INVENTORIES

LKAS 2
Resource Person
M. Shihan Haniff
MBA (Reading) - UWTSD, B.Sc. Finance (Sp.) - USJP, CBA - ICASL, DipIT- UOC
Managing Director – CSR Expert (Pvt) Ltd
Founder – SocialService.lk
Senior Lecturer – Jayasekera Management Centre
Objectives

• To prescribe accounting treatment for inventories.

• To provide guidance on determination of cost and its subsequent
recognition as an expense, including any write down to NRV.
• To provide guidance on cost formulas used to assign cost to
inventories.

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Scope
This standard applies to all inventories, except:

Types of Inventories which are outside the Types of Inventories which are exempted ONLY, from
scope of LKAS 2 measurement requirements of standard but are within the
scope of other requirements in the standard

• Work in progress arising under • Inventories held by Producers of agricultural and

construction contracts [LKAS 11] forest products, agricultural produce after
• Financial Instruments [LKAS 32 and harvest and minerals and mineral products, to
LKAS 39] the extent that they are measured at net
realizable value.
• Biological Assets related to
agricultural activity and agricultural • Commodity broker-traders who measure their
produce at the point of harvest Inventories at fair value less costs to sell.
[LKAS 41]

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Definitions
Inventories
Inventories are assets:
• held for sale in the ordinary course of business; or
• 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.

Prepared by Shihan Raw materials Work in progress Finished goods

Haniff
Definitions
Net realizable value (NRV)
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.

Fair value
Fair value is the amount for which an asset could be exchanged, or a
liability settled, between knowledgeable, willing parties in an arm’s
length transaction.

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Measurement of Inventories

The value of the inventories is measured at the lower of cost and net
realizable value for each separate item or group of inventory items.

Cost Net Realisable

Value

Whichever is lower

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Cost of inventories
Cost of purchase Cost of conversion Other costs
• Purchase price Costs of conversion includes: • Other costs are included to the
Add 1. Costs directly related to production extent they are incurred in
• Import duties (such as direct labour) bringing the inventories to
• Other taxes (other than those 2. Allocated variable production their present location and
subsequently recoverable by the entity Overheads condition.
from the taxing authorities) 3. Allocated fixed production • For example: Costs of designing
• Transportation costs Overheads (based on the normal products for specific customers
• Handling costs capacity*) can be included in the cost of
• Other costs directly attributable to the [Un-allocated overheads are inventories.
acquisition of finished goods, materials recognized as expense]  
and services. 4. In case of Joint Products; costs are  
Deduct allocated between the products on a • LKAS 23; Borrowing Costs
• Trade discounts rational & consistent basis. identifies limited circumstances
• Rebates and other similar items where borrowing costs are
*Normal Capacity is the production expected included in the costs of
** Abnormal waste and administrative overheads under normal circumstances, after adjusting inventories.
unrelated to production is not a cost of loss of capacity.
purchases.
Cost
COST

Material Labour Other

Direct Direct Direct Prime Cost

Material Labour Other Total
Production
Indirect Indirect Indirect
Overheads Cost
Material Labour Other

Non-Manufacturing Manufacturing
OH OH
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Not a cost
Costs which would not be included in the cost of inventories
 Abnormal amounts
 Storage costs
 Administrative overheads
 Selling costs

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Techniques for the measurement of cost
Standard Cost Method Retail Method
Standard costs take in to account The retail method is often used in the
normal levels materials and supplies, retail industry for measuring inventories
labour, efficiency and capacity of large numbers of rapidly changing
utilization. items with similar margins for which it is
  impracticable to use other costing
They are regularly reviewed and, if methods.
necessary, revised in the light of
current conditions. The cost of the inventory is determined
by reducing the sales value of the
inventory by the appropriate percentage
gross margin.

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Cost Formulas

 The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.
 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.
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Cost Formulas
Method Assumption Income statement effect Balance sheet effect
FIFO When a company sells The older inventory was The remaining inventory
an item from inventory, cheaper, so cost of sales is shown in the balance sheet
the oldest one is sold less, and income is higher is the newest, and most
valuable
LIFO When an item is sold The newer (more expensive) Remaining inventory is
from inventory, the inventory is sold, so the cost shown as an older and less
newest one is sold of sales is higher, and income valuable asset
is lower

AVCO The average cost of all Both cost of sales and income Inventory asset will be
inventory is used for will be between the levels between the levels
both cost of sales and recorded under LIFO or FIFO recorded under LIFO or
inventory FIFO
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Net Realizable Value (NRV)
Write-down of Inventories
 Inventories are usually written down to NRV item by item.
 Similar items which are produced & marketed in same geographical
area and which can’t be separately evaluated from other items in
the product line can be grouped. However, it’s not appropriate to
write-down inventories on the basis of classification.
 In case of Service providers, each service is treated as separate
item and costs in respect of each such service is accumulated

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Net Realizable Value (NRV)
Estimates for NRV
• Should be based on most reliable evidence
• These estimates take into consideration:
o Fluctuations of price/cost occurring after the end of period
o Purpose for which Inventory is held

Assessment for NRV

• Done in each subsequent period
• If earlier circumstances are not there, the amount of write-down is
reversed; but limited to the original write-down
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Net Realizable Value (NRV)
Net Realizable Vale Fair Value
• Estimated selling price (in the ordinary course • Amount for which an asset could be
of business) exchanged, or a liability settled,
(-) Estimated costs of completion between knowledgeable, willing
(-) Estimated costs necessary to make the sale parties in an arm’s length transaction.
   
• Amount that an entity expects to realise from • This is not entity specific.
the sale of inventory in the ordinary course of  
business. • This method is specifically mentioned
  for Commodity broker-traders.
• This method of valuation of inventories is open
to all types of inventories referred in this * “NRV” may not be equal to “Fair
standard. value (-) costs to sell

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 Recognition as an expense
Recognition

Sold Written down to Allocated to

Increase of NRV
NRV other asset

Carrying amount of Amount of Write-down and Amount of Reversal (if any) Such Inventories should be
inventories is recognized as all losses of inventories shall be recognized as a recognized as an expense
an Expense should be recognized as an reduction in the amount of during the useful life of that
Expense. inventories recognized as an asset.
expense earlier.

*Amount of Inventories recognized as expense during the period are often referred to as Cost of Sales.
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Disclosure
The financial statements shall disclose:
i. Accounting policies (Valuation method), including cost formula used;
ii. Total carrying amount of inventories and classifications;
iii. Carrying amount of inventories carried at fair value less costs to sell;
iv. Amount of inventories recognized as an expense;
v. Amount of any write-down of inventories recognized as an expense;
vi. Amount of any reversal of any write-down that is recognized as a
reduction in the amount of inventories recognized as expense;
vii. Circumstances that led to the reversal of a write-down of inventories;
viii.Carrying amount of inventories pledged as security for liabilities.
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2014 Jul AAT I

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2014 Jan AAT I

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2013 Jul AAT I

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2012 Jul AAT I

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2019 Jul AAT III Q 07 (B)

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2017 Jan AAT III Q 04

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2019 Mar KE1 Q07

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2018 Sep KE1 Q 01

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2018 Sep KE1 Q 01

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2018 Mar KE1 Q 01

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2017 Sep KE1 Q 01

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2015 Sep KE1 Q 02

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