ASHIK IQBAL ACA CPA (USA)

CERTIFICATE COURSE ON IFRS

IAS 2 INVENTORIES
15 March 2021
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auditing, please refer to the original IFRSs. Views expressed in
this document are personal.
GROUND RULES

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SCOPE
SCOPE

IAS 2 applies to all inventories except:

1. Financial instruments
2. Biological assets as per IAS 41 Agriculture

Does not apply to measurement of inventories held by:

a. Producer of agricultural and forest products, agricultural produce

after harvest and minerals and minerals products to the extent
they are measured at Net Realizable Value

b. Commodity broker-traders who measures inventories at fair

value less cost to sell
SCOPE – CRYPTOCURRENCIES
Q1: How should cryptocurrencies held for sale be classified?

Answer Q1: Cryptocurrencies held for sale in the ordinary course

of business should be classified as inventories in the scope of
IAS 2.

If the entity is acting as a commodity broker-trader in respect of

the cryptocurrency in question, it is permitted to measure its
holdings at fair value less costs to sell through profit or loss in
accordance with IAS 2:3 due to the similarities between
cryptocurrencies and more traditional commodities.

This conclusion was confirmed by the IFRS Interpretations

Committee in the June 2019 IFRIC Update.
SCOPE – ASSETS ACQUIRED FOR SALE AT THE END OF
LEASE TERM
Q2: Entity X, a lessor, leases assets ordinarily under three-year agreements. At
the end of the lease term, the lessee has the option either to return or to acquire
the asset. Some of the leases contain an extension option, which allows the
lessee an additional three months to return or to acquire the asset. The
extension option must be exercised prior to the end of the main lease term.

Entity X enters 'residual value guarantee' contracts with Entity A, a third party.
Under these contracts, Entity A will purchase the assets from Entity X at the end
of each lease term at a predetermined price. Entity A receives a fee in return for
providing the residual value guarantee.

When an extension option is exercised by the lessee, ownership of the asset is

transferred to Entity A at the end of the main lease term for the predetermined
price. During the extension period, Entity X passes the rental income to Entity A.
At the end of the extension period, Entity A sells the asset either in the market
or to the lessee. Rental income received by Entity A during the extension period
is considered incidental to Entity A’s principal activities, which are the provision
of residual value guarantee contracts and selling the assets acquired.
SCOPE – ASSETS ACQUIRED FOR SALE AT THE END OF
LEASE TERM
Answer Q2: In order to determine how to recognize the assets in the
period from acquisition at the end of the main lease term to the date of
sale (whether in the market or to the lessee), Entity A must establish
how the assets are used in the business, i.e., whether they represent
inventories or property, plant and equipment.

In the circumstances described, Entity A acquires the assets at the end

of the main lease term to profit from selling them in the market. In
accordance with IAS 2:6, the assets are classified as inventories
because they are assets 'held for sale in the ordinary course of
business'.
SCOPE – ASSET LEASED OUT FOR A SHORT PERIOD
BEFORE SALE
Bonus Question B.1:

BEX Inc. purchases and develops residential properties solely for the
purpose of a sale in its ordinary course of business. The properties are
sold shortly after the completion of the development.

However, in some cases, shortly prior to the sale, BEX leases out the
property (or a portion thereof) on a temporary basis for specific reasons
(e.g., to optimize net cash flows until a buyer is found, or to enhance
the value of the property by incorporating tenants). In these cases, the
lease agreements are not entered into with the objective of generating
rental earnings or capital appreciation in the long term and rental
earnings before the sale are not significant compared to the sale price
of the property.

Can BEX account for these properties under IAS 2?

SCOPE – ASSET LEASED OUT FOR A SHORT PERIOD
BEFORE SALE
Answer to Bonus Question B.1:

This does not automatically trigger a reclassification from inventory to

investment property. For the property to be reclassified, it must also
meet the definition of the investment property (i.e., management
intention for holding the property must also have changed so that it is
now to earn rentals or for capital appreciation or both).

In this scenario, the period of the lease prior to the sale is limited and
the rental earnings are not significant compared to the expected sale
price which indicates that BEX’s intention, strategy and business model
for a sale in the ordinary course of its business has not changed.
Accordingly, Entity A is not permitted to reclassify the property from
inventory
SCOPE – INVENTORIES ON CONSIGNMENT

Bonus Question B.2:

TRX Ltd. is a manufacturer that supplies goods to its distributors on

consignment. TRX retains the substantial risks and rewards of
ownership and legal title to the goods until some future predetermined
event occurs (e.g., sale to a third-party customer) which triggers
transfer of the legal title to the distributors.

How should the distributor account for this?

SCOPE – INVENTORIES ON CONSIGNMENT

Answer to bonus question B.2:

In such circumstances, the distributors (i.e., the buyer) will need to

determine when it is appropriate to recognize inventories on
consignment as an asset in its statement of financial position.

