IAS 2 INVENTORIES : MEASUREMENT OF COST

10. MEASUREMENT OF COST

Standard costs should be based on normal levels of output, and should be reviewed and revised regularly.

The cost of inventories of products that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs.

Specific identification of cost means that specific costs are attributed to identified items of inventory. This applies for items that are segregated for a specific project, regardless of whether they have been bought or produced. Specific identification of costs is inappropriate when there are large numbers of items of inventory that are ordinarily interchangeable. The method of selecting those items that remain in inventories could be used to obtain predetermined effects on profit.

COST FORMULAS

The cost of inventories should be measured on a first-in, first-out (FIFO) or weighted-average cost basis.

Last-in, first-out (LIFO) is not an acceptable method.

All inventories of a similar nature should use the same measurement system, regardless of their geographical location, or tax system.

Example:

Your group produces mobile phones. Your European subsidiaries use FIFO, your Asian subsidiaries use weighted-average cost and your US subsidiaries use LIFO for inventory valuation.

For IFRS group accounts, all inventories need to be valued using FIFO or weighted-average cost (though not a mixture of the two).

FIFO

FIFO assumes that the first items bought are the first items sold. Therefore, at the end of the period, any items in inventory are the items purchased (or produced) most recently.

Example: FIFO You are selling one model of car. You have no inventory at the start of the period. You buy 4 cars during the period. Due to price rises, the cars cost you: $6000, $6500, $7000, $7500 in the order you purchase them. You sell 2 cars, and use FIFO to value your inventory. The value of your inventory at the end of the period is $14500 ($7000+$7500). Your cost of sales = $12500 ($6000+$6500).
	I/B	DR	CR
Cost of sales	I	12.500
Inventory	B		12.500
Allocation of inventory costs to costs of sales

WEIGHTED-AVERAGE COST

The weighted-average cost is calculated from the inventory at the start of the period, plus any items bought (or produced) during the period.

Example: weighted average You are selling one model of car. You have no inventory at the start of the period. You buy 4 cars during the period. Due to price rises, the cars cost you: $6000, $6500, $7000, $7500 in the order you purchase them. Total cost=$27000. You sell 2 cars, and use weighted-average cost to value your inventory. The value of your inventory at the end of the period is $13.500 ($27000/2). Your cost of sales = $13.500 ($27000/2).
	I/B	DR	CR
Cost of sales	I	13.500
Inventory	B		13.500
Allocation of inventory costs to costs of sales

The “Retail Method’’

 

The retail method is often used in the retail industry for measuring inventories of large numbers of rapidly changing items with similar margins for which it is impracticable to use other costing methods.

 

The cost of the inventory is determined by reducing the sales value of the inventory by the appropriate percentage gross margin.

 

The percentage used takes into consideration inventory that has been marked down to below its original selling price. An average percentage for each retail department is often used.