accounting guideline_grap 012 inventory

7/28/2019 Accounting Guideline_GRAP 012 Inventory

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Accounting Guideline

GRAP 12 Inventory

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mechanical, photocopying, recording, or otherwise, without the prior permission of the National Treasury of South Africa.

Permission to reproduce limited extracts from the publication will not usually be withheld.

Though National Treasury (NT) believes reasonable efforts have been made to ensure the accuracy of the information contained in the guideline, it

may include inaccuracies or typographical errors and may be changed or updated without notice. NT may amend these guidelines at any time by

posting the amended terms on NT's Web site.

Note that this document is not part of the GRAP standard. The GRAP takes precedence while this guideline is used mainly to provide further

explanations on the concepts already in the GRAP.


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Contents

1. INTRODUCTION ................................................................................................................ 4

2. SCOPE ............................................................................................................................... 5

3. BIG PICTURE ..................................................................................................................... 6

4. DEFINITION AND IDENTIFICATION................................................................................. 8

5. INITIAL RECOGNITION ................................................................................................... 11

6. INITIAL MEASUREMENT ................................................................................................ 13

6.1 Purchase costs .......................................................................................................... 13

6.2 Conversion costs ....................................................................................................... 19

6.3 Other costs ................................................................................................................ 22

6.4 Cost of inventories of a service provider .................................................................. 23

6.5 Cost of agricultural produce harvested from biological assets ................................. 23

7. COST TECHNIQUES AND COST FORMULAS .............................................................. 24

7.1 General ...................................................................................................................... 24

7.2 Illustrative examples .................................................................................................. 25

8. SUBSEQUENT MEASUREMENT ................................................................................... 28

8.1 General ...................................................................................................................... 28

8.2 Cost versus net realisable value ............................................................................... 28

8.3 Cost versus current replacement cost ...................................................................... 30

8.4 Reversal of inventory write-down .............................................................................. 32

9. RECOGNITION AS AN EXPENSE .................................................................................. 33

10. DISCLOSURE ............................................................................................................... 34

11. RECOMMENDED CONTROLS .................................................................................... 36

12. INVENTORY SYSTEMS ............................................................................................... 37

13. ENTITY-SPECIFIC GUIDANCE ................................................................................... 38

13.1 Municipalities ............................................................................................................. 38

14. SUMMARY OF KEY PRINCIPLES .............................................................................. 40

14.1 Scope ........................................................................................................................ 41


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14.2 Definition and identification ....................................................................................... 41

14.3 Recognition and measurement ................................................................................. 41


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1. INTRODUCTION

This document provides guidance on the accounting treatment for inventories. It alsocontains guidance on the cost formulas used to assign costs to inventory.

The content should be read in conjunction with GRAP 12 (issued February 2010) andincludes any changes made by the Board in terms of the Improvements to Standards ofGRAP.

For purposes of this guide, entities refer to the following bodies to which the standards ofGRAP relate to, unless specifically stated otherwise:

Public entities

Constitutional institutions

Municipalities and all other entities under their control

Parliament and the provincial legislatures

Explanation of images used in the manual:

Definition

Take note

Management process and decision making

Example


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2. SCOPE

GRAP 12 is applicable to all entities preparing their financial statements on the accrual basisof accounting.

The standard does not apply to:

Work-in-progress within the scope of GRAP 11 on Construction Contracts;

Financial instruments, within the scope of GRAP 104 on Financial Instruments; and

Biological assets related to agriculture activity and agricultural produce at the point ofharvest, which falls within the scope of GRAP 27 on Agriculture (refer to section 6.5dealing withagricultural produce).

The measurement principles of GRAP 12 should not be applied to: Products relating to mining, forestry and agricultural industry which are

measured at net realisable value in accordance with well-established practice ofthe relevant industry. Changes in the net realisable value of such inventory isrecognised in surplus or deficit in the period of change; and

Inventories of commodity broker-traders which are measured at fair value lesscost to sell. Any changes in the fair value less cost to sell should be recognisedin surplus or deficit in the period of the change.

Formatted: Indent: Left: 0.75 cm,No bullets or numbering


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3. BIG PICTURE

Inventories

Measurement

InitialMeasurement

Cost

Fair Value

SubsequentMeasurement

Lower of:

Cost or

Net RealisableValue

Lower of:Cost or

CurrentReplacement Cost

Recognise AsExpense

Disclosure

Identification Recognition


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Figure 1


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4. DEFINITION AND IDENTIFICATION

Inventories include:

goods purchased and held for resale;

finished goods produced, or work-in-progress, being produced by the entity;

materials and supplies awaiting use in the production process;

goods purchased or produced by an entity, which are for distribution for no charge or fora nominal charge; and

inventories relating to provision of services rather than goods purchased and held forresale or goods manufactured for sale.

Examples of inventory in the public sector:

ammunition held by the SAPS or the Defence Force;

consumable stores;

medical supplies held by the Department of Health;

licensing stationery held by the Department of Transport;

fuel, oil and gas;

maintenance materials;

spare parts for plant and equipment that qualifies as inventory;

water held by a municipality;

work-in-progress such as educational and course materials;

land or property held for sale.

Inventories are assets:

in the form of materials or supplies to be consumed in the production process;

in the form of materials or supplies to be consumed or distributed in the renderingof services;

held for sale or distribution in the ordinary course of operations; or

in the process of production for sale or distribution.


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5. INITIAL RECOGNITION

Inventory is recognised as an asset when:

it is controlled by the entity;

as a result of a past event (acquisition or production thereof);

from which it is probable that future economic benefits or service potential associatedwith the item will flow to the entity; and

the cost (or fair value) of the inventory can be measured reliably.