IFRS Standards do not provide any guidance on accounting for

consignment arrangements from the point of view of the buyer and,
therefore, in accordance with IAS 8, the distributor should determine an
accounting treatment for inventories on consignment that results in
information that is relevant and reliable.

Until it is established that the transfer to the distributor is substantive,

the goods should be treated as the manufacturer's inventories and
excluded from the distributor's statement of financial position.
SCOPE – INVENTORIES ON CONSIGNMENT

Answer to bonus question B.2 (contd.):

Paragraphs B77 and B78 of IFRS 15 provide specific guidance on

determining whether an arrangement is a consignment arrangement
and require that revenue is not recognized (and, therefore, the
inventory is not derecognized) by the manufacturer upon delivery of the
goods if the delivered product is held on consignment.
DEFINITION
DEFINITION

Inventories are 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 value 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. (Entity specific value)

Fair value is the price that would be received to sell an asset

or paid to transfer a liability in an orderly transaction between
market participants at the measurement date.
MEASUREMENT
MEASUREMENT OF INVENTORIES

Inventories shall be measured at the lower of cost and net

realisable value.

Cost of inventories
The cost of inventories shall comprise all costs of purchase,
costs of conversion and other costs incurred in bringing the
inventories to their present location and condition.

Costs of purchase
Includes the purchase price, import duties and other taxes
(other than those subsequently recoverable by the entity from
the taxing authorities), and transport, handling and other
costs directly attributable to the acquisition of finished goods,
materials and services.

Trade discounts, rebates and other similar items are deducted

in determining the costs of purchase.
MEASUREMENT OF INVENTORIES

Q3: Entity A is a retailer that acquires products from manufacturers,

which are sold to end users. The manufacturers grant incentives to
Entity A on one of two bases:

• 10 per cent prompt settlement discount on all purchases of

inventories settled within 30 days of purchase; or
• rebates based on the volume of merchandise purchased or sold.

How should Entity A account for the above?

Answer Q3:
Prompt settlement (cash) discount
Entity A should deduct prompt settlement discounts from the cost of
the inventories. Entity A should estimate the expected settlement
discount to be received from the supplier.

Volume rebates
Similarly, volume rebates should be deducted from the cost of
inventories.
MEASUREMENT OF INVENTORIES – INTERIM FS: IAS 34

Bonus question B.3:

On 1 July 2020, in a binding arrangement, a vendor offers a cash

refund of Tk1,000 to T.rex Ltd. if during the 12 months to 30 June
2021 T.rex Ltd. purchases 1,000 units of a particular product.
Historically, on average, T.rex has purchased 1,700 units each year
and there have been no significant changes in the trading
relationship in the current period.

On 31 November 2020, T.rex Ltd. has not yet reached the threshold
for the volume rebate, but it anticipates that it will do so before 30
June 2021.

How should T.rex apply this in its interim account as per IAS 34?

Answer to bonus question B.3

If it is probable that T.rex will purchase at least 1,000 units in the

specified period (e.g., forecast purchase levels are in line with historical
volumes), the refund (which is contractual) should be accrued as the
units are purchased.
MEASUREMENT OF INVENTORIES – INTERIM FS: IAS 34

IAS 34:B23 states as follows.

Volume rebates or discounts and other contractual changes in the

prices of raw materials, labor, or other purchased goods and services
are anticipated in interim periods, by both the payer and the recipient,
if it is probable that they have been earned or will take effect. Thus,
contractual rebates and discounts are anticipated but discretionary
rebates and discounts are not anticipated because the resulting asset
or liability would not satisfy the conditions in the Conceptual
Framework that an asset must be a resource controlled by the entity as
a result of a past event and that a liability must be a present obligation
whose settlement is expected to result in an outflow of resources.
MEASUREMENT OF INVENTORIES

Cost of conversion

Costs directly related to the units of production such as:

• direct labour, including all related employment taxes, and

benefits and any share-based payment costs; and

• a systematic allocation of the fixed and variable production

overheads incurred in converting materials into finished
goods.
MEASUREMENT OF INVENTORIES

Cost of conversion

The allocation of fixed production overheads to the costs of

conversion is based on the normal capacity of the production
facilities.

Normal capacity is the production expected to be achieved

on average over a number of periods or seasons under normal
circumstances, taking into account the loss of capacity
resulting from planned maintenance.
MEASUREMENT - COST OF CONVERSION

Q4: Yelton Ltd. manufactures televisions for low-income customers.

• Under normal operating capacity: manufacture 2,000 televisions

each year.

• Total fixed production overheads for 2020 are Tk16,000.

• Based on normal production, fixed production overheads will be
allocated to televisions produced at a rate of Tk8
(Tk16,000/2,000) per television.

