ifrs: inventoriescpalicense.com/cpe_support/2015/act_ifrsinv_709_text.pdfas the name suggests, ias 2...

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IFRS: Inventories

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Publication Date – 10/15/2015

Copyright Information

Copyright 2015 by CPE Depot

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Program Description

This course presents an overview of IAS 2 Inventories, the accounting standard for classifying and measuring inventories in IFRS financial statements. This module also discusses the IASB’s and FASB’s efforts towards achieving convergence in this area of

financial reporting.

Field of Study

Accounting

Recommended CPE Credits

2 CPE Credits

Instructional Delivery Method

Self-Study

Program Level

Overview

Program Prerequisites

None

Advanced Preparation

None

Program Expiration Date

This course, including the final exam, must be completed within one year of the date of purchase or enrollment.

Instructions

In order to receive credit for this course, all students should review the learning objectives and outcomes, read and understand all program materials, answer all review questions, and complete and

pass the final exam.

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The passing score for the final exam for this course is 70% or better answered correctly. In the event that you score less than 70% correct you must retake the final exam.

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Copyright © Michael J. Walker, CPA

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Table of Contents

INVENTORIES .............................................................................................................................................1

1.0 INTRODUCTION TO IAS 2......................................................................................................................1 1.1 Objective ........................................................................................................................................1 1.2 Scope ..............................................................................................................................................1

2.0 INVENTORY CLASSIFICATIONS .............................................................................................................2 2.1 Raw materials inventory ................................................................................................................2 2.2 Work in process inventory..............................................................................................................3 2.3 Finished goods inventory ...............................................................................................................3

3.0 INVENTORY SYSTEMS...........................................................................................................................4 3.1 Perpetual inventory system ............................................................................................................4 3.2 Periodic inventory system ..............................................................................................................4 Review Questions ...................................................................................................................................6

4.0 MEASUREMENT OF INVENTORIES (PART 1) ..........................................................................................8 4.1 Items included in inventory ............................................................................................................8 4.2 Costs includes in inventory ..........................................................................................................10 Review Questions .................................................................................................................................13

5.0 MEASUREMENT OF INVENTORIES (PART 2) ........................................................................................14 5.1 Introduction to inventory cost formulas .......................................................................................14 5.2 Specific identification formula .....................................................................................................15 5.3 Average cost formula ...................................................................................................................16 5.4 First-in, first-out (FIFO) formula ................................................................................................17 Review Questions .................................................................................................................................20

6.0 MEASUREMENT OF INVENTORIES (PART 3) ........................................................................................24 6.1 Net realizable value .....................................................................................................................24 6.2 Inventory write-downs..................................................................................................................24

7.0 DISCLOSURES .....................................................................................................................................25 8.0 IFRS & U.S. GAAP CONVERGENCE ..................................................................................................26

8.1 Key differences between IFRS and U.S. GAAP – Inventories ......................................................26 8.2 Last-in, first-out (LIFO) cost formula ..........................................................................................27 Review Questions .................................................................................................................................30

9.0 SUMMARY ..........................................................................................................................................31 REVIEW QUESTION ANSWERS....................................................................................................................32 GLOSSARY .................................................................................................................................................38

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Inventories

Learning Objectives:

After studying this module participants should be able to:

Identify major classifications of inventory. Distinguish between perpetual and periodic inventory systems. Describe the items to include as inventory cost. Describe and compare the formulas used to measure inventories in IFRS financial

statements. Explain when reporting entities measure inventories at net realizable value in IFRS

financial statements.

1.0 Introduction to IAS 2

1.1 Objective

As the name suggests, IAS 2 Inventories prescribes the accounting treatment for

inventories. A primary issue in accounting for inventories is the amount of cost to be

recognized as an asset and carried forward until the related revenues are recognized. IAS

2 provides guidance on the determination of cost and its subsequent recognition as an

expense, including any write-down to net realizable value. It also provides guidance on

the cost formulas that are used to assign costs to inventories.

Accounting for inventories is important because the purchase, manufacture, and sale of

products are critical to the profitability of many companies. The cost (carrying value) of

the inventory usually has a material effect on a company’s IFRS balance sheet. Since the

ending inventory of one period is the beginning inventory of the next period, the cost of

the inventory on a company’s balance sheet will have an effect on its cost of goods sold

and net income of the next period. In addition, various accounting practices (such as

inventory cost formulas and valuation principles) are widely used and may have a

significant effect on asset valuation and income determination.

1.2 Scope

Inventories are assets of a company that are (1) held for sale in the ordinary course of

business, (2) in the process of production for sale, or (3) held for use in the production of

goods or services to be made available for sale. Inventory specifically excludes any assets

that a company does not sell in the normal course of business, such as marketable

securities, or property, plant, and equipment that the company intends to sell.

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IAS 2 specifically applies to all inventories, except:

a. Work in progress arising under construction contracts, including directly related service

contracts (see IAS 11 Construction Contracts);

b. Financial instruments (see IAS 32 Financial Instruments: Presentation and IAS 39

Financial Instruments: Recognition and Measurement); and

c. Biological assets related to agricultural activity and agricultural produce at the point of harvest (see IAS 41 Agriculture).

2.0 Inventory Classifications

A company may use several different accounts to classify inventory under IAS 2,

depending on its business:

A merchandising company, whether wholesale or retail, purchases goods for resale and does not alter their physical form. Consequently, it needs only one type of inventory

account, generally called merchandise inventory (or simply ‘inventory’).

A manufacturing company does change the physical form of the goods and typically uses three inventory accounts, generally called raw materials inventory, work in process inventory, and finished goods inventory. These classifications are discussed in further detail below.

2.1 Raw materials inventory

Raw materials inventory includes the tangible goods acquired for direct use in the

production process. The inventory includes materials that a company acquired from

natural sources, such as the iron ore used by a steel mill. Raw materials may also include

products purchased from other companies, such as the steel or subassemblies used in the

manufacture of appliances. Raw materials are different from parts inventory, which is a

term often used for the inventory of replacement parts.

Some reporting entities include in raw materials inventory those materials that are not

directly a part of the manufacturing process but are needed for it successful operation.

However, these entities often distinguish these items by classifying them as factory

supplies, manufacturing supplies, or indirect materials. Examples of such materials

include lubricating oil and cleaning supplies.

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2.2 Work in process inventory

Work in process inventory includes the products that are started in the manufacturing

process but are not yet complete. This partially completed inventory includes three cost

components:

1. Raw materials.

2. Direct labor. This term refers to the cost of the labor used directly in the manufacture of

the product.

3. Manufacturing overhead. This term refers to the costs other than raw materials and direct labor that are part of the manufacturing process. It includes variable overhead (such as supplies and some indirect labor) and fixed overhead (such as insurance, utilities, and depreciation on the assets used in the production activities).

2.3 Finished goods inventory

Finished goods inventory includes the fully manufactured products awaiting sale. The

inventory includes the same three cost components as the work in process inventory, but

all the costs are combined into a single cost per unit for all the completed units.

The exhibit below illustrates how inventory costs flow through the three categories

discussed thus far (raw materials, work in process and finished goods).

Exhibit 2.1 – Inventory Cost Flow

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As Exhibit 2.1 shows, inventory cost flows begin with the purchase of raw materials and

end with the sale of finished goods and the recognition of an expense item known as ‘cost

of goods sold’. Generally speaking, this term refers to the direct costs attributable to the

production of the inventory sold by a company. This amount includes the cost of the

materials and direct labor used in creating the goods.

3.0 Inventory Systems

Reporting entities generally use one of two types of systems for maintaining inventory

records and calculating cost of goods sold – the perpetual system or the periodic system.

3.1 Perpetual inventory system

A perpetual inventory system is an inventory system that keeps a continuous record of

the physical quantities in its inventory. Purchases and sales of inventory items are

recognized as they occur through direct adjustments to the Inventory account, allowing

management to plan and control the inventory and avoid shortages.

