SUBSEQUENT

MEASUREMENT:

LOWER OF COST AND

NET REALIZABLE VALUE
(LCNRV)
 IAS 2 - Inventories
 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. (IAS 2, par. 6)
 IAS 2 - Inventories
 Inventories encompass goods purchased and held for resale including, for
example, merchandise purchased by a retailer and held for resale, or land
and other property held for resale.

 Inventories also encompass finished goods produced, or work in progress

being produced, by the entity and include materials and supplies awaiting
use in the production process.

 Costs incurred to fulfil a contract with a customer that do not give rise to
inventories (or assets within the scope of another Standard) are accounted
for in accordance with IFRS 15 Revenue from Contracts with Customers. (IAS
2, par. 8)
 IAS 2 - Inventories
Question: How are inventory items measured at the time of recognition?

Answer: When an inventory item is initially recognized, it is measured at cost.

 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. (IAS 2, par. 10)
 IAS 2 - Inventories
 INITIAL MEASUREMENT

Costs of purchase
The costs of purchase of inventories comprise 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. (IAS 2, par. 11)
 IAS 2 - Inventories
 INITIAL MEASUREMENT

Costs of conversion
The costs of conversion of inventories include costs directly related to the
units of production, such as direct labour. They also include a systematic
allocation of fixed and variable production overheads that are incurred in
converting materials into finished goods. Fixed production overheads are
those indirect costs of production that remain relatively constant regardless of
the volume of production, such as depreciation and maintenance of factory
buildings, equipment and right-of-use assets used in the production process,
and the cost of factory management and administration. Variable production
overheads are those indirect costs of production that vary directly, or nearly
directly, with the volume of production, such as indirect materials and indirect
labour. (IAS 2, par. 12)
 IAS 2 - Inventories
 INITIAL 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. (IAS 2, par. 13)
 IAS 2 - Inventories
 INITIAL MEASUREMENT
 IAS 2 - Inventories
 SUBSEQUENT MEASUREMENT

 Inventories are measured at the lower of cost and net realizable

value (NRV). (IAS 2, par. 9)

 Net realizable value (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, par. 6)
 IAS 2 - Inventories
 SUBSEQUENT MEASUREMENT
 IAS 2 - Inventories
 SUBSEQUENT MEASUREMENT

 Net realizable value refers to the net amount that an entity expects to
realize from the sale of inventory in the ordinary course of business.

 Fair value reflects the price at which an orderly transaction to sell the
same inventory in the principal (or most advantageous) market for that
inventory would take place between market participants at the
measurement date.

 The former is an entity-specific value; the latter is not.

 Net realizable value for inventories may not equal fair value less costs
to sell. (IAS 2, par. 7)
 IAS 2 - Inventories
 SUBSEQUENT MEASUREMENT

 The cost of inventories may not be recoverable if those inventories

are damaged, if they have become wholly or partially obsolete, or if
their selling prices have declined.

 The cost of inventories may also not be recoverable if the estimated

costs of completion or the estimated costs to be incurred to make
the sale have increased.

 The practice of writing inventories down below cost to net

realizable value is consistent with the view that assets should not
be carried in excess of amounts expected to be realized from their
sale or use. (IAS 2, par. 28)
 IAS 2 - Inventories
 NET REALIZABLE VALUE

 Inventories are usually written down to net realizable value

item by item.

 In some circumstances, however, it may be appropriate to

group similar or related items. This may be the case with items
of inventory relating to the same product line that have similar
purposes or end uses, are produced and marketed in the same
geographical area, and cannot be practicably evaluated
separately from other items in that product line.

 It is not appropriate to write inventories down on the basis of a

classification of inventory, for example, finished goods, or all
the inventories in a particular operating segment. (IAS 2, par.
29)
 IAS 2 - Inventories
 NET REALIZABLE VALUE

 Estimates of net realizable value are based on the most reliable

evidence available at the time the estimates are made, of the
amount the inventories are expected to realize.

 These estimates take into consideration fluctuations of price or

cost directly relating to events occurring after the end of the
period to the extent that such events confirm conditions
existing at the end of the period. (IAS 2, par. 30)
 IAS 2 - Inventories
 NET REALIZABLE VALUE

 Estimates of net realizable value also take into consideration the

purpose for which the inventory is held.

 For example, the net realizable value of the quantity of inventory held
to satisfy firm sales or service contracts is based on the contract price.

 If the sales contracts are for less than the inventory quantities held, the
net realizable value of the excess is based on general selling prices.
Provisions may arise from firm sales contracts in excess of inventory
quantities held or from firm purchase contracts.

