Meaning
Global regulatory frameworks for financial reporting establish the criteria for the measurement and presentation of inventory on balance sheets. Adherence to international accounting standard 2 requires that assets held for sale are valued using specific cost formulas and impairment tests. This prevents companies from inflating their reported profit by overvaluing their remaining stock.
Measurement Principle
Costs included in the asset value must relate directly to the acquisition and preparation of the goods. Under international accounting standard 2, this includes purchase price, duties, taxes and transport costs. Indirect costs like general administration or selling expenses are excluded and must be charged to the income statement as they occur.
Cost Formula
Tracking the value of identical items requires a consistent mathematical approach to inventory flow. Organizations choose between the first in first out method or the weighted average cost method as permitted by international accounting standard 2. This choice influences the reported cost of goods sold and the final value of the inventory remaining at the end of the year.
Realizable Value
Market conditions sometimes drop the selling price of a product below its original manufacturing cost. When this happens, international accounting standard 2 dictates that the inventory must be written down to the amount the company expects to receive from the sale. This ensures that the balance sheet remains conservative and reflects the actual economic value of the physical assets.