Under the perpetual inventory system, cost of goods sold is recorded at the time of each

sale by debiting the Cost of Goods Sold account (on the Statement of Income) and

crediting the Inventory account (on the Statement of Financial Position). The perpetual

system therefore provides a continuous record of the balances in both these accounts.

Perpetual inventory systems have evolved rapidly over the past several years with the

computerization of accounting systems. For example, most retail stores now use “point of

sale” cash register systems in which each product has a unique code (e.g. a UPC code)

that is entered into the system as each unit is sold. Some companies utilize radio

frequency identification technologies (RFID) to track inventory by attaching RFID tags.

Both UPC codes and RFID tags enable the retailer to immediately update its inventory

and cost of goods sold accounts as each sale is made.

When a reporting entity uses a perpetual system, it also generally takes a physical count

at least once a year to confirm the balance in the inventory account. Any difference

between the physical count and the inventory account balances results from errors in

recording, shrinkage, water, breakage, theft, and other causes. The company would adjust

its Inventory account and increase its Cost of Goods Sold (or recognize a loss) for the cost

of the difference in the two quantities so that the perpetual records are in agreement with

the physical count.

3.2 Periodic inventory system

A reporting entity using a periodic inventory system does not maintain a continuous

record of the physical quantities (or costs) of inventory on hand. It records all

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acquisitions of inventory during the accounting period by debiting the Purchases account.

The entity then adds the total in the Purchases account at the end of the accounting

period to the cost of the inventory on hand at the beginning of the period. This sum

equals an amount referred to as the cost of goods available for sale (during the period).

To compute the cost of goods sold, the entity then subtracts the ending inventory from the

cost of goods available for sale. Note that under the periodic inventory system, the cost

of goods sold is a residual amount that depends on a physical count of ending inventory.

This process is referred to as “taking a physical inventory.” Reporting entities that use the

periodic system generally take a physical inventory at least once a year.

Exhibit 3.1 provides an example of the cost of goods sold calculation under the periodic

inventory system.

Exhibit 3.1 – Cost of goods sold calculation (periodic system)

Beginning inventory (Jan. 1st) $100,000 Cost of goods acquired or produced during the year 800,000 Cost of goods available for sale 900,000

Ending inventory (Dec. 31st) (200,000) Cost of goods sold

$700,000

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Review Questions

1. Which of the following items would most likely be considered outside the scope of

IAS 2?

a. Company A’s raw materials inventory.

b. Company B’s manufactured goods held for sale.

c. Company C’s financial instruments portfolio.

d. Company D’s partially completed inventory items.

Beantown Corp. is a plastic toy manufacturing company that has the following items of

inventory as of December 31, 201X: (1) 5,000 toy trucks that are fully assembled and are

awaiting sale, (2) 7,000 partially assembled toy soldiers, and (2) 20,000 gallons of crude

oil reserves (used in the creation of plastic).

2. Under IAS 2, Beantown Corp. would most likely classify its fully assembled toy

trucks as:

a. Work-in-process inventory.

b. Finished goods inventory.

c. Merchandise inventory.

d. Raw materials inventory.

3. Under IAS 2, Beantown Corp. would most likely classify its partially assembled toy

soldiers as:





4. Under IAS 2, Beantown Corp. would most likely classify its crude oil reserves as:



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5. Blue Jay Inc. uses an inventory system to maintain its inventory accounting

records. Blue Jay’s system would most likely be considered a ‘perpetual inventory

system’ if which of the following were true?

a. The system records all inventory acquisitions to the Purchases account.

b. The system maintains a continuous balance in the company’s Inventory

account.

c. The system can only calculate cost of goods sold at the end of a

reporting period.

d. The system calculates cost of goods sold by subtracting the company’s

ending inventory from its cost of goods available for sale.

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4.0 Measurement of Inventories (Part 1)

IAS 2 paragraph 9 states the following:

Inventories shall be measured at the lower of cost and net realizable value.

Sections 4 and 5 will address the primary accounting issues associated with measuring

inventories at cost under IAS 2;

Section 6 will address the primary accounting issues associated with measuring

inventories at their net realizable value under IAS 2.

Measuring inventory at cost on the Statement of Financial Position under IAS 2 can be a

complex process. It requires answering the following questions:

1. Which physical goods should be included in inventory? (i.e. who owns the goods?)

2. Which costs should be included in inventory? (i.e. product costs vs. period costs)

3. Which cost flow assumption should be adopted? (i.e. specific identification, average cost, FIFO, etc.)

4.1 Items included in inventory

The transfer of legal title is the general guideline used to determine whether a company

should include an item in inventory on its IFRS financial statements. Unfortunately,

transfer of legal title and the underlying economic substance of the transaction may not

match. For example, legal title may have passed to the purchaser, but the seller of the

goods retains the economic control of the goods (i.e. the risk and rewards of ownership).

Conversely, transfer of legal title may not occur, but the economic substance of the

transaction is such that the seller no longer retains the risk and rewards of ownership.

Therefore in more complex situations, the economic substance of the transaction takes

precedence over its legal form to determine whether the buyer or the seller has economic

control.

Goods are often shipped under one of two alternatives: FOB (free-on-board) shipping

point or FOB destination. When goods are in transit at the end of the accounting period,

the terms of shipment determine whether the seller or the buyer includes them in its

inventory:

If the goods are shipped FOB shipping point, control of (and legal title to) the goods is

transferred at the shipping point when the seller delivers them to the buyer (or to a

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transportation company that is acting as an agent for the buyer). The buyer has economic control and includes those goods in its inventory, and the seller excludes them.

If the goods are shipped FOB destination, control of (and legal title to) the goods is not

transferred until the goods are delivered to the buyer’s destination. The seller has economic control and includes those goods in its inventory, and the buyer excludes them.

Exhibit 4.1 – FOB Shipping Point vs. FOB Destination

Economic control may also transfer before or after physical possession (and legal

ownership) transfer. For example, suppose the buyer requests that the seller holds the

goods to be delivered later and the goods are segregated from the seller’s other inventory

so that the risk of ownership has passed to the buyer. In this case, control has passed, and

the seller should exclude the goods from inventory and the buyer should include them.

This is known as a “bill and hold” sale.

Also, goods may be transferred on consignment. Under this arrangement, a company

such as Boston Corp. (the consignor) ships various merchandise to New York Inc. (the

consignee), who acts as Boston’s agent in selling the consigned goods. New York Inc.

agrees to accept the goods without any liability, except to exercise due care and

reasonable protection from loss or damage, until it sells the goods to a third party. When

New York Inc. sells the goods, it remits the revenue (less a selling commission and

expenses incurred in accomplishing the sale) to Boston Corp. In this example, the

consignor (Boston Corp.) retains economic control and ownership of the consigned goods

while the consignee (New York Inc.) attempts to sell them. The consignor includes the

goods in its inventory until they are sold by the consignee.

In summary, the transfer of legal title usually determines when the seller records the sale

of goods and the buyer records the inventory in their respective accounting systems.

However, both companies should adjust the recorded amounts in situations where the

possession of legal title is not consistent with economic control on the balance sheet date.

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4.2 Costs includes in inventory

Reporting entities generally account for the acquisition of inventories on a cost basis. The

cost of inventory is the price paid or consideration given to acquire it. Under IAS 2,

inventory cost includes costs directly or indirectly incurred in bringing an item to its

existing condition and location. For each item of inventory (purchased or manufactured),

a reporting entity must make a decision as to whether or not each cost meets this

definition. If it does, the entity includes it in the cost of inventory. If it does not, the entity

immediately recognizes it as an expense.

Such costs include product costs and period costs, as well as purchase discounts (when

applicable).

Product Costs


The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition.

The costs described in the above paragraph are commonly referred to as product costs,

which are those costs that “attach” to the inventory. As a result, product costs are

recognized as “Inventories” in IFRS financial statements. These costs are directly

connected with bringing the goods to the buyer’s place of business and converting such

goods to a salable condition.