 Such provisions are dealt with under IAS 37 Provisions, Contingent

Liabilities and Contingent Assets. (IAS 2, par. 31)
 IAS 2 - Inventories
 NET REALIZABLE VALUE

 Materials and other supplies held for use in the production of

inventories are not written down below cost if the finished products in
which they will be incorporated are expected to be sold at or above
cost.

 However, when a decline in the price of materials indicates that the

cost of the finished products exceeds net realizable value, the
materials are written down to net realizable value.

 In such circumstances, the replacement cost of the materials may be

the best available measure of their net realizable value. (IAS 2, par. 32)
 IAS 2 - Inventories
 NET REALIZABLE VALUE

ILLUSTRATION:

Information on an entity’s raw materials inventory is as follows:

Cost P30,000
Replacement Cost 22,500

Q: Assuming the cost and the net realizable value of the finished goods
where the materials will be incorporated are P45,000 and P50,000,
respectively, at what amount shall the raw materials be reported at year-
end?

A: Still at P30,000 (cost) – considering that the finished goods where the
materials will be incorporated are expected to be sold above cost, raw
materials are not written down below cost.
 IAS 2 - Inventories
 NET REALIZABLE VALUE

ILLUSTRATION:

Information on an entity’s raw materials inventory is as follows:

Cost P30,000
Replacement Cost 22,500

Q: Assuming the cost and the net realizable value of the finished goods
where the materials will be incorporated are P45,000 and P40,000,
respectively, at what amount shall the raw materials be reported at year-
end?

A: Reduced to P22,500 (NRV) – considering that the finished goods where

the materials will be incorporated are expected to be sold below cost, raw
materials are written down to their net realizable value.
 IAS 2 - Inventories
 NET REALIZABLE VALUE

 A new assessment is made of net realizable value in each

subsequent period.

 When the circumstances that previously caused inventories to

be written down below cost no longer exist or when there is
clear evidence of an increase in net realizable value because of
changed economic circumstances, the amount of the
write-down is reversed (i.e., the reversal is limited to the
amount of the original write-down) so that the new carrying
amount is the lower of the cost and the revised net realisable
value.

 This occurs, for example, when an item of inventory that is

carried at net realizable value, because its selling price has
declined, is still on hand in a subsequent period and its selling
price has increased. (IAS 2, par. 33)
 IAS 2 - Inventories

 If the cost is lower than the net realizable value (Cost <
Net Realizable Value)
 Inventory is subsequently measured at cost
 No recognition of an increase in value

 If the net realizable value is lower than the cost (Cost >
Net Realizable Value)
 Inventory is subsequently measured at net realizable
value
 There is a recognition of a decrease in value
Exercise:

Determine the following:

1. Initial measurement of the inventories; and

2. Subsequent measurement of the inventories.
 IAS 2 - Inventories
 METHODS OF ACCOUNTING FOR THE INVENTORY WRITEDOWN

Inventory write-down occurs when the inventory’s net realizable

value is less than its cost.

Methods:

 Direct method or Cost of Goods Sold method

 Allowance method or Loss method

NOTE: PAS 2, paragraph 36, requires disclosure of the amount of

any inventory write-down and the amount of any reversal of
inventory write-down.
 IAS 2 - Inventories
 DIRECT METHOD

 Under this method, the inventory account will be debited

equal to the LCNRV. Thus, the loss on inventory write-down will
already be included as part of the cost of goods sold.

 The entry to record the transaction is, as follows:

Periodic System:

Inventory, End (at LCNRV) XXX

Income summary (Cost of goods sold) XXX

Perpetual System:
Cost of goods sold XXX*
Inventory XXX
*Amount is based on the difference between cost and NRV.
 IAS 2 - Inventories
 ALLOWANCE METHOD

 Under this method, the loss on inventory write-down shall be

recorded separately in a “loss” account.

 The entry to record the transaction is, as follows:

Periodic System:
Inventory, End (at cost) XXX
Cost of goods sold XXX

Loss on inventory write-down XXX

Allowance for inventory write-down XXX

In Perpetual System, only the second entry will be recognized.

 Any recognized Loss on inventory write-down will form part of

the cost of goods sold.
 IAS 2 - Inventories
 NET REALIZABLE VALUE

 The amount of any write-down of inventories to net realizable

value and all losses of inventories shall be recognized as an
expense in the period the write-down or loss occurs.

 The amount of any reversal of any write-down of inventories,

arising from an increase in net realizable value, shall be
recognized as a reduction in the amount of inventories
recognized as an expense in the period in which the reversal
occurs. (IAS 2, par. 34)
 IAS 2 - Inventories
 REVERSAL OF INVENTORY WRITE-DOWN

 Occurs when the value of inventory subsequently increases

after a write-down.

