IAS 2 INVENTORY (F3)
LEARNING OBJECTIVE
I.INVENTORY IN THE FINANCIAL STATEMENTS
II.YEAR-END INVNETORY ADJUSTMENTS
III.TYPES OF INVENTORY
IV.IAS 2 INVENTORIES
V.METHODS OF CALCULATING THE COST OF INVENTORY
I. INVENTORY IN THE FINANCIAL STATEMENTS
| $ | $ | |
| Revenue | x | |
| Opening Inventory | X | |
| Purchases | X | |
| Less: Closing Inventory | (x) | |
| Cost of Sales/cost of goods sold | (x) | |
| Gross Profit | x |
At the beginning of the financial year a business has $1,500 of inventory left over from the preceding accounting period. During the year they purchase additional goods costing $21,000 and make sales totaling $25,000. At the end of the year there are $3,000 of goods left that have not been sold.
Prepare extracts of income statement and statement of financial position.
II. YEAR-END INVNETORY ADJUSTMENTS
Cost of sale (Dr) = BB inventory ( 1.Dr. cost of sale ) + purchase (3. Dr. cost of sale)– ending inventory (2. Cr. cost of sale )
1.Inventory brought forward or opening inventory must be removed:
Dr. Cost of sales (cost of goods sold)
Cr. Inventory asset
2.Unused inventory at the end of the year is removed from purchase costs and carried forward as an asset into the next year.
Dr. inventory assets
Cr. Cost of sales
III. TYPES OF INVENTORY
Inventory consist of :
-Goods purchased for resale
-Consumable stores ( such as oil)
-Raw Material and components ( used in the production process)
-Partly-finished goods ( usually called Work in progress-WIP)
-Finished goods (manufactured by the business)
IV. IAS 2 INVENTORIES
IAS2 Inventories states that inventory is valued in the statement of financial position at the lower of cost and net realisable value (NRV).
Cost includes:
-Cost of purchase – material costs, import duties, freight. Less: trade discounts (buying in bulk or regular customer, but not settlement discounts)
-Cost of conversion- direct costs and production overheads. ( Direct cost: Labour cost, sundry material costs. Production overhead: heating and light, salary of supervisors, depreciation of plant, etc.)
Costs are excluded:
-Selling costs/marketing expense
-Storage costs
-Abnormal waste of materials, labour or other costs
-Administrative overheads.
NRV
Net realisable value is estimated as follows.
| $ | $ | |
| Selling Price ( also referred to fair value) | X | |
| Less:
Trade discounts All further costs to completion (eg. WIP) All marketing, selling and distribution costs |
(X) (X) (x) |
|
| Net realisable value | xx |
This definition ensures that all costs of selling the product are taken into account, such as discount, marketing and delivery costs.
IAS 2 disclosure requirements:
IAS 1 Presentation of Financial Statements require that companies disclose the accounting policies adopted in preparing the financial statements, including those used to account for inventories.
An example of a specimen disclosure note is as follows (note 1)
Inventories are valued at the lower of cost and net realisable value for each seprate product or item. Cost is determined by recognizing all costs required to get inventory to its location and condition at the reporting date and is applied on a ‘ first in, first out’ basis. Net realisable value is the expected selling price of inventory, less any further costs expected to be incurred to achieve the sale.
| $000 | |
| Raw materials | 200 |
| Work in progress | 600 |
| Finished goods | 350 |
| 1,050 |
Within the carrying amount of inventories, the amount carried at net realisable value is $150,000.
NRV Compared to cost
When following the rule of valuing inventory at the lower of cost and net realisable value, the valuation should normally be done on an item by item basis.
