Inventory Valuation in Egypt: The Accounting Rule and the Tax Position

Executive summary

• Egyptian Accounting Standard No. 2, "Inventories" — issued by Minister of Investment Decree No. 110 of 2015 and not touched by any later decree amending the Egyptian Accounting Standards, the most recent being Prime Minister's Decree No. 3527 of 2024 — measures inventory at the lower of cost and net realisable value (paragraph 9).
• Cost comprises the costs of purchase and conversion and any other costs incurred in bringing the inventory to its present location and condition (paragraph 10); excluded are items such as abnormal waste, unnecessary storage, general administrative overheads and selling costs (paragraph 16).
• Apart from items that are not ordinarily interchangeable or are segregated for specific projects, which carry their specifically identified cost, the standard permits only two cost formulas: first-in, first-out, or the weighted average cost (paragraphs 23 and 25) — it does not mention last-in, first-out.
• Net realisable value is reassessed in each subsequent period, and a previous write-down is reversed, wholly or partly, once its cause no longer exists, within the amount written down, so that the new carrying amount never exceeds cost (paragraph 33).
• For tax, net profit is determined on the basis of the income statement prepared under the Egyptian Accounting Standards, and the law's provisions are then applied to it (article 17 of Law No. 91 of 2005); the law has no rule specific to inventory valuation, while articles 24 and 52 exclude provisions from deductible costs.

The basic measurement: the lower of cost and net realisable value

The standard's objective is to explain the accounting treatment of inventory, on the view that determining the cost carried forward as an asset until the related revenue is recognised is the central issue (paragraph 1). Paragraph 9 states that "inventory is measured on the basis of cost or net recoverable value, whichever is lower" — meaning net realisable value (the standard's defined term, literally "net selling value"), which paragraph 6 defines as "the estimated selling price in the ordinary course of business, less the estimated costs of completion and any other costs necessary to make the sale."

Inventory covers goods and property purchased and held for resale, finished goods and work in progress, and raw materials and supplies awaiting use in production or in rendering services (paragraphs 6 and 8). The standard does not cover work in progress under construction contracts, financial instruments, or biological assets related to agricultural activity and agricultural produce at the point of harvest, each having its own standard (paragraph 2). Excluded from its measurement requirements alone are the inventories of producers of agricultural and forest products and minerals, measured at net realisable value under well-established practice in those industries, and the inventories of commodity broker-traders, measured at fair value less costs to sell (paragraphs 3 to 5).

What the cost comprises

Inventory cost comprises the costs of purchase and conversion and any other costs of bringing it to its present location and condition (paragraph 10):

For service providers, the cost of inventory (work in progress on a service) consists primarily of the costs of the personnel directly engaged in providing the service and their supervisors, and attributable overheads, but not the costs of sales or administrative staff, nor any profit margin (paragraph 19).

Cost formulas

Specific identification of cost is used for inventory not ordinarily interchangeable, or segregated for specific projects (paragraph 23). For interchangeable items, the standard permits only two formulas: first-in, first-out, or the weighted average cost (paragraph 25) — with no mention of last-in, first-out. An entity uses one formula for all inventory of a similar nature and use to it; a difference in geographical location alone is not sufficient justification for a different formula for the same type of inventory (paragraphs 25–26). Cost may be measured by the standard cost method or the retail method if the results approximate actual cost (paragraphs 21–22).

Write-down to net realisable value, and its reversal

The cost of inventory may not be recoverable if it is damaged, wholly or partly obsolete, its selling price has declined, or the estimated cost of completion or of making the sale has increased (paragraph 28). In these cases, since "assets should not be carried at more than the amount expected to be realised from their sale or use" (paragraph 28), the inventory is written down to net realisable value and the difference is expensed in the period in which it occurs (paragraph 34). The write-down is usually made item by item. It may be appropriate to group similar and related items, such as items of the same product line with the same purpose or end use, produced and marketed in the same geographical area, that cannot practicably be evaluated separately; writing down a whole classification, such as finished goods, is not appropriate (paragraph 29). Materials and supplies are not written down below cost so long as the finished products they go into are expected to sell at or above cost (paragraph 32).

Net realisable value is reassessed in each subsequent period; if the circumstances that caused the write-down no longer exist, or there is clear evidence of an increase in net realisable value because of changed economic circumstances, the write-down is reversed within its original amount, so that the new carrying amount is the lower of cost and the revised net realisable value (paragraph 33). The required disclosures include the measurement policy, including the cost formula used, the total carrying amount and the amount by classification, and the amount of any write-down or reversal recognised during the period (paragraph 36).

Illustrative example (hypothetical figures): An entity holds inventory costing EGP 500,000. At the first period-end it estimates net realisable value at EGP 420,000 because of a price fall, writes the carrying amount down to EGP 420,000, and expenses the EGP 80,000 difference. In the following period net realisable value rises to EGP 460,000 as prices recover, so the entity reverses EGP 40,000 of the write-down, bringing the carrying amount to EGP 460,000. Had net realisable value exceeded EGP 500,000, the reversal would have been limited to EGP 80,000, so the carrying amount could not exceed cost.

The tax position

Neither the Income Tax Law No. 91 of 2005 nor its executive regulations, issued by Minister of Finance Decree No. 991 of 2005, carries a separate rule on how to value inventory. The link between accounting profit and the tax base is set by the law itself: "net profit is determined on the basis of the income statement prepared under the Egyptian Accounting Standards, and the tax base is determined by applying the provisions of this law to that net profit" (article 17). The cost of goods sold computed under EAS 2, on the cost formula used in the accounts, is therefore the starting point of the tax return, and the law's provisions are then applied to it.

Article 22 requires deductible costs and expenses to be connected with and necessary to the activity, and to be real and supported by electronic invoices or receipts, except costs not customarily documented and those the Minister exempts (item 2, as replaced by Law No. 30 of 2023). Article 24 excludes from deductible costs "reserves and provisions of every kind" (item 1), and article 52, for juristic persons, excludes "amounts set aside to form or top up provisions of every kind" (item 2), with exceptions none of which concerns inventory. Neither article names inventory or its write-down. A question that arises in practice at tax examinations is whether such a write-down counts as one of the provisions these two articles exclude, which is why the basis for estimating net realisable value needs to be documented.

What this requires

• Setting one cost formula for each type of inventory of similar nature and use, and keeping to it for as long as that similarity holds.
• Excluding abnormal waste, unnecessary storage costs and general administrative overheads from inventory cost, expensing them directly instead.
• Reassessing net realisable value at each close on the most reliable evidence available, including events after the period end that confirm conditions existing at the period end, and documenting the basis for the estimate.
• Limiting the reversal of any write-down to the amount written down, so that the carrying amount of the inventory never exceeds its cost.
• Documenting the basis for every inventory write-down before the tax return is prepared, in case it is raised under articles 24 and 52.

The firm's Accounting & Bookkeeping Department reviews the inventory valuation method applied against Egyptian Accounting Standard No. 2, and documents the basis for any write-down to net realisable value when preparing the financial statements and the tax return.

Mahmoud Nassef — Chartered Accountant (Egyptian Register), Founder Partner

Member, Egyptian Society of Accountants & Auditors
Member, Egyptian Tax Society
Member, Egyptian Society for Public Finance and Taxation

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Disclaimer: This bulletin is prepared for general information on the legislation in force at the date of its publication. It does not constitute a professional opinion or tax or legal advice on any particular matter, and it should not be relied upon in place of advice based on an examination of the circumstances of each case. Nassef & Partners International accepts no responsibility for any action taken, or refrained from, in reliance on its contents. The positions stated remain subject to subsequent legislation and decisions.