During 2020, because of lower-than-expected customer demand due

to COVID 19 Pandemic and problems with production machinery,
Entity A only manufactured 1,500 televisions.

How should Yelton Ltd. allocate fixed production overhead?

MEASUREMENT - COST OF CONVERSION

Answer Q4:

• Fixed production overhead allocated to TV manufactured =

Tk12,000 (Tk8 x 1,500 TV manufactured)
• Fixed production overhead charged to profit/loss =Tk4,000
MEASUREMENT - COST OF CONVERSION

Q4 (contd.): Yelton Ltd. Experienced increased demand in the year

2021 and manufactured 4,000 televisions.

How should Yelton Ltd. allocate fixed production overhead under the
current scenario?

Answer Q4 (contd.):

Per unit fixed overhead would decrease to Tk4 (Tk16,000/4,000).

MEASUREMENT - OTHER COSTS

Other costs are included in the cost of inventories only to the extent
that they are incurred in bringing the inventories to their present
location and condition.

For example, it may be appropriate to include non-production

overheads or the costs of designing products for specific customers
in the cost of inventories.

Examples of cost EXCLUDED:

• abnormal amounts of wasted materials/labour/other production

costs;
• storage costs, unless those costs are necessary in the production
process before a further production stage;
• administrative overheads that do not contribute to bringing
inventories to their present location and condition; and
• selling costs.
MEASUREMENT - OTHER COSTS

• IAS 23 Borrowing Costs identifies limited circumstances

where borrowing costs are included in the cost
of inventories.

• An entity may purchase inventories on deferred settlement

terms. When the arrangement effectively contains a
financing element, that element, for example a difference
between the purchase price for normal credit terms and the
amount paid, is recognised as interest expense over the
period of the financing.

• When inventories are invoiced in a foreign currency, the

cost of those inventories should not include exchange
differences.
MEASUREMENT - OTHER COSTS : IAS 23 REQUIREMENTS

The extent to which borrowing costs should be included in the

cost of inventories is determined based on the requirements
of IAS 23.

IAS 23 expressly states that 'inventories that are

manufactured, or otherwise produced, over a short period of
time, are not qualifying assets'. Only inventories that take a
'substantial' period of time to get ready for their intended sale
or use can meet the definition of a qualifying asset.

IAS 23 includes an optional scope exemption which allows an

entity not to apply that Standard to inventories that are
manufactured, or otherwise produced, in large quantities on a
repetitive basis.
 TECHNIQUES

XXX
TECHNIQUES FOR MEASUREMEN OF COST

A. Standard cost method

• Results approximates costs
• Consider normal levels of material/labor/efficiency/capacity
utilization
• Regularly reviewed and revised base on current condition

B. Retail method
• Used in retail industries
• Large number of rapidly changing items
• Similar margin
• Other method is impracticable
• Cost = Sales less appropriate margin
TECHNIQUES – RETIAL METHOD

Q5: An entity reported the following:

Cost Retail Price

(Tk’000) (Tk’000)
Opening inventories 300 400
Purchases 1,000 1,600
Total 1,300 2,000
Sales - (1,500)
Closing inventories at retail - 500
value

Calculate the cost of closing inventories for the entity.

TECHNIQUES – RETIAL METHOD

Answer Q5: An entity reported the following:

• Ration of cost to retail price for the year = 65%

(Tk1,300/Tk2,000) = 65%)

• Closing value of inventories = 325,000

(Tk500,000 x 65%)

The method illustrated above results in a valuation of inventories that

approximates to average price and is, therefore, acceptable subject to
certain constraints.

The method only works satisfactorily for an entire department or shop if

all the lines held are expected to generate similar profit margins
COST FORMULA
COST FORMULA

A. Specific Identification of Cost

• Items of inventories are not ordinarily interchangeable
• Goods/services produced & segregated for specific projects

B. First-in, First-out (FIFO) or Weighted Average Cost

• All other inventories

• 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.
CHANGE IN COST FORMULA

Reporting entity may decide to change from one cost formula to

another (e.g., from the weighted average formula to FIFO) on
the basis that:

• the latter is more widely used in its industry; and

• therefore, enhance comparability.

Whether such a change constitutes a change in accounting policy

or a change in estimate?

Treat as change in policy because:

IAS 2:36 (a) requires disclosure of accounting policies for

measuring inventories including cost formula. It implies the cost
formula is a matter of policy.
NET RELISABLE VALUE
NET REALISABLE VALUE (NRV)

• Net realisable value is the net amount that an entity expects

to realise from the sale of inventories in the ordinary course of
business.

• An entity-specific value.

• Fair value is not an entity-specific value.

• The NRV may not equal their fair value less costs to sell. This
will occur, for example, when the reporting entity has secured
favourable binding sales contracts that have not been affected
by more recent adverse market conditions.

