IAS 2, or the International Accounting Standard 2, provides guidance on the accounting treatment and disclosure requirements for inventories. Inventories are 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 in the production process.
Under IAS 2, inventories are initially measured at cost, which includes all costs of purchase, production, and other costs incurred in bringing the inventories to their present location and condition. The standard also requires entities to use a consistent cost formula for each category of inventory, such as first-in, first-out (FIFO), last-in, first-out (LIFO), or weighted average cost.
Examples of costs that may be included in the cost of inventories under IAS 2 include direct materials, direct labor, and overhead costs such as depreciation, rent, and utilities. In addition, any discounts, rebates, or other similar items should be deducted from the cost of inventories.
In some cases, the net realizable value (NRV) of inventories may be lower than their cost. In such cases, IAS 2 requires entities to recognize an impairment loss, which is the difference between the NRV and the cost of inventories. The impairment loss is recognized as an expense in the income statement in the period in which it occurs.
For example, suppose a company produces and sells electronic goods. At the end of the reporting period, the company has 1,000 units of a certain model of smartphone in its inventory. The company paid $200 per unit for these smartphones, and it estimates that it will sell them for $250 each. However, due to a decline in demand, the company now estimates that it can only sell the smartphones for $180 each. In this case, the NRV of the smartphones is $180, and the company must recognize an impairment loss of $20 per unit, or a total of $20,000, in its income statement.
Overall, IAS 2 aims to ensure that inventories are measured and presented in a consistent and reliable manner, which enables users of financial statements to make informed decisions about an entity’s financial position and performance.