IAS 2 Made Easy.pdf

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InventoriesIAS

2Overview sikaca.com

Scope: Overall [2] sikaca.com



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Scope: Measurement [3 to 5, 9] sikaca.com

Definitions [6 to 8] sikaca.com

Inventories

are assets :(a) held for sale in the ordinary course of business ( finished goods );(b) in the process of production for such sale (WIP); or (c) in the form of materials or supplies to be consumed in the

production process or in the rendering of services (raw materialsand other supplies) .

NRVis the estimated selling price in the ordinary course of business lessthe estimated costs of completion andthe estimated costs necessary to make the sale.

FV is the amount for which an asset could be exchanged, or a liability settled,between knowledgeable, willing parties in an arm’s length transaction.

NRV vs. FVNRV is entity-specific value; FV is not. NRV for inventories may not equal FV-CTS.

INVENTORIES FOR A SERVICE PROVIDERIn case of a service provider, inventories include the cost of the service for which the entityhas not yet recognized the related revenue and are generally described as WIP.

Example 1-NRVAn entity has work in process inventory. Till now the cost of $70,000 has been spent on thisinventory. The estimated cost to convert the WIP inventory into finished goods is $48,000.



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The estimated selling price of inventory if sold in its present condition is $70,500 and if soldafter it has been converted to finished goods is $120,000. The entity has to pay 2% commissionto its distributors.

The entity does not sell the incomplete inventory.

Required:Calculate NRV and explain at which amount the inventories should appear in SFP.

Example 2-FV and NRVYou have a contract to supply 100 barrels of oil at $25 per barrel. The price is fixed for the 6months. At the end of the 1st month the market price of oil is $30. (The fair value is $30.) Youbuy the 100 barrels at the market price. Selling costs are $2 per barrel.Required:Record the journal entries.

Cost of Inventories: General [10-18] sikaca.com

Costs of Inventories

The costs of inventories shall comprise:

(a) all costs of purchase,(b) costs of conversion,(c) other costs incurred in bringing the inventories into their present

location and condition. For example, it may be appropriate toinclude non-POH or the costs of designing products for specificcustomers in the cost of inventories.

Costs of Purchase

Purchase price XXNon-refundable/adjustable import duties and taxes XXTransport and handling costs XXOther costs directly attributable to acquisition XXTrade discounts and rebates (X) XX

Costs of Conversion

These include:(a) costs directly related to the units of production, such as directlabour

(b) a systematic allocation of fixed and variable POH that are incurredin converting materials into finished goods.

Level of Production

The conversion costs are included in inventory on the basis of followinglevel of productions:

• Direct labour etc è actual level of production• Variable POH è actual level of production• Fixed POH è normal or actual, whichever is higher

Fixed POH

Fixed POH are those indirect costs of production that remain relativelyconstant regardless of the volume of production, such as depreciation andmaintenance of factory buildings and equipment, and the cost of factorymanagement and administration.

Variable POHVariable POH are those indirect costs of production that vary directly, or nearly directly, with the volume of production, such as indirect materialsand indirect labour.

Normalcapacity

Normal capacity is the production expected to be achieved on averageover a number of periods or seasons under normal circumstances, takinginto account the loss of capacity resulting from planned maintenance.

Allocation of Conversion

Costs to

A production process may result in more than one product beingproduced simultaneously. This is the case, for example, when jointproducts are produced or when there is a main product and a by-product.



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Joint and By-Products

When the costs of conversion of each product are not separatelyidentifiable, they are allocated between the products on a rational andconsistent basis. The allocation may be based, for example, on therelative sales value of each product either at the stage in the productionprocess when the products become separately identifiable, or at thecompletion of production.

Most by-products, by their nature, are immaterial. When this is the case,they are often measured at NRV and this value is deducted from the costof the main product. As a result, the carrying amount of the main productis not materially different from its cost.

