What is IAS 2 Inventories? Rules, Formulas & What Small Manufacturers Need to Know

Last updated: April 2026

Most small manufacturers don’t lose sleep over accounting standards. That changes fast the moment you bring in an investor, apply for a loan, or start selling to wholesale buyers who want audited financials.

IAS 2 is the standard that governs how inventory gets valued and reported under international accounting rules. Get it right and your financial statements tell a consistent, credible story. Get it wrong and your COGS figures (and therefore your reported profit) are essentially meaningless.

This guide explains what IAS 2 actually says, how the costing formulas work, and what it means practically for small manufacturers.

What is IAS 2?

IAS 2 is the International Accounting Standard covering the accounting treatment, measurement, and disclosure requirements for inventories in financial statements.

Issued by the International Accounting Standards Board (IASB), IAS 2 sits within the broader IFRS (International Financial Reporting Standards) framework. That’s the set of accounting rules used in more than 140 countries. It tells businesses how to measure the cost of their inventory, when to write that inventory down if its value has fallen, and what disclosures to include in financial statements.

The standard applies to all inventories except:

• Work in progress under long-term construction contracts (covered by IFRS 15)
• Financial instruments
• Biological assets related to agricultural activity

For most small manufacturers producing food products, cosmetics, candles, or industrial components, IAS 2 is the relevant standard.

What types of inventory does IAS 2 cover?

IAS 2 defines inventory as assets held for sale in the ordinary course of business, in production for such sale, or as materials to be consumed in that production process.

In practice, that covers three categories:

• Raw materials: the ingredients, components, and supplies you purchase and use in production
• Work in progress (WIP): goods that have started production but aren’t finished yet (see our guide on WIP inventory)
• Finished goods: completed products ready for sale

All three must be valued consistently under the same method. You can’t use one costing approach for raw materials and a different one for finished goods.

How does IAS 2 say you should measure inventory costs?

Under IAS 2, inventory must be measured at the lower of cost and net realisable value (NRV). That phrase does a lot of work, so it’s worth unpacking each part.

What counts as “cost” under IAS 2?

IAS 2 defines inventory cost as all costs incurred in bringing inventory to its present location and condition. This breaks down into three components:

Purchase costs: the invoice price plus freight, import duties, and other directly attributable acquisition costs, less trade discounts and rebates. If you bought materials at $10/kg plus $0.50 freight, your purchase cost is $10.50/kg.

Conversion costs: costs incurred in converting raw materials into finished goods. This includes direct labour and a systematic allocation of production overhead (factory rent, equipment depreciation, utilities). Importantly, the allocation must be based on normal production capacity, not actual production. If your factory runs at 60% capacity in a slow month, you don’t load all overhead onto what you actually produced. You allocate overhead at the normal rate and expense the rest.

Other costs: any costs incurred in bringing inventory to its current location and condition, such as specialist shipping for temperature-sensitive materials.

What’s explicitly excluded: IAS 2 is strict about what does not go into inventory cost:

• Abnormal waste of materials, labour, or overhead
• Storage costs (unless necessary before a further production stage)
• Administrative overhead unrelated to production
• Selling costs

This exclusion matters. A business that loads storage or admin costs into inventory will overstate its assets and understate its expenses. IAS 2 doesn’t allow it.

What costing methods does IAS 2 permit?

IAS 2 permits two inventory costing formulas: FIFO and weighted average cost. LIFO is explicitly not permitted.

FIFO (First In, First Out)

Under FIFO, the cost of inventory sold is assumed to be the cost of the oldest (earliest purchased) units. What remains on hand is valued at the most recent purchase prices.

Example: You start with 100kg of a material at $5/kg. You then buy 100kg at $6/kg. When you use 100kg in production, FIFO assumes you used the $5/kg stock first.

• COGS: 100kg x $5 = $500
• Remaining inventory: 100kg x $6 = $600

FIFO tends to produce lower COGS (and therefore higher reported profit) in periods of rising prices, because it assumes you’re always using up the older, cheaper stock first.

Weighted Average Cost

The weighted average method calculates a new average cost each time a purchase is made and applies that average to all units.

Example: You start with 100kg at $5/kg ($500 total). You buy another 100kg at $6/kg ($600 total). Your new weighted average is ($500 + $600) / 200kg = $5.50/kg.

When you use 100kg in production:

• COGS: 100kg x $5.50 = $550
• Remaining inventory: 100kg x $5.50 = $550

Weighted average smooths out price fluctuations. It’s useful when material costs vary frequently or when it’s impractical to track individual batches. This is the method Craftybase uses to calculate inventory values and COGS, which means it aligns directly with IAS 2.

What about LIFO?

LIFO (Last In, First Out) assumes you use the most recently purchased inventory first. IAS 2 does not permit LIFO under any circumstances. This is one of the clearest divergences between IAS 2 and US GAAP: GAAP allows LIFO, IFRS does not.

For businesses reporting under IFRS, LIFO is off the table. If you’ve been using it, switching to FIFO or weighted average is required.

