Inventories and revenue from contracts with customers

Every naira by which inventory is overvalued, or revenue is recognised too early, is a naira added to profit. IAS 2 Inventories and IFRS 15 Revenue from Contracts with Customers set the limits. ICAN tests them through short calculations (damaged or slow-moving items, a contract that runs across the year end), written explanations (what a contract is, what a bill-and-hold or repurchase arrangement is), and adjustments in the Section A preparation question. Expect an ethical angle too: the director who wants slow-moving goods left at cost because the company is being sold is a familiar exam character.

IAS 2: the cost of inventories

Inventories are goods held for sale in the ordinary course of business, goods being produced for sale, and materials and supplies to be used up in production or in providing services. They are measured at the lower of cost and net realisable value (NRV). Cost is everything spent to bring the inventory to its present location and condition, and nothing more.

The fixed overhead rule matters when output is unusually low. If fixed production overheads are ₦60,000,000 and normal capacity is 200,000 units, but only 150,000 are made, overheads are absorbed at ₦300 a unit (₦60,000,000 ÷ 200,000): ₦45,000,000 goes into inventory and the unabsorbed ₦15,000,000 is expensed. Idle capacity is a cost, not an asset.

Cost formulas. Items that are not interchangeable, or are made for a specific project, are costed by specific identification. Everything else uses first-in, first-out (FIFO) or weighted average cost, applied consistently to similar inventories. Last-in, first-out (LIFO) is not allowed under IAS 2, even though you meet it as a costing method in Management Accounting. Standard costs and the retail method may be used if the results approximate cost.

IAS 2: net realisable value

NRV is the estimated selling price in the ordinary course of business, less the estimated costs to complete and the estimated costs needed to make the sale (commission, delivery, repairs before sale). It falls below cost when goods are damaged or obsolete, when selling prices fall, or when costs to complete or sell rise.

• Compare cost and NRV item by item (or by groups of similar items), never in total, so profitable lines cannot hide losses on others.
• Use the best evidence available when the statements are prepared, including sales after the year end that confirm the goods' condition at the reporting date (an adjusting event under IAS 10).
• Raw materials are not written down if the finished goods they go into will sell at or above cost.
• A write-down is an expense of the period. If NRV later recovers, it is reversed, but never above original cost.

The notes disclose the policy and cost formula, carrying amounts by class, write-downs and reversals, and inventory pledged as security.

Valuation is also an ethical matter. The IESBA Code and ICAN's Code of Professional Conduct both require integrity and objectivity; knowingly carrying obsolete stock at cost breaches both. The accountant explains the rule, records the discussion, and escalates to the board or audit committee if pressed.

IFRS 15: the contract and the five steps

IFRS 15's core idea: revenue shows goods or services passing to customers, at the consideration the entity expects to be entitled to in return.

A contract is an agreement between two or more parties that creates rights and obligations the law will enforce; it may be written, oral or implied by normal business practice. IFRS 15 applies only when all five of these are met:

1. the parties have approved the contract and are committed to carrying it out;
2. each party's rights to the goods or services can be identified;
3. the payment terms can be identified;
4. the contract has commercial substance (it is expected to change the entity's future cash flows); and
5. it is probable that the entity will collect the consideration it is entitled to.

Until then, cash received from the customer is a liability, not revenue.

Step 3. Variable consideration (rebates, bonuses, penalties) is estimated as the expected value or most likely amount, and included only to the extent that a significant reversal later is highly improbable. If payment is deferred well beyond delivery, revenue is the cash price and the rest is interest income (ignore gaps of a year or less).

Step 4. On 1 October 2025 Lekki Solar Homes Ltd sells a package for ₦5,600,000: a solar system, installation and two years' maintenance, with stand-alone prices of ₦5,000,000, ₦800,000 and ₦1,200,000 (total ₦7,000,000). Each receives 5,600/7,000 = 80% of its stand-alone price: ₦4,000,000, ₦640,000 and ₦960,000. With delivery and installation in October and full payment in advance, revenue to 31 December 2025 is ₦4,000,000 + ₦640,000 + ₦120,000 (₦960,000 × 3/24) = ₦4,760,000, and ₦840,000 is a contract liability.

Step 5: over time or at a point in time

An obligation is satisfied over time if any one of these applies:

1. the customer receives and uses the benefit as the entity performs (cleaning, security, haulage);
2. the entity's work creates or improves an asset the customer controls as it is built (a building on the customer's land); or
3. the work creates an asset with no alternative use to the entity, and the entity has an enforceable right to payment for work done to date.

Otherwise it is satisfied at a point in time, when control passes: the customer must now pay, has legal title and possession, carries the significant risks and rewards, and has accepted the asset.

Over time, revenue follows progress, measured by output methods (surveys of work done) or input methods (usually costs to date as a share of total expected costs). Revenue to date is progress × price, less revenue recognised in earlier years. If progress cannot yet be reasonably measured but costs will be recovered, revenue equals costs incurred. If the contract is expected to make a loss, the whole expected loss is recognised at once, as an onerous contract under IAS 37.

Arrangements ICAN asks you to explain

In the May 2026 diet the examiner reported that many candidates could not explain repurchase agreements or bill-and-hold arrangements. Learn each one's question.

Worked example

Part A: inventory. Onitsha Power Supplies Ltd's draft inventory at 31 December 2025 is ₦74,800,000, at cost:

1. Forty solar inverters, ₦24,800,000, including ₦800,000 of warehouse rent after arrival. Each sells for ₦750,000 less 4% commission.
2. Ten flood-damaged generators, cost ₦18,000,000. Each needs ₦250,000 of repairs and will then sell for ₦1,900,000 less 5% commission.
3. Four industrial generators, cost ₦32,000,000, built for a customer who cancelled in November 2025, sold in February 2026 for ₦7,600,000 each less ₦100,000 delivery each.

Workings: warehouse rent is storage, not cost, so item 1 costs ₦24,000,000. NRV per inverter ₦750,000 × 96% = ₦720,000; per damaged generator ₦1,900,000 − ₦95,000 − ₦250,000 = ₦1,555,000; per industrial generator ₦7,600,000 − ₦100,000 = ₦7,500,000 (the February sale is evidence of value at the year end).

Inventory is ₦69,550,000. In total NRV exceeds cost, which is why the comparison is item by item: the two write-downs (₦4,450,000) are real losses. Profit falls by ₦5,250,000 (₦800,000 rent plus ₦4,450,000).

Part B: contracts over time. Abuja Build-Tech Ltd builds on its customers' land, so its contracts are satisfied over time. Two started in 2025; progress is measured on costs.

Contract 2's cost of sales is the ₦120m incurred plus a ₦30m onerous contract provision (IAS 37) for the loss on the remaining work, so the whole expected loss of ₦50m is recognised now.

Common mistakes

• Comparing total cost with total NRV instead of item by item.
• Including storage, selling or abnormal costs in inventory, or using LIFO.
• Recognising only the loss to date on a loss-making contract instead of the whole expected loss.
• Taking revenue on goods the seller must buy back, or on goods sent to a dealer on consignment.
• Explaining bill-and-hold or repurchase arrangements vaguely, without the conditions and the treatment.

Exam technique

For inventory, use a cost, NRV and lower table with each NRV working shown. For a contract, work in a fixed order: expected profit or loss, progress, cumulative revenue and costs, then the balances. In written parts, state the rule and then apply it to the facts; a bare conclusion earns little.

Study with AI

I am studying ICAN Skills level Financial Reporting: IAS 2 and IFRS 15. Set me five
short questions in naira, one at a time: an item-by-item NRV calculation, fixed
overhead absorption at low output, allocating a bundled price, a contract satisfied
over time with a contract asset, and a loss-making contract. Then ask me to explain
bill-and-hold or a repurchase agreement. Mark each answer and show the working.

Check every answer against these notes: AI can be wrong.

Lecturer's note: Both standards share one lack of symmetry: losses are recognised as soon as they are expected, profits only as they are earned. Inventory stays at cost until damage, obsolescence or a falling price makes a loss likely, and then the whole loss is taken. Revenue waits until the customer really controls the goods. That is why a loss-making contract takes its whole loss now, while a profitable one takes its profit bit by bit.

Key points

• Inventory is at the lower of cost and NRV, item by item; cost excludes storage, selling, abnormal and administrative costs.
• Fixed production overheads are absorbed on normal capacity; LIFO is not allowed.
• Revenue follows five steps and is recognised when control passes.
• Over time, revenue follows progress; an expected loss is recognised in full at once.
• Bill-and-hold, repurchase, consignment and agency all turn on one question: who controls the goods?

Quick check

1. A product cost ₦400,000. It will sell for ₦460,000 after ₦50,000 of finishing work and a 5% commission on the selling price. At what amount is it carried?
2. A contract priced at ₦80m has costs to date of ₦30m and costs to complete of ₦45m. Progress is measured on costs. What revenue and profit are recognised to date?
3. Ikeja Motors Ltd sells a vehicle to a finance house for ₦30m and must buy it back in six months for ₦31.5m. How is this accounted for?

Answers

1. NRV = ₦460,000 − ₦50,000 − ₦23,000 (5% × ₦460,000) = ₦387,000, below cost, so ₦387,000 (a write-down of ₦13,000).
2. Total expected costs ₦75m, so progress is 30/75 = 40%. Revenue 40% × ₦80m = ₦32m; cost of sales ₦30m; profit ₦2m (40% of the expected profit of ₦5m).
3. Control never passed, and the buy-back price exceeds the selling price, so this is a financing arrangement: keep the vehicle in inventory, record a ₦30m liability and recognise ₦1.5m of interest over the six months.