Costs to beexcluded

Examples of costs excluded from the cost of inventories and recognisedas expenses in the period in which they are incurred are:(a) abnormal amounts and wastages;(b) storage costs, unless necessary for the production process;(c) administrative overheads; and(d) selling costs.

Borrowingcosts

If an inventory is a qualifying asset under IAS 23, the borrowing costs areincluded in the costs of inventories.

DeferredSettlement

Termsamount paid – purchase price for normal credit terms = interest expense

Example 3 Cost of InventoriesSiKA Limited imported raw material (9,000 Units) for use in production of goods with followingdetails.

$Invoice value 990,000Trade discount 91,000Non-refundable import duties 50,000Refundable sales tax 127,000Adjustable Income tax 30,000

Carriage and Freight In 15,000Loading and Unloading charges 7,000A manager spend his time on this import specifically worth $10,000 10,000

The following costs were incurred later:$

Direct labour 450,000Variable production overheads 630,000Fixed production overheads 800,000Storage costs 27,000Administrative overheads 80,000Selling costs 35,000

The following information is relevant:• There was no opening inventory. The company only processed the items imported (as

above) during the year.• There is no raw material or WIP inventory at the year end. However, finished goods

inventory includes 800 units (remaining units were sold during the year).• The variable production overhead includes $90,000 which was incurred due to incorrect

production scheduling due to mistake of production manager.• The storage is not necessary part of production process.• The normal capacity of plant is 12,500 units.



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Required:Calculate the costs of purchase.Calculate the cost of inventory per unit and total cost of finished goods inventory.

Example 4 Joint and By ProductsThe following data relates to manufacturing process III of CD Limited.

Product Units Unit sale price $X (Main product) 1,000 $250Y (Main product) 1,500 $230B (By-product) 2,500 $5

The total common costs for the manufacturing process III are $1,875,500.Required:Calculate the cost of inventories for each product.

Example 5 Deferred Settlement TermsABC Limited purchased material worth cash price of $5,000 but they had to pay $5,600 in totalas they were allowed by the supplier to take two months extra credit period on ABC Limited

specific request.Required:Record the journal entries.

Cost of Inventories: Service Provider [19] sikaca.com

IncludeThese costs consist primarily of the labour and other costs of personneldirectly engaged in providing the service, including supervisory personnel,and attributable overheads.

ExcludeLabour and other costs relating to sales and general administrativepersonnel are not included but are recognised as expenses in the periodin which they are incurred.

Profit MarginsThe cost of inventories of a service provider does not include profitmargins or non-attributable overheads that are often factored into pricescharged by service providers.

Example 6 Cost of Inventories of a Service ProviderGB Chartered Accountants started a consultancy assignment on June 21, 2010 for AliEnterprises whose CEO was a friend of one of partners of GB Chartered Accountants. Thefollowing personnel were involved on the assignments with monthly salaries/stipends mentionedafter their name.Name Designation Days Spent on Job $Mr. Javed Supervisor 3 45,000Mr. Abid Senior 6 25,000Mr. Zain Semi Senior 7 11,000Mr. Abubakar Junior 7 6,500Mr. Shan Junior 7 6,500

The total travelling allowance claimed for the assignment till June 30, 2010 (which is year-endof GB Chartered Accountants) is $1,000.

The assignment is expected to take a long period of time. However, as the assignment has justbeen started, the amount of revenue from the assignment cannot be measured reliably.Required:Calculate the cost of inventory for GB Chartered Accountants.



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Cost of Inventories: Agriculture Produce [20] sikaca.comThe agricultural produce is measured at FV less POS costs at the time of harvest under IAS41. Subsequently IAS 2 applies on such inventories and FV less POS costs are deemed ascost of such inventories.

Techniques for the Measurement of Cost [21-22] sikaca.com

When to usethese

techniques?

Techniques for the measurement of the cost of inventories, such as thestandard cost method or the retail method, may be used for convenienceif the results approximate cost.

