Library / Technical Accounting Manual: IFRS, IAS and Ind AS Equivalents

IAS 2 - Inventories

Indian equivalent: Ind AS 2 - Inventories

Objective and scope

IAS 2 tells a business how to value the stock (inventory) it holds and how much of that value to release into expenses (cost of sales) when the goods are sold. It covers what costs go into inventory, which cost-flow formulas are allowed, and the crucial lower-of-cost-and-NRV write-down rule.

Core principle

Stock in your warehouse is an asset until sold. IAS 2's golden rule: carry it at the lower of what it cost you and what you can realistically sell it for (net of costs to complete and sell). You never let inventory sit at more than it is truly worth - that is prudence in action.

Defined terms and technical terminology

Term	Technical meaning
Inventory / Stock	Assets held for sale in the ordinary course (finished goods), in production (work-in-progress), or materials to be consumed in production.
Cost of inventory	All costs of purchase + costs of conversion + other costs to bring inventory to its present location and condition - purchase price, import duties, non-refundable taxes, freight-in, direct labour and a systematic allocation of production overheads.
Net Realisable Value (NRV)	Estimated selling price in the ordinary course minus estimated costs of completion minus estimated selling costs. In plain words: what you'll actually pocket.
Lower of cost and NRV	The valuation rule - always take the smaller of cost and NRV so the asset is never overstated.
FIFO	First-In, First-Out - assume the oldest stock is sold first, so closing stock is valued at the most recent prices.
Weighted average cost	Blend all unit costs into a single average cost per unit.
Write-down	Reducing inventory's carrying value to NRV; the reduction is an expense in the period.
Conversion costs	Costs of turning materials into finished goods - direct labour plus fixed and variable production overheads.

Application and worked illustrations

What goes into 'cost' - and what does not

Cost is far more than the invoice price. Include the purchase price, import duties and non-refundable taxes, freight-in (carriage inwards), and conversion costs (direct labour and a systematic share of production overheads). If a shopkeeper buys phones at ₹10,000 each, pays ₹500 freight and ₹200 import duty per phone, the IAS 2 cost is ₹10,700. But you must exclude: abnormal waste, storage costs of finished goods, administrative overheads unrelated to production, and selling costs - these are expensed as incurred. LIFO (Last-In-First-Out) is banned under IFRS because it distorts the balance sheet with outdated costs.

Fixed overhead absorption

Fixed production overheads are absorbed based on normal capacity. If a factory can normally make 10,000 units but only makes 6,000, you still absorb overhead as if for normal capacity - the unabsorbed overhead becomes an expense, not part of stock cost. This stops companies from parking idle-capacity costs in inventory to flatter profit.

Worked example 1 - the lower-of-cost-and-NRV write-down

A clothing store bought 100 winter jackets at a cost of ₹2,000 each (₹2,00,000). Winter ended early; jackets now sell for only ₹1,500 each and cost ₹100 per jacket to advertise and sell. NRV = ₹1,500 − ₹100 = ₹1,400. Since NRV (₹1,400) is below cost (₹2,000), IAS 2 forces a write-down to ₹1,400 per jacket (₹1,40,000 total), recognising a ₹60,000 loss now.

Journal entry - Write inventory down to NRV
Account	Debit (₹)	Credit (₹)
Cost of Sales / Inventory write-down (expense)	60,000
Inventory (asset)		60,000

If in a later period the jackets' NRV recovers (say a cold snap pushes prices back up), the earlier write-down is reversed - but only up to the original cost, never above it.

Worked example 2 - FIFO vs weighted average

A trader buys 10 units at ₹100, then 10 units at ₹120, and sells 10 units. Under FIFO, the sold units are the oldest: cost of sales = 10 × ₹100 = ₹1,000; closing stock = 10 × ₹120 = ₹1,200. Under weighted average, average cost = (₹1,000 + ₹1,200) ÷ 20 = ₹110; cost of sales = ₹1,100; closing stock = ₹1,100. Both are permitted; the method must be applied consistently and the same formula used for all inventories of a similar nature.

Common mistake: including selling and distribution costs, or storage of finished goods, in the cost of inventory. These are period expenses, not inventoriable costs.

Common mistake: comparing total cost with total NRV. The rule is applied item by item (or by group of similar items), so a profit on one line cannot hide a loss on another.

IND AS LINK

Ind AS 2 mirrors IAS 2 exactly - LIFO banned, lower-of-cost-and-NRV rule, and reversal of write-downs when NRV recovers. No India-specific carve-out.

Further worked illustrations

Extra numeric example - a manufacturer's cost build-up

FurniCraft makes a wooden table. Costs per table: timber ₹1,200; direct labour ₹400; variable production overhead ₹150; a share of fixed factory overhead ₹250 (at normal capacity); delivery to the customer ₹100; and sales commission ₹80. The IAS 2 inventory cost = 1,200 + 400 + 150 + 250 = ₹2,000. The delivery and commission (₹180) are selling costs → expensed, not included in stock. So each unsold table sits in inventory at ₹2,000, not ₹2,180.

INDIAN REGULATORY CONTEXT

When an Indian trader buys goods, the GST paid is usually recoverable as input tax credit, so it is not part of inventory cost (it's a receivable from the government). But if the buyer is not eligible for input credit (e.g., a composition dealer, or blocked credits), the GST becomes a non-refundable tax and is included in the cost of inventory. Two identical purchases can therefore carry different inventory values depending on GST eligibility.

