Inventories and Non-Financial Assets

Introduction and context

Non-financial assets generate economic benefits through use, sale, rental, biological transformation or participation in production. Their accounting is therefore central to measuring profit, financial position, operating capacity and stewardship of capital. This chapter applies the principal requirements of IFRS Accounting Standards to inventories, property, plant and equipment (PPE), intangible assets, investment property, borrowing costs, government grants, biological assets and non-current assets held for sale.

The central accounting questions are:

1. When should an expenditure be recognised as an asset?
2. At what amount should it initially be measured?
3. How should its carrying amount change subsequently?
4. When should impairment, revaluation, depreciation or amortisation be recognised?
5. When should the asset be derecognised or reclassified?

A sound answer requires more than applying isolated rules. Management must identify the asset’s nature, expected pattern of consumption, legal and economic rights, measurement uncertainty and the quality of supporting evidence.

Learning objectives

After studying this chapter, the reader should be able to:

• measure inventories under IAS 2 and analyse write-downs and reversals;
• distinguish capital expenditure from repairs and other expenses;
• apply the cost and revaluation models for PPE;
• account for component depreciation, useful lives, residual values and derecognition;
• identify and measure intangible assets under IAS 38;
• account for investment property, borrowing costs and government grants;
• explain the special measurement model for biological assets;
• apply the classification and measurement rules for assets held for sale;
• evaluate impairment, reversals, estimation uncertainty and presentation consequences;
• exercise professional judgement ethically and document management estimates.

1. The asset-recognition framework

An asset is a present economic resource controlled by the entity as a result of past events. An economic resource is a right that has the potential to produce economic benefits. Recognition is appropriate when doing so provides users with relevant information that faithfully represents the item and its measurement is sufficiently reliable. IFRS Standards often express recognition through specific criteria, but the underlying analysis remains rights, control, probable benefits and reliable measurement.

The cost of an asset includes expenditure directly attributable to bringing it to the location and condition necessary for operation. It excludes abnormal waste, general administration, start-up losses and costs that do not create or enhance the asset. Subsequent expenditure is capitalised only when it meets the recognition requirements; routine repairs and maintenance are expensed.

An asset’s carrying amount is the amount at which it is recognised in the statement of financial position after accumulated depreciation or amortisation, accumulated impairment losses and, where relevant, revaluation adjustments.

2. Inventories: IAS 2

2.1 Definition and scope

Inventories are assets:

• held for sale in the ordinary course of business;
• in the process of production for such sale; or
• in the form of materials or supplies to be consumed in production or service delivery.

IAS 2 generally applies to merchandise, raw materials, work in progress and finished goods. It does not apply to certain financial instruments, biological assets related to agricultural activity or agricultural produce at the point of harvest, and some producers’ inventories measured at net realisable value in accordance with industry practice.

2.2 Measurement principle

Inventories are measured at the lower of cost and net realisable value (NRV).

NRV is an entity-specific estimate of the amount expected to be realised. It is not necessarily fair value. Cost includes purchase costs, conversion costs and other costs incurred in bringing inventories to their present location and condition. Trade discounts and rebates reduce cost. Storage costs, unless necessary for a production process, and selling costs are normally excluded.

Conversion cost includes directly attributable production costs and a systematic allocation of fixed and variable production overheads. Fixed overhead is allocated using normal capacity, not an artificially low production level. Unallocated overhead caused by idle capacity is expensed. Abnormal waste is also expensed.

For ordinarily interchangeable items, the permitted cost formulas are first-in, first-out (FIFO) and weighted average cost. Specific identification is used for items that are not ordinarily interchangeable or are segregated for specific projects. LIFO is not permitted under IFRS.

For periodic weighted average cost:

This formula assumes that the units are interchangeable and that the relevant costs are included consistently.

2.3 Write-downs and reversals

A write-down is recognised when NRV falls below cost. The loss is normally recognised in profit or loss. NRV is reassessed in each subsequent period. A reversal is recognised when circumstances causing the original write-down no longer exist, but only to the amount of the original write-down. This prevents inventory from being carried above its original cost.

