Under IAS 2, inventories should be measured at the lower of cost and net realisable value (IAS 2.9). Net realisable value (‘NRV’) 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 2.6). In other words, inventories should be written down below their cost if e.g. they are damaged, become obsolete or simply their selling prices have declined (IAS 2.28).
Estimates of NRV take into consideration the purpose for which the inventory is held. For example, NRV of inventory held to satisfy firm sales or service contracts is based on the contract price (IAS 2.31).
Net realisable value is different from fair value less costs to sell, because NRV is an entity specific value whereas fair value is not (IAS 2.7).
The amount of the write-down of an item of inventory can be reversed in subsequent periods following a change in relevant circumstances (IAS 2.33).
Evidence obtained after the end of the reporting period
An important indicator when estimating net realisable value is the last available selling price, including selling price realised after the reporting date which usually provides evidence of conditions that existed at a reporting date and thus should be considered as adjusting events after the reporting period (IAS 2.30).
IAS 2 leaves some room for interpretation when it comes to deciding which selling costs should be included in estimating NRV. It is therefore an accounting policy choice that should be applied consistently. IFRIC explained that an entity should estimate the costs necessary to make the sale in the ordinary course of business and that an entity should not limit the scope to incremental costs only.
Materials and other supplies held 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. Therefore, a write-down to net realisable value is not allowed simply because the price of raw material fell or the future profit margins will be unsatisfactory.
But if the entity would not be able to recover the cost of finished products, materials are written down to their NRV which can be based on the replacement cost of such materials (IAS 2.32).
More about IAS 2
See other pages relating to IAS 2: