What is the cost of inventory? What items are included in it?

Inventory cost includes all costs necessary to bring inventory to its present location and condition ready for sale, including purchase price, import duties, transportation, and conversion costs for manufactured goods.

Inventory Cost Definition and Principles

According to IAS 2 Inventories, inventory cost includes all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.

Core Principle:

The cost of inventory should include all expenditures necessary to bring the inventory to a saleable condition. This follows the cost principle of accounting.

Key Requirements:

Initial Recognition: At cost
Subsequent Measurement: Lower of cost and net realizable value
Cost Formulas: Specific identification, FIFO, or weighted average cost
Exclusions: Abnormal waste, storage costs (unless necessary), administrative overheads, selling costs

Cost Components for Purchased Inventory

For inventory that is purchased (not manufactured), cost includes:

1. Purchase Price

Invoice price of goods
Less: Trade discounts and rebates
Less: Settlement discounts if taken

2. Import Duties and Taxes

Customs duties
Import taxes
Other non-recoverable taxes
Note: Recoverable VAT/GST is excluded

3. Transportation and Handling Costs

Freight and carriage inwards
Insurance during transit
Loading and unloading charges
Transportation to current location

4. Other Directly Attributable Costs

Commissions to purchasing agents
Testing and inspection costs
Costs of containers (if not returnable)
Financing costs (only if inventory requires substantial time to get ready)

Cost Components for Manufactured Inventory

For inventory that is manufactured, cost includes three main elements:

1. Direct Materials

Raw materials that become part of finished product
Materials identifiable with specific units
Materials consumed in production process
Example: Wood for furniture, fabric for clothing

2. Direct Labor

Wages of workers directly involved in production
Labor costs traceable to specific products
Overtime premiums if regular part of production
Example: Assembly line workers, machine operators

3. Manufacturing Overhead

All indirect production costs allocated systematically:

Indirect Materials: Lubricants, cleaning supplies, small tools
Indirect Labor: Supervisors, maintenance staff, quality controllers
Factory Costs: Rent, utilities, insurance, depreciation of factory equipment
Other Overheads: Factory administration, production planning

Exclusions from Inventory Cost:

Abnormal Waste: Materials wasted due to inefficiency
Storage Costs: Unless necessary for further processing
Selling Costs: Advertising, sales commissions
Administrative Overheads: General office expenses
Financing Costs: Usually expensed unless specific criteria met

Practical Application:

A company manufactures chairs:

Included: Wood ($20), upholstery ($15), direct labor ($10), factory depreciation allocation ($5), factory utilities ($3)
Excluded: Sales commission ($8), CEO salary allocation ($2), advertising ($5)
Total Cost: $20 + $15 + $10 + $5 + $3 = $53 per chair