Inventories

IAS 2 governs the accounting for inventories: how to determine their cost, how to test them against net realisable value (NRV), and when their cost becomes an expense (cost of sales or a write-down) [S1]. The core rule is short enough to memorise: inventories are measured at the lower of cost and net realisable value. Inventories are assets: (a) held for sale in the ordinary course of business (finished goods, trading stock); (b) in the process of production for such sale (work in progress); or (c) materials and supplies to be consumed in production or in rendering services (raw materials, packaging, spare consumables).

For most Nigerian trading, manufacturing, FMCG, pharmaceutical, agro-processing and construction-materials businesses, inventory is one of the two largest assets on the balance sheet (alongside receivables or PPE). Getting IAS 2 wrong distorts everything. Profit is directly affected: overstate closing inventory by 10 million Naira and you overstate profit by 10 million Naira, and understate next year's profit by the same amount. Cost build-up is a real judgement area: import duties, clearing charges, haulage from Apapa or Onne, demurrage, and FX differences on letters of credit; which of these enter cost and which are expensed matters materially for import-dependent businesses. NRV bites in a volatile economy: Naira depreciation raises replacement cost but weak consumer demand can depress selling prices; slow-moving and obsolete stock must be written down, not carried at hope. Banks lend against stock: inventory figures back working-capital facilities and stock-hypothecation arrangements, so auditors and lenders scrutinise them.

IAS 2 applies to all inventories except: financial instruments (IFRS 9 / IAS 32); and biological assets related to agricultural activity and agricultural produce at the point of harvest (IAS 41), though after harvest, produce (for example harvested cassava or palm fruit bunches) enters IAS 2 at its fair value less costs to sell at harvest, which becomes its 'cost'. In addition, the measurement rules of IAS 2 do not apply to (a) producers of agricultural and forest products, agricultural produce after harvest, and minerals or mineral products measured at NRV in line with well-established industry practice, and (b) commodity broker-traders who measure at fair value less costs to sell; those entities still follow IAS 2's disclosure logic.

Note what IAS 2 does not cover even though people often assume it does. Work in progress on customer contracts priced under IFRS 15 (for example a construction company's contract costs) sits under IFRS 15, not IAS 2, though unallocated materials on site remain inventory. Spare parts and servicing equipment expected to be used over more than one period and meeting the PPE definition go to IAS 16. Property held for rental or capital appreciation is IAS 40; but property held for sale in the ordinary course of business by a real estate developer is inventory under IAS 2, even if it takes years to build.

IAS 2 works with the general asset recognition logic plus its own expense rule. Recognise inventory when the entity controls the asset, usually on transfer of risks and control under the purchase terms. Watch Incoterms on imports: goods shipped FOB Shanghai are the buyer's inventory (goods in transit) once loaded, even though they have not landed in Lagos. Goods held on consignment belong to the consignor, not the party holding them. Derecognise to expense (cost of sales) in the period the related revenue is recognised: the matching that makes gross profit meaningful. Write-downs to NRV and inventory losses are expensed when they occur; reversals of write-downs (limited to the original write-down) reduce the inventory expense in the period of reversal. Inventory used to build another asset (for example cement used to construct the company's own warehouse) is capitalised into that asset's cost and expensed through its depreciation.

Cost = costs of purchase + costs of conversion + other costs incurred in bringing the inventories to their present location and condition [S1].

Costs of purchase: invoice price, import duties and non-recoverable taxes, transport, handling and other directly attributable costs, less trade discounts and rebates. Recoverable VAT is excluded from cost for VAT-registered entities.

Costs of conversion (manufacturers): direct labour plus a systematic allocation of fixed and variable production overheads. Fixed overheads are allocated using normal capacity; in periods of abnormally low production the unallocated overhead is expensed, not loaded onto units. This prevents idle-plant costs inflating inventory during, say, a diesel-supply or grid-power crisis.

Excluded from cost (expensed as incurred): abnormal waste; storage costs unless necessary to the production process (for example maturation); administrative overheads not related to production; selling and distribution costs; and foreign exchange differences on the payable after initial recognition (IAS 21).

Borrowing costs enter inventory cost only for qualifying assets that take a substantial period to get ready for sale, which is relevant to real estate developers under IAS 23 but not to routine trading stock.

Cost formulas: items not ordinarily interchangeable (and goods segregated for specific projects) use specific identification. Everything else uses FIFO or weighted average cost, applied consistently to all inventories of similar nature and use. LIFO is prohibited. Standard cost and retail methods are acceptable approximations if regularly reviewed against actual conditions.

Inventories are carried at the lower of cost and net realisable value. NRV = estimated selling price in the ordinary course of business minus estimated costs of completion minus estimated costs necessary to make the sale. NRV is an entity-specific value (what the entity itself can sell the item for), which distinguishes it from fair value. Materials held for production are not written down if the finished goods they will enter are still expected to sell at or above cost; when they will not, materials are written down, with replacement cost often the best available NRV proxy. NRV is reassessed each period, and write-downs are normally made item-by-item (or by groups of similar items), never as one blanket provision across all stock. Reversals of prior write-downs are required when NRV recovers, capped at the original write-down, so carrying amount never exceeds original cost.

Statement of financial position: inventories are a required IAS 1 line item, normally current; even developer stock that takes longer than 12 months qualifies as current if realised in the normal operating cycle. Sub-classify in the notes: raw materials, work in progress, finished goods, goods in transit, merchandise, consumables.

Statement of profit or loss: under a by-function format, inventory expense sits in cost of sales; under a by-nature format it appears through raw materials used and changes in inventories of finished goods and work in progress. Write-downs are part of the inventory expense; if material, disclose the amount separately and consider separate presentation.

Inventories pledged as security for borrowings (common in Nigerian stock-financing structures) must be disclosed.

A practical month-end/year-end IAS 2 routine: 1) Fix the cost build-up policy for imports. Create a landed-cost template per shipment: FOB price at the transaction-date exchange rate + duty + non-recoverable levies + clearing agent fees + terminal charges + haulage to warehouse + marine insurance. Demurrage is usually abnormal cost: expense it unless it is a normal, unavoidable feature of the supply route. 2) Pick and apply one cost formula. Weighted average suits high-volume fungible stock (FMCG, building materials); FIFO suits perishables and price-sensitive gross margin reporting. Configure it in the ERP and do not switch without an IAS 8 policy-change justification. 3) Set normal capacity for overhead absorption. Base it on expected average production over several periods under normal circumstances. Recalculate the under-absorption in months of outage and expense it. 4) Count and reconcile. Full or cycle counts, cut-off testing (last goods received notes and delivery notes of the year), goods-in-transit and consignment schedules. 5) Run the NRV test. Ageing analysis, items selling below cost post-year-end, damaged or expired stock (critical for pharma and food), technology obsolescence, and committed sales contracts below cost (which may also create an onerous-contract issue under IAS 37 for unhedged supply commitments). 6) Post write-downs and track them by item, so future reversals can be measured against the original write-down. 7) Separate accounting from tax. The general ledger follows IAS 2; the tax computation follows Nigerian tax law.