International Accounting Standard 2

1. International Accounting Standard 2 INVENTORIES IAS 2

2. History • Originally IAS 2; Valuation and presentation of Inventories in the context of the Historical cost system issued in October 1975. • Replaced by IAS 2; Inventories issued by IASC in December 1993. • SIC-1;Consistency-Different Cost Formulas for Inventories was issued by Standing Interpretations Committee in December 1997. • Limited amendments to IAS 2 were made in 1999 & 2000. • In April 2001, IASB resolved to apply ALL Standards & Interpretations issued under previous constitutions unless they were amended or withdrawn. • SIC-1 was replaced and IAS 2 was revised by IASB in December 2003. • Subsequently IAS 2 was amended by IFRS 8 Operating Segments; which was issued in November 2006. IAS 2

3. Applicability Should be applied for annual periods beginning on or after January 1, 2005 to ALL inventories except those which have been specifically excluded from its scope. IAS 2

4. Objective • 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. IAS 2

5. ScopeThis standard applies to ALL inventories, except: Types of Inventories which are outside the scope of IAS 2 Types of Inventories which are exempted ONLY from measurement requirements of standard but are within the scope of other requirements in the standard. Inventories held by Producers of agricultural and forest products, agricultural produce after harvest and minerals and mineral products, to the extent that they are measured at net realisable value. Commodity broker-traders who measure their Inventories at fair value less costs to sell. Work in progress arising under construction contracts [IAS 11] Financial Instruments [IAS 32 and IAS 39] Biological Assets related to agricultural activity and agricultural produce at the point of harvest [IAS 41] IAS 2

6. Definitions • Inventoriesare assets: (a) held for sale in the ordinary course of business; (b) in the process of production for such sale; or (c) in the form of materials or supplies to be consumed in the production process or in the rendering of services. • Net realisable valueis 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 valueis the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. IAS 2

7. Measurement of Inventories • Due to amendment in IAS 21; Effects of changes in foreign exchange rates, exchange differences arising from the acquisition of inventories invoiced in a foreign currency are not to be included in Cost Of Purchase. • Inventory purchased on deferred settlement terms Difference between Normal purchase price and amount paid to be recognised as Interest Expense. whichever is lower IAS 2

8. Cost of Inventories Costs of Purchase Purchase price + Import duties + Other taxes (other than those subsequently recoverable by the entity from the taxing authorities) + Transportation costs + Handling costs + Other costs directly attributable to the acquisition of finished goods, materials and services. (-) Trade discounts (-) Rebates and other similar items • Cost of Conversion • Costs of conversion includes: • Costs directly related to production (such as direct labour) • Allocated variable production Overheads • Allocated fixed production Overheads (based on the normal capacity*) • [Un-allocated overheads are recognised as expense] • In case of Joint Products; costs are allocated between the products on a rational & consistent basis. • Other Costs • Other costs are included to the extent they are incurred in bringing the inventories to their present location and condition. • For example: Costs of designing products for specific customers can be included in the cost of inventories. • IAS 23; Borrowing Costs identifies limited circumstances where borrowing costs are included in the costs of inventories. *Normal Capacity is the production expected under normal circumstances, after adjusting loss of capacity. IAS 2

9. COSTS OF AGRICULTURAL PRODUCE HARVESTED FROM BIOLOGICAL ASSETS Measured at: Fair Value (-) Estimated point of sale costs at the time of harvest. COSTS OF INVENTORIES OF A SERVICE PROVIDER To the extent that service providers have inventories, they are measured at: Cost of production + Labour and other Personnel costs + Attributable overheads Х Labour & other costs relating to sales and general administrative personnel. Х Profit Margins. Х Non-attributable overheads. IAS 2

10. Techniques for the measurement of cost Methods mentioned below can be used as per the convenience if the results approximate cost Standard Cost Method Standard costs take into account normal levels of materials and supplies, labour, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of current conditions. Retail Method The retail method is often used in the retail industry for measuring inventories of large numbers of rapidly changing items with similar margins for which it is impracticable to use other costing methods. The cost of the inventory is determined by reducing the sales value of the inventory by the appropriate percentage gross margin. IAS 2

