IAS 2 establishes clear principles for how inventories should be measured both at initial recognition and subsequently. The standard applies to all inventories except certain specifically excluded items such as financial instruments and biological assets related to agricultural activity (IAS 2.2).

---

Initial Measurement — Cost

Inventories must initially be measured at cost (IAS 2.9). Cost comprises all of the following elements:

• Costs of purchase — including purchase price, import duties, non-refundable taxes, transport, and handling costs, less trade discounts and rebates (IAS 2.11)
• Costs of conversion — direct labour, and a systematic allocation of fixed and variable production overheads based on normal capacity (IAS 2.12–IAS 2.13)
• Other costs incurred in bringing inventories to their present location and condition (IAS 2.15)

Costs that are excluded from inventory and expensed as incurred include abnormal waste, storage costs (unless necessary in the production process), administrative overheads unrelated to production, and selling costs (IAS 2.16).

---

Borrowing Costs

Borrowing costs may be included in the cost of inventories only when the inventory qualifies as a qualifying asset under IAS 23 — meaning it takes a substantial period of time to bring to its intended condition. Routine manufactured or produced inventories typically do not qualify (IAS 2.17, IAS 23.4).

---

Cost Formulas

When inventories are not interchangeable, specific identification of cost must be used (IAS 2.23). For other inventories, IAS 2 permits two cost formulas:

• First-In, First-Out (FIFO) — assumes items purchased or produced first are consumed or sold first (IAS 2.27)
• Weighted Average Cost — calculates cost based on a weighted average of all units available (IAS 2.27)

Importantly, the LIFO method is prohibited under IAS 2 (IAS 2.25). The same cost formula must be applied consistently to all inventories with a similar nature and use (IAS 2.25).

---

Subsequent Measurement — Lower of Cost and NRV

After initial recognition, inventories are measured at the lower of cost and net realisable value (NRV) (IAS 2.9). NRV is defined as 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 (IAS 2.6).

Write-downs to NRV are required when:

• Inventories are damaged or have become wholly or partially obsolete
• Selling prices have declined
• Estimated costs of completion or selling costs have increased (IAS 2.28)

Each write-down is recognised as an expense in the period it occurs. A reversal of write-down is required when the circumstances that caused the write-down no longer exist, limited to the original write-down amount (IAS 2.33).

---

Disclosure Requirements

Key disclosures include the accounting policies adopted, total carrying amount by classification, amount recognised as expense during the period, write-downs and reversals, and any inventories pledged as security (IAS 2.36).

---

Proper measurement of inventories directly impacts gross profit, asset values, and tax positions — making the correct application of IAS 2 critical for reliable financial reporting.