How should inventories be measured under IAS 2?

Inventories must be measured at the lower of cost and net realisable value (NRV). This single principle drives every measurement decision under IAS 2 and ensures that assets are never carried at more than the amount expected to be recovered from their sale or use. IAS 2.9 ![IAS 2 Inventories — measurement at the lower of cost and NRV](/images/ias-2-inventories.gif) The logic is straightforward: if the market has moved against you, the balance sheet should reflect economic reality, not historical optimism. Cost includes all costs of purchase, costs of conversion, and other costs incurred in bringing inventories to their present location and condition. Borrowing costs enter the picture only in the limited circumstances identified by IAS 23. IAS 2.17

Does the lower-of-cost-or-NRV test apply at the individual item level or can items be grouped?

- IAS 2.8 — Defines the scope of inventories, including goods for resale, finished goods, WIP, and raw materials. - IAS 2.9 — States the core measurement principle: lower of cost and net realisable value. - IAS 2.17 — Clarifies that borrowing costs are included in inventory cost only in limited IAS 23 circumstances. - IAS 2.20 — Establishes that fair value less costs to sell at harvest is the deemed cost for agricultural produce inventories. - IAS 2.25 — Sets out the permitted cost formulas (FIFO and weighted average) and the consistency requirement. - IAS 2.31 — Explains how NRV is determined, including the specific treatment when inventory is held under firm sales contracts.

IAS 2 Inventory Measurement

IAS 2 Inventory Measurement — Core Rule

Inventories must be measured at the lower of cost and net realisable value (NRV). This single principle drives every measurement decision under IAS 2 and ensures that assets are never carried at more than the amount expected to be recovered from their sale or use. IAS 2.9

IAS 2 Inventories — measurement at the lower of cost and NRV — Click to enlarge

The logic is straightforward: if the market has moved against you, the balance sheet should reflect economic reality, not historical optimism.

How IAS 2 Inventory Measurement Works

Building up cost

Cost includes all costs of purchase, costs of conversion, and other costs incurred in bringing inventories to their present location and condition. Borrowing costs enter the picture only in the limited circumstances identified by IAS 23. IAS 2.17

Inventories are broader than most people assume. They encompass goods purchased for resale, finished goods, work in progress, and raw materials and supplies awaiting use in production. IAS 2.8

Choosing a cost formula

Once you have identified what cost includes, you need a method to assign it to individual units. IAS 2 allows two formulas:

FIFO (first-in, first-out)

Weighted average cost

You must apply the same formula to all inventories of a similar nature and use. Different formulas are permissible only where inventories genuinely differ in nature or use. IAS 2.25

Measuring NRV

NRV is the estimated selling price in the ordinary course of business less the estimated costs of completion and selling. Estimates must reflect the purpose for which inventory is held. Where inventory is committed under a firm sales contract, NRV is based on the contract price — not the general market price — for those quantities. IAS 2.31

Writing down to NRV

When cost exceeds NRV, write the inventory down. The write-down and any inventory losses are recognised as an expense in the period they occur. Importantly, if NRV subsequently recovers, the write-down can be reversed — but only up to the original write-down amount. That reversal reduces the cost of inventories recognised as an expense in the period of recovery. IAS 2.29 establishes that write-downs are normally done item by item, though grouping similar or related items is permitted in certain circumstances.

Agricultural produce as a starting point

When inventories arise from harvesting biological assets, their opening cost is deemed to be fair value less costs to sell at the point of harvest, measured under IAS 41. From that point forward, normal IAS 2 measurement applies. IAS 2.20

IAS 2 Inventory Measurement — Common Pitfalls

Using LIFO. IAS 2 prohibits the last-in, first-out formula entirely. Entities transitioning from US GAAP often stumble here.

Inconsistent cost formulas. Switching formulas between periods for inventories of similar nature is not permitted without a justifiable accounting policy change.
Ignoring contract prices in NRV. When firm sales contracts exist, NRV for the contracted quantities must reflect the contract price, not the spot market.
Forgetting reversals. Write-downs are not permanent. A recovery in NRV requires reassessment and, where warranted, reversal.
Overlooking reallocation. Inventory used as a component of self-constructed property, plant and equipment is transferred to that asset and expensed over its useful life — not written off immediately as cost of sales. IAS 2.35

IAS 2 Inventory Measurement — Key Paragraphs

IAS 2.8 — Defines the scope of inventories, including goods for resale, finished goods, WIP, and raw materials.
IAS 2.9 — States the core measurement principle: lower of cost and net realisable value.
IAS 2.17 — Clarifies that borrowing costs are included in inventory cost only in limited IAS 23 circumstances.
IAS 2.20 — Establishes that fair value less costs to sell at harvest is the deemed cost for agricultural produce inventories.
IAS 2.25 — Sets out the permitted cost formulas (FIFO and weighted average) and the consistency requirement.
IAS 2.31 — Explains how NRV is determined, including the specific treatment when inventory is held under firm sales contracts.