For a deeper comparison of all three methods, see our guide on FIFO, LIFO and weighted average costing.

What is Net Realisable Value and how do you calculate it?

Net realisable value (NRV) is the estimated selling price of inventory in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale.

NRV = Estimated selling price minus Estimated completion costs minus Estimated selling costs

Example: You have finished goods you expect to sell for $80 per unit. Getting them to market requires $5 in packaging and $3 in shipping. NRV = $80 minus $5 minus $3 = $72 per unit.

If that inventory cost you $68 to produce, no writedown is needed. Cost ($68) is lower than NRV ($72), so you’re carrying it at the right figure.

If that inventory cost you $75 to produce (perhaps because material prices spiked mid-batch), you must write it down to $72. The writedown of $3 per unit is recognised as an expense in the period it occurs.

IAS 2 requires this “lower of cost or NRV” test to be applied item by item, or at minimum by groups of similar items. You can’t offset a writedown on one product line against unrealised gains on another.

When does NRV fall below cost? Common scenarios include:

• Raw material prices have increased sharply, making it uneconomical to complete production
• Products are damaged, obsolete, or near expiry
• Selling prices have declined due to market competition
• Estimated costs to complete have risen significantly

When NRV recovers in a subsequent period, IAS 2 allows the writedown to be reversed, but only up to the original cost. You can’t write inventory up beyond what you paid.

How does IAS 2 differ from US GAAP?

IAS 2 and US GAAP both require inventory to be valued at the lower of cost or market, but “market” is defined differently, and there are a few other meaningful divergences.

The LIFO prohibition is the biggest practical difference. Businesses that report under US GAAP and use LIFO often do so to reduce taxable income in inflationary periods. Under IFRS, that approach simply isn’t available. For manufacturers selling to international partners or seeking IFRS-compliant reporting, this is a material constraint.

The NRV vs replacement cost difference is subtler but can also affect reported values. Under GAAP’s more complex market test, the floor is NRV less a normal profit margin. That means you might not write inventory down as aggressively as IFRS requires.

What do IAS 2 journal entries look like?

Here’s how IAS 2 inventory accounting works in practice, using simplified double-entry entries.

Purchasing raw materials

Dr  Raw Materials Inventory    $5,000
    Cr  Accounts Payable                   $5,000

Recording a production run (weighted average example)

If materials consumed cost $3,000 and direct labour is $1,200:

Dr  Work in Progress           $4,200
    Cr  Raw Materials Inventory              $3,000
    Cr  Wages Payable                        $1,200

Completing production (transferring to finished goods)

Dr  Finished Goods Inventory   $4,200
    Cr  Work in Progress                     $4,200

Recording a sale and its COGS

Dr  Accounts Receivable        $8,000
    Cr  Revenue                              $8,000

Dr  Cost of Goods Sold         $4,200
    Cr  Finished Goods Inventory             $4,200

Writing down inventory to NRV

If finished goods with a book value of $4,200 have an NRV of $3,800:

Dr  Loss on Inventory Writedown   $400
    Cr  Finished Goods Inventory             $400

The writedown hits the income statement as an expense, reducing reported profit in that period.

What does IAS 2 mean for small manufacturers?

Small manufacturers are unlikely to be formally audited against IFRS unless they have external investors, operate across international borders, or are working toward a liquidity event. But the IAS 2 framework is still worth understanding, and increasingly worth following, for a few practical reasons.

Consistent costing improves your own decision-making. The discipline of choosing FIFO or weighted average and applying it consistently forces clarity about what your inventory actually costs. Businesses that switch methods or mix approaches often end up with COGS figures they can’t trust.

Lenders and wholesale buyers look at your financials. Many regional banks, credit unions, and wholesale partners expect financial statements that follow generally accepted accounting principles. IFRS-aligned reporting signals that your numbers are reliable.

LIFO creates future problems. Some small businesses (especially in the US) use informal LIFO-style tracking because it feels intuitive: use what you bought last. Under IAS 2, that’s not an acceptable method. If you’re ever presenting financials to an IFRS-aware audience, you’ll need to restate.

NRV writedowns protect against overstated assets. If you’re carrying obsolete or slow-moving stock at full cost, your balance sheet overstates your assets. The NRV test under IAS 2 forces a more honest picture.

IAS 2 aligns with good manufacturing inventory management practice. Tracking raw materials separately from WIP and finished goods, allocating overhead systematically, and running consistent cost calculations: these are the same behaviours that make your operations easier to manage day to day.

For manufacturers using batch tracking, IAS 2’s emphasis on consistent costing is particularly relevant. A weighted average approach across batches gives you reliable per-unit costs even when input prices fluctuate between production runs.

Craftybase calculates inventory values using weighted average costing, an IAS 2-approved method, and applies this automatically as materials move through manufacturing. Every manufacture you record updates material costs in real time, keeping your COGS accurate without manual recalculation.

Frequently Asked Questions

Take our free 14-day trial to see how Craftybase’s weighted average costing keeps your inventory records IAS 2-aligned — automatically.