PAS 2 Inventories
the necessary, normal or usual business
Introduction
PAS 2 prescribes the accounting treatment
inventories. PAS 2 recognizes that a
primary issue in the accounting for
inventories is the determination of cost to be
recognized as asset and carried forward until
it is expensed. Accordingly, PAS 2 provides
guidance in the determination of cost of
inventories, including the use of cost
formulas, and their subsequent measurement
and recognition as expense.
PAS 2 applies to all inventories except for
the following:
 Assets accounted for under other
standards
a. Financial instruments(PAS 32 and
PFRS 9); and
b. Biological assets and agricultural
produce at the point of harvest (PAS 41).
 Assets mot measured under the lower
of cost or net realizable value (NVR)
under PAS 2
a. Inventories of producers of
agricultural, forest, and mineral products
measured at net realizable value in
accordance with well-established practices
in those industries.
b. Inventories of commodity broker-
traders measured at fair value less costs to
sell.
Inventories
Inventories are as assets:
a. Held for sale in the ordinary course of
business(finished goods);
b. In the process of production for such sale
(work in process); or
c. In the form of materials or supplies to be
consumed in the production process or in
the rendering of services (raw materials and
manufacturing supplies).
Examples of inventories:
a. Merchandise purchased by a trading
entity and held for resale
b. Land and other property held for sale in
the ordinary course of business
c. Finished goods, goods undergoing
production, and raw materials and supplies
awaiting use in the production process by a
manufacturing entity.
Ordinary course of business refers to
activities of an entity.
Measurement
Inventories are measured at the lower of
cost and net realizable value.
Cost
The cost of inventories comprises the
following:
a. Purchase cost- this includes the purchase
price (net of trade discounts and other
rebates), import duties, non-refundable or
non-recoverable purchase taxes, and
transport, handling and other costs directly
attributable to the acquisition of the
inventory.
b. Conversion costs- these refer to the costs
necessary in converting raw materials into
finished goods. Conversion costs include the
costs of direct labor and production
overhead.
c. Other costs necessary in bringing the
inventories to their present location and
condition.
The following are excluded from the
cost of inventories and are expensed in the
period in which they are incurred:
a. Abnormal amounts of wasted materials,
labor or other production costs;
b. Storage costs, unless those costs are
necessary in the production process before a
further production stage (e.g., the storage
costs of partly finished goods may be
capitalized as cost of inventory, but the
storage costs of completed goods are
expensed);
c. Administrative overheads that do not
contribute to bringing inventories to their
present location and condition; and
d. Selling costs.
When a purchase transaction
effectively contains a financing element,
such as when payment of the purchase price
is deferred, the difference between the
purchase price for normal credit terms and
the amount paid is recognized as interest
expense over the period of the financing.
Illustration:
Entity A acquires inventories and incurs the
following costs:
Purchase price, 100,000 individually unique) and those that are
gross of trade segregated for specific projects.
discount Under this formula, specific costs are
Trade discount 20,000 attributed to identified items of inventory.
Accordingly, cost of sales represents the
Non-refundable 5,000 actual costs of the specific items sold while
purchase tax, not ending inventory represents the actual costs
included in the of the specific items on hand.
purchase price above For example, if an inventory with a
Freight-in 15,000 serial number of “ABC-123” costing
(transportation P10,948.67 is sold, the amount charged to
costs) cost of sales is also P10,948.67. If that
Commission to 2,000 inventory remains unsold, the amount
broker included in ending inventory is also
Advertisement costs 10,000 P10,948.67.
In this regard, records should be
Requirement: How much is the cost of the maintained that enables the entity to identify
inventories purchased? the cost and movement of each specific
Solution: inventory.
Purchase price, 100,000 Specific identification, however, is not
gross of trade appropriate when inventories consist of
discount large number of items that are ordinarily
Trade discount (20,000) interchangeable. In such cases, the entity
shall choose between formulas 2 and 3
Non-refundable 5,000 below.
purchase tax, not 2. First-In, First-Out(FIFO)- under this
included in the formula, it is assumed that inventories
purchase price above that were purchased or produced first
Freight-in 15,000 are sold first, and therefore unsold
(transportation inventories at the end of the period are
costs) those most recently purchased or
Commission to 2,000 produced.
broker Accordingly, cost of sales
Total cost of 102,000 represents costs from earlier purchases
inventories while the cost of ending inventory
represents costs from the most recent
The advertisement costs are selling purchases.
costs. These are expensed in the period in 3. Weighted Average- Under this
which they are incurred. formula, cost of sales and ending
inventory are determined based on the
Cost Formulas weighted average cost of beginning
The cost formulas deal with the computation inventory and all inventories purchased
of cost of inventories that are charged as or produced during the period. The
expense when the related revenue is average may be calculated on a
recognized (i.e., ‘cost of sales or ‘cost of periodic basis, or as each additional
goods sold’) as well as the cost of unsold purchase is made, depending upon the
inventories at the end of the period that are circumstances of the entity.
recognized as asset (i.e., ;ending The cost formulas refer to “cost
inventory’). PAS 2 provides the following flow assumptions,” meaning they
cost formulas: pertain to the flow costs(i.e., from
1. Specific identification- this shall be inventory to cost of sales) and not
used for inventories that are not ordinarily necessarily to the actual physical flow
interchangeable (i.e., those that are of inventories. Thus, the FIFO or
Weighted Average can be used
 regardless of which item of inventory is
physically sold first.