An entity should recognise inventory on the day when the risk and rewards of ownership ofthe inventory have been transferred to the entity. This will normally be the date on which theinventory is delivered. However there are exceptions, for example when inventory is shippedfree on board (FOB), in which case the risk and rewards are transferred to the buyer whenthe goods are loaded onto the ship, resulting in the buyer recognising inventory on the FOBdate.

Example 3: Initial recognition of inventory

Entity Z ordered 1 million units of special paper for R500, 000 on 31 March 2010. Theinvoice was received on 2 April 2010. The paper was delivered on 5 April 2010.

Based on above, the accounting treatment is:

On 31 March 2010, no entry is made.

On date of delivery (5 April 2010) the following journal entry would be made:

5 April 2010 Debit Credit

a third party (parties) in service delivery development that will beheld to generate futurerental income

Where the entity controls the right to create and issue assets such as revenuestamps, these items are recognised as inventory and measured at their printingcosts.

Strategic stockpiles of reserves maintained by the entity (e.g. fuel, food,medicines etc.), for use in emergency situations, are recognised as inventoriesand falls within scope of GRAP 12.


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R R

Inventory (paper) 500,000

Creditor 500,000

On 5 April 2010, the paper was delivered to the entitys premises. Entity Z has torecognise the inventory and relevant liability.

Assume the following additional information:

If Entity Z made a payment on 2 April 2010, when the invoice was received, butinventory has yet to be received, the entity should recognise a prepayment on 2 April2010. On date of payment (2 April 2010) the following journal entry would be made:


R R

Prepayment 500,000Bank 500,000

On date of delivery (5 April 2010) the following journal entry would be made:


R R

Inventory 500,000

Prepayment 500,000

Only once the inventory is delivered, should it be recognised as an asset (inventory), as

that is when risks and rewards of ownership have been transferred.

When recognising an asset in the public sector, the focus would most likely be on servicepotential rather than future economic benefits. These two concepts are discussed below.

Future economic benefits is usually in the form of future receipts of cash or cash equivalents,however it may also have the capacity to lower cash outflows, such as when an alternativeprocess lowers the cost of providing a service.

Example 4: Economic benefits

An entity provides electricity to the public at Rx a unit. Therefore future economicbenefits exist, as it is probable that the entity will receive payment for the electricityconsumed by the public.

Service potential is the capacity of an asset, individually or in a group with other assets, tocontribute directly or indirectly to achieving the objectives of the entity. These objectives mayinclude delivering a service to the public without receiving any economic return. Thereforeassets that are used to deliver goods and services in accordance with an entitys mandate


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but do not directly generate net cash inflows are often described as embodying servicepotential.

Example 5: Service potential

An entity distributes vaccines for foot and mouth disease for free to farmers. In thiscase there is no direct economic benefit to the entity distributing the vaccines, butthere is a service potential value (of containing and eradicating the disease) that canbe associated with the vaccines.

The vaccines provide benefit to the entity that controls the vaccines and thedistribution thereof supports service delivery. The vaccines also have a resale value(even though the entitys mandate is to distribute them for free). The vacc ines couldbe exchanged for something else that is useful to the entity and it may save the entitymoney in the future (costs associated with its distribution). The vaccines thereforehave service potential.

6. INITIAL MEASUREMENT

Inventories are initially recognised at cost which includes all costs of purchases, cost ofconversion and any other costs incurred to bringing the inventories to its present locationand condition.

Where inventories are acquired at no cost of for nominal consideration, it should berecognised at fair value at the date of acquisition.

6.1 Purchase costs

Purchase costs include the purchase price of finished goods or raw materials, import dutiesand other taxes that will not be refunded from taxing authorities, transport costs of gettingthe inventory from the supplier to the entitys premises, handling costs and any other costsdirectly involved in the acquisition of finished goods, materials and supplies.

VAT, if applicable, is generally recoverable and is therefore not included in the cost ofinventory. If only a portion of the VAT is recoverable, then the portion which is notrecoverable should be included in the cost of inventory.

Example 6: Purchase cost

Entity B bought inventory for R228, 000 (including VAT) and paid cash. The inventorywas transported to Entity Bs premises by truck and the total transport cost was R1,140 (including VAT). Entity B also insured the inventory while in transit and theinsurance amounted to R2, 280 (including VAT).

The total cost of the inventory will be calculated as follows:

Fair value is an approximation of cost where there was no actual cost incurred inacquiring the inventories.

For example, where inventory was donated to the entity, the inventory should bemeasured at its fair value at date when it was received. The value can be determinedby obtaining the value of similar inventory in the same condition.


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R

Purchase price 228,000

Plus transport cost 1,140

Plus insurance cost

Sub-total (payable to suppliers)

Less VAT @14% (R228,000 x 14/114) +

(1,140 + 2,280 c 14/114)

2,280

231,420

(28,420)

Total cost of inventory 203,000

Inventory will be recorded as follows on transaction date:

Debit Credit

R R

VAT Input 28,420

Inventory 203,000

Bank 231,420

Rebates, trade discounts and similar items and finance cost, if deferred settlement terms areallowed by the supplier, should be deducted from the purchase costs. These are discussedin more detail below.

Rebates

Rebates to be received from the supplier, which represent a refund of part of the purchaseprice, should be estimated at the date of purchase of the inventories and should be

deducted from the cost of the inventories. If however, the rebates represent a refund ofselling expenses incurred by the buyer of the inventories, the rebates should not affect thecost of the inventories.


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Example 7: Rebates

Entity A purchases water at R9, 000 per mega litre. The supplier has agreed toprovide a 2.5% rebate if Entity A buys 1,000 mega litres of water in the financial

period. The rebate is payable by the supplier at the end of the financial period.Entity A should, based on past experience, determine the probability that they willpurchase at least a minimum of a 1,000 mega litres in the financial period.

