Inventories IAS 2

PRESENTED BY: ZAHEER ABBAS

ACMA, CIMA-UK, ACIS, APA, B.COM (IT)

Overview of session
1. Introduction definitions 2. Measurement 3. Recognition 4. Disclosure

5. Questions

Inventories

1. Introduction definitions

Definitions
Inventories are assets:
a) held for sale in the ordinary course of business; a) in the process of production for such sale; or a) in the form of materials or supplies to be consumed in the production process or in the rendering of services

An asset is a resource controlled by the entity as a result of past events and from which future economic benefits are expected to flow to the entity.
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Inventories

2. Measurement

Measurement

Inventories are stated at the lower of cost of and net realisable value.

Cost
Cost of Production:

Cost of Purchase

Other Costs

Cost of Conversion
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Cost components
Cost of purchase comprises

i. purchase price
ii. import duties iii. transport and handling costs

iv. any other directly attributable costs

v. less trade discounts, rebates and subsidies vi. may include foreign exchange differences, which arise directly on acquisition of inventories invoiced in a foreign currency (refer IAS 21)
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Cost components
Cost of conversion comprises:

i. Costs, which are specifically attributable to units of production, that is direct labour, direct expenses and sub-contracted work.
ii. Production overheads: overheads incurred in respect of materials, labour or services for production, based on the normal level of activity, taking one year with another.

Cost components
Other costs may include overheads, attributable in the particular circumstances of the business to bringing the product or service to its present location and condition, e.g. design costs.

Excluded costs: Usually selling expenses, general administrative overheads, research and development costs and interest costs are not considered to relate to putting the inventories in their present location and condition.

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Cost Formulae
Specify the components attributable to the cost of inventory Cost formulae:
First in First Out (FIFO) formula Weighted Average Cost formula

Prohibited Treatment:
Last in First Out (LIFO) formula

Consistency required across each type of inventory:

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Cost Formulae
FIFO: the calculation of the cost of inventories on the basis that quantities on hand represent the latest purchases or production. This method assumes that the oldest inventories are used up first. Weighted average cost: the calculation of inventories by using an average price computed by dividing the total cost of units by the total number of such items. An entity needs to use the same cost formula for all inventories of a similar nature and use to the entity

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Cost components
Which of the above cost categories do the following costs belong to? Cost Selling costs Direct labour Design of finished goods Import duties on raw material Fixed production overhead Purchase of raw material Abnormal amounts of wasted material
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Cost Category

Cost components
Answer Cost Selling costs Direct labour Design of finished goods Import duties on raw material Fixed production overhead Purchase of raw material Abnormal amounts of wasted material
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Cost Category Excluded Cost of conversion Other costs Cost of purchase Cost of conversion Cost of purchase Excluded

Cost Formulae
Question: ABC trades in chocolates and made the following purchases and sales in the period. There are 10 units left at balance sheet date. Calculate the cost of stock using FIFO and weighted average cost formulae
Transaction Purchase Purchase Sale Purchase Period June July August September Quantity 3 units 7 units 4 units 4 units
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Price $ 20 $ 30

Total $ 60 $ 210

WAC

$ 40

$160

Cost Formulae
Answer:
FIFO: 4 at $40 plus 6 at $30 = 160 plus 180 = $ 340 Weighted average:
Transaction Purchase Purchase Remaining Sale August Period June July Quantity 3 units 7 units 10 units 4 units Price $20 $30 Total $60 $210 $270 $27.0 $27.0 WAC

Remaining
Purchase Remaining September

6 units
4 units 10 units
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$162
$ 40 $160 $322

$27.0

$32.2

Net realisable value

Measured at lower of : Cost and Net Realisable Value

Net Realisable Value

The estimated selling price in the ordinary course of business less the estimated costs of completion and estimated costs necessary to make the sale

Selling Price
Trade Discounts Costs to Completion

X
(X) (X) (X) X

Marketing, Selling and Distribution Costs

Net Realisable Value

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Cost vs. NRV calculation

Item Cost Selling price Modification cost to enable sale Marketing costs Units held A 20 30 7 200 B 9 12 2 2 150 C 12 22 8 2 300

A Cost NRV Valuation Quantity Total value

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Item B 9 8 8 150 1,200

C 12 12 12 300 3,600

Total

20 23 20 200 4,000

8800

Inventories

3. Recognition

Recognition
Inventory is a current asset Inventory is expensed when the related revenue is recognised

What are the Dr and Cr involved in a sale of inventory?

The expense of a write down to NRV is recognised when the write down occurs

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Recognition
Inventory: Dr Cost of Sales 100 Cr Inventory Sale: Dr Cash Cr Sales Write-down to NRV Dr Profit and Loss Inventory write down Cr Inventory
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100

150 150

Inventories

4. Disclosures

Disclosures
Accounting policy

Balance Sheet

Income Statement

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Disclosures
Accounting policy:
identify cost formula used (FIFO or weighted average) Cost components Valuation (lower of cost or NRV)

Balance Sheet

Carrying amount of inventories (on face of BS)

Analyse inventories by classification (e.g. raw materials, finished goods etc)

Income Statement
Cost of inventories expensed in period Expense of inventory write-downs included under other operating expenses
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Inventories

5. Questions