Study Unit 10. Inventories (IAS 2)

Transcription

1 Study Unit 10 Inventories (IAS 2)

2 IAS 2: Inventories SUMMARY STANDARD ON A PAGE (SOAP)

3 IAS 2 Inventories Held for sale in ordinary course of business In the process of production for such sales To be consumed in the production of G/S for sale Excludes: WIP under construction contracts Financial instruments Biological assets Cost Costs incurred to get into usable form and current location Measurement LOWER of: Net realisable value Estimated selling price in ordinary course of business less estimated costs of completion and costs of selling Cost formulas Weighted average First-in first-out Entity must use same cost formula for inventories with similar nature and use Variable Production Overheads Conversion Costs Fixed production overheads Exclude Abnormal Wastage Techniques of measuring cost If producing in mass you can approximate costs Standard costing Retail method No units x SP = x Markup = (x) x Approx cost of sales

4 IAS 2: Inventories NATURE OF INVENTORIES

5 Remember the asset definition Asset Definition per the Framework A resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity

6 What is inventory? Assets that are: Held for sale in the ordinary course of business In the process of production to sell in future (partially completed manufactured goods) Going to be used in the process of producing saleable goods or services (raw materials) or are going to be consumed in the rendering of a service (consumables)

7 Conceptually. Dr Inventory (SFP) Cr Bank/ Creditors(P/L) Purchase inventory XX xx Dr Bank / Debtors (SFP) Cr Revenue (P/L) Record revenue from sale transaction Dr Costof Sales(P/L) Cr Inventory(SFP) Record cost of sales from sale transaction XX XX xx xx

8 IAS 2: Inventories MEASUREMENT -OVERVIEW

9 How do we measure inventory? There are two main components that need to be quantified: Quantity of inventory Physical inventory counts Cost of inventory (Historical cost vs Net Realisable Value) Determining the cost price Applying a chosen cost formula (cost allocation technique) which will be used in measuring the value of inventory Determining the net realisable value of the inventory Record inventory at the lower of cost and net realisable value

10 IAS 2: Inventories COST OF INVENTORIES

11 How do we determine the historical cost of inventories? Take into account the following: Cost of purchases Conversion costs (manufacturing) Other costs incurred in bringing the inventory to its present location and current condition

12 Cost of inventories excludes Abnormal spillage / wastage of raw materials, labour & other production costs; Administrative costs not directly related to bringing inventories to the location and condition required for sale; Selling expenses

13 Calculation Purchasing Costs Conversion Costs Other Costs Purchase Price X Direct costs incurred in Product design costs for Import duties X converting raw materials into customers Transport costs X finished goods, including: Handling costs X Storage costs in the Directly attributable costs X Direct labour costs X production process LESS where required (eg. for Trade discounts (X) Variable production O/H costs X raw material storage) Cash/ settlement discount (X) Rebates on purchases (X) Fixed production O/H costs X Borrowing costs can be capitalisedunder certain circumstances (IAS 23)

14 IAS 2: Inventories ALLOCATION OF OVERHEAD COSTS

15 Overhead Costs (Indirect Costs) 1 Production Overhead Costs Costs incurred in the manufacturing process Other than direct raw materials& direct labour Eg. Indirect materials, indirect labour, depreciation on production machinery ALLpartofinventory/costofsales 2 OtherOverheadCosts Costs that are generally not directly related to the production function Eg. Human resource/ personnel function; research& development; accounting and financial management; marketing etc Generally not included in cost of inventory, except for costs that are clearly linked to bringing inventory to their present location and condition, including: Design costs and some research& development costs Borrowing costs(ias 23) Storage costs that are necessary in the production process

16 Production Overheads Variable Production Overhead Costs Variable as allocated cost per unit produced Number of units produced generally used to allocate these costs ie. Actual Production Capacity used to allocate cost Fixed Production Overhead Costs Totalcostisfixedregardlessofnumberofunitsproduced Costperunitreducesasthenumberofunitsproducedincreases Cost allocated to individual units based on NORMAL CAPACITY for production, not the actual production (actual capacity only used if it approximates normal capacity.

