2. unit 1 inventories students

Outcomes
• When you have completed this unit
you should be able to:
 discuss the objective and scope
 identify, recognise, measure, present
and disclose inventories in AFS
 integrate inventories with other
statements of IFRS

How will you be assessed?
• Determine cost per unit (calculations)
• Determine the value of closing inventory
(calculations)
• Journals
• Present on the SFP
• Disclose in the notes to the SFP NB

Objective of IAS 2
• To prescribe:
• how the cost of inventory is determined
and
• which useful and understandable
information is provided in the financial
statements

Scope
Types of inventories:
 Raw Material
 Work in progress ,
 Finished goods
 Consumables

Scope
Excludes:
Work in progress from construction
contracts (IAS 9)
Financial instruments (IAS 32;IFRS 9)
Bbiological assets (IAS 41)
Mineral and mineral products
CCommodity brokers

Definition
• Inventories are assets:
held for sale in the ordinary course of
business;
in the process of production for sale; or
in the form of materials or
supplies to be consumed in the production
process or in the rendering of services.

Inventory systems
• Periodic method
 Accounting for inventory done only at
Year end ,
• Perpetual method
 Inventory accounts are updated per
transaction n

Periodic method
Example
Opening inventories R 20 000
+ Net Purchases R300 000
- Closing inventories (R 40 000)
= Cost of sales R280 000
Inventory a/c not done during the year!
Work in purchases account!
Correct position at end of reporting period

Perpetual method
Example:
Purchases cost price = R100
Selling price (VAT inclusive) = R171
Journals:
Dr Cost of sales R100
Cr Inventories R100
Dr Bank / Receivables R171
Cr Sales R150
Cr VAT output R 21
Update records per transaction

Measurement of inventories
• Inventories should be measured at the
llower of:
cost and
net realisable value (NRV)

Steps for measurement of
Inventories
1. Determine the cost
2. Applying cost allocation technique
(FIFO ,Weighted average)
3. Determining NRV
4. Lower of cost and NRV in FS

Cost of inventories
• The cost of inventories should
comprise:
 All costs of purchase
 costs of conversion and
 other costs incurred in bringing the
inventories to their present location
and condition

Costs of purchase
Purchase price :
• Less: trade discounts, rebates & subsidies
Excluding:
• VAT, Interest
Add:
• Import duties and other taxes (only taxes
we cannot recover from tax authorities,
VAT???)
• Transport , handling and other costs directly
attributable to the acquisition of inventories

Thus: Cost of inventory
Includes:
• Cost of purchases
• Import duties &
handling fees
• Exchange rate when
ownership passes
• Transport cost to
place of sale
• conversion costs
Excludes:
• Vat
• Storage costs
• Agent’s
commissions
• Selling and
marketing costs
• Administration costs
• Abnormal wastage
• Finance costs
• Borrowing costs 18

Example 1
AB Ltd imported 50 laptops from China
Price according to the invoice - R20 000
each unit with a 25% trade discount.
Import charges incurred:
-Freight & marine insurance 63 000
-Import duty 100 000
-Clearing agents charges 26 500
REQUIRED:
Determine the cost price of inventory

Example 1 – Solution cont…

What method used?

Cost of inventories
• The cost should comprise:
 other costs incurred in bringing the
inventories to their present location
and condition

Cost of conversion
Typically for manufacturing:
• These are all costs incurred in
converting raw materials into finished
products ready for sale.

