expense in the period
● The circumstances or events that led to the reversal of a write-down of inventories
● The CA of inventories pledged as security for liabilities