17 IAS 2: Inventories COST ALLOCATION TECHNIQUES & COST FORMULAS

18 Why do we need to allocate costs or make use of cost formula? Inventory is bought for different prices at different times Inventory on hand at year end may include similar items that were bought at different prices Which price do you use to value the cost of inventory?

19 Options for costing? 1. Use actual costs (per unit) As discussed in previous lecture with actual costs and allocated overheads 2. Cost allocation techniques (to individual units) Standard Costing Retail method 3. Cost Formula (larger group of closing inventory) Weighted average method First-in, First-out method Specific identification

20 IAS 2 notes The same cost formula must be used for inventories havingthesamenature&usetotheentity. Where the nature/ use differs, different formulas are allowed. If the same use / nature but different geographic locations, must still use the same cost formula

21 IAS 2: Inventories COST ALLOCATION TECHNIQUES STANDARD COSTING & RETAIL METHOD

22 Standard Costing Based on expected standard costs, based on normal levels of operations Management must set predetermined standard costs for inputs into production Direct material Direct labour Fixed and variable overheads Standard costing system must approximate cost, therefore regular review and amendment to standard costs and costing inputs

23 Retail Method Formula used at end of reporting period: Selling price value of inventories Less average profit margin Equals approximate cost of inventory XX (X) XX Only applied if results approximate cost, NB only if profit margins of homogenous groups of products are known Suitable for businesses that do not maintain complete records of purchases and inventories

24 Retail Method illustration The inventories of a chess store based on selling price values are equal to CU100,000 at reporting date. Thepolicyforthemarkuponcostis25% 100,000X100/125=80000Cost Alternatively, you could be told that a gross profit percentage (margin on selling price) of 20% is maintained: 100,000X80/100=80000Cost

25 IAS 2: Inventories COST FORMULA WEIGHTED AVERAGE METHOD

26 Weighted Average method Average cost method, Used by entities that retain goods for a longer time, or interchangeable items with high volumes of lowvalue, fluctuating prices. Formula periodically or before sales: Total cost / No. of units purchased This will give the cost per unit purchased Multiply this by units on hand at year end

27 Example weighted average Date purchased/ sold Units purchased / (sold) Unit price CU Value CU Purch 1 June Purch 15 June (WA) (CU 335 / 150 units) Sale 26 June (75) 2.23 (WA) (167.25) Purch 29 June (WA) (CU / 195 units) Sale 30 June (155) 2.40 (WA) (372.00) Closing inventory (WA) (CU / 40 units) 95.75

28 IAS 2: Inventories COST FORMULA FIRST-IN, FIRST-OUT (FIFO) METHOD

29 FIFO method Assumes that inventory is sold in the order in which they were purchased. Older inventory items are debited to the income statement (as cost of sales) first along with the credit to sales. This means that closing inventory is calculated using more current prices

30 Date purchased/ sold Units purchased / (sold) Example FIFO Unit price CU A 1 June B 15 June C 29 June Value CU Purch 1 June Purch 15 June Sale 26 June (75) 2.30 (75) (172.50) Purch 29 June Sale 30 June A: B: C: (155) (25) (50) (80) (57.50) (105.00) (200.00) Closing inv 40 Nil Nil

31 IAS 2: Inventories COST FORMULA SPECIFIC IDENTIFICATION

32 When to apply specific identification Specific costs are attributed to identified items of inventory in the following to circumstances: The cost of inventories when the items of inventory are not ordinarily interchangeable Goods / services produced & segregated for specific projects All other costs assigned using either Weighted Average or FIFO formulas.

33 IAS 2: Inventories LOWER OF HISTORICAL COST OR NET REALISABLE VALUE (NRV)

34 Net realisable value (NRV) NRV is calculated as the Estimatedselling price in the ordinary course of business Less Estimatedcosts to completethe product and to sell the product Costs to sell include relevant Marketing costs and Distribution costs NRV is an entity-specific value Different to fair value less cost to sellwhich is NOT entity specific but rather from view of market participant

35 Lower of Cost or NRV IAS 2 requires the inventory is measured at the LOWER OF COST OR NRVin the Financial Statements. This means that you need to Determine both historical cost and the NRV, Evaluate which is lower, if cost then leave at cost, if NRV is lower then you must write down the inventory