If it is likely that Entity A will purchase the minimum quantity of water, then each timea purchase is made, a mega litre at a cost of R8,775 (R9,000 x 97.5%) should berecognised with the resulting rebate of R225 being recognised as a receivable untildate of receipt. Assume that Entity A purchased 120 mega litres in July.

Journal entries:

The following journal entry would be made on transaction date:

Debit Credit

R R

Inventory (Water) (120 x R8,775) 1,053,000

Receivable (rebate) 27,000

Bank (120 x R9,000) 1,080,000

Purchases in July and recognition of rebate receivable on purchases

Assume the following information:

On the other hand, if based on past experience it does not seem probable that theentity will buy the minimum quantity of water to receive the rebate, and then it shouldrecognise a mega litre at a cost of R9, 000.

Should it then at a later stage become probable that Entity A will buy the minimumquantity of water, then the portion of the rebate for water already sold should berecognised as an expense while the remainder should be deducted from inventory.

If we assume that in the beginning of the financial period, the entity did not anticipatebuying the minimum of a 1,000 mega litres of water. During the first 6 months theentity purchased 550 mega litres of which it sold 500 mega litres.

However, after the first 6 months, the entity decided that it is now probable that theywill purchase at least a minimum of a 1,000 mega litres. In month 7 the entitypurchased another 110 mega litres.

Journal entries:

The journal entries will be as follows:

Debit Credit

R R

Inventory (Water) 4,950,000

Bank (550 x R9,000) 4,950,000

Purchase of inventory in first 6 months


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Example 8: Settlement discount

An ent ity buys inventory with a cost of R100, 000 from supplier B, who offers a 10%discount if the amount due is settled within 15 days.

At initial recognition, the entity needs to determine if they will make use of thesettlement discount. If so, the journal entry would be as follows on transaction date:

Debit Credit

R R

Inventory (R100, 000 x 90%) 90,000

Supplier B 90,000

Assume the following additional information:

If 15 days have passed and the entity did not make use of the settlement discount,the entity needs to reverse the rebate. The portion of the inventory already soldshould be recognised as an expense, while the remainder should be reversed against

inventory.

Assume that the entity already sold 15% of the inventory on hand.

The journal entries for the selling of inventory and the reversal of the rebate would beas follows:

Debit Credit

R R

Cost of sales (100,000 x 15%) 15,000

Inventory 15,000

Recognise inventory as expense when it is sold

Debit Credit

R R

Inventory [(R100,000 R15,000) x 10%] 8,500

Cost of sales (R15, 000 x 10%) 1,500

Supplier B (R100, 000 x 10%) 10,000

Adjust the expense and inventory amounts and reverse the rebate, as the entity didnot make use of the settlement discount

Deferred settlement terms

If an entity purchases inventories on deferred settlement terms or over an extended periodgranted by the supplier, the effect of the time value of money should be taken into account, ifmaterial.

This is done by discounting the future cash flows back to a present value. This present valueis then recognised as the cost of inventory. Any difference between this present value andthe amount actually paid is accounted for as interest over the period of the financing.

Comment [MS1]:

FOR ASB - is the settlement discount

forfeited a finance cost (like Gripping G

example)

Is the discount calculated on the right

inventory amount R100 vs. R90?


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6.2 Conversion costs

Conversion costs are costs to convert items from raw materials into finished goods which aremainly found in a manufacturing environment. This would include costs directly related to the

production such as direct labour, variable production overheads and fixed productionoverheads based on normal capacity.

Variable productions overhead are indirect costs of production that vary with the volume ofproduction, e.g. indirect materials, water consumption, and electricity usage. These costs areallocated to each unit of product based on actual usage.

Fixed production overheads are those indirect costs that will be incurred irrespective of thevolume of production, such as insurance of the factory building and depreciation of plant andequipment.

Fixed production overheads are allocated based on the normal capacity of production.

Normal capacity as described by the standard is the normal production expected to be

achieved on average over a number of periods or seasons under normal circumstances,taking into account the loss of capacity resulting from planned maintenance.

If actual level of production approximates normal capacity, the actual capacity may be used.

Where there is abnormally high production, the fixed overhead allocated to each unit isdecreased, so that inventories are not measured above cost. If there are unallocatedoverheads, such expenses are recognised in the period in which they are incurred in thesurplus or deficit.

Example 10: Allocation of fixed production overheads

Below normal capacity:

Assume that production overheads amount to R500, 000 and normal capacity equals50,000 units. The actual production during the period amounted only to 45,000 units.

The allocation of the overheads should be based on the normal capacity of 50,000units, resulting in a cost of R10 per unit (R500, 000 / 50,000). As the actualproduction only amounts to 45,000, the cost allocated to inventory is only R450, 000(45,000 x R10). The remaining R50, 000 (under-recovery) should be recognised insurplus or deficit as part of cost of sales.

The following illustrates the disclosure that will be made in the annual financialstatements of the entity:

Extract from Statement offinancial performance

Note 20x1 20x0

R R

Revenue XX XX

Cost of inventory 3 (500,000) (XX)

Gross profit XX XX


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Figure 2 summary for allocation of conversion costs

A production process may result in more than one product being produced simultaneously.This is the case, for example, when joint products are produced or when there is a mainproduct and a by-product. When the costs of conversion of each product are not separatelyidentifiable, they are allocated between the products on a rational and consistent basis.

The allocation may be based, for example, on the relative sales value of each product eitherat the stage in the production process when the products become separately identifiable, orat the completion of production.

Most by-products, by their nature, are immaterial. When this is the case, they are oftenmeasured at net realisable value or current replacement cost and this value is deducted fromthe cost of the main product. As a result, the carrying amount of the main product is notmaterially different from its cost.