The term “all costs of purchase” used in IAS 2 includes:

1. The purchase price, 2. Import duties and other taxes, 3. Transportation costs, and 4. Handling costs directly related to the acquisition of the goods.

Conversion costs generally include direct materials, direct labor, and manufacturing

overhead costs. Manufacturing overhead costs include indirect materials, indirect labor,

and various costs (such as depreciation, taxes, insurance, and utilities).

“Other costs” include costs incurred to bring the inventory to its present location and

condition ready to sell. An example of these other costs is the costs to design a product

for specific customer needs.

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Period Costs

Period costs are those costs that are indirectly related to the acquisition or production of

goods. Period costs (such as selling expenses and administrative expenses) are therefore

not included as part of the inventory costs.

IAS 2 paragraph 15 provides examples of “period costs”:

Examples of costs excluded from the cost of inventories and recognized as expenses in the period in which they are incurred are:

a. abnormal amounts of wasted materials, labor or other production costs; b. storage costs, unless those costs are necessary in the production

process before a further production stage; c. administrative overheads that do not contribute to bringing inventories to

their present location and condition; and d. selling costs.

Purchase Discounts

Purchase discounts are reductions in the selling prices granted to customers. These

discounts may be used to provide an incentive for a first-time purchaser or as a reward for

a large order. In some cases, incentives are provided to encourage early payment. There

has been some diversity in practice regarding the U.S. GAAP accounting for these

discounts, with some entities recording the discount as a reduction in inventory while

others treating the discount as revenue. However these discounts must be recorded as a

reduction from the cost of inventories (and not as revenue) under IFRS.

IFRS reporting entities may account for this cost reduction using one of two methods: the

gross price method or the net price method.

Under the gross price method, a reporting entity records the purchase at the gross price

and records the amount of the discount in the accounting system only if the discount is taken. This discount should be deducted from the purchase price of the inventory.

Under the net price method, a reporting entity records the purchase at its net price and records the amount of the discount in the accounting system only if the discount is not

taken. This discount lost is treated as an expense and is reported in the “Other income and expense” section of the income statement.

The gross price and net price methods are illustrated in the exhibit below. Assume that a

company purchases $1,000 of goods under terms of 1/10, n/30 (a 1% discount is allowed

if payment is made within 10 days; otherwise, full payment is due within 30 days).

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Exhibit 4.2 – Purchase Discounts: Gross Price Method vs. Net Price Method

Some prefer the net price method because (1) it provides a correct reporting of the cost of

the asset and related liability, and (2) it can measure management inefficiency by holding

management responsible for discounts not taken. However many believe that the

somewhat more complicated net method is not justified by the resulting benefits. As a

result, the gross method is the much more widely used method.

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Review Questions

6. Met Corp. is an online sporting goods retailer. The company’s orders are received

exclusively through its website, and its products are shipped “FOB destination” to

customers. Under IAS 2, Met Corp. would relinquish economic control of its

merchandise after which of the following events occur?

a. The company purchases the raw materials necessary to create the

products.

b. The products are fully manufactured.

c. The company receives the purchase order through its website.

d. The products are delivered to the customer’s destination.

7. Companies A, B, C & D are assessing whether or not to include certain

expenditures in the cost bases of its inventories under IAS 2. Which of the following

inventory accounting practices would most likely comply with the Standard’s

requirements?

a. Company A includes conversion costs in its inventory cost basis.

b. Company B excludes the product’s purchase price from its inventory cost

basis.

c. Company C includes selling and administrative expenses in its inventory

cost basis.

d. Company D excludes direct labor costs from its inventory cost basis.

8. Philly Inc. recently purchased some wholesale goods from East Corp. The terms of

the purchase order stated that Philly would receive a 2% discount if payment was

made to East Corp. within 10 days. However due to an accounting system error,

the payment was not made until 30 days after the purchase date. Assuming that

Philly uses the net price method, which of the following best describes the proper

accounting treatment for this purchase discount under IAS 2?

a. The company must recognize the lost discount as revenue.

b. The company must not recognize the lost discount on its IFRS financial

statements.

c. The company must recognize the lost discount as an expense.

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d. The company must add the lost discount to the purchase price of the

inventory.


5.1 Introduction to inventory cost formulas

Exhibit 5.1 – Inventory Unit and Cost Flow Relationships

A reporting entity typically starts an accounting period with some units in the beginning

inventory and then purchases (or produces) additional units during the period. Together

these are the goods available for sale, which the company then either sells or retains in its

ending inventory.

For IFRS financial statement purposes, a company must assign costs to these units. The

cost of the beginning inventory (i.e. the cost of the ending inventory of the preceding

period) is the beginning balance in the Inventory account. As discussed previously, the

beginning balance in Inventory plus the cost of purchases is the cost of goods available

for sale. Under IAS 2, this total cost is allocated between the cost of goods sold and

ending inventory using a cost formula.

Consider the following example of Patriot Corp., which had the following transactions in

its first month of operations:

Date Purchases Sold or issued Balance

March 2 2,000 @ $4.00 2,000 units March 15 6,000 @ $4.40 8,000 units March 19 4,000 units 4,000 units March 30 2,000 @ $4.75 6,000 units

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From this information, Patriot Corp. computes the ending inventory of 6,000 units and

the cost of goods available for sale (beginning inventory + purchases) of:

900,43$75.4$@000,240.4$@000,600.4$@000,2

The question is which price (or prices) should the company assign to the 6,000 units of

ending inventory? The answer depends on which cost formula it uses. The cost formulas

permitted by IAS 2 include specific identification, average cost and first-in, first-out

(FIFO).

5.2 Specific identification formula

Specific identification calls for identifying each item sold and each item in inventory. A

company includes in cost of goods sold the costs of specific items sold. It includes in

inventory the costs of the specific items on hand. This formula may be used only in

instances where it is practical to separate physically the different purchases made. As a

result, most companies only use this formula when handling a relatively small number of

costly, easily distinguishable items. In the retail trade, this includes some types of

jewelry, fur costs, automobiles, and some furniture. In manufacturing, it includes special

orders and many products manufactured under a job cost system.

To illustrate, assume that Patriot Corp.’s 6,000 units of inventory consists of 1,000 units

from the March 2 purchase, 3,000 units from the March 15 purchase, and 2,000 from the

March 30 purchase. Patriot Corp. would compute its ending inventory and cost of goods

sold as follows.

Exhibit 5.2 – Measuring Inventories using the Specific Identification Formula

Date No. of Units Unit Cost Total Cost

March 2 1,000 $4.00 $4,000 March 15 3,000 4.40 13,200 March 30 2,000 4.75 9,500 Ending inventory 6,000 $26,700

Cost of goods available for sale (computed in the section 5.1)

$43,900

Less: Ending inventory (26,700) Cost of goods sold $17,200


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The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs.

Conceptually, the specific identification formula is ideal because it matches actual costs

against actual revenue and results in ending inventory being reported at its actual cost.

Therefore IAS 2 requires the use of this formula in cases where inventories are not

ordinarily interchangeable or for goods and services produced or segregated for specific

projects. Unfortunately for most companies, the specific identification formula is not

practicable. Only in situations where inventory turnover is low, unit price is high, or

inventory quantities are small are the specific identification criteria met.

5.3 Average cost formula

As its name implies, the average cost formula prices items in the inventory on the basis

of the average cost of all similar goods available during the period. There are two

versions of the average cost formula: the weighted-average formula (for periodic

inventory systems) and the moving-average formula (for perpetual inventory systems).

Weighted-average formula

When a reporting entity uses the periodic inventory system, the average cost formula is

known as the weighted-average formula. The entity calculates the cost of the units for the

period based on the cost of the beginning inventory and the average cost of the units

purchased or manufactured, weighted according to the number of units at each cost. In

other words, the average cost per unit for the period is the cost of goods available for

sale divided by the number of units available for sale. Under IAS 2, the reporting entity

would use this average cost for both its ending inventory and cost of goods sold.