 Allowed to be recognized but only to the extent of the

allowance for inventory write-down balance. Gain on
reversal of inventory write-down is recognized only under the
allowance method.

 Treated as a deduction from the cost of goods sold.

 The entry to record the reversal of inventory write-down is, as

follows:

Allowance for inventory write-down XXX

Gain on reversal of inventory write-down XXX
 IAS 2 - Inventories
 METHODS OF ACCOUNTING FOR THE INVENTORY WRITEDOWN
 IAS 2 - Inventories
 DIRECT METHOD / COST OF GOODS SOLD METHOD

Inventory 530,000
Income summary 530,000
 IAS 2 - Inventories
 DIRECT METHOD / COST OF GOODS SOLD METHOD

Assume by the following year, the cost of inventory is P550,000 and

the NRV is P520,000, the entry to record the subsequent
measurement of the inventory is, as follows:

Inventory 520,000
Income summary 520,000
 IAS 2 - Inventories
 ALLOWANCE / LOSS METHOD

Inventory 600,000
Income summary 600,000

Loss on inventory write-down 70,000

Allowance for inventory write-down 70,000
 IAS 2 - Inventories
 ALLOWANCE / LOSS METHOD

Assume by the following year, the cost of inventory is P550,000 and the NRV
is P520,000, the entry to record the subsequent measurement of the
inventory is, as follows:

Inventory 520,000
Income summary 520,000

Allowance for inventory writedown 40,000

Gain on reversal of inventory writedown 40,000

NOTE: The gain on reversal of inventory writedown is presented as a

deduction from cost of goods sold.
CONDITIONAL SALES
AND
INSTALLMENT SALES
 IAS 2 - Inventories
 CONDITIONAL SALES AND INSTALLMENT SALES

 In an installment contract, although the title will be retained

by the seller until the full payment of the price, the control over
the goods has already been transferred to the buyer.
(Substance over form)

 The seller anticipates completion of the contract (i.e., full

payment of all installment payments) and the ultimate
passing of the title, which deems the transaction as a regular
sale.

 The goods are recorded as sold when delivered and excluded

from the inventory of the seller.
 IAS 2 - Inventories
 CONDITIONAL SALES AND INSTALLMENT SALES

 Other merchandise owned by an enterprise but in the

possession of others (included as part of the inventory of the
enterprise that economically controls the goods):

 Goods in the hands of salespersons and agents;

 Goods held by the customer on approval;
 Goods held by others for storage;
 Goods held by others for further processing; and
 Goods held by others for shipment.
GOODS SOLD WITH
BUYBACK
AGREEMENT
 IAS 2 - Inventories
 CONDITIONAL SALES AND INSTALLMENT SALES

 A buyback agreement, accompanying sale of goods, is in

substance, a form of product financing arrangement.

 The owner of the goods sells the inventory to another party

and agrees to repurchase the goods at a specified price, which
covers all costs of inventory plus related holding costs.

 The inventory is used as a collateral for a loan obtained

either directly from the buyer, or from a financing
company with the buyer as intermediary.

 The customer does not obtain control of the asset

(inventory), and the transferor (seller) shall account for
the transfer as a financing agreement and shall retain
the inventory in its books. Any consideration received
from the transfer shall be credited to a financial liability.
GOODS SOLD WITH
REFUND OFFERS
 IAS 2 - Inventories
 GOODS SOLD WITH REFUND OFFERS

 There are sale transactions when buyers are given the right to
rescind the purchase of goods for certain reasons as may be
provided in the sales contract itself.

 To account for the transfer of products with a right to return,

an entity shall recognize:

 Revenue for the transferred products (at the amount of

the transaction price);
 A refund liability; and
 An asset for its right to recover the products from the
customer on settling the refund liability.

 The recognition of revenue implies that the corresponding

transferred goods be removed for the inventory at their
carrying amount.
LAW AWAY PLANS
AND BILL AND
HOLD SALES
 IAS 2 - Inventories
 LAY AWAY PLANS AND BILL AND HOLD SALES

 In lay away plans, the customer pays a fraction or a portion of

the selling price of merchandise and agrees to pay in an
installment or pay the full amount at a future date.

 The store holds the merchandise and delivers it to a

customer only upon full payment of the goods.