Conversioncosts

Direct cost

Direct labour

Allocated

based onactual usage

Indirectcosts

Variableoverhead

Allocated

based onactual usage

Fixedoverhead

Allocatedbased onnormal

capacity

Net realisable value is the estimated selling price in the ordinary course of operationsless the estimated costs of completion and the estimated costs necessary to makethe sale, exchange or distribution.

Current replacement cost is the cost the entity would incur to acquire the asset on thereporting date.

These concepts are discussed in detail undersubsequent measurement.


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Example 11: Joint products

X Resources extracts chemical Y and chemical Z from liquid concentrate residuepurchased. The depreciation on the machine used to extract chemical Y and

chemical Z is R10, 000 per day, while the machine operator is paid R1, 000 per day.The machine can process up to 100 litres of concentrate in a day. About 60% of whatis extracted is chemical Y, 35% chemical Z and the rest is scrap.

The selling prices of chemical Y and Z amounts to R500 and R1, 250 per litrerespectively. It is the entitys policy to absorb the normal loss in the joint productbased on their sales value.

Information and calculations based on above:

Sales value of chemical Y R30,000

(100 x 60% x R500)

Sales value of chemical Z R43,750

(100 x 35% x R1,250)

Total cost of extracting 1 litreof residue

R110

(R10,000 / 100 + R1,000 / 100)

Cost to be allocated tochemical Y

R44.75 per

(R110 x (R30,000 / (R30,000+ R43,750)))

Co t to be allocated tochemical Z

R65.25 per

(R110 x (R43,750 / (R30,000+ R43,750)))

6.3 Other costs

Other costs may only be included in the cost of inventories if they are incurred in bringing theinventories to their present location and condition. Such cost may include packaging costsincurred to prepare inventory for sale and borrowing costs that may be capitalised in terms ofGRAP 5 on Borrowing Costs. Refer to the accounting guideline on GRAP 5 for moredetail.

Certain expenditures are excluded from the cost of inventories and should be recognised asan expense in the period that it is incurred, such as:

abnormal amounts of wasted materials or labour;

storage costs, unless those cost are necessary in the production process before afurther production stage;

administrative expenses that were not required to bring inventories to their presentlocation and condition; and

selling expenses.


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6.4 Cost of inventories of a service provider

Inventories of a service provider include the costs of service for which the related revenuehas not been recognised. The costs are primarily labour costs, cost of personnel directly

involved in providing the service as well as the attributable overheads.

Costs of labour that are not directly engaged in providing the service such as generaladministrative personnel and sales costs should be excluded and recognised as an expensewhen incurred. Profit margins and other overheads are excluded from the cost of inventory.

Example 12: Cost of inventory of a service provider

Entity A provides accounting services at a fixed rate per hour. The revenue for EntityA will be the service fee received or receivable and the inventory at year-end will bethe cost of services rendered for which the related service has not yet beenrecognised.

The entitys employees complete time sheets recording their time spent on specificprojects. At 31 March 2011 there was unbilled work-in-progress of 485 hours for

various clients.

These hours should be valued as inventory at the cost of compensation to theemployees. Assuming the cost is R100 per hour, the inventory at year-end isR485,000 (485 x R100).

The journal entry at reporting date will be as follows:

Debit Credit

R R

Inventory (work-in-progress)

(485 hours x R100)

485,000

Employee cost (liability) 485,000

6.5 Cost of agricultural produce harvested from biological assets

In terms of GRAP 27 on Agriculture, agricultural produce that have been harvested frombiological assets are measured on initial recognition at fair value less selling cost at the pointof harvest. This is the cost of the inventories at that date for application of GRAP 12.

Agricultural produce is accounted for in accordance with GRAP 27 Agriculture, onlyup to the point of harvest, thereafter it is classified as inventory and accounted for inaccordance with GRAP 12. The deemed cost of agricultural produce transferred toinventory is measured at fair value less selling cost at the point of harvest. Forsubsequent measurement, the inventory will be carried at the lower of its deemedcost and net realisable value or current replacement cost.


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7. COST TECHNIQUES AND COST FORMULAS

7.1 General

Now that we have discussed which types of costs can (and cannot) be included as part ofthe total cost of inventory, it is important to know which type of cost formulas should be usedin order to measure inventory correctly in the statement of financial position.

The following types of costs formulas should be used in terms of GRAP 12:

Cost formula Circumstances in which the formula willbe used

Specific identification Items which are not ordinarilyinterchangeable and goods or servicesproduced and segregated for specificprojects.

First-in, first out (FIFO) All other items apart from those that are

required to use specific identificationmethod.

Weighted average cost formula All other items apart from those that arerequired to use specific identificationmethod.

Cost of inventories that are similar in nature and use to the entity should be determined byusing the same cost formula. Cost formulas should not be different simply as a result ofdifferent geographical locations of inventories.

Selecting a cost formula(s) is an accounting policy choice. If an entity decides tochange the cost formula used to measure its inventory (subject to compliance with therequirements of GRAP 3), it will result in a change in accounting policy and should beapplied retrospectively in accordance with GRAP 3.

Specific identification of costs means that specific costs are attributed to identifieditems of inventory


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7.2 Illustrative examples

Example A applying the first-in-first-out or weighted average cost formulas

Applying the first-in-first-out formula

On 1 April 2009 Entity A buys 1,000 units of product X at R2.00 per unit. On 1 December2009 Entity A buys another 500 units of product X at R2.50 per unit. At 31 March 2009, 600units were on hand, thus 900 units were sold during the year.

Calculat ions:

The 900 units sold were calculated as follows:

Units sold = Units on hand at beginning of reporting period + Purchases

Units on hand atend of reporting period

Units sold = 0 + 1,500 600

I.e. 900 units

Calculat ions:

Specific identification of costs would not be suitable when there are large numbers ofitems of inventory that are ordinarily interchangeable.