To illustrate, Patriot Inc. computes the ending inventory and cost of goods sold as

follows.

Exhibit 5.3 – Measuring Inventories using the Weighted-average Formula


March 2 2,000 $4.00 $8,000 March 15 6,000 4.40 26,400 March 30 2,000 4.75 9,500 Total goods available 10,000 $43,900

Weighted-average cost per unit = $43,900 / 10,000 units = $4.39

Inventory in units 6,000 units Ending inventory 6,000 * $4.39 = $26,340


$43,900

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In computing the average cost per unit, Patriot Corp. includes its beginning inventory (if

any), both in the total units available and in the total cost of goods available.

Moving-average formula

When a reporting entity uses the perpetual inventory system, the average cost formula is

known as the moving-average formula. This formula applies the same principles as the

weighted average formula; however, it is known as the “moving” average formula

because a new weighted average cost must be computed after each purchase.

To illustrate, Patriot Inc. computes the ending inventory and cost of goods sold as

follows.

Exhibit 5.4 – Measuring Inventories using the Moving-average Formula

Date Purchased Sold/Issued Balance

March 2 2,000 @ $4.00 $8,000 2,000 @ $4.00 $8,000 March 15 6,000 @ $4.40 26,400 8,000 @ $4.30 34,400 March 19 4,000 @ $4.30

$17,200 4,000 @ $4.30 17,200

March 30 2,000 @ $4.75 9,500 6,000 @ $4.45 26,700

In this formula, Patriot Corp. computes a new average unit cost each time it makes a

purchase. For example, on March 15th, after purchasing 6,000 units for $26,400, Patriot

Corp. has 8,000 units costing $34,400 (i.e. $8,000 plus $26,400) on hand. The average

unit cost is $34,400 divided by 8,000 units, or $4.30. Patriot Corp. uses this unit cost in

measuring withdrawals until it makes another purchase. At that point, Patriot Corp.

computes a new average unit cost. Accordingly, the company shows the cost of the 4,000

units withdrawn on March 19 at $4.30, for a total cost of goods sold of $17,200. On

March 30, following the purchase of 2,000 units for $9,500, Patriot Corp. determines a

new unit cost of $4.45, for an ending inventory of $26,700.

5.4 First-in, first-out (FIFO) formula

The FIFO (first-in, first-out) formula assumes that a company uses goods in the order

in which it purchases them. In other words, the FIFO formula assumes that the first goods

purchased are the first used or sold (and therefore the first costs incurred are the first

transferred to cost of goods sold). The inventory remaining must therefore represent the

most recent costs.

Exhibit 5.5 – FIFO cost flow assumptions

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To illustrate, assume that Patriot Corp. uses a periodic inventory system. The company

determines the cost of its ending inventory by taking the cost of the most recent purchase

and working back until it accounts for all units in the inventory. Patriot Corp. then

determines its ending inventory and cost of goods sold as follows.

Exhibit 5.6 – Measuring Inventories using the FIFO Formula (Periodic)


March 30 2,000 $4.75 $9,500 March 15 4,000 4.40 17,600 Ending inventory 6,000 $27,100


$43,900


If Patriot Corp instead uses a perpetual inventory system in quantities and dollars, it

assigns a cost amount to each withdrawal. Then the cost of the 4,000 units removed on

March 19 consists of the cost of the items purchased on March 2 and March 15. Patriot

Corp. determines its ending inventory and cost of goods sold as follows.

Exhibit 5.7 – Measuring Inventories using the FIFO Formula (Perpetual)


March 2 2,000 @ $4.00 $8,000 2,000 @ $4.00 $8,000 March 15

6,000 @ $4.40

26,400

2,000 @ $4.00 6,000 @ $4.40

34,400

March 19

2,000 @ $4.00 2,000 @ $4.40

$16,800

4,000 @ $4.40

17,600

March 30

2,000 @ $4.75

9,500

4,000 @ $4.40 2,000 @ $4.75

$27,100

Here, the ending inventory is $27,100, and the cost of goods sold is $16,800 [i.e. (2,000

@ 4.00) + (2,000 @ $4.40)].

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Notice that the cost of goods sold ($16,800) and ending inventory ($27,100) are the same

in the two FIFO examples provided. In all cases where FIFO is used, the inventory and

cost of goods sold would be the same at the end of the month whether a perpetual or

periodic system is used. This is because the same costs will always be first in and,

therefore, first out. This is true whether a company computes cost of goods sold as it sells

goods throughout the accounting period (the perpetual system) or as a residual at the end

of the accounting period (the periodic system).

One objective of FIFO is to approximate the physical flow of goods. When the physical

flow of goods is actually first in, first out, the FIFO method closely approximates specific

identification. At the same time, it prevents manipulation of income. With FIFO, a

company cannot pick a certain cost item to charge to expense.

Another advantage of the FIFO method is that the ending inventory is close to current

cost. The first goods in are the first goods out, and therefore the ending inventory consists

of the most recent purchases. This is particularly true with rapid inventory turnover. This

approach generally approximates replacement cost on the IFRS statement of financial

position (a.k.a. the balance sheet) when price changes have not occurred since the most

recent purchases.

However, the FIFO method fails to match current costs against current revenues on the

income statement. A company charges the oldest costs against the more current revenue,

possibly distorting gross profit and net income.

20

Review Questions

Brave Corp. uses the specific identification formula for calculating its ending inventory

and cost of goods sold under IAS 2. The company had the following transactions during

the month ended July 31, 201X (the company’s first month of operations):

Date Purchases Sold or Issued Balance

July 1 3,000 @ $5.00 3,000 units

July 19 1,000 units 2,000 units

July 26 2,000 @ $5.50 4,000 units

9. Based on the information provided above, Brave Corp.’s cost of goods available

for sale for the month ended July 31, 201X equals:

a. $21,000.

b. $25,000.

c. $26,000.

d. $27,500.

10. Based on the information provided above, Brave Corp. would report $________

ending inventory on its IFRS balance sheet for July 31, 201X.

a. $20,000.

b. $21,000.

c. $22,000.

d. $23,000.

11. Based on the information provided above, Brave Corp.’s cost of goods sold for

the month ended July 31, 201X equals:

a. $5,000.

b. $5,500.

c. $11,000.

d. $15.000.

21

Marlin Inc. uses a periodic inventory system and the average cost formula for

calculating its ending inventory and cost of goods sold under IAS 2. The company had

the following transactions during the month ended December 31, 201X (the

company’s first month of operations):


December 3 10,000 @ $4.25 10,000 units

December 8 13,000 @ $4.50 23,000 units

December 16 17,000 units 6,000 units

December 30 15,000 @ $5.00 21,000 units

12. Based on the information provided above, Marlin Inc.’s cost of goods available

for sale for the month ended December 31, 201X equals:

a. $161,500.

b. $171,000.

c. $176,000.

d. $190,000.

13. Based on the information provided above, Marlin Inc. would report

approximately $________ ending inventory on its IFRS balance sheet for December

31, 201X.

a. $60,211.

b. $69,474.

c. $78,737.

d. $97,263.

14. Based on the information provided above, Marlin Inc.’s cost of goods sold for the

month ended December 31, 201X equals:

a. $78,737.

b. $97,263.

c. $106,526.

d. $115,789.

22

National Corp. uses a periodic inventory system and the first-in, first-out (FIFO) formula

for calculating its ending inventory and cost of goods sold under IAS 2. The company

had the following transactions during the month ended May 31, 201X (the company’s

first month of operations):


May 5 8,000 @ $6.50 8,000 units

May 12 3,000 @ $7.00 11,000 units

May 20 6,000 units 5,000 units

May 30 4,000 @ $7.25 9,000 units

15. Based on the information provided above, National Corp.’s cost of goods

available for sale for the month ended May 31, 201X equals:

a. $97,500.

b. $102,000.

c. $105,000.

d. $108,750.