StandardCosts Method

Standard costs take into account normal levels of materials and supplies,labour, efficiency and capacity utilization. They are regularly reviewedand, if necessary, revised in the light of current conditions.

Retail Method

It is often used in the retail industry having of large numbers of rapidlychanging items with similar margins for which it is impracticable to useother methods. The cost is determined by reducing the sales value of theinventory by the appropriate percentage gross margin. The percentageused takes into consideration inventory marked down to below its originalselling price. An average percentage for each department is often used.

COST FORMULAS [23-27] sikaca.com

Consistency An entity shall use the same cost formula for all inventories having asimilar nature and use to the entity.

Differentformulas

For inventories with a different nature or use, different cost formulas maybe justified.

FIFO

The FIFO formula assumes that the items of inventory that werepurchased or produced first are sold first, and consequently the itemsremaining in inventory at the end of the period are those most recentlypurchased or produced.

WeightedAverage

Under the weighted average cost formula, the cost of each item isdetermined from the weighted average of the cost of similar items at thebeginning of a period and the cost of similar items purchased or producedduring the period. The average may be calculated on a periodic basis, or as each additional shipment is received, depending upon thecircumstances of the entity.

Example 7 FIFO and Weighted Average Method



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The following information is available from records of K Limited, in respect of Chemical X, forthe year ended December 31, 2007.Opening inventory as at January 01, 2007: 20,000 litres valuing Rs. 220,000Purchases: 15.01.07 11,000 litres @ Rs. 12 per litre 21.04.07 8,000 litres @ Rs. 13 per litre 07.07.07 7,000 litres @ Rs. 14 per litre 08.11.07 14,000 litres @ Rs. 12 per litreSold: 11.01.07 9000 litres @ Rs. 15 per litre 22.04.07 18,000 litres @ Rs. 15 per litre 11.05.07 9,000 litres @ Rs. 16 per litre 20.12.07 12,000 litres @ Rs. 15 per litreRequired:What is value of stock as at December 31, 2007 under FIFO and Weighted Average method?

NRV [28-33] sikaca.com

RationaleThe practice of writing inventories down below cost to NRV is consistentwith the view that assets should not be carried in excess of amountsexpected to be realised from their sale or use.

Item by Item

Inventories are usually written down to NRV item by item. In somecircumstances, however, it may be appropriate to group similar or relateditems. It is not appropriate to write inventories down on the basis of aclassification of inventory, for example, finished goods, or all theinventories in a particular operating segment.

Service providers generally accumulate costs in respect of each servicefor which a separate selling price is charged. Therefore, each suchservice is treated as a separate item.

Estimate

Estimates of NRV are based on the most reliable evidence available atthe time the estimates are made, of the amount the inventories areexpected to realise. These estimates take into consideration fluctuationsof price or cost directly relating to events occurring after the end of theperiod to the extent that such events confirm conditions existing at theend of the period.

Estimates of NRV also take into consideration the purpose for which theinventory is held. For example, the NRV of the quantity of inventory heldto satisfy firm sales or service contracts is based on the contract price. If the sales contracts are for less than the inventory quantities held, theNRV of the excess is based on general selling prices.

ProvisionsProvisions may arise from firm sales contracts in excess of inventoryquantities held or from firm purchase contracts. Such provisions are dealtwith under IAS 37.

NRV of RawMaterial

Materials and other supplies held for use in the production of inventoriesare not written down below cost if the finished products in which they willbe incorporated are expected to be sold at or above cost. However, whena decline in the price of materials indicates that the cost of the finishedproducts exceeds NRV, the materials are written down to NRV. In suchcircumstances, the replacement cost of the materials may be the bestavailable measure of their NRV.