Under the FIFO basis, inventories are valued with the assumption that items thatwere purchased or produced first, will be sold first.

Under the weighted average cost basis, the cost of an item is determined fromweighted average of the cost of similar items at the beginning of a period and thecosts of similar items purchased or produced during the period. It can be calculatedon a periodic basis, or per consignment, depending on the situation of the entity.

Calculating cost of sales (units sold) at reporting dateCost of sales = Opening balance of inventory on hand + Purchases Closing balanceof inventory on hand

Calculating closing balance of inventory on hand at reporting dateClosing balance of inventory on hand = Opening balance of inventory on hand +Purchases Cost of sales


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The value of inventory on hand at year end will be calculated as follows:

R1,250 (500 x R2.50) + R200 (100 x R2.00) = R1,450

How do you determine how many units to use at which purchase price: There are 600 unitson hand, FIFO assumes that items on hand were purchased last, therefore the last purchaseprice of R2.50 will be used for the first 500 units (also the maximum that can be used). Thereare still 100 units short, therefore the price should be taken from the second last purchasemade, which was R2 per unit.

Applying the weighted average formula

On 1 April 2009 Entity A buys 1,000 units of product X at R2.00 per unit. On 1 December2009 Entity A buys another 500 units of product X at R2.50 per unit. At 31 March 2009, 600units were on hand, thus 900 units were sold during the year.

Calculat ions:

The weighted average cost per unit is:

[R2,000 (1,000 x R2.00) + R1,250 (500 x R2.50)] / 1,500 = R2.17

The value of inventory on hand at year end will therefore be:

R2.17 x 600 = R1,300

For this example it was assumed that the weighted average cost per unit is calculatedperiodically, i.e. on a yearly basis (note that the weighted average cost can be calculatedafter each purchase or periodically, e.g. weekly, monthly, yearly, etc., consequently,depending on how it is done, it could result in different costs per unit).

To illustrate the concept above, assume that Entity A calculates the weighted average costper unit after every purchase.

The following inventory transactions took place during the month of October 2009:

Date Movement Units Cost / sale priceper unit (R)

01 October Opening balance 200 20

02 October Sales (120) 40

05 October Purchases 300 24



Weighted average cost per unit is calculated by dividing inventory purchased by thesum of opening inventory plus purchases minus inventory sold.


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31 October Closing balance 180 ?

The calculation of the weighted average cost per unit will be done as follows:

Date Movement Units Cost per unit (R)

01 October Opening balance 200 20


80 20


380 23.16 [(80x20) + (300x24)] / 380

15 October Sales (200) 23.16

180 23.16


330 26.27 [(180x23.16) + (150x30)] / 330

25 October Sales (150) 26.27

31 October Closing balance 180 26.27

Calculat ions:

The value of inventory on hand at month end will therefore be:

R1, 250 (500 x R2.50) + R200 (100 x R2.00) = R1, 450. R26.27 x 180 = R4,729

Assume the fo l lowing addi t ional informat ion:

If we take the same example, but calculate the weighted average on a yearly basis (as in ourfirst example), the outcome will be as follows:

Units Cost price per unit(R)

Total cost price

(R)

Opening balance 200 20 4,000

Purchases 300 24 7,200

Purchases 150 30 4,500

Total 650 15,700

Calculat ions:

The weighted average cost per unit is:

15,700 / 650 = R24.15

The value of inventory on hand at year end will therefore be:

R24.15 x 180 = R4,347


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As can be seen from the previous calculations, the weighted average cost per unit andultimately the value of inventory on hand will differ depending on the basis used to calculatethe cost per unit.

8. SUBSEQUENT MEASUREMENT

8.1 General

Under subsequent measurement, the requirement of GRAP 12 is that inventory should bemeasured at the lowerof cost and net realisable value, with the following exception:

Inventory should be measured at the lowerof cost and current replacement cost wherethey are held for:

o distribution at no charge or for a nominal charge; or

o consumption in the production process of goods to be distributed at no cost or for anominal charge.

8.2 Cost versus net realisable value

Cost incurred on inventories may become irrecoverable if those inventories are damaged,obsolete, selling prices declined due to market conditions, or the estimated costs incurred tocomplete has increased.

To write down inventories to net realisable value is consistent with the view that assetsshould not be reflected in excess of the future economic benefits or service potentialexpected to be realised from their sale, exchange, distribution or use. Inventories that areheld for distribution at a market price are measured at the lower of cost and net realisablevalue upon subsequent measurement.

Example 13: Inventory write-down to net realisable value

Entity Zs reporting date is 30 June 2009. During 2008, Entity Z, operating in South

Africa, imports diesel from Iraq at R5 per litre which is sold at R7.5 per litre.

During 2009, scientists and geologists discovered oil fields in Malawi. As from 2009diesel can be imported at R2 per litre from Malawi. This results in an announcementfrom the South African government that diesel can only be sold at a maximum of R4.5per litre.

At the reporting date, Entity Z still holds 5,000 litres of diesel imported from Iraqduring 2008.

Net realisable value is the estimated selling price in the ordinary course of operationsless the estimated costs of completion and the estimated costs necessary to makethe sale, exchange or distribution.


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The net realisable value of diesel on hand at 30 June 2009 is R4.5 per litre. Theinventory carrying amount before any write-down at reporting date is R25, 000 (5,000x R5).

Based on above:

Inventory must be written down to its net realisable value of R22, 500 (5,000 x R4.5).The difference of R2, 500 is recognised as an expense in surplus or deficit for theperiod.

Disclosure:

The following illustrates the disclosure that will be made in the annual financialstatements of Entity Z.