16. Based on the information provided above, National Corp. would report

approximately $________ ending inventory on its IFRS balance sheet for May 31,

201X.

a. $58,500.

b. $61,200.

c. $63,000.

d. $65,250.

17. Based on the information provided above, National Corp.’s cost of goods sold for

the month ended May 31, 201X equals:

a. $39,000.

b. $40,800.

c. $42,000.

d. $43,500.

24



Inventories shall be measured at the lower of cost and net realizable value. (Emphasis added)

Inventories are recorded at their historical cost. However, if inventory declines in value

below its original cost, a major departure from the historical cost principle occurs.

Whatever the reason for this decline – obsolescence, price-level changes, or damaged

goods – a company should write down the inventory to net realizable value to report this

loss. Under IAS 2, a reporting entity abandons the historical cost principle when the

future utility (i.e. revenue-producing ability) of the asset drops below its original cost.

6.1 Net realizable value

Under IAS 2, cost is the acquisition price of inventory computed using one of the

historical cost-based methods – specific identification, average cost or FIFO. The term

net realizable value (NRV) refers to the net amount that a company expects to realize

from the sale of inventory. Specifically, IAS 2 states the following:

Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale.

To illustrate, assume that Yawkey Corp. has unfinished inventory with a cost of $950, a

sales value of $1,000, estimated cost of completion of $50, and estimated selling costs of

$200. Yawkey’s net realizable value is computed as follows: Exhibit 6.1 – Computation of Net Realizable Value

Inventory value – unfinished $1,000 Less: Estimated cost of completion ($50) Less: Estimated cost to sell ($200) ($250) Net realizable value $750

6.2 Inventory write-downs


When inventories are sold, the carrying amount of those inventories shall be recognized as an expense in the period in which the related revenue is recognized. The amount of any write-down of inventories to net realizable value and all losses of inventories shall be recognized as an expense in the period the write-down or loss occurs. The amount of any

25

reversal of any write-down of inventories, arising from an increase in net realizable value, shall be recognized as a reduction in the amount of inventories recognized as an expense in the period in which the reversal occurs.

As illustrated in Exhibit 6.1, Yawkey reports its inventory on its IFRS statement of

financial position at $750. In its IFRS income statement, Yawkey would report a Loss on

Inventory Write-Down of $200 (i.e. $950 - $750). A departure from cost is justified

because inventories should not be reported at amounts higher than their expected

realization from sale or use. In addition, IAS 2 requires reporting entities to charge the

loss of utility against revenues in the period in which the loss occurs, not in the period of

sale.

After inventories have been written down under IAS 2, a new assessment is made of the

net realizable value in each subsequent period. When the circumstances that previously

caused inventories to be written down below cost no longer exist or when there is clear

evidence of an increase in net realizable value because of changed economic

circumstances, the amount of the write-down is reversed (i.e. the reversal is limited to the

amount of the original write-down) so that the new carrying amount is the lower of the

cost and the revised net realizable value. This occurs, for example, when an item of

inventory that is carried at net realizable value, because its selling price has declined, is

still on hand in a subsequent period and its selling price has increased.

7.0 Disclosures

IFRS financial statements should include the following inventory-related disclosures (per

IAS 2 p. 36):

a. The accounting policies adopted in measuring inventories, including the cost formula

used;

b. The total carrying amount of inventories and the carrying amount in classifications appropriate to the entity;

c. The carrying amount of inventories carried at net realizable value;

d. The amount of inventories recognized as an expense during the period (through cost of goods sold);

e. The amount of any write-down of inventories recognized as an expense in the period;

f. The amount of any reversal of any write-down that is recognized as a reduction in the amount of inventories recognized as expense in the period;

g. The circumstances or events that led to the reversal of a write-down of inventories; and

h. The carrying amount of inventories pledged as security for liabilities.

26

This information can be disclosed in the statement of financial position or in a separate

schedule in the notes. The relative mix of raw materials, work in process, and finished

goods helps in assessing liquidity and in computing the stage of inventory completion.

Significant or unusual financing arrangements relating to inventories may require note

disclosure. Examples include transaction with related parties, product financing

arrangements, firm purchase commitments, and pledging of inventories as collateral.

8.0 IFRS & U.S. GAAP Convergence

Since 2002, the Financial Accounting Standards Board (FASB) and the International

Accounting Standards Board (IASB) have had formal convergence projects in the works.

The term convergence refers to the efforts by the IASB and FASB to reduce the

numerous differences that exist between IFRS and U.S. GAAP. These convergence

projects are designed to bring U.S. GAAP and IFRS closer together; the ultimate goal of

‘convergence’ is to create a single set of high quality financial reporting standards.

8.1 Key differences between IFRS and U.S. GAAP – Inventories

ASC 330 Inventory is the primary source of guidance on accounting for inventories

under U.S. GAAP.

Both U.S. GAAP and IFRS define inventories as assets that are (1) held for sale in the

ordinary course of business, (2) used in the process of production for sale, or (3)

materials or supplies to be consumed in the production of inventory or in the rendering of

services. The cost of inventory under both U.S. GAAP and IFRS generally includes direct

expenditures of getting inventories ready for sale, including overhead and other costs

attributable to the purchase or production of inventory.

The following table summarizes the key differences between IAS 2 and ASC 330.

Exhibit 8.1 – Key differences between IFRS 8 and ASC 280

Subject IAS 2 ASC 330

Measurement of carrying value

Lower of cost or net realizable value.

Lower of cost or market.

Cost formulas: similar inventories

The same formula used to determine the cost of inventory must be applied to all inventories that have a similar nature and use to the entity.

The same formula used to determine the cost of inventory does not need to be applied to all inventories that have a similar nature and use to the entity.

Cost formulas permitted FIFO and weighted-average cost are acceptable

First-in, first-out (FIFO); last-in, first-out (LIFO); weighted-

27

accounting methods for determining cost of inventory; LIFO is not permitted. The

specific identification method is required for inventory items that are not ordinarily interchangeable and for goods or services produced and segregated for specific projects.

average cost; and specific identification are acceptable accounting methods for determining cost of inventory.

Reversal of write-downs Write-downs taken to reduce inventories to the lower of cost or net realizable value are reversed for subsequent increases in value.

Write-downs taken to reduce inventories to the lower of cost or market may not be reversed for subsequent increases in value.

Although a lower-of-cost-or-market approach is used under ASC 330 to determine the

carrying value of inventory, under IAS 2 a lower-of-cost-or-net-realizable-value

approach is used. Under ASC 330, the term "market" generally means current

replacement cost, except that this replacement cost should not (1) exceed net realizable

value or (2) be lower than net realizable value less a normal profit margin. Similarly to

ASC 330, IAS 2 defines net realizable value as estimated selling price less estimated

costs of completion and sale.

8.2 Last-in, first-out (LIFO) cost formula

As noted in Exhibit 8.1, a major difference between IFRS and U.S. GAAP relates to the

LIFO cost formula. U.S. GAAP permits the use of LIFO cost formula for inventory

valuation, while IFRS prohibits its use.

Under the LIFO (last-in, first out) cost formula, a reporting entity includes the most

recent inventory costs incurred in the cost of goods sold and includes the earliest costs

(part or all of which are costs incurred in previous periods) in the ending inventory.

Exhibit 8.2 – LIFO cost flow assumptions

28

Recall from Section 5.1 that Patriot Corp. had the following transactions in its first month

of operations:

Date Purchases Sold or issued Balance

March 2 2,000 @ $4.00 2,000 units March 15 6,000 @ $4.40 8,000 units March 19 4,000 units 4,000 units March 30 2,000 @ $4.75 6,000 units

If Patriot Corp. uses a periodic inventory system, it assumes that the cost of the total

quantity sold or issued during the month comes from the most recent purchases. Patriot

Corp. prices the ending inventory by using the total units as a basis of computation and

disregards the exact dates of sales or issuances. For example, Patriot Corp. would assume

that the cost of the 4,000 units withdrawn absorbed the 2,000 units purchased on March

30 and 2,000 of the 6,000 units purchased on March 15. Exhibit 8.3 shows how Patriot

Corp. computes the inventory and related cost of goods sold.