 In bill-and-hold sale, an entity bills a customer for a product

but retains physical possession of that product until it is
transferred to the customer at a point in time (e.g., when a
customer has already made payments of a substantial portion
of the goods’ selling price).
 IAS 2 - Inventories
 LAY AWAY PLANS AND BILL AND HOLD SALES

 Here, revenue is recognized when the customer obtains

control over the product when the following conditions will be
met:

 The product must have been identified separately as

already belonging to the customer;
 The product must be ready for transfer to the customer;
and
 The entity does not have ability to use the product or
direct it to another customer.

 The recognition of revenue is made simultaneous to

derecognition of inventory in the seller’s accounting records.
AGRICULTURE,
FOREST AND
MINERAL
PRODUCTS
 IAS 2 - Inventories
 AGRICULTURE, FOREST AND MINERAL PRODUCTS

 Inventories of agricultural, forest and mineral products are

measured at the net realizable value at certain stages of
production. (IAS 2, par. 4)

 Agricultural crops that have been harvested or mineral

products that have been extracted are measured at net
realizable value:

 When a sale is assured under a forward contract or

government guarantee.

 When a homogenous market exists and there is a

negligible risk of failure to sell.
COMMODITIES OF
BROKER-TRADERS
 IAS 2 - Inventories
 COMMODITIES OF BROKER-TRADERS

 Commodities of broker-traders are measured at fair value less

cost of disposal. (IAS 2, par. 3)

 Broker-traders are those who buy and sell commodities for

others or on their own account.

 The inventories of broker-traders are principally acquired with

the purpose of selling them in the near future and generating
a profit from fluctuations in price or broker-traders’ margin.
 PURCHASE
COMMITMENTS
 IAS 2 - Inventories
 PURCHASE COMMITMENTS

 Purchase commitments are obligations of the entity to acquire certain

goods sometime in the future at a fixed price and fixed quantity.

 In a purchase commitment, a purchase contract has already been made for

future delivery of goods fixed in price and in quantity.

 Where the purchase commitments are significant or unusual, disclosure is

required in the accompanying notes to financial statements.

 While a purchase commitment can protect an entity from a price increase,

this also creates a problem when the price of the product falls below the
contract (or fixed) price.

 A purchase commitment can either be:

 Cancellable (or may be subject to revision)
 Non-cancellable (or not subject to revision)
 IAS 2 - Inventories
 CANCELLABLE PURCHASE COMMITMENTS

 Under this type of purchase commitment, the entity can simply cancel the
contract (or agreement) when the circumstances become unfavorable on its
part.

 No provision (or journal entry) is required when the price of the product falls
below the contract (or agreed) price. Thus, disclosure is only required
especially when the amount of the estimated loss is material.

 A disclosure in the notes to financial statements is required for a

cancellable purchase commitment if:
 A future loss is possible;
 The amount of the commitment can be reasonably estimated; and
 The amount is material.
 IAS 2 - Inventories
 NON-CANCELLABLE PURCHASE COMMITMENTS

 Under this type of purchase commitment, the entity is obligated to perform

under the contract even if the circumstances are unfavorable on its part.

 When the price of the product falls below the contract (or agreed) price, a loss
on purchase commitment shall be recognized.

 The loss on purchase commitment is classified as “other expense” and the

estimated liability for purchase commitment is classified as “current liability”.

 The actual purchase is recorded at the lower between the amount of

purchase commitment and the current replacement cost or current market
price.

 NOTE: A purchase commitment must be non-cancellable in order that a loss

on purchase commitment can be recognized.
 IAS 2 - Inventories
 PURCHASE COMMITMENTS

 If there is a decline in purchase price after a purchase commitment has

been made, a loss is recorded in the period of the price decline:

Loss on Purchase Commitment XXX

Estimated Liability for Purchase Commitment XXX

 If there is a further decline in purchase price when the actual purchase is

made after a purchase commitment has been made, the journal entry is:

Purchases XXX
Loss on Purchase Commitment XXX
Estimated Liability for Purchase Commitment XXX
Accounts Payable XXX
 IAS 2 - Inventories
 PURCHASE COMMITMENTS

 If the market price rises by the time the entity makes the purchase, a gain
on purchase commitment would be recorded, as follows:

Purchases XXX
Estimated Liability for Purchase Commitment XXX
Accounts Payable XXX
Gain on Purchase Commitment XXX

 Note that the amount of gain to be recognized is limited to the loss on

purchase commitment previously recorded.
 DISCLOSURE
REQUIREMENTS
 IAS 2 - Inventories
 DISCLOSURE
 IAS 2 - Inventories
 DISCLOSURE

 Information about the carrying amounts held in different

classifications of inventories and the extent of the changes in
these assets is useful to financial statement users.

Common classifications of inventories are merchandise,

production supplies, materials, work in progress and finished
goods. (IAS 2, par. 37)
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