Inventories
Treatment under IFRS
Inventories are measured at the lower of cost and net realisable value. The LIFO method is prohibited.
- Comparison measure: net realisable value (NRV).
- Cost formulas: FIFO or weighted average (LIFO prohibited).
- Cost of conversion: fixed and variable production overheads must be included based on normal capacity.
- A reversal of a previous write-down is mandatory when NRV recovers (capped at cost).
Treatment under German GAAP (HGB)
Inventories follow the strict lower-of-cost-or-market principle (§ 253 (4) HGB). LIFO and FIFO are both permitted. Production cost under § 255 HGB has partly different inclusion options.
- § 253 (4) HGB: the strict lower-of-cost-or-market principle for current assets.
- § 256 HGB: the LIFO and FIFO cost formulas are both permitted.
- § 255 (2) HGB: an option to include reasonable portions of material and production overheads in production cost.
- Reversal of a write-down once the reason for it ceases to apply (§ 253 (5) HGB).
Key differences
- LIFO is permitted under HGB but prohibited under IAS 2 (can lead to materially different inventory values).
- Production cost: HGB makes certain overheads optional, whereas IAS 2 requires production overheads to be included.
- Benchmark for the write-down: HGB uses the exchange/market price or fair value, IFRS uses net realisable value (NRV).
- Reversal once the reason ceases: mandatory under both HGB and IFRS (comparable in this respect).
Example
Worked example
Assumptions: A trader buys identical units during the year at rising prices. Purchases: 100 units @ €100, 100 @ €120, 100 @ €140 (300 units in total, €36,000). 200 units are sold at €200 each (revenue €40,000); closing inventory 100 units. No opening inventory; any write-down to a lower value is considered separately. IFRS allows only FIFO or the weighted average; HGB additionally permits LIFO. All amounts in euros.
Step 1 – Source data (purchases)
| Purchase | Quantity | Unit price | Value |
|---|---|---|---|
| 1 | 100 | 100 | 10,000 |
| 2 | 100 | 120 | 12,000 |
| 3 | 100 | 140 | 14,000 |
| Σ available | 300 | — | 36,000 |
200 units are sold at €200 each → revenue €40,000. Closing inventory 100 units.
Step 2 – FIFO (allowed under IFRS and HGB)
- Cost of sales (first in, first out) = 100 × €100 + 100 × €120 = €22,000
- Closing inventory (most recent units) = 100 × €140 = €14,000
Step 3 – Weighted average (allowed under IFRS and HGB)
- Average price = €36,000 ÷ 300 units = €120/unit
- Cost of sales = 200 × €120 = €24,000; closing inventory = 100 × €120 = €12,000
Step 4 – LIFO (permitted only under HGB)
- Cost of sales (last in, first out) = 100 × €140 + 100 × €120 = €26,000
- Closing inventory (oldest units) = 100 × €100 = €10,000
Step 5 – Comparison and admissibility
| Method | Closing inventory | Cost of sales | Gross profit | IFRS | HGB |
|---|---|---|---|---|---|
| FIFO | 14,000 | 22,000 | 18,000 | Yes | Yes |
| Weighted average | 12,000 | 24,000 | 16,000 | Yes | Yes |
| LIFO | 10,000 | 26,000 | 14,000 | No (prohibited) | Yes |
Gross profit = revenue €40,000 − cost of sales.
Step 6 – Journal entries (sale)
IFRS – weighted average:
| Account | Debit | Credit |
|---|---|---|
| Trade receivables / bank | 40,000 | |
| Revenue | 40,000 | |
| Cost of sales (cost of materials) | 24,000 | |
| Inventories | 24,000 |
HGB – LIFO: identical revenue entry, but higher cost of sales:
| Account | Debit | Credit |
|---|---|---|
| Cost of sales (cost of materials) | 26,000 | |
| Inventories | 26,000 |
Key takeaway
With rising prices, LIFO produces the lowest closing inventory and the highest cost of sales – the most prudent (lowest) result. IFRS prohibits LIFO (IAS 2.25) and allows only FIFO or the weighted average; HGB additionally permits LIFO (§ 256 HGB). As a result, inventory carrying amounts and reported profit can differ materially depending on the method. Note: the benchmark for the lower-of-cost test is net realisable value (NRV) under IFRS, but the “applicable value” / exchange or market price under HGB.