Exhibit 8.3 – Measuring Inventories using the LIFO Formula (Periodic)


March 2 2,000 $4.00 $8,000 March 15 4,000 4.40 17,600 Ending inventory 6,000 $25,600


$43,900


If Patriot Corp instead uses a perpetual inventory system in quantities and dollars, use of

the LIFO formula results in different ending inventory and cost of goods sold amounts

than the amounts calculated under the periodic method. See Exhibit 8.4.

Exhibit 8.4 – Measuring Inventories using the LIFO Formula (Perpetual)


March 2 2,000 @ $4.00 $8,000 2,000 @ $4.00 $8,000 March 15

6,000 @ $4.40

26,400

2,000 @ $4.00 6,000 @ $4.40

34,400

March 19

4,000 @ $4.40

$17,600

2,000 @ $4.00 2,000 @ $4.40

16,800

March 30

2,000 @ $4.75

9,500

2,000 @ $4.00 2,000 @ $4.40 2,000 @ $4.75

$26,300

29

The month-end periodic inventory computation presented in Exhibit 8.3 (inventory

$25,600 and cost of goods sold $18,300) shows a different amount from the perpetual

inventory computation (inventory $26,300 and cost of goods sold $17,600). The periodic

system matches the total withdrawals for the month with the total purchases for the

month in applying the last-in, first-out method. In contrast, the perpetual system matches

each withdrawal with the immediately preceding purchases. In effect, the periodic

computation assumed that Patriot Corp. included the cost of goods sold that it purchased

on March 30 in the sale or issue on March 19.

In prohibiting LIFO, the IASB noted that use of LIFO results in inventories being

recognized in the statement of financial position at amounts that may bear little

relationship to recent cost levels of inventories. While some argued for use of LIFO

because it may better match the costs of recently purchased inventory with current prices,

the Board concluded that it is not appropriate to allow an approach that results in a

measurement of profit or loss for the period that is inconsistent with the measurement of

inventories in the statement of financial position. Nonetheless, LIFO is permitted for

financial reporting purposes in the United States and is permitted for tax purposes in

some countries1.

1 IAS 2 paragraphs BC13 – BC14.

30

Review Questions

Tiger Corp. has unfinished inventory with a cost basis of $1,000,000 and an estimated

sales price of $1,200,000. Tiger estimates that it will cost them $300,000 to complete

these items and an additional $100,000 to sell them in the market.

18. The “net realizable value” of Tiger Corp.’s unfinished inventory (as defined by IAS

2) equals:

a. $600,000.

b. $800,000.

c. $900,000.

d. $1,100,000.

19. Based on the information above, Tiger Corp is required to measure its unfinished

inventory at $________ under IAS 2.

a. $800,000.

b. $1,000,000.

c. $1,100,000.

d. $1,200,000.

20. Which of the following inventory accounting practices is permitted under U.S.

GAAP but not under IFRS?

a. Company A values its ending inventory using the weighted-average cost

formula.

b. Company B uses the net price method when accounting for its purchase

discounts.

c. Company B uses the gross price method when accounting for its

purchase discounts.

d. Company D values its ending inventory using the LIFO cost formula.

31

9.0 Summary

IAS 2 Inventories prescribes the accounting treatment for inventories under IFRS. Inventories are assets of a company that are (1) held for sale in the ordinary course of business (finished goods inventory), (2) in the process of production for sale (work in process inventory), or (3) held for use in the production of goods or services to be made available for sale (raw materials).

Cost of goods sold includes the material and direct labor costs used in creating inventories. Reporting entities generally use one of two types of systems for maintaining inventory records and calculating cost of goods sold – the perpetual system or the periodic system.

Under IAS 2, inventories must be measured at the lower of cost and net realizable value.

The cost of inventory is the price paid or consideration given to acquire it. Under

IAS 2, inventory costs include product costs and period costs, as well as purchase

discounts (when applicable).

Cost formulas are used to allocate total inventory costs (i.e. the cost of goods available for sale) between the income statement (i.e. cost of goods sold) and the balance sheet (i.e.

inventories). The cost formulas permitted by IAS 2 include:

o Specific identification. This formula allocates inventory costs by identifying each item

sold and each item in inventory.

o Average cost. This formula prices items in the inventory on the basis of the average cost

of all similar goods available during the period.

o First-in, first-out (FIFO). This formula assumes that the first goods purchased are the

first used or sold (and therefore the first costs incurred are the first transferred to cost of

goods sold). The inventory remaining must therefore represent the most recent costs.

Net realizable value is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. Under IAS 2, inventories must be written down to net realizable value if this value is less than their historical cost. These write-downs are recognized as an expense in the period the write-down or loss occurs. Write-downs taken to reduce inventories to the lower of cost or net realizable value are reversed for subsequent increases in value.

ASC 330 Inventory is the primary source of guidance on accounting for inventories under U.S. GAAP.

The primary difference between ASC 330 and IAS 2 is that ASC 330 permits the use of

the last-in, first-out (LIFO) cost formula. Under the LIFO formula, a reporting entity includes the most recent inventory costs incurred in the cost of goods sold and includes the earliest costs (part or all of which are costs incurred in previous periods) in the ending inventory. IAS 2 prohibits the use of the LIFO cost formula.

32

Review Question Answers

1. C. IAS 2 specifically excludes financial instruments from its scope.

Answer A is incorrect. Raw materials inventory is included in the scope of IAS

2.

Answer B is incorrect. Manufactured goods held for sale are included in the

scope of IAS 2.

Answer D is incorrect. Partially completed inventory items (i.e. “work in

process” inventories) are included in the scope of IAS 2.

2. B. Under IAS 2, finished goods inventory includes fully manufactured

products awaiting sale.

Answer A is incorrect. The toy trucks would be considered finished goods (not

work-in-process) inventory under IAS 2 because they are fully assembled

products that are awaiting sale.

Answer C is incorrect. Beantown Corp. is a manufacturing company, and

therefore none of their inventories would be classified as merchandise

inventory under IAS 2. This designation is generally appropriate for only

merchandising companies.

Answer D is incorrect. The toy trucks would be considered finished goods (not

raw materials) inventory under IAS 2 because they are fully assembled

products that are awaiting sale.

3. A. Under IAS 2, work-in-process inventory includes products that have

started the manufacturing process but have not yet been completed.

Answer B is incorrect. The partially assembled toy soldiers have not yet

completed the manufacturing process; therefore they would not be classified

as finished goods inventory under IAS 2.





Answer D is incorrect. Work-in-process inventory (not raw materials inventory)

includes products that have started the manufacturing process but have not

yet been completed.

4. D. Under IAS 2, raw materials inventory includes the tangible goods acquired

for direct use in the production process. Beantown Corp.’s crude oil reserves

are an example of such materials as they are a basic component used in the

production of the company’s plastic toys.

Answer A is incorrect. Work-in-process inventory includes products that have

started the manufacturing process but have not yet been completed.

Beantown Corp.’s crude oil reserves do not meet this definition.

33

Answer B is incorrect. Finished goods inventory includes fully manufactured

products awaiting sale; Beantown Corp.’s crude oil reserves do not meet this

definition.





5. B. A perpetual inventory system is one that keeps a continuous record of the

physical quantities in a company’s Inventory account.

Answer A is incorrect. Under a perpetual system, purchases and sales are not

recorded to a Purchases account; rather, they are recorded directly to the

Inventory account as they occur.

Answer C is incorrect. Cost of goods sold can only be calculated at the end of a

reporting period under a periodic (not perpetual) system. Under a perpetual

system, cost of goods sold can be determined instantaneously as sales are

made.

