1. Measurement Principles
Under IAS 2 (Inventories), inventory represents assets held for sale in the ordinary course of business, in the process of production for such sale, or in the form of materials or supplies to be consumed.
The foundational rule is that inventories must be measured at the lower of cost and net realizable value (NRV). This represents a direct application of prudence, ensuring assets are not overstated.
┌───────────────────────────────────────────────────────────────────────────┐
│                        IAS 2 INVENTORY MEASUREMENT                        │
├─────────────────────────────────────┬─────────────────────────────────────┤
│             TOTAL COST              │     NET REALIZABLE VALUE (NRV)      │
├─────────────────────────────────────┼─────────────────────────────────────┤
│ • Purchase Cost (net of trade discounts)│ • Estimated Selling Price in the    │
│ • Conversion Costs (Direct Labor)   │   ordinary course of business       │
│ • Allocated Fixed/Variable Factory Overhead│ • LESS: Estimated Costs to Complete │
│ [EXCLUDES: Storage, abnormal waste] │ • LESS: Estimated Costs to Sell     │
└─────────────────────────────────────┴─────────────────────────────────────┘

2. Allowed Cost Formulas
IAS 2 permits two standard cost allocation formulas for inventory items that are ordinarily interchangeable:
  • First-In, First-Out (FIFO): Assumes that the items of inventory that were purchased or produced first are sold first.
  • Weighted Average Cost (WAC): The cost of each item 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.
  • Strict Prohibition: LIFO (Last-In, First-Out) is completely forbidden under IFRS because it often distorts inventory values on the Statement of Financial Position during inflationary periods (unlike US GAAP, where LIFO is permitted for tax matchings).

3. Write-down Recognition and Reversals
If the NRV of an inventory item drops below its historical cost due to damage, obsolescence, or falling market prices, the inventory must be written down to NRV. The write-down amount is charged directly as an expense to the profit or loss statement (typically within Cost of Goods Sold).
  • Reversal Rule: If the circumstances that caused the write-down cease to exist, or if there is clear evidence of an increase in NRV due to changed economic circumstances, the write-down must be reversed. The reversal is limited to the amount of the original write-down, ensuring the new carrying amount never exceeds the original cost.

 
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