Extract from Statement of

financial position

Note 2009 2008

R R

Current assets

Inventory 3 22,500 XX

Extract from Notes to thefinancial statements

2009 2008

R R

3. Inventory

Inventory consists of the following:

Finished goods 22,500 XX

At the end of the reporting period, finished goods were written down to their netrealisable value due to a decrease in the import cost of fuel. The write-downamounted to R2, 500 which is recognised as part of the cost of inventory in thestatement of financial performance.

Inventories can be written down to net realisable value on an item by item basis, or whereappropriate similar items may be grouped. The write-down should not be done based on aclassification of inventory (such as finished goods) or a particular operation or geographicalsegment (such as all the inventories in a specific operation).

In most cases, service providers would accumulate cost for each service that has a separateselling price charged. It would then be appropriate to treat each service as a separate item.

Estimates of net realisable value are based on the most reliable evidence available at thetime when estimates are made.


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To estimate net realisable value, the following will be considered:

Fluctuations of price; and

Cost directly related to adjusting events (as defined in terms of GRAP 14 on Eventsafter Reporting Period).

Management will also consider the purpose for which the inventory is held. In a situationwhere an entity holds inventory for the purpose of satisfying a firm sale or in terms of aservice contract based on a fixed contract price, the net realisable value of those inventoriesrequired to satisfy the contract would be the contract selling price. On the other hand, the netrealisable value of the excess quantity of inventory held will be based on the general sellingprice and not the contract price.

Example 14: Net realisable value of inventory held for a firm sale

Entity A purchased 600 units of inventory with a cost of R200 per unit. A contract wasentered into 2 days later whereby 500 units will be sold at R180 per unit in terms ofcontract entered into with entity B. These inventories are normally sold at R250 perunit.

The 500 units to which the contract relate, have a net realisable value of R180 perunit and should be written down from R200 to R180 per unit. The remaining 100 unitsshould remain at cost, since the net realisable value is higher than cost.

Raw materials and supplies held to be used in the production of inventories will not bewritten down if the finished goods are expected to be sold or exchanged at, or above cost.However, when a decrease in the price of raw materials shows that the cost of finishedgoods will exceed its net realisable value, raw materials should be written down to netrealisable value. In a situation like this, the replacement cost of the materials may be thebest estimate of net realisable value.

8.3 Cost versus current replacement cost

In certain situations, an entity may hold inventories with future economic benefits or servicepotential that are not directly related to their ability to generate net cash inflows, i.e.inventories are distributed at no charge or for nominal value.

Therefore, where market rates are not applicable for distribution of inventories, they aremeasured at the lower of cost and current replacement cost upon subsequent measurement.

Current replacement cost is the cost the entity would incur to acquire the asset on thereporting date.

Therefore, it is the value that the entity would need to pay to replace the inventoryshould the need arise.


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Example 15: Current replacement cost of inventory that will be discharged atno cost

Entity B purchased 200 units of inventory X with a cost of R65 per unit, to be

distributed to the various departments at no cost. At year end there were 20 units onhand and the cost to acquire inventory X is now R60 per unit.

Based on above:

As inventory is distributed it will be recognised as an expense. The remaining units onhand should be written down to their replacement cost of R60 per unit.

Journal entries:

The journal entries will be as follows:

At transaction date Debit Credit

R R

Inventory (200 x R65) 13,000

Bank 13,000

Purchase of inventory X

At date of distribution Debit Credit

R R

Inventory distributed/used (180 x R65) 11,700

Inventory 11,700

Recognise inventory X as expense when it is distributed/used

At year end Debit Credit

R R

Write-down of inventory to current replacementcost [20 x R5 (R65 - R60)]

100

Inventory 100

Inventory X on hand written down to its current replacement cost of R60 per unit

Disclosure:

The following illustrates the disclosure that will be made in the annual financialstatements of Entity B.

Extract from Statement offinancial position

Note 2009 2008

R R

Current assets

Inventory 3 1,200 XX


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2009 2008

R R

3. Inventory


Consumables held for distribution 1,200 XX

At the end of the reporting period, consumables were written down to their currentreplacement cost. The write-down amounted to R100, which is recognised as partof the cost of inventory in the statement of financial performance.

8.4 Reversal of inventory write-down

At each subsequent period, a review is made of the net realisable value, if the inventory isstill on hand in those subsequent periods. If the conditions that previously resulted in a writedown of inventory below cost is no longer applicable, or there are new circumstances thatresults in an increase of the net realisable value, the write-down will be reversed to reflectthe new carrying amount at the lower of cost and net realisable value. It is important to bearin mind that the reversal of the write-down is limited to the original amount of the write-down.

Example 16: Reversal of inventory write-down

Assume the same information as inExample 13above.

During the 2010 financial period, the Malawian government announces newlegislation to limit the exporting of diesel to South Africa. This results in an increase ofdiesel cost to R3.5 per litre, after which the South African government makes a new

amendment allowing diesel to be sold at a maximum of R5.5 per litre. At 30 June2010 Entity Z still holds 2,000 litres of diesel from the previous period.

Based on above:

The net realisable value of diesel has now increased to R5.5 per litre. As a result thewrite-down in 2009 is reversed. The difference between the current net realisablevalue and the carrying amount is R1 per litre; however, as the write-down in 2009was R0.5 per litre, the reversal will be limited to the write-down in 2009.

Calculations:

The inventory carrying amount before any reversal of write-down at reporting date is

R9, 000 (2,000 x R4.5). The reversal for 2010 to adjust the carrying amount ofinventory is R1, 000 (2,000 x R0.5) which is recognised as a reduction in the amountrecognised as an expense in surplus or deficit for the period. The new carryingamount will therefore be R10, 000 (R9, 000 + R1, 000).


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Disclosure:

The following illustrates the disclosure that will be made in the annual financial

statements of Entity Z.