Answer D is incorrect. This describes how cost of goods sold is calculated

under a periodic inventory system (not a perpetual system).

6. D. When goods are shipped FOB destination, control of (and legal title to) the

goods is not transferred until the goods are delivered to the buyer’s

destination. Therefore Met Corp. would maintain economic control of the

merchandise until the products are delivered to the customer’s destination.

Answer A is incorrect. Economic control of the goods would not transfer to the

customer (under FOB destination) simply because the raw materials used to

create the products have been purchased. Rather, economic control would

transfer after the finished goods have been delivered to the customer’s

destination.

Answer B is incorrect. Economic control of the goods would not transfer to the

customer (under FOB destination) simply because the goods have been fully

manufactured. Rather, economic control would transfer after the finished

goods have been delivered to the customer’s destination.

Answer C is incorrect. Economic control of the goods would not transfer to the

customer (under FOB destination) simply because the company has received a

purchase order. Rather, economic control would transfer after the finished

goods have been delivered to the customer’s destination.

7. A. Under IAS 2, reporting entities must include conversion costs (i.e. direct

materials, direct labor and manufacturing overhead costs) in the cost basis of

inventory.

Answer B is incorrect. A product’s purchase price should be included in (not

excluded from) the cost basis of inventory under IAS 2.

34

Answer C is incorrect. Selling and administrative expenses should be excluded

from (not included in) the cost basis of inventory under IAS 2.

Answer D is incorrect. Direct labor and other conversion costs should be

included in (not excluded from) the cost basis of inventory under IAS 2.

8. C. Under the net price method, lost purchase discounts are recognized as an

expense in a reporting entity’s IFRS income statement.

Answer A is incorrect. The company would recognize the lost discount as an

expense (not revenue) under the net price method.

Answer B is incorrect. The company would recognize the lost discount as an

expense under the net price method.

Answer D is incorrect. The company would recognize the lost discount as an

expense under the net price method; the discount would not be added back to

the purchase price of the inventory.

9. C. Brave Corp’s cost of goods available for sale equals $26,000, i.e. (3,000

units X $5.00) + (2,000 units X $5.50).

Answer A is incorrect. This amount is the value of Brave Corp.’s ending

inventory as of 7/31/201X (not its cost of goods available for sale).

Answer B is incorrect. This amount is the result of an incorrect calculation that

multiplies the company’s total purchases (5,000 units) by the price paid for

the units purchased on July 1 (i.e. $5.00).

Answer D is incorrect. This amount is the result of an incorrect calculation that


the units purchased on July 26 (i.e. $5.50).

10. B. Brave Corp’s ending inventory using the specific identification formula

equals (2,000 X $5.00) + (2,000 X $5.50) = $21,000. Note that the cost of

the company’s entire inventory as of 7/19 was $5.00 per unit; therefore the

company was able to specifically identify these costs when calculating the

cost of the 1,000 items that were sold on this date.

Answer A is incorrect. This amount is the result of an incorrect calculation that

multiplies the company’s ending inventory in units by the price paid for the

units purchased on July 1 (i.e. $5.00).

Answer C is incorrect. This amount is the result of an incorrect calculation that


units purchased on July 26 (i.e. $5.50).



units purchased on July 26 (i.e. $5.50) and then adds the number of units sold

on 7/19.

35

11. A. Brave Corp’s cost of goods sold using the specific identification formula

equals 1,000 units sold X $5.00 = $5,000. Note that the cost of the

company’s entire inventory as of 7/19 was $5.00 per unit; therefore the

company was able to specifically identify these costs when calculating the

cost of the 1,000 items that were sold on this date.


multiplies the number of units sold on 7/19 by the price paid for the units

purchased on July 26 (i.e. $5.50).

Answer C is incorrect. This amount is the cost of the units purchased on 7/26

(not the cost of the units sold on 7/19).

Answer D is incorrect. This amount is the cost of the units purchased on 7/1

(not the cost of the units sold on 7/19).

12. C. Marlin Inc.’s cost of goods available for sale equals (10,000 units X $4.25)

+ (13,000 units X $4.50) + (15,000 units X $5.00) = $176,000.



the units purchased on December 3 (i.e. $4.25).







13. D. Marlin Inc.’s ending inventory using the average cost formula equals

($176,000 cost of goods available for sale / 38,000 units purchased) * 21,000

units ending inventory = $97,263.


multiplies the company’s inventory purchases on 12/8 (13,000 units) by the

weighted average cost per unit ($4.6316). The ending inventory units should

instead be used in the calculation.


multiplies the company’s inventory purchases on 12/30 (15,000 units) by the

weighted average cost per unit ($4.6316). The ending inventory units should

instead be used in the calculation.

Answer C is incorrect. This amount is the company’s cost of goods sold (not

ending inventory) for the month ended 12/31/20X1.

14. A. Marlin Inc.’s cost of goods sold using the average cost formula equals

($176,000 cost of goods available for sale / 38,000 units purchased) * 17,000

units sold = $78,737.

Answer B is incorrect. This amount is the company’s ending inventory (not

cost of goods sold) for the month ended 12/31/20X1.

36


multiplies the company’s inventory purchases on 12/3 and 12/8 (23,000 total

units) by the weighted average cost per unit ($4.6316). The 17,000 units sold

on 12/16 should instead be used in the calculation.


multiplies the company’s inventory purchases on 12/3 and 12/30 (25,000 total

units) by the weighted average cost per unit ($4.6316). The 17,000 units sold

on 12/16 should instead be used in the calculation.

15. C. National Corp.’s cost of goods available for sale equals (8,000 units X

$6.50) + (3,000 units X $7.00) + (4,000 units X $7.25) = $102,000.



the units purchased on May 5 (i.e. $6.50).







16. C. National Corp. had 9,000 units in its ending inventory. Under IAS 2, these

units would be valued at $63,000 using the FIFO cost formula. This amount

equals (4,000 units X $7.25) + (3,000 units X $7.00) + (2,000 units X

$6.50).


multiplies the company’s ending units (9,000) by the price paid for the 8,000

units purchased on May 5 ($6.50).

Answer B is incorrect. This amount is the value of National Corp.’s ending

inventory using the average cost formula (not the FIFO cost formula).


multiplies the company’s ending units (9,000) by the price paid for the 8,000


17. A. The FIFO cost formula assumes that the first goods purchased by a

company are the first ones sold. Therefore National Corp.’s cost of goods sold,

which is valued using the earliest inventory price available during the

reporting period, equals 6,000 units sold X $6.50 = $39,000.

Answer B is incorrect. This amount is the value of National Corp.’s cost of

goods sold using the average cost formula (not the FIFO cost formula).


multiplies the company’s sold units (6,000) by the price paid for the 3,000


37


multiplies the company’s sold units (6,000) by the price paid for the 4,000


18. B. The net realizable value of Tiger Corp.’s unfinished inventory equals the

$1,200,000 estimated selling price – $300,000 estimated cost of completion –

$100,000 estimated selling costs = $800,000.


subtracts the estimated cost of completion and estimated selling costs from

the inventory’s cost basis (rather than the estimated selling price).


subtracts only the estimated cost of completion (and not the estimated selling

costs) from the estimated selling price to arrive at the net realizable value.


subtracts only the estimated selling costs (and not the cost of completion)

from the estimated selling price to arrive at the net realizable value.

19. A. Tiger Corp. is required to measure its unfinished inventory at net realizable

value ($800,000) under IAS 2 because this amount is less than the

inventory’s cost basis ($1,000,000).

Answer B is incorrect. The company would not measure its unfinished

inventory at cost ($1,000,000) because this amount is greater than the

inventory’s net realizable value ($800,000). IAS 2 requires entities to measure

such items at the lower of cost or net realizable value.

Answer C is incorrect. The company would measure its unfinished inventory at

net realizable value ($800,000), not at this incorrect amount.