Inventory write-downs may arise from damage, obsolescence, falling selling prices, completion-cost inflation or an unavoidable loss-making sales commitment. The analysis should be performed at an appropriate level: item by item where possible, or by related groups where items cannot be evaluated separately.

Illustration. A retailer has 1,000 units costing $18 each. Expected selling price is $16 per unit, selling costs are $1 per unit and there are no completion costs.

Cost = 1,000 × $18 = $18,000.

NRV = 1,000 × ($16 − $1) = $15,000.

The required write-down is $3,000. If the following year NRV rises to $17 per unit, the carrying amount may be increased to $17,000, but not above the original cost of $18,000.

2.4 Disclosure and professional risks

Important disclosures include accounting policies, carrying amounts by classification, expense recognised, write-downs, reversals and inventory pledged as security. Common risks include premature revenue recognition, capitalising selling costs, using unrealistic NRV forecasts and allocating fixed overhead on abnormal production volumes.

3. Property, plant and equipment: IAS 16

3.1 Recognition and initial measurement

PPE are tangible items held for production, supply, rental or administrative purposes and expected to be used during more than one period. An item is recognised when future economic benefits are probable and cost can be measured reliably.

Initial cost may include:

• purchase price, including non-refundable taxes and import duties;
• directly attributable costs such as delivery, installation, testing and professional fees;
• the initial estimate of dismantling, removal and site-restoration obligations;
• for qualifying assets, borrowing costs under IAS 23.

Proceeds from selling items produced while testing an asset and the related production costs are recognised in profit or loss; they are not automatically deducted from the asset’s cost. Costs of opening a new facility, advertising, staff training, relocation and general administration are expensed unless another Standard requires different treatment.

3.2 Subsequent measurement models

After recognition, an entity applies either the cost model or the revaluation model to an entire class of PPE.

Under the cost model:

Under the revaluation model, an asset is carried at fair value at the revaluation date, less subsequent depreciation and impairment. Revaluations must be sufficiently regular to ensure that carrying amount does not differ materially from fair value. The policy applies to the entire class, avoiding selective upward revaluation of favourable assets.

An upward revaluation is generally recognised in other comprehensive income and accumulated in revaluation surplus, except to the extent that it reverses a previous decrease recognised in profit or loss. A downward revaluation is generally recognised in profit or loss, except to the extent of an existing surplus for that asset. On disposal, the related surplus may be transferred directly to retained earnings; it is not recycled through profit or loss.

3.3 Component accounting

Significant parts of an asset with different useful lives or consumption patterns are depreciated separately. For example, an aircraft’s airframe, engines and major inspection component may have different replacement cycles. Component accounting prevents the cost of a short-lived part from being depreciated over the life of the whole asset.

When a significant component is replaced, the carrying amount of the old component is derecognised, even if its original cost is not separately identifiable. The replacement is capitalised if recognition criteria are satisfied. Major inspections are treated similarly when they are necessary for continued operation.

3.4 Depreciation

Depreciation is the systematic allocation of the depreciable amount over useful life. Depreciable amount is cost or revalued amount less residual value.

For straight-line depreciation:

The formula assumes a constant pattern of consumption and a residual value that can be estimated reliably. Depreciation begins when the asset is available for use, not necessarily when it first generates revenue. It ceases on derecognition or classification as held for sale, whichever occurs first. Land normally has an indefinite useful life and is not depreciated, while buildings are depreciated.

The depreciation method must reflect the pattern in which benefits are consumed. Revenue-based depreciation is prohibited for PPE because revenue reflects factors beyond physical consumption. Estimates of useful life, residual value and method are reviewed at least annually and treated as changes in accounting estimates when revised.

Illustration. Equipment costs $240,000, has a residual value of $20,000 and a useful life of 8 years. Straight-line depreciation is:

($240,000 − $20,000) ÷ 8 = $27,500 per year.

After three full years, carrying amount is $157,500, before any impairment or revaluation.

