PS2 prescribes the accounting treatment for inventories.

PAS2 recognizes 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 not measured under the lower of cost or net realizable value (NRV) 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 the necessary, normal or usual business

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 (eg, 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 (e.g., freight out and advertisement costs). (PAS 216)

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.

Cost Formulas

The cost formulas deal with the computation of cost of inventories that are charged
as expense when the related revenue is recognized (i.e., 'cost of sales' or 'cost of
goods sold') as well as the cost of unsold inventories at the end of the period that are
recognized as asset (i.e., 'ending inventory'). PAS 2 provides the following cost
formulas:

1. Specific identification - this shall be used for inventories that are not ordinarily
interchangeable (i.e., those that are individually unique) and those that are
segregated for specific projects.

Under this formula, specific costs are attributed to identified items of inventory.
Accordingly, cost of sales represents the actual costs of the specific items sold while
ending inventory represents the actual costs of the specific items on hand.

For example, if an inventory with a serial number of "ABC-123" costing P10,948.67 is

sold, the amount charged to cost of sales is also P10,948.67. If that inventory
remains unsold, the amount included in ending inventory is also P10,948.67.
In this regard, records should be maintained that enables the entity to identify the
cost and movement of each specific inventory.

Specific identification, however, is not appropriate when inventories consist of large

number of items that are ordinarily interchangeable. In such cases, the entity shall
choose between formulas 2 and 3 below.

2. First-In, First-Out (FIFO) - Under this formula, it is assumed that inventories that
were purchased or produced first are sold first and therefore unsold inventories at
the end of the period are those most recently purchased or produced.

Accordingly, cost of sales represents costs from earlier purchases, while the cost of
ending inventory represents costs from the most recent purchases.

3. Weighted Average - Under this formula, cost of sales and ending inventory are
determined based on the weighted average cost of beginning inventory and all
inventories purchased or produced during the period. The average may be
calculated on a periodic basis, or as each additional purchase is made, depending
upon the circumstances of the entity.

The cost formulas refer to "cost flow assumptions," meaning they pertain to the flow
of costs (i.e., from inventory to cost of sales) and not necessarily to the actual
physical flow 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 inventories with similar nature and use.
Different cost formulas may be used for inventories with different nature or use.
However, a difference in geographical location of inventories, by itself, is not
sufficient to justify the use of different cost formulas. (PAS 2.26)

PAS 2 does not permit the use of a last-in, first out (LIFO) cost formula.

Net realizable value (NRV)

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. (PAS 2.6)

NRV is different from fair value. "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."
Measuring inventories at the lower of cost and NRV is in line with the basic
accounting concept that an asset shall not be carried at an amount that exceeds its
recoverable amount.

The cost of an inventory may exceed its recoverable amount if, for example, the
inventory is damaged, becomes obsolete, prices have dedined, or the estimated
costs to complete or to sell the inventory have increased. In these circumstances,
the cost of the inventory is written-down to NRV. The amount of write-down is
recognized as expense

If the NRV subsequently increases, the previous write- down is reversed. However,
the amount of reversal shall not exceed the original write-down. This is so that so
that the new carrying amount is the lower of the cost and the revised NRV.

Write-downs of inventories are usually carried out on an item by item basis, although
in some circumstances, it may be appropriate to group similar items. It is not
appropriate to write down inventories on the basis of their classification (e.g., finished
goods or all inventories of an operating segment).

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. If, however, this is
not the case, the raw materials are written down to their NRV. The best evidence of
NRV for raw materials is replacement cost.

Recognition as an expense
The carrying amount of an inventory that is sold is charged as expense (ie, cost of
sales) in the period in which the related revenue is recognized. Likewise, the
write-down of inventories to NRV and all losses of inventories are recognized as
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."
(PAS 2.34)

Inventories that are used in the construction of another asset is not expensed but
rather capitalized as cost of the constructed asset. For example, some inventories
may be used in constructing a building. The cost of those inventories is capitalized
as cost of the building and will be included in the depreciation of that building.

Disclosures
a. Accounting policies adopted in measuring inventories, including the cost formula
used;
b. Total carrying amount of inventories and the carrying amount in classifications
appropriate to the entity;
c. Carrying amount of inventories carried at fair value less costs to sell
d. Amount of inventories recognized as an expense during the period;
e. Amount of any write-down of inventories recognized as an expense in the period;
f. Amount of any reversal of write-down that is recognized as a reduction in the
amount of inventories recognized as expense in the period;
g. Circumstances or events that led to the reversal of a write- down of inventories;
and
h. Carrying amount of inventories pledged as security for liabilities.