TECHNICAL EDGE CASE

A company holds steel that cost ₹100/kg; the market price of steel has crashed to ₹80/kg. Should it write the steel down? Not necessarily. IAS 2 says raw materials are not written below cost if the finished products they go into will still sell at or above cost. Only if the finished product's NRV also falls below its cost do you write the raw material down - and even then, replacement cost is often the best estimate of NRV for the material.

Extended technical analysis

Cost formulas, overhead absorption and the NRV mechanism

IAS 2's technical core lies in three areas: what is admitted into cost, which cost formula allocates that cost, and how the net realisable value test constrains the carrying amount. Errors in inventory measurement flow directly to cost of sales and gross margin, making it a perennial area of audit focus and, historically, of financial statement fraud.

Determining cost - inclusions and exclusions

Cost of Inventories - Admitted vs Excluded
Cost element	Treatment	Technical basis
Purchase price, import duties, non-refundable taxes	Include	Cost of purchase (IAS 2.11)
Freight inward, handling, directly attributable acquisition costs	Include	Cost of purchase
Trade discounts, rebates, settlement discounts	Deduct	Reduce cost of purchase
Direct labour	Include	Cost of conversion (IAS 2.12)
Variable production overheads	Include (allocated on actual usage)	Cost of conversion
Fixed production overheads	Include (allocated on normal capacity)	IAS 2.13 - unabsorbed portion expensed
Abnormal waste of material, labour, overheads	Exclude - expense	IAS 2.16(a)
Storage costs (unless necessary before a further production stage)	Exclude - expense	IAS 2.16(b)
Administrative overheads not contributing to present location/condition	Exclude - expense	IAS 2.16(c)
Selling and distribution costs	Exclude - expense	IAS 2.16(d)
Borrowing costs	Exclude unless a qualifying asset under IAS 23	IAS 2.17 / IAS 23
Recoverable GST / input tax credit	Exclude	Not a non-refundable tax

Normal capacity and the unabsorbed overhead trap

Fixed production overhead must be allocated on the basis of normal capacity - the production expected on average over a number of periods under normal circumstances. Where actual production is abnormally low, the allocation rate is not increased; the unabsorbed overhead is recognised as an expense in the period. Conversely, in periods of abnormally high production, the rate is decreased so inventories are not measured above cost. This mechanism prevents entities from capitalising idle-capacity costs into inventory to defer losses.

Illustration. Normal capacity 10,000 units; fixed overhead ₹20,00,000 → absorption rate ₹200/unit. Actual production is 6,000 units. Overhead absorbed into inventory = 6,000 × ₹200 = ₹12,00,000. The unabsorbed ₹8,00,000 is expensed immediately, not carried in inventory. Had the entity divided ₹20,00,000 by 6,000 units (₹333/unit), it would have overstated inventory by ₹8,00,000 and deferred a genuine loss.

Cost formula selection

IAS 2 - Cost Formula Decision Tree
■ Identify the nature of the inventory item
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◆ Are the items ordinarily interchangeable?
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✖ NO - items are segregated for specific projects, or not interchangeable → Use SPECIFIC IDENTIFICATION (IAS 2.23)
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✔ YES - items are interchangeable and produced/purchased in bulk
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▸ Select FIFO or WEIGHTED AVERAGE COST (IAS 2.25). LIFO is PROHIBITED.
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▸ Apply the SAME formula consistently to all inventories of similar nature and use (IAS 2.25)
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■ Techniques permitted if results approximate cost: Standard Cost, Retail Method (IAS 2.21-22)

The NRV test - level of application and reversal

NRV is assessed item by item, or by groups of similar or related items where they cannot practicably be evaluated separately. It is not permissible to assess NRV on the basis of an entire classification of inventory (e.g., all finished goods) or by segment, because that would allow profits on some items to mask losses on others. A new assessment is made each period; where the circumstances causing a write-down no longer exist, the write-down is reversed, limited to the amount of the original write-down, so the new carrying amount never exceeds original cost.

Journal entry - Write-down to NRV (₹60,000)
Account	Debit (₹)	Credit (₹)
Cost of sales / Inventory write-down	60,000
Inventory (or allowance for write-down)		60,000

Journal entry - Subsequent reversal on NRV recovery (₹25,000)
Account	Debit (₹)	Credit (₹)
Inventory (or allowance)	25,000
Cost of sales - reversal of write-down		25,000

IFRS vs Ind AS - Comparative Analysis
Aspect	IFRS / IAS position	Ind AS position (carve-out / carve-in)
Core measurement	Lower of cost and NRV.	Ind AS 2 - identical. No carve-out.
LIFO	Prohibited.	Prohibited.
Reversal of write-down	Required when NRV recovers, capped at original write-down.	Identical.
Machinery spares	Major spares meeting PPE definition → IAS 16; others → IAS 2.	Identical treatment; Schedule II useful lives apply to capitalised spares.
Presentation	IFRS flexible.	Schedule III prescribes inventory sub-classification (raw materials, WIP, finished goods, stock-in-trade, stores and spares, loose tools) and disclosure of goods-in-transit.