Two checks instead of one
IAS 2 describes measuring inventory at the lower of cost and net realisable value. For interchangeable inventories, the official overview names FIFO or weighted average; for certain non-interchangeable items, specific identification applies. The historical presence of a method in a teaching corpus does not mean its permissibility is identical across standards and jurisdictions.
Separate the allocation question from the recoverability question. First determine which cost belongs to sales and which remains; then test whether the remaining amount can be recovered.
A tax-free teaching batch
A shop buys 10 identical items at 100 each and then 10 at 140 each. It sells 12. The model excludes freight, discounts and losses. Total purchase cost is 10 × 100 + 10 × 140 = 2400. Under FIFO, cost of sales is 10 × 100 + 2 × 140 = 1280, leaving eight items at 1120.
Under weighted average, each unit costs 120. Cost of sales is 1440 and the balance is 960. Allocation differs, but the total purchase payment does not. Higher profit under one method does not show that the seller received more cash or served the customer more efficiently.
When is a write-down needed?
Suppose the eight remaining items can be sold for 130 each and necessary selling costs are 10 per item. Model NRV per unit is 130 − 10 = 120. NRV for the FIFO balance is 960; the difference from cost of 1120 is a 160 write-down. This concerns recoverability, not a change in the order used to relieve layers.
The IAS 2 overview defines NRV by expected selling price less necessary completion and selling costs. A market quotation alone may not be the right amount if packaging, processing or selling costs remain. The example is deliberately simplified.
Do not assess warehouse quality from the total alone
Inventory growth may support expanding sales, reflect seasonal preparation or mean accumulation of unwanted goods. Separate raw materials, work in progress and finished goods, then compare the structure with sales and the production cycle. A sharp rise in finished goods with weak shipments poses a different question from raw materials bought for a confirmed order.
A common error is to expense the whole purchase and also expense cost of goods sold. Another is to treat a write-down as a cash payment in the same period. Cash left at purchase, expense at sale and a write-down answer different questions. See [inventory and depreciation](/guides/inventory-and-depreciation/) and [working capital](/guides/working-capital/).
Boundaries and working questions
Check the method, consistency, cost components and basis for NRV. For heterogeneous goods, an average write-down percentage can hide problem items. Do not transfer the conclusion for one batch to the entire warehouse. This guide does not replace stocktaking, verification of title or the detailed requirements of IAS 2; it separates allocation arithmetic from the economic risk of unsold goods.
Does the company actually own the goods?
Physical presence in a warehouse and recognition on the balance sheet do not always answer the same question. Check delivery terms, goods in transit, custody arrangements and restrictions. This guide does not determine when title transfers; counting units alone does not settle ownership or valuation.
For production inventory, identify where the amount accumulates: raw materials, work in progress or finished goods. A rise in work in progress may reflect a long cycle, delayed completion or higher volume. A rise in finished goods with weak sales raises other questions. Total value and average days can conceal these distinctions.
A write-down and physical disposal need not occur at the same time. The loss of the ability to sell at the former amount may become visible before destruction or sale. Track purchase, storage, changed expectations and sale separately so one problem balance is not counted as expense twice.
LIFO is a cost-layer order, not a box route
For the same batch, before any write-down and without taxes, periodic LIFO assigns the latest purchases first: 10 × 140 + 2 × 100 = 1600; the eight-unit balance is 800. This is a cost-allocation assumption. Physical dispatch may still take the oldest boxes first; movement of objects need not match accounting cost layers.
At an assumed selling price of 200 per item, revenue under every method is 2400. FIFO gives cost 1280 and gross profit 1120; weighted average gives 1440 and 960; LIFO gives 1600 and 800. Cost plus ending inventory equals 2400 each time, while cash receipts are unchanged. “LIFO always lowers profit” is false without the direction of prices and layer consumption. Periodic and perpetual calculations must not be mixed.
IAS 2 specifies FIFO or weighted average for interchangeable inventories, not LIFO: **ca-ias2-text**, 25–27. **ga-irs-lifo**, LIFO Method, concerns a separate U.S. tax context. It confirms the reverse-order mechanism, not a universal right to use it. For unique items, specific identification links expense to the cost of that item: if two unique devices cost 90 and 160 and the second is sold, cost is 160, not the average 125.
An accounting bridge and a covenant do not create cash
If FIFO ending cost is 1120 and LIFO ending cost is 800, the 320 difference is a comparative adjustment between bases at one date, not cash or automatic current-year income. If the comparable difference was 200 one year earlier, and there are no other movements, current-period LIFO cost exceeds FIFO cost by the change of 120, not the full ending difference of 320. At an assumed 20% tax rate, the comparable after-tax profit adjustment is 96. These are analytical assumptions; an accounting-policy change is governed by applicable rules, including the retrospective approach in IAS 8, not by a desire to lift one period’s profit.
Suppose equity on the LIFO basis is 700. For an analytical balance only, adding 320 and deferred tax of 64 gives 956. If a fictional covenant requires equity of at least 900, apparent compliance depends on the covenant’s definition. One word, “equity”, cannot determine whether a basis change or tax is allowed. The adjustment improves neither cash nor collection of receivables.
A borrowing-base limit may use another formula. If 70% of eligible receivables of 200 and 40% of eligible inventory of 300 are allowed, the base is 260. Excluding unsuitable inventory of 50 reduces it to 240. That is not a 20 accounting write-down; the contractual collateral allowance changed. These figures and percentages do not describe Industrial Distributors; without its primary agreements the historical conclusion cannot be reproduced.
Inventory names describe different axes
“In transit” describes location and delivery stage; recognition depends on the contract and control, not merely arrival. “Merchandise” means goods bought for resale; “production inventory” means resources in production; raw materials, work in progress and finished goods differ by stage. One balance may be production inventory, safety stock and in transit at once. These classifications are not independent buckets.
For planning, cycle stock covers ordinary use between deliveries; safety stock covers demand and delay uncertainty; seasonal stock covers an expected peak; preparation stock covers receipt and preparation; carryover stock remains at a period boundary. These are working definitions, not extra mandatory IAS 2 lines or adequacy rules. Obsolete inventory has weak use or sale prospects, which calls for an NRV test but does not automatically make value zero.
In a fictional production process using 6 units per day with delivery every 10 days, maximum cycle stock without uncertainty is 60 and average stock under even use is 30. A safety layer of 12 raises the relevant average to 42. If preparation takes two further days, another 12 units may be tied up. Add layers only if the model distinguishes them and has not already included preparation in delivery time. Seasonal volume needs a demand calendar.
Ordering cost, holding cost and balance-sheet cost
Ordering costs arise from placing, approving and receiving a purchase; holding costs depend on time and volume, including space, spoilage and tied-up capital. Total inventory-management cost may combine both for a lot-size decision. That does not mean every management cost is capitalised in inventory: IAS 2 distinguishes allowable cost from expenses and excludes certain storage and selling costs.
For an independent comparison, annual demand is 720 units, ordering cost is 25 per order and annual holding cost is 4 per average unit; safety stock and discounts are excluded. A lot of 60 requires 12 orders: ordering cost 300 plus holding cost for average stock 30 of 120, total 420. A lot of 120 requires 6 orders: 150 + 240 = 390. This compares two options, not proof that 120 is optimal; shortages, spoilage, financing, space and demand timing may change the decision.