Reversal of A new assessment is made of NRV in each subsequent period. When the



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write down circumstances that previously caused inventories to be written downbelow cost no longer exist or when there is clear evidence of an increasein NRV because of changed economic circumstances, the amount of thewrite-down is reversed (i.e. the reversal is limited to the amount of theoriginal write-down) so that the new carrying amount is the lower of thecost and the revised NRV. This occurs, for example, when an item of inventory that is carried at NRV, because its selling price has declined, is

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

Example 8 NRV LevelThe following data relates to inventory of King Limited:

Particulars Cost NRV$ $

Material A 87,000 98,000Material B 94,000 82,000Total Raw Material Inventory 181,000 180,000

WIP AX 105,000 116,000WIP BY 97,000 87,000

Total WIP Inventory 202,000 203,000

Product X 120,000 135,000Product Y 105,000 102,000Total Finished goods Inventory 235,000 237,000

Total Inventory 618,000 620,000

Required:Calculate the amount of write down to NRV, if required.

Example 9 Provision

SK Limited is engaged in trading of chemical products and has entered into following twocontracts.• On December 15, 2010 with ABC Limited to supply 1,000 units of Product A at $10 to be

delivered on Jan 15, 2011. On December 31, 2010 SK Limited has 800 units (at $9 perunit) of Product A in inventory and the purchase price of Product A has increased to $12per unit.

• On December 20, 2010 with XYZ Limited (a firm contract) to buy 500 units of ProductX at $10 to be delivered on Jan 20, 2011. On December 31, 2010 the purchase price ofProduct X has fallen to $7 per unit.

Required:Record journal entries due to change in purchase prices

Example 10 NRV of Raw MaterialCE Limited is engaged in the manufacturing of plastic toys. The price of plastic acquired by CELimited has fallen from $200 per unit to $170 per unit. At the year end, CE Limited has 2,000units which it purchased at $200 per unit. The toys made from this plastic are sold at $425 pertoy. The total cost of production of one toy (including plastic costs) is $350. One unit of plasticis converted into one toy.Required:At which value, the plastic material should be shown in SFP.The amount of write down required, if any.



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Example 11 NRV of Raw MaterialPM Limited is engaged in the manufacturing of plastic toys. The price of plastic acquired by PMLimited has fallen from $200 per unit to $170 per unit.

At the year end, PM Limited has 2,000 units which it purchased at $200 per unit. The toys madefrom this plastic are sold at $340 per toy. The total cost of production of one toy (including

plastic costs @200 per unit) is $350. One unit of plastic is converted into one toy.Required:At which value, the plastic material should be shown in SFP.The amount of write down required, if any.

Example 12 Reversal of write downAn item of inventory had a cost of $10,000 and NRV of $9,500 at December 31, 2010 and sothe inventory was written down by $500. It is now December 31, 2010 and that item ofinventory is still with the entity but its NRV has increased to $9,800.

Required:

Calculate the amount of Reversal of write down to NRV.

Example 13 Reversal of write downAn item of inventory had a cost of $10,000 and NRV of $9,500 at December 31, 2010 and sothe inventory was written down by $500. It is now December 31, 2010 and that item ofinventory is still with the entity but its NRV has increased to $10,800.

Required:Calculate the amount of Reversal of write down to NRV.

Recognition as an Expense [34-35] sikaca.com

When Inventoriesare sold

The carrying amount of those inventories shall be recognized as anexpense in the period in which the related revenue is recognized.

Write down andlosses Recognised as an expense in the period the write-down or loss occurs.

Reversal of writedown

Recognised as a reduction in the amount of inventories recognized asan expense in the period in which the reversal occurs.

Allocation toother assets

Some inventories may be allocated to other asset accounts, for example, inventory used as a component of self-constructed property,plant or equipment. Inventories allocated to another asset in this wayare recognised as an expense during the useful life of that asset.

Disclosure [36-39] sikaca.comThe financial statements shall disclose:(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 FV-CTS;(d) the amount of inventories recognised as an expense during the period;(e) the amount of any write-down of inventories recognised as an expense in the period;(f) the amount of any reversal of any write-down that is recognised as a reduction in the

amount of inventories recognised 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.



