What is inventory

Inventory

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. (IAS2)

*Measurement

Inventory must be recorded/Measured at the lower of cost or net realizable value.

Cost. Includes the purchase cost and any other costs necessary in bring the inventories to their present location and condition.

 For example if a company has raw material costing $50, which will be sold as finished products for $80 after additional $10 of labor costs are incurred to complete, its NRV will be $70 ($80 - $10). there fore inventory should be recorded at a lower of cost 50 &Nrv 70.

These may include costs incurred directly in the production of inventory such as 

1.direct labor cost

2.production overheads (i.e. conversion costs) and 

3.other expenses such as transportation and handling charges, 

4.taxes and duties that may not be recoverable from tax authorities. 

However, costs do not include general and administrative costs which cannot reasonable attributed to the cost of inventory. Similarly, selling and distribution expenses, storage costs and excessive expenditure resulting from abnormal wastage shall not be included in the cost of inventory.

*Net realizable value

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(IAS 2). 

This is simply the expected revenue from the sale of inventory after deducting any further costs that are necessary in order to sell the inventory. 

For example if a company has raw material costing $50, which will be sold as finished products for $80 after additional $10 of labor costs are incurred to complete, its NRV will be $70 ($80 - $10).

The need to value the inventory at the lower of cost and NRV stems from the concept of prudence which requires that the assets of the entity, which in this case is inventory, must not be stated above the amount expected to be earned from its use or sale. 

For example, if an inventory costs $100 but its NRV is only $70, the inventory is recorded at the year end at $70. Recording inventory at a lower amount has the effect of reducing profit because a decrease in closing inventory increases the cost of sales (expense)

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