IAS 2 specifically allows making approximations when measuring the cost of inventories. Popular approximations include standard cost method or the retail method (IAS 2.21-22).
Standard costs take into account normal levels of materials and supplies, labour, efficiency and capacity utilisation.
Under retail method, the cost of inventory is determined by reference to selling prices adjusted (decreased) by a profit margin. In practice, an average percentage is used as it would be impracticable to take into account all factors impacting selling price of a particular type of merchandise. Averaging is explicitly allowed by paragraph IAS 2.22.
Inventories that are not interchangeable
The cost of inventories that are not ordinarily interchangeable should be measured by specifically identifying their costs. This approach should also be followed for items that are segregated for a specific project (IAS 2.23-24).
General requirements for interchangeable inventories
Cost of inventories that are interchangeable and are not segregated for a specific project should be assigned using FIFO (First-In, First-Out) or weighted average cost formula. The same cost formula should be applied consistently for all inventories having a similar nature and use to the entity (IAS 2.25-26).
FIFO assumes that inventories that were purchased or produced first are sold first and consequently the items remaining in inventory are those most recently purchased or produced (IAS 2.27).
Example – FIFO method
At 1 January 20X1 Entity A has an opening balance of 1,000 items of product X with a cost of $10 per item. During January 20X1, the following purchases are made:
|Date||Volume||Cost per item|
In January 20X1, Entity A sold 1,400 of products X and is therefore left with 500 products at 31 January 20X1. Under the FIFO method, it is assumed that products that were purchased first are sold first, therefore the closing balance of 500 products consists of 400 items purchased on 20 January for $9.6 per item and 100 items purchased on 11 January for $9.7 per item. Therefore, the closing balance of inventories amounts to $4,810. The cost of goods sold amounts to $13,820 and is calculated as follows:
|Date of purchase||Volume||Cost per item||Total cost in P/L|
Weighted average cost
Under weighted average cost formula, the cost of each item of inventory is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The weighted average may be calculated on a periodic basis or at each shipment received (IAS 2.27).
On 1 January 20X1 Entity A has an opening balance of 1,000 items of product X with an average cost of $10 per item. During January 20X1, the following purchases are made:
|Date||Volume||Cost per item|
* weighted average (you can download an excel file for this example)
In January 20X1, Entity A sold 1,500 of products X and is therefore left with 400 products at 31 January 20X1. The 400 items left in stock are valued at $3,924 (400 x $9.81). The cost of goods sold relating to 1,500 products sold in January is recorded at $14,715 (1,500 x $9.81).
LIFO method (Last-In, First-Out) is not allowed (IAS 2.BC9-BC21), but this does not preclude an entity from adopting specific costing formulas where actual physical flows of inventory are matched with direct costs, which may yield results similar to LIFO.
Recognition in P/L
General requirements for recognition in P/L
When inventories are sold, their carrying amount is recognised as an expense in the period in which the related revenue is recognised (see IFRS 15 for revenue recognition criteria). When inventories are allocated to other assets, they become part of their cost. Write-downs to net realisable value (and reversals) are immediately included in P/L (IAS 2.34-35).
Inventory delivered to another party (a dealer, a distributor) in a consignment arrangement should be kept in the accounts of the delivering party until the criteria for revenue recognition are met. Consignment arrangements are specifically covered by IFRS 15 (IFRS 15.B77-78).
More about IAS 2
See other pages relating to IAS 2: