Which Costs Are Included in the Cost of Inventories Under IAS 2?

The cost of inventories is the total of the costs incurred in bringing an item to its present location and condition. Not every cost an entity incurs in connection with inventory qualifies. Whether a cost is capitalised or expensed directly affects gross margin, inventory carrying amounts and profit before tax. This article explains the requirements of IAS 2 Inventories, as published in Turkey by KGK as TMS 2, with a worked example and illustrative journal entries, and then compares the same topic under BOBİ FRS, the Turkish framework for large and medium-sized entities.

Short Answer

Under IAS 2 (TMS 2), the cost of inventories comprises costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition (TMS 2, paragraph 10). Taxes that the entity can subsequently recover are excluded, and trade discounts are deducted (TMS 2, paragraph 11). Abnormal wastage, storage costs not needed in the production process before a further stage, administrative overheads and selling costs are not capitalised; they are expensed as incurred (TMS 2, paragraph 16). Fixed production overheads are allocated on the basis of normal capacity, and the share relating to idle capacity is expensed (TMS 2, paragraph 13).

Basis: which paragraphs of TMS 2 apply?

References in this article are to the TMS 2 text in KGK’s TFRS 2026 Set (Blue Book), which contains the requirements effective for annual periods beginning on or before 1 January 2026. TMS paragraph numbering follows IAS 2.

The three components of cost

1. Costs of purchase

Under TMS 2, paragraph 11, costs of purchase comprise the purchase price, import duties and other taxes (other than those subsequently recoverable by the entity from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition. Trade discounts, rebates and similar items are deducted. In practice, freight, transit insurance, customs duty, customs broker fees and transport to the warehouse fall into this group. Taxes the entity can recover, for example through input tax credits, are not added to cost; they are tracked as a separate receivable.

2. Costs of conversion

For manufacturers, costs of conversion include direct labour and a systematic allocation of fixed and variable production overheads (TMS 2, paragraph 12). Fixed production overheads, such as factory depreciation, maintenance and factory management, are allocated on the basis of the normal capacity of the production facilities. When production is low, the amount allocated to each unit is not increased; unallocated overheads are expensed in the period incurred (TMS 2, paragraph 13). Variable production overheads are allocated on the basis of actual use.

3. Other costs

Other costs are included only to the extent that they are incurred in bringing the inventories to their present location and condition (TMS 2, paragraph 15). Designing products for a specific customer may qualify. Borrowing costs are included only in the limited circumstances permitted by IAS 23 (TMS 2, paragraph 17); see the separate article on capitalising borrowing costs.

Costs excluded from inventories

TMS 2, paragraph 16 gives examples of costs that are excluded from inventories and expensed as incurred:

• abnormal amounts of wasted materials, labour or other production costs;
• storage costs, unless necessary in the production process before a further production stage;
• administrative overheads that do not contribute to bringing inventories to their present location and condition;
• selling costs.

Where inventories are purchased on deferred settlement terms, the difference between the amount paid and the price for normal credit terms is not part of cost; it is recognised as interest expense over the period of the financing (TMS 2, paragraph 18). The article on deferred-payment inventory purchases illustrates this with numbers.

Worked example

The example below is hypothetical; amounts are chosen only to illustrate the mechanics. Tax rates and tax-law consequences are not included.

Assumptions

Company A imports a raw material and uses it to manufacture a single product. Period data:

• List price TRY 500,000; trade discount granted by the supplier 4% (TRY 20,000).
• Non-recoverable customs duty TRY 24,000; freight and insurance TRY 18,000; customs broker TRY 6,000; transport to the warehouse TRY 4,000.
• In the same period, advertising by the sales department TRY 10,000 and general administrative expenses TRY 12,000.
• Production: 8,000 units. Direct materials used TRY 400,000; direct labour TRY 160,000; variable production overheads TRY 64,000.
• Fixed production overheads TRY 300,000. Normal capacity of the plant is 10,000 units.
• Abnormal material wastage TRY 12,000.

Formula and calculation

Purchase cost of raw material = List price − Trade discount + Customs duty + Freight and insurance + Customs broker + Transport to warehouse
= 500,000 − 20,000 + 24,000 + 18,000 + 6,000 + 4,000 = TRY 532,000

Advertising (TRY 10,000) and general administration (TRY 12,000) do not contribute to bringing the inventory to its present location and condition, so they are excluded.