Answer D is incorrect. The company would measure its unfinished inventory at

net realizable value ($800,000), not at the estimated selling price.

20. D. The LIFO cost formula is permitted under U.S. GAAP, but not under IFRS.

Answer A is incorrect. The weighted-average cost formula is permitted under

both U.S. GAAP and IFRS.

Answer B is incorrect. The net price method for purchase discounts is

permitted under both U.S. GAAP and IFRS.

Answer C is incorrect. The gross price method for purchase discounts is

permitted under both U.S. GAAP and IFRS.

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Glossary

Asset – 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. Average cost formula – A cost formula under IAS 2 that prices items in the inventory on the basis of the average cost of all similar goods available during the period. There are two versions of the average cost formula: the weighted-average formula (for periodic inventory systems) and the moving-average formula (for perpetual inventory systems). Cost of goods available for sale – The sum of all inventory purchases made during a reporting period plus the beginning inventory. Cost of goods sold – The direct costs attributable to the production of the inventory sold by a company. Consignment – An arrangement under which a company (the consignor) ships various merchandise to another company (the consignee), who acts as the consignor’s agent in selling the consigned goods. Convergence – Ongoing project initiated by the FASB and IASB to reduce the differences between U.S. GAAP and IFRS and ultimately create one single set of global accounting standards. Conversion costs – Costs that are directly connected with bringing goods to the buyer’s place of business and converting such goods to a salable condition. These costs generally include direct materials, direct labor, and manufacturing overhead costs. Cost formula – Under IAS 2, a method for allocating inventory costs between the income statement (i.e. cost of goods sold) and the balance sheet (i.e. ending inventory). The cost formulas permitted by IAS 2 include specific identification, average cost and first-in, first-out (FIFO). Direct labor – The cost of the labor used directly in the manufacture of a product.

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Equity – The residual interest in the assets of the entity after deducting all of its liabilities. Expenses – Decreases in economic benefits during the accounting period in the form of outflows or depletion of assets or incurrences of liabilities that result in decreases in equity, other than those relating to distributions to equity participants. The definition of expenses encompasses losses as well as those expenses that arise in the course of the ordinary activities of the entity. FIFO (first-in, first-out) formula – A cost formula under IAS 2 that assumes that the first goods purchased are the first used or sold (and therefore the first costs incurred are the first transferred to cost of goods sold). The inventory remaining must therefore represent the most recent costs. Financial Accounting Standards Board (FASB) - a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States in the public's interest. The FASB's mission is "to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information”. Financial statements – Presentation of financial data including balance sheets, income statements and statements of cash flows, or any supporting statement that is intended to communicate an entity’s financial position at a point in time and its results of operations for a period then ended. Finished goods inventory – Fully manufactured products awaiting sale. FOB (free-on-board) shipping point – A convention that determines when legal title of goods has passed from the seller to the buyer. If goods are shipped FOB shipping point, control of (and legal title to) the goods is transferred at the shipping point when the seller delivers them to the buyer (or to a transportation company that is acting as an agent for the buyer). The buyer has economic control and includes those goods in its inventory, and the seller excludes them. FOB (free-on-board) shipping point – A convention that determines when legal title of goods has passed from the seller to the buyer. If goods are shipped FOB destination, control of (and legal title to) the goods is not transferred until the goods are delivered to the buyer’s destination. The seller has economic control and includes those goods in its inventory, and the buyer excludes them.

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Generally Accepted Accounting Principles (GAAP) – Conventions, rules and procedures necessary to define accepted accounting practice at a particular time. The highest level of such principles is set by the FASB. Gross price method – A method for accounting for purchase discounts on inventory items. Under the gross price method, a reporting entity records the purchase at the gross price and records the amount of the discount in the accounting system only if the discount is taken. This discount should be deducted from the purchase price of the inventory. Income – Increases in economic benefits during the accounting period in the form of inflows or enhancements of assets or decreases of liabilities that result in increases in equity, other than those relating to contributions from equity participants. The definition of income encompasses both revenue and gains. International Accounting Standards Board (IASB) – A privately funded, London-based organization whose goal is to establish a single set of enforceable global financial reporting standards. International Financial Reporting Standards (IFRS) – International standards, interpretations and the “Framework for the Preparation and Presentation of Financial Statements” adopted by the IASB. Inventories – Assets of a company that are (1) held for sale in the ordinary course of business, (2) in the process of production for sale, or (3) held for use in the production of goods or services to be made available for sale. Liability – The present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits. LIFO (last-in, first-out) formula – A cost formula permitted under U.S. GAAP that includes the most recent inventory costs incurred in the cost of goods sold and includes the earliest costs (part or all of which are costs incurred in previous periods) in the ending inventory. Unlike U.S. GAAP, IAS 2 prohibits the use of the LIFO method. Manufacturing overhead – The costs other than raw materials and direct labor that are part of the manufacturing process. It includes variable overhead (such as supplies and some indirect labor) and fixed overhead (such as insurance, utilities, and depreciation on the assets used in the production activities).

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Materiality – A convention relating to the importance/significance of an amount, transaction, or discrepancy. Omissions or misstatements of items are material if they could (individually or collectively) influence the economic decisions that users make on the basis of the financial statements. Materiality depends on the size and nature of the omission or misstatement judged in the surrounding circumstances. Measurement – The process of determining the monetary amounts at which the elements of the financial statements are to be recognized and carried in the balance sheet and income statement. Merchandise inventory – Inventory held for resale by a merchandising company. Net price method – A method for accounting for purchase discounts on inventory items. Under the net price method, a reporting entity records the purchase at its net price and records the amount of the discount in the accounting system only if the discount is not taken. This discount lost is treated as an expense and is reported in the “Other income and expense” section of the income statement. Net realizable value – A measurement basis for inventories under IAS 2; it is the estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs necessary to make the sale. Period costs – Costs that are indirectly related to the acquisition or production of inventories. Period costs (such as selling expenses and administrative expenses) are therefore not included as part of the inventory costs. Periodic inventory system – An inventory system that does not maintain a continuous record of the physical quantities (or costs) of inventory on hand. It records all acquisitions of inventory during the accounting period by debiting the Purchases account. Perpetual inventory system – An inventory system that keeps a continuous record of the physical quantities in its inventory. Purchase discounts – Reductions in the selling prices granted to customers. Product costs – All costs of purchase, costs of conversion and other costs incurred in bringing inventories to their present location and condition.

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Raw materials inventory – Tangible goods acquired for direct use in the production process. Recognition – The process of incorporating in the balance sheet or income statement an item that meets the definition of an element and satisfies the criteria for recognition set out in the IFRS Framework. The Framework states that an item that meets the definition of an element should be recognized if (1) it is probable that any future economic benefit associated with the item will flow to or from the entity and, (2) the item has a cost or value that can be measured with reliability. Specific identification formula – A cost formula under IAS 2 that calls for identifying each item sold and each item in inventory. A company includes in cost of goods sold the costs of specific items sold. It includes in inventory the costs of the specific items on hand. Statement of cash flows – A financial statement that provides information that enables users to evaluate the changes in net assets of an entity, its financial structure (including its liquidity and solvency) and its ability to affect the amounts and timing of cash flows in order to adapt to changing circumstances and opportunities. Statement of changes in equity – A financial statement that is used to bridge the gap between the amount of equity the owners have in the business at the beginning of the accounting period and the amount of their equity at the end of the period. Statement of comprehensive income – A financial statement that presents all items of income and expense recognized in a period. Statement of financial position – A financial statement that presents an entity’s assets, liabilities and owner’s equity as of a specific date. It is also referred to as a balance sheet. Work in process inventory – Products that are started in the manufacturing process but are not yet complete. This partially completed inventory includes three cost components: raw materials, direct labor and manufacturing overhead.

ifrs: inventoriescpalicense.com/cpe_support/2015/act_ifrsinv_709_text.pdfas the name suggests, ias 2...

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