Same cost formula shall be used for all Date Transactio Units Unit Total
inventories with similar nature and use. n cost cost
Different cost formulas may be used for Jan. Beginning 100 P10 P1,000
inventories with different nature or use. 1 inventory
However, a difference in geographical 7 Purchase 300 12 3,600
location of inventories, by itself, is not 21 Purchase 200 14 2,800
sufficient to justify the use of different cost Total goods 600 7,400
formulas. available for sale
PAS 2 does not permit the use of a last- Less Ending (280) (3,760)
in, first out(LIFO) cost formula. inventory
Cost of sales 320 P3,640
Illustration:
Entity A, a trading entity, buys and sells Case 2.1: Weighted Average
Product A. Movements in the inventory of Compute for the ending inventory and cost
Product A during the period are as follows: of sales using the Weighted Average cost
Date Transaction Units Unit Total formula. The average is calculated on a
cost cost periodic basis.
Jan. Beginning 100 P10 P1,000
1 inventory Step 1: Compute for the total goods
7 Purchase 300 12 3,600 available for sale in units and at cost.
12 Sale 320 Date Transaction Units Unit Total
21 Purchase 200 14 2,800 cost cost
Jan. Beginning 100 P10 P1,000
Case 1: FIFO 1 inventory
Compute for the ending inventory and cost 7 Purchase 300 12 3,600
of sales using the FIFO cost formula. 21 Purchase 200 14 2,800
Total goods 600 7,400
Step 1: Compute for ending inventory in available for sale
units.
Date Transaction Units Step 2: Compute for the weighted average
Jan. 1 Beginning 100 unit cost.
inventory Formula:
7 Purchase 300 Weighted average Total goods
12 Sale (320) cost = available for sale
21 Purchase 200 (TGAS) in pesos
Ending 280 Total goods
inventory(i available for sale
n units) (TGAS) in units

Step 2: compute for ending inventory at Weighted average unit cost= P7,400 + 600 =
cost. P12.33
Units Unit Total Step 3: Compute for ending inventory at
cost cost cost.
From 200 P14 P2,800 Ending inventory (in 280
Jan.21 units)
purchase Weighted average P12.33
From Jan.7 80 12 960 unit cost
purchase Ending inventory (at P3,452.40
(280-200) cost)
Ending inventory (at cost) P3,760

Step 3: compute for cost of sales.

 is not. Net realizable value for inventories
may not equal fair value less costs to sell.”
Step 4: Compute for cost of sales. Measuring inventories at the lower of
Total goods P7,400,00 cost and NRV is in line with the basic
available for sale (at accounting concept than an asset shall not
cost) be carried at an amount that exceeds its
Less: Ending (3,452.40) recoverable amount.
inventory (at cost) The cost of an inventory may exceed its
Cost of sales P3,947.60 recoverable amount if, for example, the
inventory is damaged, becomes obsolete,
Case 2.2: Weighted Average prices have declined, or the estimated costs
Compute for the ending inventory and cost to complete or to sell the inventory is
of sales using the Weighted Average cost written-down to NRV. The amount of write-
formula. The average is calculated as each down is recognized as expense.
additional purchase is made (also called If the NRV subsequently increases, the
‘moving average’). previous write-down is reversed. However,
Dat Transactio Unit Unit Total the amount of reversal shall not exceed the
e n s cost cost original write-down. This is so that the new
Jan. Beginning 100 P10 P1,000 carrying amount is the lower of the cost and
1 inventory the revised NRV.
7 Purchase 300 12 3,600 Write-downs of inventories are usually
400 11.5 4,600.00 carried out on an item by item basis,
0 although in some circumstances, it may be
(320 (3,680.0 appropriate to group similar items. It is not
) 0) appropriate to write down inventories on the
12 Sale 320 basis of their classification (e.g., finished
goods or all inventories of an operating
21 Purchase 200 14.0 2,800.00
segment).
0
Raw materials inventory is not written
Ending inventory 280 P3,720.0
down below cost if the finished goods in
0
which they will be incorporated are
expected to be sold at or above cost. If,
Moving ave. cost = TGAS at cost + TGAS
however, this is not the case, the raw
in units = (P4,600+400) = P11.50
materials are written down to their NRV.