• Estimates of NRVs are made on an item-by-item basis.

• It may be appropriate to group items of similar or related

inventories.
NET REALISABLE VALUE

• NRV is the estimated selling price in the ordinary course of

business

• Write down is recognized as an expenses

• Previous write down is reversed if it subsequently increases.

The amount of reversal is limited to the amount of the original
write-down. Recognise in profit/loss.
NET REALISABLE VALUE

Example: ABC Limited writes down its inventory from a carrying

amount of Tk100 to its NRV of Tk95. The inventory is still on
hand and its NRV increases to Tk103.

ABC limited recognizes a reversal of Tk5. The carrying amount of

the inventory is the lower of its cost of Tk100 and its revised
NRV of Tk103.
NET REALISABLE VALUE – INVENTORY UNDER
DEVELOPMENT

Q5: P Real Estate Ltd is a property developer. It is preparing its financial

statements for the year ended 31 December 2020, which will be
authorised for issue on 15 March 2021. At 31 December 2020, P holds a
property as development work in progress. Cost details are as follows:

• Costs incurred to date are Tk20 million.

• Estimated costs to complete are Tk10 million (therefore, total costs
will be Tk30 million).

Completion and sale of the development are expected within 18 to 24

months.

P estimates net realisable value for development work in progress

based on the projected sales price for the property when it is complete,
discounted back to current value. Based on market information on sales
prices for similar, finished properties at 31 December 2020, net
realisable value is estimated at Tk32 million (implying a net
development profit of Tk2 million).
NET REALISABLE VALUE – INVENTORY UNDER
DEVELOPMENT (CONTD.)

Q5 (Contd.): However, property prices in the relevant market

are falling.

At 15 March 2021 (date of authorization of financial statements),

the observed sales prices for similar, finished properties have
declined to Tk27 million (implying a net development loss of Tk3
million).

Estimated costs to complete (and other applicable factors) are

unchanged since year end.

Should P recognize an inventory write-down in its 31 December

2020 financial statements?
NET REALISABLE VALUE – INVENTORY UNDER
DEVELOPMENT (CONTD.)

Answer Q5:

P should recognize an inventory write-down in its 31 December 2020

financial statements.

The development property is not available for sale at the year end. IAS
2:30 acknowledges that 'fluctuations of price or cost directly relating to
events occurring after the end of the period' are relevant to estimates
of net realisable value 'to the extent that such events confirm conditions
existing at the end of the period'.

Because P estimates net realisable value based on projected sales

prices of completed property, discounted back to current value,
information received after the end of the reporting period (including
revised sales price estimates) provides further evidence as to conditions
that existed at the end of the reporting period, unless the changes in
sales prices clearly relate to a separate event after the period end.
NET REALISABLE VALUE – LONG OPERATING CYCLE

Q6: Assured Ltd. is engaged in the production of an item of

inventory with a long operating cycle. Production of the item
normally takes 6 years to complete.

Costs are accumulated over time and recognized as inventory.

At the end of the second year of production, a further four years
of work is required for the inventory item to be completed.

No relevant market exists for the inventory in its current state.

How should management perform the NRV analysis for this

inventory?
NET REALISABLE VALUE - LONG OPERATING CYCLE

Answer Q6:

When estimating the net realisable value of inventories at the

end of the second year of production, management should
consider all the facts relating to the type of inventory and the
operating environment at that time.

Because no relevant market exists for the two-year work in

progress, it may be the case that the entity uses as its starting
point the current selling price for the inventory in its completed
state, deducting expected holding costs (including finance costs),
outstanding costs of conversion and costs to sell.
NET REALISABLE VALUE – POST YEAR END SALE
Q7:

Can you assist the CFO as their adviser?

NET REALISABLE VALUE – POST YEAR END SALE

Answer Q7:

A sale after the reporting period at a lower price generally

provides evidence of the net realisable value of the inventories at
the end of the reporting period. However, this will not always be
the case.

If, for example, further investigation shows that the decrease in

sales price arose because of damage to the inventories that
occurred after the reporting period, this would indicate that the
Tk80 sales price did not reflect conditions existing at the end of
the reporting period and that the loss in value should not be
accounted for until the next period.

In these circumstances, it would be necessary to assess whether

the item could have been sold undamaged for an amount at or in
excess of its cost (Tk100) plus any costs to sell. If so, no write-
down would be required at the end of the reporting period.
PRESENTATION
AND
DISCLOSURE
PRESENTATION AND DISCLOSURE

Source: Deloitte Model Financial Statements

PRESENTATION AND DISCLOSURE

Source: Deloitte Model Financial Statements

PRESENTATION AND DISCLOSURE

Source: Deloitte Model Financial Statements

Q&A
THANK YOU