Extract from Statement offinancial position

Note 2010 2009

R R

Current assets

Inventory 3 10,000 22,500


2010 2009

R R

3. Inventory


Finished goods 10,000 22,500

At the end of the reporting period, a write-down recognised in the previous periodwas reversed due to an increase in the import cost of fuel. The reversal of thewrite-down amounted to R1, 000 which is recognised as a reduction in the cost ofinventory in the statement of financial performance.

9. RECOGNITION AS AN EXPENSE

Once inventories are sold, exchanged or distributed, the carrying amount of thoseinventories should be recognised as an expense in the same period in which thecorresponding revenue was recognised. Where there is no related revenue, the expense isrecognised when the goods are distributed, or related services are rendered.

Any inventory write-down to net realisable value or current replacement cost and any lossesof inventory should be recognised as an expense in the period which the write-down or lossoccurs. In periods where the inventory write-downs are reversed, it will be recognised as areduction in the amount of inventories recognised as an expense in that period.

In certain situations inventories may be included in other asset accounts, for exampleinventory used as a component of property, plant and equipment. Such inventory isrecognised as an expense over the useful life of that asset.


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Example 17: Recognition as expense

1,000,000 units of paper were purchased for R500, 000 on 5 April 2010. At 28 June2010, the entity sells 300,000 units of paper. The entitys reporting date is 30 June.

Journal entries:

The journal entries would be as follows:


R R

Inventory (asset) 500,000

Bank 500,000

28 June 2010 Debit Credit

R R

Stationery (expense) 150,000

Inventory (asset) (300,000 x R0.5) 150,000

Disclosure:

The disclosure in the statement of financial performance will be as follows.

Extract from Statement offinancial performance

Note 2010 2009

R RCost of sales

Consumables 150,000 -

In the statement of financial position, the value of the paper on hand (R350,000) willbe included in the inventory note as a separate line item.

10. DISCLOSURE

Inventory disclosed in the notes to the financial statements should be separatelydisclosed per class. Common classifications of inventories are merchandise,

production supplies, finished goods, materials and work-in-progress.


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Include the nature of inventories written-down to net realisable value or currentreplacement cost, and in the case of a reversal, the nature and reasons for the reversal.

15. Cost of inventory

20x1 20x0

R R

Consumables used 94,682 XX

Cost of sales of finished goods 1,653,428 XX

Labour 485,328 XX

Fixed production overhead costs 540,000 XX

Variable production overhead costs 582,100 XX

Opening inventory 146,000 XX

Closing inventory (100,000) (146,000)

Raw materials write-down to netrealisable value

46,210 XX

Reversal of inventory write-down (21,800) (XX)

Under-recovery of fixed productionoverhead costs

36,100 XX

Abnormal spillage of raw materials 8,200 XX

Inventory stolen 10,180 XX

Total cost of inventory 1,827,000 XXX

11. RECOMMENDED CONTROLS

The following are examples of controls or procedures an entity can implement to assist ininventory management:

Appoint or designate an inventory manager;

Have an inventory management policy;

Implement controls over the safeguarding of assets;

Ensure there is maintenance of records over inventory movement;

Perform inventory counts periodically to ensure that actual inventory agrees withtheoretical inventory records and to ensure inventory is still in the condition as intendedby management (i.e. not obsolete); and

Annual review of inventory management policy.

Approval of write-offs due to obsolescence or damage


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12. INVENTORY SYSTEMS

There are two types of inventory systems, periodic inventory system and perpetual inventorysystem. The main differences between the two systems are as follows:

Perpetual inventory system Periodic inventory system

Purchased item is recorded in inventoryaccount

Purchased item is recorded in a purchaseaccount

When goods sold, inventory account isreduced

Purchase account is not adjusted whengoods are sold

When goods are returned to supplier, theinventory account is adjusted

A purchase return account is used forgoods returned

When goods are returned by the customers,the cost of sale account is reduced

When goods are returned by the customer,the purchase account is increased

Cost of sale amount is available all the time Cost of sale is only determined when thephysical inventory count is performed

Under the perpetual inventory system, the inventory on hand at year end can becalculated by using this formula:

inventory at the beginning of the period + purchases during the period cost of sales= inventory at the end of the period

This balance can then be verified by performing a stock count, any differencebetween the physical stock count and theoretical amount (determined by the formulaor on an entitys system) will most likely be as a result of theft and/or losses and/orcalculation errors.

Assume that the opening balance of inventory on hand as at 30 June 2009 was R55,000. During the period, the entity purchased inventory to the value of R215, 000.

The physical stock count as at 30 June 2010 reflected 30,000 units on hand at R6 perunit.

Assume that the 15,000 units were sold during the period at R7 per unit.

Cost of inventory sold (cost of sales): R90,000 (15,000 x R6)

Value of sales: R105,000 (15,000 x R7)

The closing balance of inventory on hand (theoretical) as at 30 June 2010 will be:

R55,000 + R215,000 R90,000 = R180,000

Units on hand will be 30,000 at R6 per unit.


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13. ENTITY-SPECIFIC GUIDANCE

Entity-specific guidance has been included where appropriate to provide specific guidanceon a subject that only relates to those types of entities.

13.1 Municipalities

Accounting for water stock by municipalities

Water stock must be accounted for as inventory. This will include water purchased and notyet sold at reporting date insofar as it is stored (controlled) in reservoirs and pipes at year

end. Water stock also includes any water purification costs incurred for non-purchasedwater. Pre-purified, non-purchased water should not be capitalised as part of inventory. Thecost of water purchased and not yet sold at reporting date comprises the purchase price,import duties and other taxes (other than those subsequently recoverable by the municipalityfrom the taxing authorities, such as VAT) and transport, handling and other costs directlyattributable to the acquisition of finished goods, materials and services. Importantly, tradediscounts, rebates and other similar items are deducted in determining the costs ofpurchase.

