INVENTORY VALUATION THEORY AND PRACTICE

In theory inventory (stock and work in in progress) can be valued using either of the following valuation bases Output valuation models Input valuation models

INVENTORY VALUATION BASES OUTPUT VALUE MODELS Income reporting When applicable Discounted money receipts All revenues reported except interest Sale price known and timing of cash receipts known Current selling price All revenues and gains and losses included Sale price known and collection period short Net realisable value All net revenue reported Sale price known and costs of disposal known or predictable

INVENTORY VALUATION BASES INPUT VALUE MODELS (1) Income reporting When applicable Historical cost No recognition of operating revenue or gains and losses from changes in specific prices until time of sale Revenue not yet earned and sale price uncertain Current replacement cost Gains and losses from specific price changes included in income but operating revenue not included until time of sale Revenue not yet earned, sale price uncertain, and current costs can be measured objectively

INVENTORY VALUATION BASES INPUT VALUE MODELS (2) Income reporting When applicable Standard cost Income includes abnormal gains and losses arising from inefficiency or idle capacity but operating revenue not included until time of sale Reflects current production cost under efficient and normal conditions Normal (base) stock valuation No recognition of gains and losses from specific price changes relating to base stock Theoretically acceptable for income - distorts inventory valuation

INVENTORY VALUATION BASES INPUT VALUE MODELS (3) Income reporting When applicable Net realisable value less a normal profit margin All value changes included in income but with deferral of normal gross profit An approximation to replacement cost or as a minimum valuation when above replacement cost - not recommended Lower of cost or market value Income includes losses but not gains from specific price changes, operating revenue reported at time of sale Acceptable but little justification in Accounting Theory

Fundamental Accounting Concepts going concern accruals consistency materiality prudence

No area of accounting has produced wider differences in practice than the computation of the amount at which inventories and work in progress are stated in financial accounts IAS 2 seeks to define the practices, to narrow the differences and variations in those practices and to ensure adequate disclosure in the financial statements

IAS 2 - OBJECTIVES to narrow the difference and variation in accounting practice on stocks and work in progress to ensure adequate disclosure in the financial accounts

INVENTORY AND WORK IN PROGRESS COMPRISE goods purchased for resale consumable stores materials purchased for manufacture into products for sale products and services in the course of completion finished goods

Inventory should be valued at the lower of cost and net realisable value Expenditure incurred in the normal course of business in bringing the product or service to its present location and condition. Cost will include direct costs, production overheads, and any other attributable overheads Net realisable value: The estimated selling price less all costs to completion and all costs relating to the sale of the product

INVENTORY VALUATION BASES unit cost - the cost of identifiable units of stock average cost - total cost divided by the number of units FIFO - first in first out LIFO - last in first out

INVENTORY VALUATION BASES base stock - a predetermined fixed base level standard cost - based on predetermined costs replacement cost - cost of an identical item current cost - lower of replacement cost and net realisable value

DISCLOSURE RE INVENTORY raw materials and consumables work in progress finished goods and goods for resale payments on account

IAS 2 DISCLOSURE The total of the lower of cost and net realisable value of the separate items of stock, or of groups of similar items, should be sub-classified in the balance sheet or in the notes to the financial statements so as to indicate the amounts held in each of the main categories in the standard balance sheet formats

IAS 2 FIFO weighted average any other similar method overheads to be included absorption costing

LONG-TERM CONTRACT WORK IN PROGRESS IAS 11 LONG-TERM CONTRACT WORK IN PROGRESS

LONG-TERM CONTRACT A contract to create a single substantial asset, service, or combination of asset and service, where a substantial proportion of the contract work will extend over a period in excess of one year

THE PROBLEM To determine the most appropriate method to allocate the contract profit over the term of the contract

ATTRIBUTABLE PROFIT That part of the total profit currently estimated to arise over the period of the contract (taking into account likely irrecoverable cost increases and estimated remedial and maintenance costs) which fairly reflects the profit attributable to the part of the work performed at the accounting date. Profit cannot be regarded as attributable until the outcome of the contract can be assessed with reasonable certainty

ATTRIBUTABLE PROFIT - THE MAIN ISSUES taking into account likely irrecoverable cost increases taking into account estimated remedial and maintenance costs the profit attributable to the part of the work performed at the accounting date must be fairly reflected the outcome of the contract can be assessed with reasonable certainty

FORESEEABLE LOSSES Losses which are currently estimated to arise over the duration of the contract allowing for remedial and maintenance costs and any likely irrecoverable cost increases

FORSEEABLE LOSSES - THE MAIN ISSUES estimated to arise over the duration of the contract taking into account likely irrecoverable cost increases taking into account estimated remedial and maintenance costs must be accounted for as soon as the losses become apparent

PERCENTAGE OF COMPLETION METHOD (1) ATTRIBUTABLE PROFIT PERCENTAGE OF COMPLETION METHOD (1)

PERCENTAGE OF COMPLETION METHOD (2) ATTRIBUTABLE PROFIT PERCENTAGE OF COMPLETION METHOD (2)

ATTRIBUTABLE PROFIT ESTIMATED VALUE METHOD Estimated value of work to date less cost of work to date (does not take into account estimated total profit)

Profits are not recognised until the contract has been completed ATTRIBUTABLE PROFIT COMPLETED CONTRACTS METHOD Profits are not recognised until the contract has been completed

CONTRACT DISCLOSURE should be assessed on a contract by contract basis turnover and related costs to be included in income statement as contract progresses where the outcome of the contract can be assessed with reasonable certainty the recognised attributable profit will be the difference between recorded turnover and recorded costs where the amount recorded as turnover exceeds payments received on account the difference should be reported in the balance sheet as a debtor “amounts recoverable on contracts”

CONTRACT DISCLOSURE any costs incurred, but not yet recorded as costs in the income statement, should be included as stocks in the balance sheet the amount by which payments received on account exceed the amount recorded as turnover should be recorded in the balance sheet as a reduction from stocks the amount by which payments received on account exceed the amount recorded as turnover and stocks should be reported in the Balance Sheet as a creditor “payments on account”

CONTRACT DISCLOSURE any foreseeable losses should be charged to the income statement and deducted from the balance sheet stocks value the amount by which foreseeable losses exceed the stocks value of the contract should be recorded in the balance sheet as a provision in all cases attributable profit and foreseeable losses will be taken into account after allowing for estimated remedial and maintenance costs