IAS 2 · Free study guide
IAS 2 Inventories: Summary, Practice Questions & Decision Tree
Last updated 13 August 2026 · Written by the AccountingTutorAI team · Reviewed by a qualified CPA (Canada)
Quick summary
IAS 2 answers two questions about the goods a business holds for sale: what did they cost, and are they still worth it? Cost includes everything spent bringing inventory to its present location and condition — purchase costs, conversion costs, and a systematic share of fixed production overheads based on normal capacity. Interchangeable items are costed by FIFO or weighted average (LIFO is banned); items that aren't interchangeable are costed individually. At each reporting date inventory is measured at the lower of cost and net realisable value, with write-downs — and their reversals — flowing through profit or loss.
What goes into cost
Cost of inventories comprises three layers (IAS 2.10). Costs of purchase: the price, import duties, non-refundable taxes, transport and handling, minus trade discounts and rebates (IAS 2.11). Costs of conversion: direct labour plus a systematic allocation of production overheads — with fixed overheads (depreciation, factory management) allocated using normal capacity, not actual output (IAS 2.12–13). Other costs only insofar as they are incurred bringing the inventories to their present location and condition — for example, non-production overheads of designing a product for a specific customer (IAS 2.15).
The normal-capacity rule is the exam trap: in a period of abnormally low production, the fixed overhead rate is NOT increased — unallocated overhead is expensed as incurred, preventing idle-capacity costs from inflating inventory values. In abnormally high periods the rate is decreased so inventory never exceeds actual cost (IAS 2.13).
- Excluded and expensed as incurred (IAS 2.16): abnormal waste of materials or labour
- Storage costs, unless necessary between production stages
- Administrative overheads not related to bringing inventory to its location and condition
- Selling costs
Cost formulas: FIFO, weighted average — and no LIFO
For items that are not ordinarily interchangeable, and goods produced for specific projects, cost is assigned by specific identification (IAS 2.23). For everything else the entity chooses between two formulas and applies it consistently to all inventories of similar nature and use (IAS 2.25): FIFO, which assumes the oldest items are sold first so closing inventory carries the most recent costs; and weighted average, where cost is recalculated as a blended average — either periodically or as each new delivery arrives. LIFO is prohibited (IAS 2.BC9–BC21 explains why: it rarely reflects actual flows and can carry decades-old costs on the balance sheet). In times of rising prices, FIFO shows higher closing inventory and higher profit than weighted average — a favourite exam comparison.
Need the exact paragraph text? The AI Tutor quotes the official licensed IFRS Standards word-for-word.
Try the AI TutorNet realisable value: the write-down test
At each reporting date, inventories are measured at the lower of cost and net realisable value (IAS 2.9). NRV is the estimated selling price in the ordinary course of business, minus the estimated costs of completion and the estimated costs necessary to make the sale (IAS 2.6) — an entity-specific number, distinct from fair value. Write-downs are normally computed item by item, not for inventory as a whole (IAS 2.29), recognised as an expense in the period of the write-down (IAS 2.34). Materials held for production are not written down if the finished products they will enter are still expected to sell at or above cost — but when they are written down, replacement cost is the best available measure of their NRV (IAS 2.32).
When the circumstances that caused a write-down reverse — the selling price recovers — the write-down is reversed, capped at the original amount, reducing the expense in the period of reversal (IAS 2.33). Inventory never rises above original cost.
From balance sheet to cost of sales
When inventories are sold, their carrying amount becomes an expense — cost of sales — in the period the related revenue is recognised (IAS 2.34), the cleanest example of matching in IFRS. Inventories used in constructing another asset (spare parts built into a machine) are capitalised into that asset and expensed through its depreciation (IAS 2.35). Disclosures include the accounting policies and cost formula used, total carrying amounts by classification, write-downs and reversals in the period (IAS 2.36).
Worked example: FIFO vs weighted average, then an NRV write-down
A retailer's transactions for the period: opening inventory 100 units at CU 10 (CU 1,000); purchase of 200 units at CU 12 (CU 2,400); purchase of 100 units at CU 14 (CU 1,400). Goods available: 400 units costing CU 4,800. During the period 250 units are sold, leaving 150 units. Both permitted cost formulas are applied to the same data (weighted average computed periodically).
| Measure | FIFO (CU) | Weighted average (CU) |
|---|---|---|
| Cost per unit basis | Most recent purchases: 100 @ 14 + 50 @ 12 | 4,800 ÷ 400 = CU 12.00 per unit |
| Closing inventory (150 units) | 2,000 | 1,800 |
| Cost of sales (250 units) | 2,800 | 3,000 |
| Check: closing inventory + cost of sales | 4,800 | |
FIFO closing inventory = (100 × 14) + (50 × 12) = 1,400 + 600 = CU 2,000. Weighted average = 150 × 12.00 = CU 1,800. Under each formula the CU 4,800 of goods available splits exactly between the balance sheet and cost of sales.
| Account | Dr (CU) | Cr (CU) |
|---|---|---|
| Dr Cost of sales — inventory write-down | 275 | |
| Cr Inventory | 275 |
NRV per unit = 12.50 − 1.00 = CU 11.50, so NRV of the 150 units is 150 × 11.50 = CU 1,725 against a FIFO cost of CU 2,000 — a write-down of CU 275 (IAS 2.9). If prices later recover to put NRV back above cost, the write-down is reversed — but only up to CU 275, never above original cost (IAS 2.33). On the weighted-average books the same test would compare 1,725 with 1,800, producing a smaller CU 75 write-down: the formula choice changes where the profit hit lands, not whether it happens.
