Inventory is an item presented in the financial statements as current assets. It is normally applicable for trading or merchandising as well as production company as they need to buy produce product or goods for resale. So what is inventory?
Definition of Inventory
There are a number of definitions; however, as per IAS 2, Inventory is defined as asset held for sale in the ordinary course of business activities, in the process of production for such sale, or in the form of materials or supplies to be consumed in the production process or in the rendering of services.
There are different items considered as inventory depend on each type of company. For the merchandising company either for retailer or wholesale, the inventory are goods purchased and held for resale or land and other property held for resale.
For production company, inventory includes finished goods which are internally produced, or work in progress being produced by the entity. It also includes materials and supplies which are awaiting for use in the production process.
In the case of a service provider such as law and tax service firm, inventory includes the costs of the service which is the hours incurred in corresponding to the performance of service for their clients. This is also considered unbilled working in progress that can be billed to clients when the project is completed or at the certain period as the percentage of completion depending on the underlying contract. The revenue recognition of such work in progress is covered under IFRS 15 – Revenue from contract with customers which effectively from 01 January 2018.
IAS 2 applies to all inventories except:
- Work in progress (WIP) arising under construction contracts, including directly related service contracts which is under cover under IAS 11 Construction Contracts. This IAS 11 is subsequently replace by IFRS 15 – Revenue from contract with customers which is effective from 01 January 2018 onward.
- Financial instruments which cover under IAS 32 Financial Instruments: Presentation and IAS 39 Financial Instruments: Recognition and Measurement) and subsequently under IFRS 9 for the measurement especially on expected credit loss.
- Biological assets include the agricultural activity and agricultural produce at the point of harvest which covers under IAS 41 Agriculture.
In addition, this standard does not apply to the measurement of inventory which is held by:
- Producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realizable value in accordance with well-established practices in those industries. When such inventory is measured at net realizable value, changes in that value are recognized in profit or loss in the period of the change.
- Commodity broker-traders who measure their inventory at fair value less costs to sell. When such inventories are measured at fair value less costs to sell, changes in fair value less costs to sell are recognized in profit or loss in the period of the change.
In accordance with IAS2, inventories shall be measured at the lower of cost and net realizable value meaning if the net realization value is lower than cost, those inventories shall measure at net realizable value.
Net realizable value is the cost of the inventory less any reasonable cost associated with sale of such inventory. The cost of inventories shall include all related costs of purchase such as purchase price, import duties, transportation as well as other taxes.
Inventory cost should also include costs of conversion such as labor and other costs incurred in bringing the inventory to their present location and condition.