1. Chapter 17
Inventories

2. Contents Inventories Inventory systems
Accounting for inventories under IFRS

3. Inventories for commercial companies
Merchandise: goods purchased for resale without transformation

4. Inventories for manufacturing companies
Raw materials, parts, components and consumables: goods that, once incorporated in the production process, become integrally and physically part of the product
Manufacturing supplies: items used in supporting production and not part of the product

5. Inventories for manufacturing companies (cont’d)
Work in progress (WIP): products still in the manufacturing process at the close of the day
Semi-finished goods: items that are finished with regard to one stage of production but are nonetheless not sellable in that condition.
Finished goods: completed products ready for sale

6. Inventories for service companies
Work in progress: accumulated costs incurred in fulfilling a contract and not yet billed

7. An overview of possible methods to determine the value of the inventory
Unit cost
First in, first out (FIFO)
Last in, last out (LIFO)
Weighted average
Base inventory

8. Inventory systems
Each company needs a system to record the physical and monetary movements in the inventory. A company needs to keep track of the beginning inventory, the purchases, the goods sold and the closing inventory. Two inventory recording systems exist:
the periodic inventory system
the perpetual inventory system

9. The periodic inventory system
Within this system inventory is determined by a physical count at a specific date. As long as the count is made frequently enough for reporting purposes, it is not necessary to maintain extensive inventory records. The inventory shown in the balance sheet is determined by the physical count and is priced in accordance with the inventory method used. The net charge between the beginning and ending inventories enters into the computation of costs of goods sold.

10. The perpetual inventory system
In a perpetual system, inventory records are maintained and updated continuously as items are purchased and sold. The system has the advantage of providing inventory information on a timely basis but requires the maintenance of a full set of inventory records. Audit practice will certainly require that a physical check of perpetual inventory records be made periodically.

11. Accounting for inventories under IAS 2
Definitions
Measurement
Disclosure

12. IAS 2 – definitions
Inventories are assets:
held for sale in the ordinary course of the business;
in the process of production for such sale; or
in the form of materials or supplies to be consumed in the production process or in the rendering of services

13. IAS 2 – measurement
Inventories shall be measured at the lower of cost or net realisable value
the cost of inventories should comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition
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

14. Cost of inventory + costs of conversion
Cost of purchases
+ costs of conversion
+ other costs incurred in bringing the inventory to the present location and condition

15. Cost of inventory (cont’d)
Cost of purchase = Purchase cost +
+ Import duties and other non-recoverable taxes
+ Transport and handling costs +
+ Other costs directly attributable to acquisition
– trade discounts/rebates

16. Cost of inventory (cont’d)
Conversion cost includes
cost directly related to the units of production, such as direct labour
systematic allocation of fixed and variable production overheads that are incurred in converting materials to finished goods
the allocation of fixed production overheads is based on the normal capacity of the production facilities

17. Cost of inventory (cont’d)
Other costs are costs incurred in bringing the inventories to their present location and condition.
costs which can not be included are e.g.:
abnormal amounts of waste
storage costs
administrative overhead
selling costs

18. Question
Which can be included in the inventory costs according to IAS 2
Discounts on purchase price
Travel expenses of buyers
Import duties
Transport insurance
Storage costs for materials that are necessary in the production process
Salaries of sales department
Research for new products
Audit and tax consultation fees
Adapted from Activity 17.8 alexander et al International Financial Reporting ed. 6

19. Cost formulas allowed for inventory valuation by IAS 2
The cost of inventories of items that are not ordinarily interchangeable and goods and services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs
The cost of other inventories shall be measured by FIFO, or weighted average cost

20. Lets do a question

21. J Jones runs a computer shop. He sells pen drives to wholesalers
J Jones runs a computer shop. He sells pen drives to wholesalers. He has heard of FIFO and AVCO but is not sure what they are. During April he has the following purchases and issues from stock.
Opening stock of 40 units at £3 each
Bought 20 units costing £3.60 each
Sold 36 units for £6 each
Bought 20 units at £3.75 each
sold 25 units for £6 each
Show J Jones how the stock valuations would change using each system.

22. 2 Methods
FIFO First In First Out
AVCO Average Cost

23. FIFO
What does this mean?

24. FIFO Definition Materials are issued out of stock
in the order in which they were delivered into stock

25. FIFO Advantages Logical
Often the reality of what happens in the stores
Easy to understand and explain
Stock valuation is close to replacement price

26. FIFO Disadvantages Time consuming if the company has received batches
Managers may not understand why stocks not a current prices

27. AVCO
What does this mean?

28. AVCO Definition
The goods are issued at the average price of all of the goods.
The price of the stock is recalculated every time a new delivery is made

29. AVCO Advantages Price fluctuations are smoothed out
Easier to run the system

30. AVCO Disadvantages Price can run into several decimal places
Price is rarely the actual cost of the goods

31. Net realisable value
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
The amount of any write-down on inventories to net realisable value will be recognized as an expense in the period the write-down occurs

32. Question
The factory has 3 distinct products in its inventories and the value of each is
What according to IAS 2 should be the value of the inventories
Alpha
Beta
Gamma
Cost 25 50 20
Net realisable value 60 30

33. Answer As 3 distinct products each valued individually 90 Alpha Beta
Gamma
Cost 50 20
Net realisable value

34. IAS 2 disclosure
The accounting policies adopted in measuring inventories, including the cost formulas used
The total carrying amount of inventories and the carrying amount in classifications appropriate to the enterprise
The carrying amount of inventories carried at fair value less costs to sell
The amount of any write down of inventories recognized as an expense in the period in accordance with para. 34

35. IAS 2 disclosure (cont’d)
The carrying amount of inventories pledged as security for liabilities
The cost of inventories recognized as an expense during the period
The amount of any reversal of any write down that is recognized as a reduction in the amount of inventories recognized as an expense in the period in accordance with para. 34
The circumstances or events that led to the reversal of a write down of inventories in accordance with para. 34

36. Question
Which can be included in the inventory costs according to IAS 2
Discounts on purchase price
Yes
Travel expenses of buyers No
Import duties
Transport insurance
Storage costs for materials that are necessary in the production process
Salaries of sales department
Research for new products
Audit and tax consultation fees
Adapted from Activity 17.8 alexander et al International Financial Reporting ed. 6