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Illustration 1Notes to the Financial Statements

Significant Accounting PoliciesInventories are measured at lower of cost and net realizable value. Cost is measured by usingweighted average formula.

Inventories $Raw Material 5,000 Work in process 6,000 Finished goods 7,000 Total 18,000

Carrying amount of inventories carried at fair value less cost to sell is Nil.

Inventories sold and recognized as an expense 288,000Amount of write down to NRV recognizes as an expense 400Amount of reversal of write down recognized as reduction in expense 600

The reason for reversal is market rate fluctuation of certain products especially due toshortage of supply, the price has increased.

Inventories have been pledged as security against running finance obtained from Bank A andBank B.

Abbreviations Key:LCN Lower of Cost and NRV NRV Net Realisable ValuePL Profit or loss FV Fair valueFV-CTS Fair value less cost to sell POH Production Overheads



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Answers to Examples sikaca.comAnswer 1 Lower of Cost and NRV

$Estimated selling price in ordinary course of business 120,000Less: Estimated cost of completion (48,000)Less: Estimated cost necessary to make the sale $120,000 x 2% (2,400)

NRV 69,600

Cost 70,000

The amount at which inventories should appear in SFP (lower) 69,600

Answer 2 - FV and NRVDr. Cr.

Inventories (purchases) SFP 3,000 Bank SFP 3,000Purchase of 100 barrel at $30 per barrel

Inventory loss SFP 700 Inventories PL 700Write down of inventory to its NRV i.e. $25 - $2 = $23 x 100 barrels = $2,300

Answer 3 Cost of InventoriesCosts of purchase $Invoice value 990,000Less: Trade discount (91,000)

899,000Non-refundable import duties 50,000Carriage and Freight In 15,000Loading and Unloading charges 7,000Directly chargeable - Manager Salary 10,000

981,000

Cost of Inventory per Unit Total$ Units Per Unit$Cost of Purchase 981,000 9,000 109Direct Labour 450,000 9,000 50Variable production overhead $630,000-90,000 540,000 9,000 60Fixed production overhead 800,000 12,500 64

283

Total value of Inventory$283 x 800 units = $226,400



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Answer 4 Joint and By Products$

Product X W3 782,773Product Y W3 1,080,227Product B W1 12,500

1,875,500

W1Total common costs 1,875,500NRV of Byproduct B $5 x 2,500 (12,500)Cost to be apportioned between Joint products 1,863,000

W2 Estimated Sales of ProductProduct X 1,000 x $250 250,000Product Y 1,500 x $230 345,000

595,000W3 Cost Apportionment Joint productsProduct X 250,000/595,000 x 1,863,000 782,773Product Y 345,000/595,000 x 1,863,000 1,080,227Total 1,863,000

Answer 5 Deferred Settlement TermsDr. Cr.

Inventories (purchases) SFP 5,000 Supplier SFP 5,000Purchase of Inventories

Supplier SFP 5,000Interest exp PL 600 Bank SFP 5,600

Payment for InventoriesAnswer 6 Cost of Inventories of a Service Provider

Name $Mr. Javed $45,000 x 3/30 days 4,500Mr. Abid $25,000 x 6/30 days 5,000Mr. Zain $11,000 x 7/30 days 2,567Mr. Abubakar $6,500 x 7/30 days 1,517Mr. Shan $6,500 x 7/30 days 1,517Travelling allowance 1,000Total 16,101



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Answer 7 FIFO and Weighted Average MethodChemical X: Stock Ledger Card under FIFO method

Date Purchase Sales BalanceQuantity Rate Value Quantity Rate Value Quantity Rate Value

