IAS 2 Inventory

IAS 2 does not apply to

• Work in progress arising under construction contracts including directly related service contracts

• Financial instruments• Biological assets relating to agricultural activity and

agricultural product at the point of harvest• Producers of agricultural and forest products, minerals

and mining products etc• Commodity broker – traders that measure their

inventories at fair value less selling costs

These are all covered under specific standards.

Definition of Inventory

• Held for sale in the ordinary course of business• In the process of production for such sale (WIP)• In the form of materials or supplies to be

consumed in the production process or the rendering of services.

Valuation of Inventory

• Physical Inventory Count at end of year – guarantees correct quantities

• Impacts on profits and tax liability in the Statement of Profit & Loss

• Strengthens the position of the Statement of Financial Position

The larger the closing inventory the smaller the cost of sales, the larger the gross profit

Trading A/C

Trading 10,000

Less cost of sales

Opening inventory 2,000

Purchases 1,500

3,500

Less Closing inventory 1,200

Cost of Sales 2,300

GROSS PROFIT 7,700

• If a company could manipulate the value of closing inventory, it could influence profit figures and tax liabilities

• Different types of inventory require different treatments. Eg specialist products, custom built items, products that mature in value over time, products that are work in progress etc

• IAS 2 was introduced to provide clarity

Fundamental Principle

• Inventory valued at the lower of Cost or NRV• Prudence – not to overstate/understate the

assets

Definition of NRV

• NET Realisable Value is the estimated selling price in the ordinary course of business, less the estimated costs of completion and the estimated cost of sale.

NRV greater than Cost but…

• NRV may be lower if…– Damaged– Obsolete– Change in market demand– Physical deterioration

Calculate NRV

• Sale Price – further costs that may be incurred to complete

the production of the item – costs to sell and distribute the item

Calculating Cost

• Costs of purchase including tax, import duty, transport and handling

– trade discount+ Cost of conversion including fixed and variable overheads+ other costs incurred in bringing the inventories to their present location and condition

Excluded from Cost

• Abnormal waste or spoilage• Factory Idle time• Storage costs – except when necessary in the

production process before a production stage. This implies that storage costs of raw materials and finished goods are excluded.

• General administration overheads• Marketing and other sales costs.

Measurement

1. Actual unit cost2. FIFO3. Weighted average costs4. Standard cost5. Retail method

Measurement

1. Actual unit cost2. FIFO3. Weighted average

costs4. Standard cost5. Retail method

• Actual Unit CostCost of each item valued individually by including all costs incurred to bring it to its present location and condition. Usually only feasible for high-valued, low-quantity inventory eg Car dealership

Measurement

1. Actual unit cost2. FIFO3. Weighted average

costs4. Standard cost5. Retail method

• First In First OutInventory is made up of the latest purchases.LIFO method banned.

Measurement

1. Actual unit cost2. FIFO3. Weighted average

costs4. Standard cost5. Retail method

• Weighted Average Weighted average purchase price over the year used to value closing inventory

Measurement

1. Actual unit cost2. FIFO3. Weighted average

costs4. Standard cost5. Retail method

• Standard CostStandard costs reviewed frequently to ensure that they bear a reasonable relationship to actual costs during the period

Measurement

1. Actual unit cost2. FIFO3. Weighted average

costs4. Standard cost5. Retail method

• Retail MethodUsed in retail for measuring large quantity of inventory with similar margins that are rapidly changing. Cost determined by using a reduced sale value.

Write down of inventory to NRV

• Where the cost of inventories may not be recoverable e.g. goods are damaged, obsolete or selling prices declined etc. then inventories are written down to value expected to be realised from their sale or use.

• Inventories are usually written down to NRV on an item by item basis.

• Losses associated with write down are an expense in the period of the write down

Reversal of Write Down

• Increase in NRV- Expense “Reversal of Write Down”

Disclosure

The financial statements should disclose the following:a) The accounting policies adopting in measuring inventories, including cost formulas.b) The total carrying amount of inventories broken into appropriate classificationsc) The carrying amount at fair value less costs to dated) The amount expended in the periode) The amount of any writedowns of inventoriesf) The amount of any reversal of any writedowns.g) The circumstances or events that led to the writedown(s).h) The carrying amount of inventories pledged as security for liabilities Common classifications include retail merchandise, production supplies, materials, work in progress and finished goods.

Q1

• Inventories should be valued at the lower of Cost or NRV

Q2

• Stock cost 60,000• NRV 40,000• 40,000 x 2.5% = 1,000• Write down = 20,000 + 1,000 = 21,000

Journal Dr Cr

Inventory Write Down Expense A/C (P&L)

21,000

Inventory A/C (SFP) 21,000

Being the write down of slow moving stock

Q3

• The following costs cannot be included as part of the cost of inventory:– Selling costs

Q4• + receivables 55,000• + sales 50,000• + VAT 5,000

• + Expense 45,000• - CA inventory 45,000

Journal Dr Cr

Receivables 55,000

Sales 50,000

VAT 5,000

Being the sale of goods on credit not accounted for

Journal Dr Cr

Inventory Expense (P&L)

45,000

Inventory (SFP) 45,000

Being the correction of overestimation of closing stock

Q5• Write down 300,000

• 300,000 x 50% = 150,000 Insurance receivable CA

• Recoverable value

Journal Dr Cr

Insurance Compensation Receivable (SFP)

150,000

Compensation receivable (SPL)

150,000

Being the compensation for stock destroyed in fire

Journal Dr Cr

Inventory expenses (P&L)

300,000

Inventory (SFP) 300,000

Being the write down of stock destroyed in fire

Q6• + receivables 50 x 280• + sales 50 x 280

• 700 x 280 = 196,000• 750 x 300 = 225,000Adjustment 29,000• + expense• - CA inventory

Journal Dr Cr

Receivables 14,000

Sales 14,000

Being the sale of goods on credit not accounted for

Journal Dr Cr

Inventory expense (P&L)

29,000

Inventory (SFP) 29,000

Being the write down of inventory to NRV

Q7NRV P Q

Selling Price 150 295

Sales & Marketing (15) (18)

Delivery to customer (21) (40)

NRV 114 237

Cost P Q

Purchase Cost 100 200

Delivery from Supplier 20 30

Import Duty 1.20 2.60

COST 121.20 232.60

Q9Week Qty € € Balance

Open 140 10 1,400

Week 1 Bought 140 13 1,820 3,220

Week 2 Used -195 140 x 10 1400

55 x 13 715

2115 1105

Week 3 Bought 80 11 880 1985

Week 4 Used -100 85 x 13 1105

15 x 11 165

1270 715

Balance 65

AVCO

(140 * 10) + (140 * 13) 11.50 11.50 * 195 2242.50 (140 * 10) + (140 * 13) + (80*11)

280 360

(85*11.50) + (80*11) 11.61 11.61 * 100 1160.00 4100/360 = 11.39

160 65 * 11.39 = 740.27

Q10

• IAS 2 states that inventory be measured as the lower of cost or Net Realisable Value

• Cost = cost of purchase and cost of conversion• NRV = actual or estimated selling price less

and further costs of conversion

Cost NRV

Materials 15,000 Selling Price 250

Labour 20,000 Less Marketing Costs 25

Depreciation 10,000 1 table 225

Factory Rates 5,000 50 x 225 11,250

Factory Expenses 10,000

Other production Expenses 5,000

500 tables 6,500

1 table 130

50 x 130 6,500