3.5 Derecognition

PPE is derecognised on disposal or when no future economic benefits are expected from use or disposal. The gain or loss is:

The gain is not revenue from ordinary activities unless the entity routinely sells such assets. Compensation from third parties for impaired or lost assets is recognised when receivable, separately from the replacement asset.

4. Intangible assets: IAS 38

An intangible asset is an identifiable non-monetary asset without physical substance. Identifiability exists when the asset is separable or arises from contractual or other legal rights. Control requires the ability to obtain benefits and restrict others’ access, although legal enforceability supports rather than wholly determines control.

4.1 Research and development

Research expenditure is expensed as incurred because future benefits cannot yet be demonstrated. Development expenditure is capitalised only when the entity can demonstrate all relevant conditions, including technical feasibility, intention and ability to complete and use or sell the asset, probable future benefits, adequate resources and reliable measurement of costs.

Capitalisation begins only when all criteria are satisfied. Earlier expenditure cannot subsequently be reinstated as an asset. Internally generated goodwill, brands, mastheads, publishing titles and customer lists are not recognised. Training, advertising, start-up and relocation costs are generally expensed.

4.2 Subsequent measurement and amortisation

An entity uses the cost model or, only where an active market exists, the revaluation model. Most intangible assets have finite useful lives and are amortised from the date they are available for use. Assets with indefinite useful lives are not amortised but are tested for impairment annually and whenever indicators arise. “Indefinite” does not mean infinite.

For a finite-life asset:

The residual value is normally zero unless a third party is committed to purchase the asset, an active market exists, or the residual value is probable from such a market. The method must reflect consumption; if the pattern cannot be reliably determined, straight-line amortisation is used.

5. Impairment of non-financial assets: IAS 36

An asset is impaired when its carrying amount exceeds recoverable amount. Recoverable amount is the higher of fair value less costs of disposal and value in use.

Value in use is the present value of future cash flows expected from continuing use and ultimate disposal. Cash-flow forecasts must be reasonable, supportable and consistent with approved budgets; they exclude financing cash flows and income tax effects when applying the pre-tax discount rate. Goodwill and indefinite-life intangible assets are tested annually, as are intangible assets not yet available for use. Other assets are tested when impairment indicators exist.

Where an asset does not generate independent cash inflows, it is tested within its cash-generating unit (CGU), the smallest identifiable group generating largely independent inflows. Goodwill is allocated to CGUs or groups of CGUs expected to benefit from synergies, subject to the limits in IAS 36.

An impairment loss is recognised in profit or loss unless it reverses a revaluation surplus. Reversals are permitted for assets other than goodwill when estimates change, but not above the carrying amount that would have existed had no impairment been recognised. Goodwill impairment is never reversed.

6. Investment property: IAS 40

Investment property is land or a building, or part of one, held to earn rentals, for capital appreciation, or both. Owner-occupied property is PPE; property held for sale in the ordinary course of business is inventory. Mixed-use property is separated when portions can be sold or leased separately; otherwise classification depends on the significance of owner occupation.

After initial recognition, an entity chooses the fair value model or cost model for its investment property portfolio, subject to IAS 40 requirements. Under the fair value model, changes in fair value are recognised in profit or loss and depreciation is not charged. Under the cost model, IAS 16’s cost model is applied, with fair value generally disclosed. Transfers occur only when there is a change in use supported by evidence, not merely a change in management intention.

7. Borrowing costs: IAS 23

Borrowing costs directly attributable to the acquisition, construction or production of a qualifying asset form part of that asset’s cost. A qualifying asset takes a substantial period to get ready for intended use or sale. Examples include major facilities and some inventories, but not assets ready for use when acquired.

Capitalisation begins when the entity incurs expenditure, incurs borrowing costs and undertakes activities necessary to prepare the asset. It is suspended during extended interruptions in active development and ceases when substantially all activities necessary for intended use or sale are complete.

