Understanding Inventory Accounting Under IFRS
IFRS requires audit firms in Dubai to measure inventories at their lowest cost and highest net realizable value. The estimated selling price for the business in an ordinary course of business, less any estimated costs required to make the sale, is called the net realizable value.
Background of Standard IAS 2
IAS 2 guides company financial audit specialists in Dubai to determine the cost of inventories and then recognize it as an expense. This includes any write-downs to net realizable value. It also contains guidance on cost formulas used to assign inventories costs. Reissued IAS 2 was published in 2003 December. It will apply to all annual periods that begin on or after January 1, 2005.
The Objective of Standard IAS 2
This Standard IAS 2 aims to guide internal and external auditors on accounting for inventories. Accounting for inventories involves the recognition of the cost as an asset. This amount is carried forward until revenues are recognized. These Standard guides determine the cost and recognize it as an expense. It also includes any write-downs to net realizable value. This Standard also contains guidance on cost formulas used to assign inventories costs.
The Scope of The Standard
This Standard applies to all types of inventories except a few:
Financial instruments based on under IAS 32 Financial Tools: Presentation and IFR 9 Financial Instruments.
Biological assets that are related to agricultural activity or agricultural produce at harvest.
The Standard does not apply to inventories that are held by:
Producer of agricultural and forest products, agricultural products that arise after harvesting, and minerals and mineral products up to the amount calculated at net realizable value (NRV), according to established practices in related industries. When inventories are measured at their net attainable values, any changes are recognized in profit or loss.
Commodity brokers who recognize their inventories at a fair price minus selling cost, any changes in fair value or selling costs are recognized in profit and loss for the period they occurred.
Read also: Auditing Firms In Dubai Overview Of IFRS 9
Critical Definitions for Company Audit Professionals
Net Realizable Value
This is the average selling price for a business, minus any estimated completion costs or the costs required to sell the item.
The price will be received for selling an asset or transfer liability in an orderly transaction among market participants on the measurement day.
Assets Are Inventories
The following are the cases:
- Held for sale in the ordinary course of business
- In the production process for such sales
- In the form of supplies or materials used in the production process or the rendering of services.
The inventories shall be measured at their lowest cost and the highest net realizable value.
These are the components of inventory costs for Dubai audit services to consider:
- Costs of purchase
- Costs of conversion
- Other costs are associated with bringing inventories to their current location and condition.
1. What is the Cost of Purchase?
It includes purchase price, import duties, and any other taxes not recoupable by the entity from taxing authorities. Also, transport, handling, and any additional costs directly related to the acquisition or supply of finished goods, materials, and services. In determining the purchase cost, audit services in Dubai, UAE consider trade discounts, rebates, and similar items.
2. What is the Cost of Conversion?
The conversion cost of inventories also includes direct labor costs. It should also be clear how fixed and variable production overhead was allocated. These overheads are incurred when materials are converted into finished goods. Fixed production overheads refer to the indirect costs of production, which are relatively constant regardless of production volume. These include depreciation, maintenance, equipment, right-of-use assets, and cost of management and administration. Variable production overheads refer to indirect costs that change or affect production volumes, such as indirect labor and indirect materials.
3. What are the other costs?
It may be appropriate to include in the cost of inventories, non-production overheads, and the costs associated with designing products for specific customers. These are examples of expenses financial auditors in Dubai don’t include in the price of inventory but are recognized as expenses for the time they were incurred:
- Abnormal amounts of wasted materials, labor, or other production costs
- Storage costs must be incurred before any further production stages can be initiated.
- Administrative overheads that don’t contribute to the actual location and condition of inventories
According to IAS 41, the cost of agricultural produces an entity in Dubai or UAE harvests from its biological assets is measured at initial recognition at fair value fewer costs at the harvest. This is the cost for the inventories as of that date.
Techniques To Measure Cost
If the results are close to cost, you can use the standard cost or retail methods for measuring inventory costs. Typical costs include normal material and supplies, labor efficiency, capacity utilization, and labor. They are reviewed regularly and, if needed, updated to reflect current conditions.
The cost of inventory of items that aren’t ordinarily interchangeable and the cost of goods or services produced and separated for specific projects shall all be determined by using particular identifications of their costs.
Net Realizable Value (NRV)
NRV stands for the estimated selling price in an ordinary business transaction minus the estimated completion cost and the estimated cost of making the sale.
In the following situations, inventory costs may not be recoverable:
- Inventory is damaged
- Totally or partially out of date
- Selling prices have fallen.
- Recognized as an expense
The carrying amount of inventories sold shall be recognized as an expense during the period in which revenue related to them is recognized. In the period of write-down or loss, the inventories’ net realizable value shall be reduced, and any losses of inventories will be recognized as an expense. Company auditors shall recognize any reversal in inventories due to an increase in net realizable value as a decrease in inventories expensed when the reversal takes place.
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Theshani is a Senior auditor and has experience of 4+ years in providing audit assurance and advisory services to a wide range of industry clients. She continues to stay on top of ever-changing industry dynamics by continuously learning and developing expertise.