Chapter 4 - Asset valuation: Inventories and construction contracts

Abstract

This chapter focuses on the standards for valuation of inventories and construct contracts. The IAS 2 standard prescribes the accounting treatment for inventories and determines the cost to be recognized as an asset. It also provides guidance on cost formulas and on writing-down inventories to net realizable value (NRV). The standard applies only to inventories and does not apply to work in progress arising in construction and service contracts, financial instruments, biological assets related to agricultural activity, inventories of agricultural and forest products and mineral ores, and commodity broker traders who measure inventories at NRV. Inventories are usually written down to NRV on an item-by-item basis. Estimates of NRV are based on the most reliable evidence of amounts expected to realize and should take into account price fluctuations of post balance sheet data to the extent that they can confirm conditions at that data. If inventories are for a specific contract, reference should be made only to the contract price of that specific contract but if they are for sale generally, then reference should be made to general selling prices. The objective of IAS 11 is to prescribe the accounting treatment of revenue and costs associated with construction contracts. The basic principle of IAS 11 is that when the outcome of a construction contract can be estimated reliably, contract revenue and associated costs with the construction contract should be recognized as revenue and expenses respectively by reference to the stage of completion of the contract activity at the balance sheet date. An expected loss on the construction contract should be recognized as an expense immediately.