01.01.07 20,000 11 220,00011.01.07 9,000 11 99,000 11,000 11 121,000

15.01.07 11,000 12 132,000 11,00011,000 1112 121,000132,00021.04.07 8,000 13 104,000 11,000

11,0008,000

111213

121,000132,000104,000

22.04.07 11,0007,000

1112

121,00084,000

4,0008,000

1213

48,000104,000

11.05.07 4,0005,000

1213

48,00065,000

3,000 13 39,000

07.07.07 7,000 14 98,000 3,0007,000

1314

39,00098,000

08.11.07 14,000 12 168,000 3,000

7,00014,000

13

1412

39,000

98,000168,000

20.12.07 3,0007,0002,000

131412

39,00098,00024,000 12,000 12 144,000

Chemical X: Valuation under Weighted Average MethodWeighted avg. rate =(Value of opening inventory + Value of purchases) / (opening stock units + Units purchased) = (Rs. 220,000 + Rs. 502,000) / (20,000 + 40,000) = Rs. 12.03 per litre

Value of closing stock = 12,000 litres x Rs. 12.03 = Rs. 144,360Workings:Number of units purchased=11,000+8,000+7,000+14,000 =40,000 LitresValue of purchases = (11,000 x 12)+(8,000 x 13)+(7,000x14)+(14,000x12) = Rs. 502,000Number of units sold =9,000+18,000+9,000+12,000 =48,000 LitresValue of sales = (9,000x15)+(18,000x15)+(9,000x16)+(12,000x15) = Rs. 729,000Units in closing inventory = 20,000+40,000-48,000 =12,000 Litres



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Answer 8 NRV LevelParticulars Cost NRV Write down

$ $ $Material A 87,000 98,000 0Material B 94,000 82,000 12,000Total Raw Material Inventory 181,000 180,000

WIP AX 105,000 116,000 0WIP BY 97,000 87,000 10,000Total WIP Inventory 202,000 203,000

Product X 120,000 135,000 0Product Y 105,000 102,000 3,000Total Finished goods Inventory 235,000 237,000

Total 618,000 620,000 25,000

Answer 9 Provision

Dr. Cr.Loss PL 400 Provision for expected loss (onerous contract) SFP 400Supply contract, increased price on short quantities$12-10 = $2 x (1,000-800 units) = $400

Loss SFP 1,500 Provision for expected loss (onerous contract) SFP 1,500Firm purchase contract$10-7=$3 x 500 units = $1,500

Answer 10 NRV of Raw Material

As the finished goods are sold above cost, there is no need to write down raw materials.Value of Plastic Materials in SFP $200 x 2,000 units = $400,000

Answer 11 NRV of Raw MaterialAs the finished goods are not sold at or above cost, the materials need to be written down to itsNRV / replacement cost.

Value of Plastic Materials in SFP $170 x 2,000 units = $340,000Amount of write down required $400,000 - $340,000 $60,000

Answer 12 Reversal of write downReversal $9,800 - $9,500 $300

Answer 13 Reversal of write downReversal $10,000 - $9,500 $500



Financial Reporting

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DOCUMENT PROPERTIESDISCLAIMER

The text in this material and any others made available by any SiKA Groupcompany does not amount to advice on a particular matter and should not betaken as such. No reliance should be placed on the content as the basis for anyinvestment or other decision or in connection with any advice given to thirdparties. Please consult your appropriate professional adviser as necessary.SiKA expressly disclaim all liability to any person in respect of any losses orother claims, whether direct, indirect, incidental, consequential, or otherwisearising in relation to the use of such materials.

RIGHTS RESERVED

All rights reserved. For details, please visit Terms and Conditions section onwww. sikaca .com

AUTHOR

Kashif Adeel ACA

PREPARATION DATE

June 03, 2010

LATEST UPDATION

June 03, 2010

PRIMARY SOURCE

IFRSs bounded volume 2009 issued by IASB.

AVAILABILITY

This material can be downloaded free of cost from www. sikaca .com

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