Conversion Cost
Conversion
Cost
Direct cost
Directly related to
units of production
Production
overheads
Indirect costs of
production

Conversion Cost
Production
overheads
Variable
overheads
Fixed production
overheads

Conversion Cost
Variable Overheads
• Indirect costs of production that vary
d directly with the volume of
production such as:
 Relatively labour
 Example : A supervisor is paid
R5 per unit inspected
• How to allocate the cost
 Allocate cost per item

Conversion Cost – Fixed Overheads
• Those indirect costs of production that
remain unchanged regardless of the
volume of production
 Depreciation , salaries, factory
rental etc…
 How to allocate the cost
• Based on normal capacity unless
inventory levels are particularly
for that period then use ACTUAL

Conversion Cost
• Normal Capacity vs Actual Capacity
• Normal Capacity
• IAS 2: Production expected to be achieved
on high over a number of periods under
average circumstance taking into account
normal losses
• Actual Capacity
• Actual Production that can be produced

Example 2
Actual units : 80 000 units
Normal capacity : 100 000 units
Actual Fixed overheads : R 100 000
Question
 Given capacity utilisation what is the
allocation rate?
 What happens to the unallocated portion?
For the allocation
of fixed
production o/h

Example 3
Normal capacity :100 000 units
Fixed overheads :R100 000
Actual production :120 000 units due to
abnormally high production
Question:
 What is the allocation rate?
 Prepare necessary journal entries
Abnormally
high production
therefore -
Actual

Normal vs Abnormal wastage
Why?
Asset definition / overstating inventories
Normal Abnormal
As part of normal production? Yes No
What happens to the “cost” of
the wastage?
Capitalise as part of
inventory
Expense through SCI
as part of Cost of
Sales

Other costs of inventory
• Only in highly exceptional
circumstances
 All cost incurred to bring inventory
to its present location and condition
 Storage costs > Wine, cheese
 Borrowing costs, in long production
processes > Wine

Cost of inventories
• The cost should comprise:
 other costs incurred in bringing
the inventories to their present
location and condition

Joint products
Products produced at the same
time, the costs of which are not separately
.
•Joint products (Material products)
Divide cost between products based on a
rational and consistent basis either be:
• Sales units or
• Sales amount
•Example: Full cream milk
Cream
Plain Yoghurt

By products
• By-products ( immaterial
products)
• Example: leather buttons from off cut
materials
Treatment:
• The By- product will not have any cost
allocated to it and will be shown at its
NRV
• subtract sales (NRV) amount
of by-products from the cost of main

Example 5
• Total Production Cost is R101 000
• In the production process we produced:
Gold 70kg, selling at R400 a kilo
Silver 30kg, selling at R300 a kilo
Bronze 5kg, selling at R200 a kilo (by product)
Required
Calculate the cost per metal using both the
i. Sales units and
ii. Sales value;
to divide the cost among the metals

Road map
What to do for the next class…
• Class notes
• Chapter 3 Introduction to IFRS
• Do some research on the Net Realisable
Value

“Use action to cure fear
and gain confidence.. Do
what you fear and fear
disappears.. Just try it and
se..”
David Schwartz,, Ph..D
50

Steps for measurement of
Inventories
1. Determining the cost
2. Applying cost allocation
technique (Retail, Standard Cost)
3. Determining NRV
4. Lower of cost and NRV in FS

STANDARD COST
• Working with expected costs
• Based on normal level of production
• Uses predetermined information
• Must approximate cost
• Must be reviewed regularly
Cost Measurement
Techniques:

RETAIL METHOD
• Technique used by entities not maintaining
complete records of purchases and
inventories
• Hhomogenous products with known similar
profit margins
• Should only be used if the results obtained
approximates the cost formula
Cost Measurement
Techniques:

Retail method continued . . .
• Inventory values are determined at the
end of the reporting period, by
• Determining the selling (value) of
inventory which is reduced by the profit
margin
• CP + GP=SP
• To determine the approximate cost

Retail method cont..
Cost plus method
• Cost plus 20%
• COS + GP = SALES
• 100% + 20% = 120%
GP% (Gross profit on sales)
• GP% of 20%
• COS + GP = SALES
• 80% + 20% = 100%
Want
Have

Example 6
Sales = R25 000
Cost of sales:
• Cost plus 25%
How much is COS?
= R25 000 x 100/125 = R20 000
• GP% of 25%
How much is COS?
= R25 000 x 75/100 = R18 750
Rx
Have

