IAS 2 inventory costing: why normal capacity decides your margin

Under IAS 2, the cost of inventory is not just materials and direct labour. It includes a systematic allocation of production overheads, and the rule for fixed overheads is precise: they are allocated based on the normal capacity of the production facilities. Get that allocation wrong and you misstate two numbers at once, the inventory on your balance sheet and the cost of sales in your P&L.

What IAS 2 actually requires

Variable production overheads are allocated to each unit on the basis of actual use of the production facilities. Fixed production overheads, things like factory depreciation, plant management salaries and building costs, are allocated on normal capacity: the production expected on average over several periods under ordinary conditions, after allowing for planned maintenance.

The consequence is strict. In a period of low production or idle plant, the fixed overhead allocated per unit is not increased. The unabsorbed overhead is recognised as an expense in the period it is incurred, not buried in inventory. In a period of abnormally high production, the rate per unit is reduced so inventory is never carried above cost.

Where most companies get it wrong

The common shortcut is a single, volume-based absorption rate applied across everything. It is simple, and it is wrong wherever your products differ in complexity. High-complexity, low-volume products end up under-costed; simple, high-volume products end up over-costed. The inventory value is distorted, the cost of sales is distorted, and the margin you report by product is fiction.

How TDABC makes the IAS 2 number defensible

Time-Driven Activity-Based Costing gives you exactly what IAS 2 asks for and your auditor wants to see: a measured view of capacity and an allocation traced to the activity that consumed it. You can show what normal capacity is, what the cost of unused capacity was, and why each unit of inventory carries the overhead it carries. The same model that satisfies the standard also tells you which products are genuinely profitable, so compliance and decision-making come from one source of truth.

We are not your auditor and we do not issue compliance opinions. We build the cost model that makes applying IAS 2 robust and defensible. See how IFRS and the cost model fit together, or how we attribute cost to where it is consumed.