Under the periodic inventory system, the cost of sales for the period can becalculated by using this formula:

inventory at the beginning of the period + purchases during the period inventory at

the end of the period = cost of sales

The inventory account is only updated once the physical stock count is performed.

Assume that the opening balance of inventory on hand as at 30 June 2009 was R55,000. During the period, the entity purchased inventory to the value of R215, 000.

The physical stock count as at 30 June 2010 reflected 30,000 units on hand at R6 perunit, therefore R180, 000.

The cost of sales for the period ending 30 June 2010 will be:

R55,000 + R215,000 R180,000 = R90,000

As can be seen, no matter which inventory system is used, the amount for cost ofsales (R90, 000) will be the same, the method of calculation is the only difference.


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Valuation of purchased and purified water stock

Figure 3 steps for valuating water stock

Further detail on step 1:

Detailed plans of the municipalitys waterreticulation systems needs to be obtained whichindicate the length and diameter of the water pipes used in the reticulation system. Thevolume of water stored in the pipes needs to be calculated based on these detailed plans.

If detailed plans of the municipalitys water reticulation system are not available, then themunicipalitys engineering department or a consulting firm needs to be appointed for there-measurement and drafting of these plans.

All reservoirs of the municipality need to be identified and each reservoirs capacityshould be determined.

Dip readings should be taken at every reservoir as at 30 June each year.

1. The capacity (volume) of water that is stored(controlled) in reservoirs and pipes needs to be

calculated.

2. Municipalities that purify and purchase watershould determine the mix of purified vs. purchasedwater controlled by the municipality.

3. Determine what valuation methodology will best serve to valuewater on hand i.e. production cost per unit, FIFO or weighted averagemethod. The municipality must use the same cost formula for allinventories having a similar nature and use to the municipality.

4. Value purified water on hand at year end by determininga production cost per unit of water purified and thenapplying this to the volume of purified water on hand atyear end.

5. Closing inventories of purchased water, where theprice of water purchased during the year differs fromone purchase to the next, needs to be valued by usingeither the FIFO or the weighted average method.

6. Where the municipality is unable to assignpurification cost to specific volumes of waterpurified, the weighted average method will be a

more practicable approach.


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The municipality should ensure that systems are in place to determine what percentageof water on hand at year end has been purchased and what percentage has been

produced (purified).

Water stock that was purchased should be disclosed at cost in the annual financialstatements.

Purified, non-purchased water should be disclosed at purification cost in the annualfinancial statements.

Further detail on step 4: The production cost per unit must be based on:

Cost directly related to the units of production such as direct materials and direct labour.This could include expense items such as wage costs of plant workers and chemicalsused in the production process. Another example is the DWAF monthly fee paid for thevolume of water purified.

A systematic allocation of fixed production overheads, which are indirect costs ofproduction that remain relatively constant, provided the level of production approximatesnormal capacity, such as depreciation of manufacturing equipment and the productionfacility (water purification plant).

A systematic allocation of variable production overheads, which are indirect costs ofproduction that vary in accordance with variances in the volume of production. Examplesare indirect labour such as the salary of a factory foreman, and also indirect materials.


The FIFO method will most likely present the most accurate cost calculation forpurchased water as water that is purchased first is also sold first.

Thus value purchased water at year end by utilising the FIFO methodology andmultiplying purchased water on hand at year-end with the latest purchase price.

14. SUMMARY OF KEY PRINCIPLES

GRAP 12 provides guidance on the accounting treatment for inventories - the costs to berecognised in inventory as an asset and the subsequent recognition as an expense, as wellas any write-down to net realisable value. It also contains guidance on the cost formulas

used to assign costs to inventory.


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14.1 Scope

Includes: Excludes

Inventories held for sale or distribution in

the ordinary course of operation orrendering of services;

Material or supplies to be consumed inthe production process; and

Inventories to be consumed in theordinary course of operations.

Work-in-progress from construction

contracts; Financial instruments; and

Biological assets at the point of harvest.

Measurement principles excluded for:

Mining, mineral, forestry and agriculturalproducts measured at net realisablevalue; and

Inventory commodity broker-traders.

14.2 Definition and identification

To classify an asset as inventory, management should consider the definition, nature, timingand materiality of the item.

Inventory types:

Assets held for sale or distribution in theordinary course of business

E.g. finished goods

Assets in the production process for sale ordistribution

E.g. work-in-progress

Materials and supplies consumed in

production process

E.g. raw materials and consumable spare

parts

Materials and supplies consumed ordistributed in the rendering of services

E.g. consumable stores

14.3 Recognition and measurement

Inventory is recognised when it meets the definition and recognition criteria: it is probablethat future economic benefits or service potential will flow to the entity and its cost or fairvalue can be measured reliably.

Inventory is initially recognised at cost, except when it is acquired at no cost in which case itis recognised at fair value.

Inventory is reflected at the lowerof cost and net realisable value or current replacementcost where inventory is held at no or nominal charge.

Inventory is managed, accounted for and calculated by using either the perpetual or periodicinventory system.


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Once inventory is sold, consumed, distributed, etc., it is recognised as an expense in thestatement of financial performance.

Costs include:

Cost of purchase;

Cost of conversion;

Other cost; and

Excludes abnormal spillages, sellingexpenses, admin overheads, etc.

For joint-products, costs are allocatedbased on sales value.

For by-products the net realisable value isdeducted from cost of the main product.

Net realisable value:

Selling price less costs to sell;

Consider events after the reportingdate;

Consider the purpose for whichinventory is held; and

Net realisable value of raw materialonly written down if the net realisablevalue of finished goods is lower thancost

Current replacement cost:

Cost entity would incur to acquireinventory on reporting date

Cost technique: Standard cost Cost formulas: Specific identification, FIFO,Weighted average

accounting guideline_grap 012 inventory

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