The comparison may, however, be made on a category by category basis where relevant.
| Item | Cost | NRV | Valuation (lower of Cost and NRV) |
| A | $2,000 | Item to be sold for $3,500. no other costs are anticipated, so NRV=$3,500 | $2,000 |
| B | $500 | Item to be sold for $600. Selling costs will be $50 and a 10% trade discount, so NRV=$600-50-60=$490 | $490 |
| Total | $2,500 | $3,990 | $2,490 |
Cole’s business sells three products X, Y and Z. the following information was available at the year-end:
| X | Y | Z | |
| $ | $ | $ | |
| Cost | 7 | 10 | 19 |
| Fair Value less further costs to sell (NRV) | 10 | 8 | 15 |
| Units | 100 | 200 | 300 |
What was the value of the closing inventory ?
Hurricane, an entity, has 1,500 units of product Y at 30 June 20X8. The product had been purchased at a cost of $30 per unit and normally sells for $40 per unit. Recently, product Y started to deteriorate and can now be sold for only $38 per unit, provided that some rectification work is undertaken at a cost of $10 per unit.
What was the value of inventory at 30 June 20X8?
V. METHODS OF CALCULATING THE COST OF INVENTORY
When items of inventory are individually distinguishable and of high value.
We will use unit cost ( actual cost or specific cost)
ii. Where inventories consist of a large number of interchangeable (ie identical or very similar) items.
FIFO- is a method of estimating cost which assumes that inventory is used or sold in the same order that it is purchased by the business.
AVCO (average cost)- method of estimating cost which assumes that all inventory purchased is mixed together. This assumption would be true for liquid inventory. Two possible AVCO- 1. periodic weighted average or simple weighted average 2. continuous weighted average.
Example:
In November 1,000 units were purchased as follows:
3 November 400 units at $60 per unit
11 November 300 units at $70 per unit
21 November 300 units at $80 per unit
During the same period, some inventories are sold 200 units each, on 5,14,22 and 27 November.
First In First Out (FIFO) Method:
| Date | Receipts | Sold | Balance | |
| No. of invntory | $ | |||
| 3 Nov | 400 x $60 | 400 | 24,000 | |
| 5 Nov | 200 x $60 | 200 | 12,000 | |
| 11 Nov | 300 x $70 | 500 | 33,000 | |
| 14 Nov | 200 x $60 | 300 | 21,000 | |
| 21 Nov | 300 x $80 | 600 | 45,000 | |
| 22 Nov | 200 x $70 | 400 | 31,000 | |
| 27 Nov | 100 x $70
100 x $80 |
200 | 16,000 | |
| Cost of sale is $53,000 and the value of closing inventory is $16,000. | ||||
Continuous Weighted Average Cost (AVCO) Method:
Weighted average cost is calculated each time that there is a new delivery into stores.
Weighted average price =
(inventory value of items in stores + purchase cost of units received)/(Quantity already in stores + Quantity received)
| Date | Quantity | Purchase Price | Value | Weighted average price |
| $ | $ | $ | ||
| 3 Nov | 400 | 60 | 24,000 | 60 |
| 5 Nov | (200) | (12,000) | 60 | |
| 200 | 12,000 | 60 | ||
| 11 Nov | 300 | 70 | 21,000 | |
| Balance | 500 | 33,000 | 66 (33,000/500) | |
| 14 Nov | (200) | (13,200) | 66 | |
| 300 | 19,800 | 66 | ||
| 21 Nov | 300 | 80 | 24,000 | |
| Balance | 600 | 43,800 | 73(43,800/600) | |
| 22 Nov | (200) | (14,600) | 73 | |
| 27 Nov | (200) | (14,600) | 73 | |
| 30 Nov (bal) | 200 | 14,600 | 73 | |
| Cost of sale is $54,400 and the closing inventory is $14,600. | ||||
Periodic Weighted Average Cost Method:
Period weighted average price= ( cost of opening inventory + cost of all receipts in the period)/(units in opening inventory + units received)
Periodic weighted average price = (400×60+300×70+300×80)/(400+300+300)=$69 per unit.
Cost of sale = 800 units x 69$
Inventory of end = 200 units x 69$
Source: Kaplan and BPP