Cost formulas
Measure cost at the end of the year
ie Closing Inventories
• First in first out (FIFO)
Cost of first items is sold first
• Weighted average cost method
Calculate average with each purchase
• Specific identification method
Allocate cost to specific item
For bigger products

Cost formulas
measure cost at the end of the year
• NB: Same cost formula used for:
 all inventories
 with similar nature and use –
 geographical location can not justify diff
formula!
• Last in first out (LIFO)
 Not acceptable

Example 7
Bought
• 1 January:100 cricket bats for R500 each
• 1 February:150 cricket bats for R600 each
Sold
• 120 cricket bats for R1 000 each
Required
Calculate closing inventories and cost of
sales using:
i. Weighted average cost method
ii. FIFO

NRV vs FV less cost to sale
• NRV- entity specific amount realized
from the sale of inventories in the
of business by that entity
• FV less Cost to sell- Not entity
specific, price that would be received
to sell the same inventories in an
ordinary transaction with market
participants

Net realisable value (NRV)
Net realisable value is:
Estimated selling price in the ordinary
course of business R40 000
Less: estimated costs for completion (R10 000)
Less: estimated costs necessary to
make the sale (R5 000)
= Net Realisable Value R25 000
Definition

Why would NRV be below cost?
• inventory damaged .
• inventory wholly or partially obsolete
• selling prices have declined
• estimated cost of completion or
selling costs have increased

Net realisable value
• Inventories are USUALLY written down to NRV
on an item by item basis
• Sometimes, it may be more appropriate to group
similar or related items
• Based on most reliable evidence at the time the
estimate of the NRV is made
• The estimates take into account fluctuations of
price or cost directly relating to events occurring
after the end of the period, to the extent that such
events confirm conditions existing at the end of
the period – IAS 37 Provisions
• Also take into account the purpose of the
inventory

NRV of materials
• If NRV of material is below cost and
• If the finished goods in which they will be
incorporated are expected to be sold at prices
exceeding cost price , then
 do not write them down
• If the cost of the finished goods will exceed
NRV of the finished goods, then
 write down the value of the materials to
NRV
REMEMBER SIMMILAR TREATMENT???

NRV - reversal of situation
• NRV is assessed at the end of every
reporting period
• expense FF in the period of occurrence:
• amount of Inv write-down to NRV
• all losses of inventories
• If situation turns around, and
• NRV is higher than cost again,
• amount of write down is reversed ,
• reversal is limited to amount of original
write down

Example 8
Furniture Shop:
Damaged desk cost R2 500
Other similar desks selling price R3 800
Cost to repair desk R1 500
NRV of desk (R3 800-R1500) R2 300
Thus NRV lower than cost (R2300 < R2500)
Dr Cost of Sales 200
Cr Inventory 200
All write-downs to NRV, as well a write back up
to cost are included in Cost of Sales as an
inventory expense

Presentation
• Inventories
On the face of statement of financial
position: as current asset
• Cost of sales
On face of the statement of
comprehensive income

Disclosure
Accounting policy
• Measurement base (Lower of cost and NRV
) of inventories (including cost formula e.g.
FIFO, Weighted average)
Statement of comprehensive income
• inventory items sold
• Amounts written down to NRV
• Over/under recovery
• Abnormal cost

Disclosure
Statement of Financial position
• The carrying amount in main classifications
• Finished goods
• Materials
• Consumables
• Work in progress
Total inventories
• Carrying amount of inventories carried at NRV
• The amount of any reversal of a NRV write-down that
caused us to have a reduction in Cost of Sales
(credit)
• The circumstances that led to the reversal above
• The carrying amount of inventories pledged as
security for liabilities

Road map Where to go from here…
• Class notes
• Chapter 3 Introduction to IFRS
• IFRS Applications
• IAS 2 Summary
• Questions:
• Pre-read: Unit 2 - Provisions, Contingent
liabilities and contingent assets

2. unit 1 inventories students

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