36 Indicators of Write Down A new assessment of net realisable value is made in each financial year, indicators to potential adjustments to NRV include: Damaged inventories Wholly or partially obsolete inventories A decline in selling prices Increases in estimated costs to completion Increases in selling costs

37 Net realisable value Write-down and reversal of write-down Impairment to net realisable value is recognised as an expense: Dr Expense (PL) Cr Inventory (FP) xxx xxx Reversal of previous impairment is recognised in profit or loss in period in which reversal occurs: Dr Inventory (FP) Cr Expense/Income (PL) xxx xxx

38 Inventory obsolescence When inventory will not be realised, i.e., it will not be sold, it is impaired and recognised in profit or loss: Dr Expense (PL) Cr Inventory (FP) xxx xxx Management needs to apply judgement

39 IAS 2: Inventories EXAMPLE OBSOLETE INVENTORY

40 Example Allowance for obsolete inventory Example: A purchases inventory for 100 Dr Inventory (FP) 100 Cr Bank (FP) 100 At the end of the first quarter, Aestimates that inventory of 20 is obsolete (i.e., old study material) At reporting date, the entity impairs inventory by 20

41 What journal entry should be recorded at the end of the first quarter? 1. Dr Inventory (FP) 20 Cr Allowance for obsolescence (FP) Dr Expense (PL) 20 Cr Allowance for obsolescence (FP) Dr Allowance for obsolescence (FP) 20 Cr Inventory (FP) No journal entry required

42 What journal entry should be recorded at reporting date for the inventory impairment? 1. Dr Allowance for obsolescence (FP) 20 Cr Inventory (FP) Dr Expense (PL) 20 Cr Inventory (FP) No journal entry required

43 IAS 2: Inventories NRV RAW MATERIAL TO BE USED IN PRODUCTION OF FINISHED GOODS

44 Exceptions to lower of cost or NRV IAS 2 par 32 notes that raw materials still to be incorporated into a finished product are not written down below cost IF the finished product is expected to realise at least the cost of the material and other inputs.

45 Example 1 NRV Raw material & Finished Goods A is a manufacturer of goods Raw materials Cost = CU1 000 per unit NRV = CU 900 per unit Finished goods Cost = CU3 000 per unit NRV = CU3 200 per unit

46 Should raw materials be impaired? Answer = No There is no impairment to raw materials as it is used in finished goods. Finished goods will be realised and need not be impaired. The raw materials will never be realised other than through the finished goods, therefore no need to impair.

47 IAS 2: Inventories SPARE PARTS & SERVICING EQUIPMENT

48 Spare parts &servicing equipment Spare parts and servicing equipment are classified as inventory unless - they are expected to be used during more than one period; or - can be used only in connection with an item of Property, Plant and Equipment (PPE) Product catalogues and samples used for promotional/advertising purposes are expensed not classified as inventory

49 Spare parts &servicing equipment Packaging or parts that are sold to a customer, but will be returned, are not inventory items if they will be used during more than one period Packaging costs directly attributable to an inventory item are included as part of the cost of inventory

50 IAS 2: Inventories DISCLOSURES

51 Disclosures Accounting Policies measurement & cost formula Carrying amounts in suitable classifications: Raw materials (direct materials & spare parts) Finished goods Consumable goods inventories (incl. maintenance spares) Work in Progress (WIP) The amount of inventories recognised as cost of sales during the reporting period Write downs included in cost of sales (and any reversals) Inventory pledged as security

52 Statement of Profit or Loss Revenue Cost of Sales: Opening Inventory Plus: Purchases Less: Closing Inventory Gross Profit XXX (XXX) xxx xxx xxx (xxx) XXX

53 Statement of Financial Position Current Assets Inventories Trade and other Receivables (1) Cash and Cash Equivalents xxx xxx xxx

54 Accounting Policy example Inventories are initially measured at cost and are subsequently valued at the lower of cost or net realisable value. The following cost formula were applied: Raw materials: First-in, First-out Work-in-Progress: Standard Cost Finished Goods: Standard Cost Merchandise: Weighted Average Consumables: First-in, First-out Excess and slow-moving inventory were identified and written off to their estimated net realisable values