IAS 2.9 stipulates that inventories must be measured at the lower of their cost and net realisable value (NRV). NRV is defined as the estimated selling price in the ordinary course of business minus the forecasted costs of completion and estimated expenses to facilitate the sale (IAS 2.6). This means that inventories should written down to below their original cost in situations where they’re damaged, become obsolete or if their selling prices have fallen (IAS 2.28).
The estimated NRV also reflects the specific purpose for which the inventory is kept. For instance, the NRV of inventory reserved for confirmed sales or service agreements is derived from the agreed contract price (IAS 2.31). It’s essential to understand that the NRV is different from fair value. The former is specific to an entity, while the latter isn’t (see IAS 2.7).
Should there be any change in circumstances that affects an inventory’s value, the amount written down must be reversed in subsequent periods (IAS 2.33).
Evidence after the the reporting period
A key factor in estimating the NRV is the most recent selling price. This includes any selling price realised after the reporting date. Such prices typically reflect conditions present at the reporting date, hence they are treated as adjusting events after the reporting period (IAS 2.30).
Selling costs
The guidelines provided by IAS 2 offer some flexibility in deciding which selling costs to include when calculating the NRV. As such, it’s an accounting policy choice that needs consistent application. The IFRS Interpretations Committee clarified that entities should estimate costs necessary to make the sale in the ordinary course of business, emphasising that the costs should not be restricted merely to incremental expenses.
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Materials
Materials and other supplies intended for production are not written down below their purchase price, especially if the final products they’re used in are projected to sell at or above cost. Thus, a write-down isn’t permitted solely because of a decline in raw material prices or if expected profit margins are unsatisfactory. However, if an entity foresees it won’t recover the cost of finished products, then the materials are written down to their NRV, potentially using the replacement cost as a base (IAS 2.32).
More about IAS 2
See other pages relating to IAS 2:
IAS 2: Scope, Definitions and Disclosure
IAS 2: Cost of Inventories
IAS 2: Cost Formulas (FIFO, LIFO and Weighted Average Cost)
IAS 2: Net Realisable Value (NRV)