AS 2: Inventories in Practice

Inventory accounting appears simple until the close raises difficult questions: Which costs belong in inventory? How should production overhead be absorbed when output is below normal capacity? When does slow-moving stock require a write-down? What evidence supports net realisable value?

This guide converts the core principles of AS 2 into a practical closing and review process. It is not a substitute for the notified standard; it is a working framework for applying the standard consistently.

1. The reporting objective

The objective is to carry inventory at an amount that represents recoverable cost—not an inflated amount created by avoidable inefficiency, abnormal waste or unsupported selling assumptions. Inventory is generally measured at the lower of cost and net realisable value.

2. Build cost deliberately

Cost normally includes purchase costs, conversion costs and other costs incurred in bringing inventory to its present location and condition. The ledger label is not enough; each cost must be assessed by its nature and purpose.

Administrative costs, selling costs, abnormal waste and storage not required in the production process are common areas of error. They should not be included merely because they appear in an operational cost centre.

3. Normal capacity matters

Fixed production overhead should be allocated using normal capacity. When actual production is unusually low, increasing the rate to force all fixed overhead into inventory can overstate assets. The unallocated amount is generally recognised as an expense in the period.

The accounts team should preserve the capacity basis, actual production, downtime reasons, allocation rate and management review. This documentation is especially important when plants are new, disrupted or seasonal.

4. Net realisable value is evidence-based

NRV is not simply the latest selling price. It considers the estimated selling price in the ordinary course of business, less estimated costs of completion and costs necessary to make the sale. Assessment is usually made item by item or by appropriately grouped similar items.

• Use selling information available close to the reporting date.
• Consider subsequent sales when they provide evidence about conditions existing at year end.
• Adjust for completion, rework, packing, commission and other necessary selling costs.
• Identify damaged, obsolete, expired, slow-moving and discontinued items separately.
• Document why a group-level assessment is appropriate when individual assessment is not used.

5. Inventory close checklist

1. Freeze and reconcile quantity data across ERP, warehouse records and physical counts.
2. Investigate negative stock, unusual unit costs, dormant codes and large manual adjustments.
3. Validate landed cost and production overhead absorption.
4. Review WIP stage of completion and incomplete-cost elements.
5. Perform ageing and movement analysis.
6. Prepare NRV evidence and write-down calculation.
7. Reconcile inventory value to the general ledger.
8. Review classification, expense recognition and disclosures.

6. Common errors

• Capitalising abnormal production loss.
• Using actual low output to inflate fixed-overhead absorption.
• Ignoring costs required to complete or sell an item when calculating NRV.
• Applying one broad provision percentage without product-level evidence.
• Reversing a write-down without demonstrating that circumstances changed.
• Reconciling only total value while quantity differences remain unresolved.

7. Reviewer questions

A reviewer should ask whether the costing method is consistent, whether exceptions are visible, whether NRV evidence is current and whether the closing balance can be traced from physical quantity to financial statement amount. The best working paper makes this chain obvious.