For a specific borrowing:

For general borrowings, apply a weighted-average capitalisation rate to qualifying expenditures. The rate is based on the borrowings outstanding during the period, excluding specific borrowings until the qualifying asset is substantially complete. Capitalisation cannot exceed borrowing costs incurred.

8. Government grants: IAS 20

A government grant is recognised only when there is reasonable assurance that the entity will comply with its conditions and receive the grant. Grants related to assets may be presented as deferred income, recognised systematically in profit or loss over the useful life, or deducted from the asset’s carrying amount. Grants related to income are presented either separately or as a deduction from the related expense, using a consistent policy.

A grant does not justify recognising an asset at an amount above its recoverable economic cost. Repayment of a grant is accounted for as a change in estimate, increasing the asset’s carrying amount or reducing deferred income as appropriate, with cumulative additional depreciation recognised immediately where necessary.

9. Biological assets and agricultural produce: IAS 41

Biological assets include living animals and plants. They are measured at fair value less costs to sell on initial recognition and at each reporting date, unless fair value cannot be measured reliably in limited circumstances. Agricultural produce at the point of harvest is also measured at fair value less costs to sell; that amount becomes its cost for subsequent application of IAS 2.

Changes in fair value less costs to sell are recognised in profit or loss. This approach reflects biological transformation, such as growth, degeneration, production and reproduction, before sale. Bearer plants used to produce agricultural produce are accounted for under IAS 16 after reaching maturity, while produce growing on them remains within IAS 41.

10. Non-current assets held for sale: IFRS 5

A non-current asset or disposal group is classified as held for sale when its carrying amount will be recovered principally through sale rather than continuing use. The asset must be available for immediate sale in its present condition, the sale must be highly probable, management must be committed to a plan, an active programme to locate a buyer must have begun, the asset must be marketed at a reasonable price and completion should generally be expected within one year, subject to limited exceptions.

Once classified, the asset is measured at the lower of carrying amount and fair value less costs to sell. Depreciation and amortisation cease. A subsequent increase in fair value less costs to sell may reverse a previous loss, but not beyond the cumulative impairment recognised under IFRS 5 or IAS 36. Assets held for distribution to owners are subject to a related, distinct classification model.

A discontinued operation is a component disposed of or classified as held for sale that represents a separate major line of business or geographical area, is part of a coordinated plan, or is a subsidiary acquired exclusively for resale. Its results are presented separately from continuing operations.

Integrated applied case: Meridian Manufacturing Ltd (illustrative)

Background

Meridian manufactures medical equipment. At year-end it has a production line, a patented design under development, a rented warehouse, biological research animals and a production line offered for sale.

Problems

The finance director proposes to:

• capitalise staff training and advertising for a new plant;
• depreciate the whole production line over ten years despite a major inspection every three years;
• carry finished goods at cost despite a fall in selling prices;
• classify the rented warehouse as PPE;
• continue depreciating the production line after it is advertised for sale;
• capitalise all design expenditure from the date the project began.

Analysis and solution

Training and advertising do not bring the plant to the location and condition necessary for operation and are expensed. The major inspection is a separate component if it is necessary for continued operation and has a different consumption pattern. Its cost is depreciated over the inspection interval, while the previous inspection component is derecognised when replaced.

Finished goods are compared with NRV. If NRV is below cost, the difference is recognised as an inventory write-down. The warehouse is investment property because it is held to earn rentals rather than used by Meridian in production or administration; Meridian applies its chosen IAS 40 model.

The production line is classified as held for sale only when all IFRS 5 criteria are satisfied. From that date, depreciation ceases and measurement becomes the lower of carrying amount and fair value less costs to sell. Design expenditure is capitalised only from the date all IAS 38 development criteria are demonstrated; earlier research expenditure remains expensed.

Outcome and learning points

The case demonstrates that classification follows economic purpose, not management preference. Componentisation improves matching, NRV prevents overstatement of inventories, and held-for-sale classification changes both measurement and depreciation. Documentation should include technical feasibility evidence, board approval, valuation support, useful-life assessments, sales plans and impairment calculations.