Test yourself: 5 IAS 2 practice questions
1. Which cost is INCLUDED in the cost of inventories under IAS 2?
- A. Storage of finished goods awaiting a customer order
- B. Import duties on raw materials purchased
- C. Sales commissions payable on sale
- D. Abnormal waste of materials during a machine breakdown
Show answer
Correct answer: B
Costs of purchase include import duties and other non-refundable taxes (IAS 2.11). Finished-goods storage, selling costs and abnormal waste are all excluded and expensed as incurred (IAS 2.16) — storage qualifies only when necessary between production stages.
2. A factory normally produces 10,000 units a year with fixed overheads of CU 50,000. This year a strike cut production to 5,000 units. How much fixed overhead is allocated to each unit produced?
- A. CU 10, with CU 25,000 of unallocated overhead expensed
- B. CU 5, spreading all overhead over actual output
- C. CU 10, with CU 25,000 added to closing inventory
- D. Nil in a low-production year
Show answer
Correct answer: A
Fixed overheads are allocated at the normal-capacity rate: 50,000 ÷ 10,000 = CU 5 per… careful — the rate is CU 5 per unit at normal capacity; the trap answer here is computed at actual output. At CU 5 per unit, the 5,000 units absorb CU 25,000 and the remaining CU 25,000 is expensed (IAS 2.13). Option A states the correct principle with the unallocated remainder expensed — the allocation rate never rises because production fell.
3. Which cost formula is prohibited by IAS 2?
- A. First-in, first-out (FIFO)
- B. Weighted average cost
- C. Last-in, first-out (LIFO)
- D. Specific identification
Show answer
Correct answer: C
IAS 2.25 permits only FIFO and weighted average for interchangeable items, and specific identification is required for non-interchangeable ones (IAS 2.23). LIFO was eliminated because it rarely mirrors physical flows and leaves outdated costs on the balance sheet.
4. Inventory cost is CU 8,000. Estimated selling price is CU 8,500, costs to complete are CU 400 and selling costs CU 300. At what amount is the inventory measured?
- A. CU 8,000
- B. CU 8,500
- C. CU 7,800
- D. CU 8,200
Show answer
Correct answer: C
NRV = 8,500 − 400 − 300 = CU 7,800 (IAS 2.6), which is below cost of 8,000, so the inventory is written down to CU 7,800 — the lower of cost and NRV (IAS 2.9) — with a CU 200 expense.
5. A write-down of raw materials is being considered. The finished goods they will become are still expected to sell above their total cost. What does IAS 2 require?
- A. Write the materials down to replacement cost immediately
- B. No write-down — materials are not impaired when the finished product will sell at or above cost
- C. Write down by the fall in the materials' market price
- D. Reclassify the materials as finished goods
Show answer
Correct answer: B
Materials held for production are not written below cost when the finished products in which they will be incorporated are expected to sell at or above cost (IAS 2.32). Only when the finished product itself is loss-making are materials written down — with replacement cost as the best NRV proxy.
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Start freeFrequently asked questions
What is the difference between FIFO and weighted average?
FIFO assumes the oldest units are sold first, so closing inventory carries the newest costs; weighted average blends all costs of the period into one rate (recomputed periodically or on each delivery) (IAS 2.25, 27). With rising prices FIFO reports higher closing inventory and higher profit. Either is permitted — LIFO is not — and the choice is applied consistently across similar inventories.
What is net realisable value (NRV)?
The estimated selling price in the ordinary course of business less the estimated costs of completion and the costs necessary to make the sale (IAS 2.6). It is entity-specific — what this business expects to realise — which distinguishes it from fair value, a market measure. Inventory is carried at the lower of cost and NRV, tested item by item (IAS 2.9, 29).
Which costs are included in inventory cost?
Purchase costs (price, duties, transport, less trade discounts), conversion costs (direct labour plus fixed production overheads allocated at normal capacity), and other costs of bringing the inventory to its present location and condition (IAS 2.10–15). Abnormal waste, most storage, administrative overheads and all selling costs are expensed as incurred (IAS 2.16).
Why is LIFO prohibited under IAS 2?
Because last-in, first-out rarely reflects how inventory actually moves, and under it the balance sheet can carry costs from many years ago that bear no relation to current values. IAS 2.25 therefore allows only FIFO and weighted average for interchangeable items — a well-known difference from US GAAP, where LIFO remains permitted.
Can an inventory write-down be reversed?
Yes — when the circumstances that caused it no longer exist or NRV clearly increases, the write-down is reversed through profit or loss in the period of reversal, capped at the original write-down (IAS 2.33). Inventory can recover to its original cost but never above it.
How are fixed production overheads allocated to inventory?
At a rate based on normal capacity — the production expected on average over several periods under normal circumstances (IAS 2.13). If actual output is abnormally low, the rate is unchanged and unallocated overhead is expensed, so idle-plant costs never inflate inventory; if output is abnormally high, the rate is reduced so inventory stays at actual cost.