Difference Between IAS 2 Under Going Concern and IAS 2 Under Liquidation

Introduction

IAS 2, “Inventories,” prescribes the accounting treatment for inventories. It provides guidance on the determination of cost and subsequent recognition as an expense, including any write-downs to net realizable value (NRV). This report explores the key differences in applying IAS 2 under a going concern assumption and during liquidation.

IAS 2 Under Going Concern

Core Principle

Under IAS 2, inventories are measured at the lower of cost and net realizable value. The cost of inventories includes all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.

Cost of Inventories

The cost of inventories is determined using one of the following cost formulas:

• First-in, First-out (FIFO)

• Weighted Average Cost

Specific identification of costs is used for inventories that are not ordinarily interchangeable and goods or services produced and segregated for specific projects.

Example: A retail company using FIFO determines the cost of its inventories based on the costs of the oldest items in stock.

Net Realizable Value (NRV)

NRV is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated costs necessary to make the sale. Entities regularly assess inventories to ensure they are carried at the lower of cost and NRV.

Example: A manufacturer assesses its inventory of raw materials and finished goods at each reporting period, ensuring that any items with a cost higher than NRV are written down.

Write-Downs and Reversals

Write-downs to NRV are recognized as an expense in the period in which the write-down occurs. If circumstances that previously caused inventories to be written down no longer exist, the amount of the write-down is reversed to the extent of the original write-down.

Example: An electronics retailer writes down obsolete stock to NRV and later reverses the write-down if the market for the stock improves.

IAS 2 Under Liquidation

Core Principle

During liquidation, the primary objective is to sell inventories quickly to maximize cash flows. The measurement focus shifts to the expected liquidation proceeds rather than ongoing operations.

Cost of Inventories

While the cost determination remains based on FIFO, weighted average cost, or specific identification, the relevance of these methods diminishes as the focus shifts to NRV in a liquidation context.

Example: A clothing retailer in liquidation continues to use FIFO for record-keeping but prioritizes assessing inventories at liquidation values.

Net Realizable Value (NRV)

Under liquidation, NRV may be significantly impacted by the urgency to sell inventories. The NRV becomes the estimated selling price under forced sale conditions, which is typically lower than the NRV under going concern.

Example: A furniture manufacturer in liquidation estimates NRV based on discounted prices offered to quickly clear out inventory, reflecting forced sale conditions.

Write-Downs and Reversals

Write-downs to NRV are likely to be more frequent and substantial under liquidation due to the lower expected selling prices. Reversals of write-downs are less common as the liquidation process progresses.

Example: A pharmaceutical company in liquidation writes down its inventory of medications to reflect discounted prices for quick sale. Given the finality of liquidation, reversals are unlikely.

Liquidation Proceeds

During liquidation, inventories are measured at the lower of cost and the liquidation proceeds, which may be lower than the regular NRV. This conservative approach ensures that the inventories are not overstated.

Example: A toy manufacturer measures its inventories at expected liquidation proceeds, which are lower than both cost and regular NRV, due to the need for rapid disposal.

Inventory Management and Sales Strategy

Under liquidation, entities focus on rapid inventory turnover and cash generation. Discounted sales, bulk sales, and auctions are common strategies to liquidate inventories quickly.

Example: A home appliances retailer holds a liquidation sale, offering significant discounts to clear out inventory as quickly as possible.

Conclusion

The application of IAS 2 under a going concern assumption and during liquidation involves the same fundamental principles but different practical considerations. Under going concern, the focus is on sustainable inventory management aligned with normal business operations, ensuring that inventories are measured at the lower of cost and NRV. Under liquidation, the emphasis shifts to immediate realization of inventories at expected liquidation proceeds, reflecting the urgency to generate cash flows. Entities must carefully reassess their inventory values and write-downs to ensure accurate and transparent financial reporting during liquidation. This adjustment ensures that stakeholders receive a true and fair view of the entity’s financial position and performance during the liquidation process.

From Blogger iPhone client