Professional judgement, governance and technology

These accounting areas are estimation-intensive. Useful lives, residual values, NRV, fair values, biological growth, discount rates and probability of sale can materially affect reported performance. Governance should therefore require:

• independent review of significant valuations;
• sensitivity analysis for material assumptions;
• reconciliations between fixed-asset registers and the general ledger;
• physical verification and impairment indicators;
• controls over component replacement and disposals;
• documented approval of capitalisation decisions;
• consistency between budgets, forecasts and impairment models.

Technology can improve control through barcode or RFID inventory systems, automated depreciation registers, satellite or sensor evidence for biological assets, and machine-learning analysis of slow-moving inventory. However, automation does not resolve recognition judgements. AI-generated valuations or forecasts require human review, traceable source data, model governance and controls against biased or unsupported assumptions. The preparer remains responsible for compliance, faithful representation and disclosure.

Challenges and contemporary developments

The most difficult issues arise where legal ownership and economic control differ, where assets are integrated systems, or where markets are inactive. Climate risk may affect useful lives, residual values, impairment forecasts, insurance, restoration obligations and the viability of biological assets. Supply-chain disruption can increase completion costs and make NRV volatile. Digital assets and internally developed software raise difficult questions about identifiability, control and development-stage evidence; the applicable Standard depends on the asset’s substance and contractual rights.

The conceptual tension between historical cost and current-value measurement remains important. Cost often provides verifiability and stability, whereas fair value or NRV can improve relevance when economic conditions change rapidly. Professional reporting requires transparent disclosure of the model selected, estimation uncertainty and sensitivity to reasonably possible changes.

Chapter Summary

Inventories are measured at the lower of cost and NRV, with cost determined using appropriate purchase, conversion and allocation principles. PPE is initially measured at cost and subsequently accounted for under the cost or revaluation model. Significant components are depreciated separately, and estimates are reviewed prospectively.

Intangible assets require identifiability and control; research is expensed while qualifying development expenditure is capitalised. Impairment compares carrying amount with recoverable amount and uses CGUs when independent cash inflows do not exist. Investment property is distinguished by its rental or capital-appreciation purpose. Borrowing costs are capitalised only for qualifying assets during active preparation. Government grants require reasonable assurance and systematic matching. Biological assets are generally measured at fair value less costs to sell, while assets held for sale are measured at the lower of carrying amount and fair value less costs to sell, with depreciation discontinued.

Across all categories, faithful reporting depends on classification, reliable estimates, disciplined documentation, appropriate disclosures and ethical challenge of management bias.

Key Terms

Asset: A present economic resource controlled by an entity.

Carrying amount: Amount recognised after accumulated depreciation, amortisation, impairment and revaluation adjustments.

Component accounting: Separate depreciation of significant parts with different useful lives or consumption patterns.

Cost model: Measurement at cost less accumulated depreciation or amortisation and impairment.

Development expenditure: Expenditure capitalised only after IAS 38 development criteria are met.

Fair value: The price that would be received to sell an asset in an orderly transaction between market participants.

Impairment: A condition in which carrying amount exceeds recoverable amount.

Investment property: Property held for rentals, capital appreciation or both.

Net realisable value: Estimated selling price less completion and selling costs.

Non-current asset held for sale: Asset whose carrying amount will be recovered principally through sale.

PPE: Tangible assets used in production, supply, rental or administration for more than one period.

Qualifying asset: Asset requiring a substantial period to become ready for intended use or sale.

Recoverable amount: Higher of fair value less costs of disposal and value in use.

Revaluation model: Measurement at fair value at revaluation date less subsequent depreciation and impairment.

Residual value: Estimated disposal value at the end of useful life, net of disposal costs.

Useful life: Period or output over which an asset is expected to be available for use.

Value in use: Present value of future cash flows expected from continuing use and disposal.

Weighted average cost: Average unit cost based on total cost and total units available.