Fixed overhead absorption rate = 300,000 / 10,000 units = TRY 30 per unit
Fixed overhead absorbed into inventory = 8,000 × 30 = TRY 240,000
Unabsorbed fixed overhead = 300,000 − 240,000 = TRY 60,000 (period expense)

Cost of finished goods = 400,000 + 160,000 + 64,000 + 240,000 = TRY 864,000; unit cost 864,000 / 8,000 = TRY 108.

Independent check

Rebuilding the cost per unit: direct materials TRY 50 (400,000 / 8,000), direct labour TRY 20, variable overhead TRY 8, fixed overhead TRY 30. Total TRY 108 × 8,000 units = TRY 864,000. Both routes agree. Had the entire fixed overhead been spread over actual output, the fixed cost per unit would be TRY 37.5 and inventory would be overstated by carrying the cost of idle capacity; TMS 2, paragraph 13 prevents this.

Illustrative journal entries

Account codes are taken from the Turkish uniform chart of accounts (Tekdüzen Hesap Planı) used in statutory books, to give readers a familiar frame. IAS 2 does not prescribe account codes; they depend on the entity’s chart of accounts.

In entry 3, total debits are TRY 936,000 and total credits are TRY 936,000. Which account holds the period expenses depends on the entity’s costing system; in TFRS financial statements these amounts are expenses in profit or loss.

Effect on the financial statements

• Statement of financial position: finished goods of TRY 864,000. Remaining raw materials are carried at the unused amount.
• Profit or loss: unabsorbed fixed overhead of TRY 60,000 and abnormal wastage of TRY 12,000 are expenses of this period, as are advertising and administration (TRY 22,000 in total).
• Had these amounts been capitalised in error, current profit would look higher and cost of sales would be inflated when the goods are sold.

Is the answer different under BOBİ FRS?

The inventories section of BOBİ FRS defines the components of cost in broadly similar terms: purchase costs include non-recoverable taxes and directly attributable costs, and trade discounts are deducted (BOBİ FRS, paragraph 6.7). The list of costs excluded from inventories also matches IAS 2 (BOBİ FRS, paragraph 6.15). BOBİ FRS is a Turkish standard and should not be equated with IFRS or IFRS for SMEs; three differences matter here:

• Fixed production overheads: BOBİ FRS uses full costing as the base method for conversion costs; all fixed and variable production overheads are included, except fixed overheads of departments whose activities have been suspended or have not yet started (BOBİ FRS, paragraph 6.12). Allocation based on normal capacity (normal costing) is permitted as an option (BOBİ FRS, paragraph 6.13). Under IAS 2, normal capacity is required.
• Borrowing costs: BOBİ FRS states that borrowing costs directly attributable to inventories that normally take more than one year to get ready for sale are included in cost (BOBİ FRS, paragraph 6.14A).
• Deferred purchases: under BOBİ FRS, the financing element is not separated for purchases with payment terms of one year or less (BOBİ FRS, paragraph 6.8).

The example above would therefore produce a different result for an entity applying BOBİ FRS that chooses full costing: the full TRY 300,000 of fixed overhead would be allocated to the 8,000 units.

Common mistakes in practice

• Adding recoverable taxes to the cost of inventories.
• Recording trade discounts as income instead of deducting them from cost.
• Capitalising all fixed production overheads in low-output periods (for an entity applying IAS 2).
• Capitalising rent and staff costs of a finished-goods warehouse when that storage is not part of the production process.
• Capitalising selling and marketing costs because they are “product-related”.
• Leaving the financing element of a deferred-payment purchase in inventory cost.

Checklist

• Have discounts on the purchase invoice been deducted from cost?
• Have recoverable and non-recoverable taxes been separated?
• Have freight, insurance, customs and transport costs been assigned to the related items?
• Is normal capacity documented, and is the fixed overhead rate based on it?
• Have abnormal wastage and idle-capacity costs been expensed?
• Which framework applies, TFRS or BOBİ FRS? Is the costing method disclosed in the accounting policies?

For subsequent measurement, see net realisable value; for foreign currency effects, see exchange differences on inventory purchases. Financial reporting services are described here.

Sources

• KGK, TMS 2 Inventories, TFRS 2026 Set (Blue Book) (Turkish)
• KGK, Financial Reporting Standard for Large and Medium-Sized Entities (BOBİ FRS, 2021 version) (Turkish)

This article is for general information. The standard text and professional judgement should be applied to the specific facts of an entity.