The best evidence of NRV for raw materials
Cost of sales= 320 units sold x P11.50
is replacement cost.
moving ave. cost = P3,680
Illustration 1:
Net realizable value (NRV)
Information on Entity A’s inventories is as
Net realizable value is “the estimated selling
follows:
price in the ordinary course of business less
the estimated costs of completion and the
Product A Product B
estimated costs necessary to make sale.”
Cost 100,000 200,000
NRV is different from fair value. “net
realizable value refers to the net amount that Estimated 140,000 220,000
an entity expects to realize from the sale of selling price
inventory in the ordinary course of business. Estimated 20,000 30,000
Fair value reflects the price at which an costs to sell
orderly transaction to sell the same
inventory in the principal cost (or most Requirement: Compute for the valuation of
advantageous) market for that inventory Products A and B in Entity A’s statement of
would take place between market financial position.
participants at the measurement date. The
former is an entity-specific value; the latter
 Cost 60,000 100,000
Replacemen 50,000 120,000
Solution:
t cost/NRV
Product A Product B
Requirement: Compute for the valuation of
Cost 100,000 200,000
the inventories in Entity A’s statement of
Estimated 140,000 220,000
financial position.
selling price
Estimated (20,000) (30,000) Answer:
costs to sell P160,000 total cost (60,000 +100,000). the
120,000 190,000 raw materials need not be written-down to
replacement cost because the NRV of the
Lower 100,000 190,000 finished goods exceeds the cost.
Amount of - 10,000
write-down Recognition as an expense
The carrying amount of an inventory that is
Analysis: sold is charged as expense (i.e., cost of
 Product A need not be written-down sales) in the period in which the related
because its cost is lower than its NRV revenue is recognized. Likewise, the write-
 Product B shall be written-down by down of inventories to NRV and all losses
P10,000 because its cost exceeds its of inventories are recognized as expense in
NRV (200,000 cost less 190,000 the period the write-down or loss occurs.
NRV). “The amount of any reversal of any
 The total inventory to be shown in the write-down of inventories, arising from an
statement of financial position is increase in net realizable value, shall be
P290,000 (100,000 for Product A + recognized as a reduction in the amount of
190,000 for Product B). inventories recognized as an expense in the
 The P10,000 write-down is recognized period in which the reversal occurs.”
as expense in profit or loss. Inventories that are used in the
construction of another asset is not expensed
Continuation: but rather capitalized as cost of the
Assume that in a subsequent period, the constructed asset. For example, some
NRV of Product B increases as follows: inventories may be used in constructing a
building. The cost of those inventories is
Product B capitalized as cost of the building and will
Cost 80,000 be included in the depreciation of that
building.
Net 100,000
realizable Disclosures
value a. Accounting policies adopted in measuring
inventories, including the cost formula used;
Analysis: b. Total carrying amount of inventories and
 The increase is P20,000 (100,00 - the carrying amount in classifications
80,000). However, the amount of appropriate to the entity;
reversal that Entity A can recognize is c. Carrying amount of inventories carried at
limited to P10,000, i.e., the amount of fair value less costs to sell;
the original write-down. d. Amount of inventories recognized as an
 The amount of inventory to be shown expense during the period;
in the statement of financial position is e. Amount of any write-down of inventories
P90,000 (80,000 + 10,000 reversal). recognized as an expense in the period;
Illustration 2: f. Amount of any reversal of write-down
Information on Entity A’s inventories is as that is recognized as a reduction in the
follows: amount of inventories recognized as
Raw Finished expense in the period;
Materials goods
g. Circumstances or events that led to the
reversal of write-down; and
h. Carrying amount of inventories pledged
as security for liabilities.
Summary:
 Inventories include goods that are held
for sale in the ordinary course of
business, in the process of production
for such sale, and in the form of
materials and supplies to be consumed
in the production.
 Inventories are measured at the lower
of cost and net realizable value (NRV).
 The cost of inventories comprises all
costs of purchase, costs of conversion
and other costs incurred in bringing the
inventories to their present location and
condition.
 Trade discounts, rebates and other
similar items are deducted in
determining the costs of purchase.
 The following are excluded from the
cost of inventory: Abnormal cots,
Storage costs, unless necessary,
Administrative costs, and Selling costs.
 The cost formulas permitted under PAS
2 are (a) specific identification, (b)
FIFO, and (c) weighted average.
 Specific identification shall be used for
inventories which are nor ordinarily
interchangeable.
 Net realizable 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.
 Inventories are usually written down to
NRV on an item by item basis.
 Raw materials inventory is not written
down below cost if the finished goods
in which they will be incorporated are
expected to be sold at or above cost.
 Reversal of inventory write-downs
shall not exceed the amount of the
original write-down.