Assets

IAS 2 · Inventories

The lower of cost and NRV, item by item.

Draft: not yet reviewed by a teacher

Why it exists

Goods still in the warehouse at the year end are unsold, so their cost is carried into next year as an asset instead of being expensed. But an asset must not be shown at more than the business will get for it: if goods are damaged or their price has fallen, the loss is recognised now.

Key rules

Measure at the lower of cost and net realisable value (NRV), comparing each item or group of similar items separately.
NRV = expected selling price − costs to complete − costs to sell.
Cost includes the purchase price, import duties, carriage inwards and conversion costs. It excludes storage, carriage outwards, selling costs and abnormal waste.
FIFO and AVCO (weighted average) are allowed; LIFO is not.
Cost of sales = opening inventory + purchases − closing inventory. Closing inventory entry: Dr Inventory (SOFP), Cr Cost of sales.
When prices rise, FIFO gives a higher closing inventory and a higher profit than AVCO.

Examples

A Gəncə tea importer holds 200 boxes at a cost of 30 each. 40 boxes are damaged: they can be sold for 22 each after repacking costing 3.

NRV of the damaged boxes: 22 − 3 = 19, below cost of 30
Sound boxes: 160 × 30 = 4,800
Damaged boxes: 40 × 19 = 760
Inventory: 4,800 + 760 = 5,560 (a write-down of 6,000 − 5,560 = 440)

Cost or NRV, item by item

Opening 100 units at 10 (1,000), bought 200 units at 13 (2,600), sold 180, 120 left.

FIFO: the latest units remain, 120 × 13 = 1,560; cost of sales 3,600 − 1,560 = 2,040
Periodic AVCO: 3,600 / 300 = 12 a unit, 120 × 12 = 1,440; cost of sales 2,160
Prices are rising: FIFO profit is 120 higher

FIFO and AVCO on the same data

How it works

Closing inventory reduces this year's cost of sales and becomes next year's opening inventory. So an error in closing inventory distorts two years' profit: one way this year and the other way next year.

Periodic records count inventory at the period end; continuous (perpetual) records update the balance after every purchase and sale.

Traps

Taught in the course

Key rules

Measure at the lower of cost and net realisable value (NRV), comparing each item or group of similar items separately.

NRV = expected selling price − costs to complete − costs to sell.

Cost includes the purchase price, import duties, carriage inwards and conversion costs. It excludes storage, carriage outwards, selling costs and abnormal waste.

FIFO and AVCO (weighted average) are allowed; LIFO is not.

Cost of sales = opening inventory + purchases − closing inventory. Closing inventory entry: Dr Inventory (SOFP), Cr Cost of sales.

When prices rise, FIFO gives a higher closing inventory and a higher profit than AVCO.