Review Questions

5 Short Answer Questions

1. Define net realisable value and state its components.
2. Why are significant PPE components depreciated separately?
3. What is the difference between research and development expenditure?
4. When does depreciation cease for an asset held for sale?
5. State the two elements of recoverable amount under IAS 36.

5 Long Answer Questions

1. Explain the initial and subsequent measurement of PPE, including revaluation accounting.
2. Discuss the recognition and measurement requirements for inventories, including overhead allocation and reversals of write-downs.
3. Explain IAS 38’s treatment of internally generated intangible assets.
4. Compare the accounting models for investment property and owner-occupied property.
5. Explain the recognition, commencement, suspension and cessation of borrowing-cost capitalisation.

3 Analytical / Application Questions

1. A manufacturer has equipment with a major inspection component and an obsolete product line. Explain the component accounting, impairment and derecognition decisions required.
2. Evaluate whether a warehouse, biological research asset and development project should be classified under IAS 40, IAS 41 and IAS 38 respectively. Identify the evidence needed.
3. A company plans to sell a production facility but has not begun marketing it and continues to use it fully. Analyse whether IFRS 5 classification is appropriate and explain the consequences if classification later becomes appropriate.

Multiple Choice Questions with Answers

Question 1

Inventory is measured under IAS 2 at:

A. Fair value in all circumstances

B. The higher of cost and net realisable value

C. The lower of cost and net realisable value

D. Replacement cost

Correct Answer: C. The lower of cost and net realisable value

Question 2

Which cost is normally excluded from the cost of PPE?

A. Installation cost

B. Testing cost necessary to prepare the asset for use

C. Initial site-restoration estimate

D. Staff training cost

Correct Answer: D. Staff training cost

Question 3

Equipment costs $240,000, have a residual value of $20,000 and a useful life of eight years. Straight-line annual depreciation is:

A. $20,000

B. $27,500

C. $30,000

D. $32,500

Correct Answer: B. $27,500

Question 4

Under IAS 36, recoverable amount is the higher of:

A. Cost and fair value

B. Value in use and fair value less costs of disposal

C. NRV and replacement cost

D. Carrying amount and value in use

Correct Answer: B. Value in use and fair value less costs of disposal

Question 5

Which expenditure may be capitalised as development expenditure under IAS 38?

A. All expenditure incurred before technical feasibility is established

B. Advertising expenditure for the completed product

C. Expenditure incurred after all development recognition criteria are demonstrated

D. General employee training expenditure

Correct Answer: C. Expenditure incurred after all development recognition criteria are demonstrated

Question 6

A major inspection component of PPE should generally be:

A. Expensed immediately in every case

B. Depreciated separately when it has a different useful life

C. Included in inventory

D. Recognised only when the asset is sold

Correct Answer: B. Depreciated separately when it has a different useful life

Question 7

For an investment property measured using the fair value model:

A. Fair-value changes are recognised in other comprehensive income only

B. Depreciation is charged and fair value changes are ignored

C. Fair-value changes are recognised in profit or loss

D. The property is always measured at historical cost

Correct Answer: C. Fair-value changes are recognised in profit or loss

Question 8

Capitalisation of borrowing costs ceases when:

A. The first expenditure is incurred

B. The asset is advertised for sale

C. Substantially all activities necessary to prepare the asset are complete

D. The loan is legally repaid

Correct Answer: C. Substantially all activities necessary to prepare the asset are complete

Question 9

Once a non-current asset is classified as held for sale:

A. Depreciation continues until disposal

B. It is measured at the higher of carrying amount and fair value less costs to sell

C. Depreciation ceases and it is measured at the lower of carrying amount and fair value less costs to sell

D. It is automatically classified as inventory

Correct Answer: C. Depreciation ceases and it is measured at the lower of carrying amount and fair value less costs to sell

Question 10

Which statement about goodwill impairment is correct?

A. It may always be reversed when profits recover

B. It is tested only when the business is sold

C. An impairment loss on goodwill is not reversed

D. It is measured using NRV

Correct Answer: C. An impairment loss on goodwill is not reversed