International Accounting standard about Inventory Valuation: providing guidelines to financial accountants and auditors as how to value inventory for accounting and reporting purposes. It also provides choice of acceptable method of calculating Cost of inventories. Being accountant, auditor and accountancy student you need to understand this IAS with respect to:
IAS 2 considers following components as total cost of an inventory: (A)Purchase price net of discount including VAT paid, transportation and (B) direct variable and fixed costs incurred in production process as well as (C) cost incurred in bringing the inventory to the condition of to be sold. Excluded components of cost are : Interest cost when buying inventory, Selling cost, indirect overhead cost, storage as well as abnormal loss/waste, cost of foreign exchange if inventories are priced as different inventories.
For reporting purposes, IAS 2 recognizes value of inventories as “lower of cost and net realisable Value (NRV)”. So here comes another point of deciding the cost of inventories and for this purpose IAS 2 has devised an approach to use Inventory costing methods like Last-in-first-out (LIFO), First-In-First-Out (FIFO) and weighted average cost. IAS 2 prefers use of FIFO and Weighted average method for calculating the cost of inventories after the revision of IAS 2 in year 2003. Next step is to compare it with its Net realizable value and record the lower value among these two as the value of inventory in balance sheet (statement of Financial Position).
IAS 2 provides basis to accountants regarding accounting treatment of inventories in financial statements and ultimately recognizing its NRV as expenses or income. NRV is calculated as per selling price on the inventory minus completion and selling cost associated with the inventory to be sold. Written down value of NRV is recognized as expense in income statement while reversal is recorded as income.
All inventories arising as a result of ordinary production process and categories as raw material, work in process and finished goods inventory comes under scope / periphery of IAS. Make sure inventory arising because of construction contracts of all tangible and intangible products are not treated as per IAS 2, also the financial instruments inventory and agricultural inventories going through harvesting are not within the scope of IAS2.
Ideally, companies are required to follow this standard on or after January 2005 and in case company is using this standard before January 2005, the fact should be disclosed in notes to the accounts of respective period.