11. 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. IAS 2

12. Net Realisable Value • Where cost of inventories is not recoverable due to damage, obsolescence, decline in selling price, or if estimated costs of completion or estimated costs to be incurred to make sale have increased. • Materials and other supplies held for use in 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. • However, when a decline in price of materials indicates that cost of finished products exceeds NRV, the materials are written down to NRV. In such circumstances, the replacement cost of the materials may be the best available measure of their NRV. IAS 2

13. Net Realisable Value • 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. • Estimates for NRV • Should be based on most reliable evidence. • These estimates take into consideration: • Fluctuations of price/cost occurring after the end of period. • 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. IAS 2

14. Net Realisable ValueVsFair Value Net Realisable Value Estimated selling price (in the ordinary course of business) (-) Estimated costs of completion (-) Estimated costs necessary to make the sale Amount that an entity expects to realise from the sale of inventory in the ordinary course of business. This method of valuation of inventories is open to all types of inventories referred in this standard. Fair Value Amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. This is not entity specific. This method is specifically mentioned for Commodity broker-traders. * “NRV” may not be equal to “Fair value(-) costs to sell” IAS 2

15. Recognition as an expense • When Inventories are sold Carrying Amount of inventories is recognised as an Expense • When Inventories are written Amount of Write-down and down to NRV all losses of inventories should be recognised as an Expense. • In case of increase of NRV Amount of Reversal (if any) shall be recognised as a reduction in the amount of inventories recognised as an expense earlier. • In case Inventories are Such Inventories should be allocated to other asset recognised as an expense accounts (such Plant & Equipment) during the useful life of that asset. *Amount of Inventories recognised as expense during the period are often referred to as Cost Of Sales. IAS 2

16. Classifications Common classifications Merchandise Materials Finished Goods Production Supplies Work in Progress The inventories of a service provider may be described as work in progress. IAS 2

17. Disclosure The financial statements shall disclose: (a) Accounting policies, including cost formula used; (b) Total carrying amount of inventories and classifications; (c) Carrying amount of inventories carried at fair value less costs to sell; (d) Amount of inventories recognised as an expense; (e) Amount of any write-down of inventories recognised as an expense; (f) Amount of any reversal of any write-down that is recognised as a reduction in the amount of inventories recognised as expense; (g) Circumstances that led to the reversal of a write-down of inventories; and (h) Carrying amount of inventories pledged as security for liabilities. IAS 2

18. Significant Differences between AS-2 and IAS-2 • AS 2 • WIP of service providers is specifically excluded. • The Standard does not contain any exclusion or separate provisions relating to inventories held by commodity broker-traders. • The measurement basis laid down in the Standard, viz., lower of COST and NRV, applies to inventories of commodity trader-brokers. • IAS 2 • WIP of service providers is covered. • The measurement requirements of the Standard do not apply to the measurement of inventories held by commodity broker-traders who measure their inventories at FAIR VALUE less COSTS TO SELL.

19. Significant Differences between AS-2 and IAS-2 • AS 2 • The cost of inventories of items (other than those which are not ordinarily interchangeable and goods or services produced and segregated for specific projects) should be assigned by using the FIFO or weighted average cost formula (It is specifically required that the formula usedshould reflect the fairest possibleapproximation to the cost). • Thus, the Standard does not give a free choice between FIFO and weighted average cost formula. • IAS 2 • The cost of inventories of items (other than those which are not ordinarily interchangeable and goods or services produced and segregated for specific projects) should be assigned by using the FIFO or weighted average cost formula. Unlike AS 2, IAS 2 does not require that the formula used should reflect the fairest possible approximation to the cost. • Thus, the Standard gives a somewhat free choice between FIFO and weighted average cost formula.

20. Significant Differences between AS-2 and IAS-2 • AS 2 • There is no explicit requirement for use of same cost formula. • The Standard specifically lists “selling and distribution costs” among the costs for which it is appropriate that they be recognised as expenses in the period in which they are incurred. • AS 2 does not deal with the issues relating to recognition of inventories as an expense. • IAS 2 • Same cost formula should be used for all inventories having a similar nature and use to the entity. • The Standard specifically lists “selling costs” (but not distribution costs) among the costs for which it is appropriate that they be recognised as expenses in the period in which they are incurred. • Issues relating to recognition of expense. • Refer slide number 13

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