IAS 2 / Ind AS 2 explained for 2026: lower of cost and NRV, FIFO and weighted average, write-downs, reversals, and key disclosures for Indian companies.
IAS 2 - Inventories (mirrored in India by Ind AS 2 and AS 2 under the legacy framework) is the standard that controls how raw materials, work-in-progress and finished goods sit on your balance sheet. In 2026, with regulators scrutinising inventory write-downs, related-party transfers and discount schemes more closely, getting IAS 2 right matters for gross margin reporting, GST input tax credit, and the credibility of the audit opinion.
What IAS 2 Covers and Excludes
IAS 2 applies to all inventories except work-in-progress under construction contracts (covered by IFRS 15), financial instruments (IFRS 9), and biological assets related to agricultural activity at the point of harvest (IAS 41). Within scope, inventories are assets:
- Held for sale in the ordinary course of business (finished goods)
- In the process of production for such sale (work-in-progress)
- In the form of materials or supplies to be consumed in production or in rendering services
The Core Measurement Rule
Inventories are measured at the lower of cost and net realisable value (NRV). This single sentence anchors the entire standard.
Cost of Inventories
Cost includes:
- Costs of purchase - purchase price, import duties, freight inward, less trade discounts and rebates
- Costs of conversion - direct labour, plus systematic allocation of fixed and variable production overheads
- Other costs incurred in bringing inventories to their present location and condition
Excluded from cost: abnormal wastage, storage costs (unless required for production), administrative overheads not contributing to inventory cost, and selling costs.
Net Realisable Value
NRV is the estimated selling price in the ordinary course of business less estimated costs of completion and estimated costs necessary to make the sale. It is entity-specific and reflects expected future events. Where NRV falls below cost, the inventory must be written down to NRV with the charge recognised in P&L.
Permitted Cost Formulas
For inventories not ordinarily interchangeable, specific identification is required. For interchangeable inventories, IAS 2 permits:
- FIFO - first-in, first-out
- Weighted average cost
LIFO is prohibited under IAS 2 and Ind AS 2. The same cost formula must be applied consistently to all inventories of similar nature and use within the entity.
Reversal of Write-Downs
Where the circumstances that caused inventory to be written down below cost no longer exist, or there is clear evidence of an increase in NRV, the write-down is reversed to the extent it brings the carrying amount up to the lower of revised cost and NRV. The reversal is recognised in P&L in the period it arises. This is a key difference from impairment of fixed assets under IAS 36, which permits limited reversals only.
Disclosures Required
Entities must disclose:
- Accounting policies adopted, including cost formula used
- Total carrying amount of inventories with classification into raw materials, WIP, finished goods, stores and spares
- Carrying amount of inventories at fair value less costs to sell, if any
- Amount of inventories recognised as expense during the period (cost of materials consumed plus changes in inventories)
- Amount of write-down and any reversal of write-down recognised in the period, with circumstances
- Inventories pledged as security for liabilities
Common Issues for Indian Companies
Recurring practical issues in 2026 include:
- Allocation of fixed overheads at normal capacity vs actual production
- Inclusion or exclusion of GST input tax credit availed in cost of purchase
- Borrowing costs capitalisation under Ind AS 23 for inventories requiring substantial period to prepare
- Valuation of by-products and joint products on rational and consistent basis
- Inventory in transit and bill-to-ship-to arrangements
Practical Year-End Procedures for Indian Companies
At year-end, Indian companies under Ind AS 2 and Schedule III should run a structured set of inventory procedures. Conduct physical verification of inventory at all locations, reconcile counts to the inventory ledger, identify slow-moving and obsolete stock (typically inventory aged beyond 180 to 365 days based on industry norms), and assess NRV against current selling prices and customer commitments. Document the NRV assessment with supporting evidence - market quotations, customer purchase orders, post-period sales realisation - because auditors and tax authorities scrutinise inventory write-downs closely.
Coordinate with GST records: physical inventory should reconcile with stock declared under e-way bills and the GST stock register. Material discrepancies trigger questions under Section 65 GST audit on suppressed sales or unaccounted purchases. Also reconcile with the Tax Audit Report under Section 44AB - Clause 18 requires disclosure of method of valuation and any change in method. Consistency of cost formula (FIFO or weighted average) across years is monitored; a change in method must be disclosed as a change in accounting policy under Ind AS 8 with retrospective application and quantitative impact disclosure.
Conclusion
IAS 2 in 2026 is a foundation standard with high regulatory visibility. Apply the lower-of-cost-and-NRV rule rigorously, allocate overheads at normal capacity, choose between FIFO and weighted average consistently, and document write-downs and reversals with evidence. Done well, IAS 2 protects gross margin, supports clean GST reconciliation, and reduces audit friction at year-end.
