How is net realisable value determined and how is inventory written down under IAS 2?

Under IAS 2, inventories must be measured at the lower of cost and net realisable value (NRV), with any write-down recognised immediately as an expense in the period it arises. The IAS 2 Net Realisable Value Write-Down mechanism requires a systematic comparison of carrying amount against NRV at each reporting date. Key mechanics include: - NRV definition: NRV is 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). It is an entity-specific value, not a fair value measure — this distinction is critical. - Item-by-item assessment: Write-downs are assessed item by item, or at most by grouping similar or related items (e.g., a product line). Aggregating all inventories to offset write-downs against uplifts in other categories is prohibited (IAS 2.29). - Indicators triggering write-down: IAS 2.28 identifies circumstances warranting write-down — physical damage, partial or full obsolescence, declining selling prices, increased completion costs, and inventory held for unprofitable contracts. - Finished goods vs. WIP/raw materials: For work-in-progress and raw materials, current replacement cost is often the best available measure of NRV. Raw materials are not written down below cost merely because commodity prices fall, provided the finished goods into which they are incorporated will still sell at or above cost (IAS 2.32). - Reversal of write-downs: If the circumstances that caused the write-down no longer exist — for instance, a recovery in selling prices — the write-down must be reversed, but only up to the original cost. The reversal is recognised as a reduction in the inventory expense (cost of goods recognised in profit or loss) in the period of reversal (IAS 2.33). - Disclosure: The financial statements must disclose the amount of any inventory write-down recognised as an expense, any reversal recognised, and the circumstances or events that led to the reversal (IAS 2.36(e)–(f)).

Can an entity use an inventory valuation allowance (contra-asset) rather than reducing the inventory account directly, and what are the disclosure implications?

| Account | Dr (€) | Cr (€) | |---|---|---| | Inventory | 20,000 | | | Cost of Sales (Reversal of Inventory Write-Down) | | 20,000 | - Using fair value instead of NRV: Practitioners sometimes substitute market price data (e.g., broker quotes) directly for NRV without deducting costs to complete and costs to sell. IAS 2.6 is explicit that NRV is a net figure — skipping deductions overstates inventory and understates the write-down required. - Aggregating dissimilar items to avoid write-downs: Grouping fast-moving, appreciating items with slow-moving or damaged inventory to produce an acceptable blended average violates IAS 2.29. Auditors routinely challenge overly broad product groupings that mask individual item impairments. - Capping reversals at NRV rather than original cost: A recovery in NRV beyond original cost does not permit inventory to be written up above cost. IAS 2.33 strictly caps the reversal at the amount of the original write-down — recognising a gain beyond original cost is a common examination and audit error. - IAS 2.6 — Defines NRV and distinguishes it from fair value; foundational for any NRV calculation. - IAS 2.28–2.29 — Sets out indicators for write-down and prohibits aggregation across dissimilar inventory categories. - IAS 2.32 — Addresses raw materials and the circumstances where replacement cost proxies for NRV. - IAS 2.33 — Governs reversal of write-downs: trigger, ceiling (original cost), and income statement treatment. - IAS 2.36(e)–(f) — Disclosure requirements for write-down amounts, reversals, and the events prompting them.

IAS 2 Net Realisable Value Write-Down

IAS 2 Net Realisable Value Write-Down — Core Rule

Under IAS 2, inventories must be measured at the lower of cost and net realisable value (NRV), with any write-down recognised immediately as an expense in the period it arises.

How IAS 2 Net Realisable Value Write-Down Works

The IAS 2 Net Realisable Value Write-Down mechanism requires a systematic comparison of carrying amount against NRV at each reporting date. Key mechanics include:

NRV definition: NRV is 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). It is an entity-specific value, not a fair value measure — this distinction is critical.
Item-by-item assessment: Write-downs are assessed item by item, or at most by grouping similar or related items (e.g., a product line). Aggregating all inventories to offset write-downs against uplifts in other categories is prohibited (IAS 2.29).
Indicators triggering write-down: IAS 2.28 identifies circumstances warranting write-down — physical damage, partial or full obsolescence, declining selling prices, increased completion costs, and inventory held for unprofitable contracts.
Finished goods vs. WIP/raw materials: For work-in-progress and raw materials, current replacement cost is often the best available measure of NRV. Raw materials are not written down below cost merely because commodity prices fall, provided the finished goods into which they are incorporated will still sell at or above cost (IAS 2.32).
Reversal of write-downs: If the circumstances that caused the write-down no longer exist — for instance, a recovery in selling prices — the write-down must be reversed, but only up to the original cost. The reversal is recognised as a reduction in the inventory expense (cost of goods recognised in profit or loss) in the period of reversal (IAS 2.33).
Disclosure: The financial statements must disclose the amount of any inventory write-down recognised as an expense, any reversal recognised, and the circumstances or events that led to the reversal (IAS 2.36(e)–(f)).

IAS 2 Net Realisable Value Write-Down — Practical Example

A retailer holds 1,000 units of a consumer electronics product at a cost of €120 per unit (total carrying amount: €120,000). Due to a competitor product launch, the estimated selling price falls to €95 per unit. Selling costs (packaging and delivery) are estimated at €8 per unit.

NRV calculation

Estimated selling price: €95
Less: costs to sell: (€8)
NRV per unit: €87

Write-down required: (€120 – €87) × 1,000 = €33,000

Journal entry — write-down

Account	Dr (€)	Cr (€)
Cost of Sales / Inventory Write-Down Expense	33,000
Inventory (Allowance or direct reduction)		33,000

In the following period, the competitor withdraws the product and selling prices recover to €115 per unit; selling costs remain €8. NRV is now €107. The write-down can be partially reversed — but only up to original cost of €120.

Reversal = (€107 – €87) × 1,000 = €20,000 (not a full reversal to €120 since NRV of €107 < cost of €120)

Journal entry — partial reversal

Account	Dr (€)	Cr (€)
Inventory	20,000
Cost of Sales (Reversal of Inventory Write-Down)		20,000

IAS 2 Net Realisable Value Write-Down — Common Pitfalls

Using fair value instead of NRV: Practitioners sometimes substitute market price data (e.g., broker quotes) directly for NRV without deducting costs to complete and costs to sell. IAS 2.6 is explicit that NRV is a net figure — skipping deductions overstates inventory and understates the write-down required.
Aggregating dissimilar items to avoid write-downs: Grouping fast-moving, appreciating items with slow-moving or damaged inventory to produce an acceptable blended average violates IAS 2.29. Auditors routinely challenge overly broad product groupings that mask individual item impairments.
Capping reversals at NRV rather than original cost: A recovery in NRV beyond original cost does not permit inventory to be written up above cost. IAS 2.33 strictly caps the reversal at the amount of the original write-down — recognising a gain beyond original cost is a common examination and audit error.

IAS 2 Net Realisable Value Write-Down — Key Paragraphs

IAS 2.6 — Defines NRV and distinguishes it from fair value; foundational for any NRV calculation.
IAS 2.28–2.29 — Sets out indicators for write-down and prohibits aggregation across dissimilar inventory categories.
IAS 2.32 — Addresses raw materials and the circumstances where replacement cost proxies for NRV.
IAS 2.33 — Governs reversal of write-downs: trigger, ceiling (original cost), and income statement treatment.
IAS 2.36(e)–(f) — Disclosure requirements for write-down amounts, reversals, and the events prompting them.