1. Connolly – International Financial Accounting and Reporting – 4 th Edition CHAPTER 11 INVENTORIES

2. Connolly – International Financial Accounting and Reporting – 4 th Edition 11.1 INTRODUCTION Inventory refers to:  Raw materials  Work-in-progress  Finished goods produced  Goods purchased and held for resale Why hold inventory?  Time  Uncertainty  Economies of scale

3. Connolly – International Financial Accounting and Reporting – 4 th Edition 11.2 IAS 2 INVENTORIES The key points:  Inventory is measured at the lower of cost and net realisable value (NRV)  NRV 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 Therefore how are cost and NRV measured?

4. Connolly – International Financial Accounting and Reporting – 4 th Edition COST Cost includes:  cost of purchase (exclude trade discounts and rebates)  cost of conversion (include ‘normal’ production overheads)  other costs necessary to bring to present location and condition Fixed production overheads must be allocated to items of inventory on the basis of normal capacity of the production facilities

5. Connolly – International Financial Accounting and Reporting – 4 th Edition COST Cost excludes:  abnormal amounts of wasted materials, labour or other production costs  storage costs, unless necessary in the production process before the next production stage  administrative overheads  selling costs

6. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.1: Valuing inventory (1) DEF Plc manufactures mechanical parrots, which trade under the name ‘Parker’. In the year ended 31 December 2012, 10,000 Parkers are manufactured and the related costs were: Requirement At 31 December 2012, there were 1,000 Parkers in inventory. Assuming that these have a resale value of €4 each, what value should be placed on the closing inventory? € Materials Labour Depreciation of Machinery Factory rates Sundry factory expenses Production storage costs Selling expenses Expenses at head office 3,000 4,000 2,000 1,000 2,000 1,000 2,000 4,000 19,000

7. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.1: Valuing inventory (1) Solution € Materials Labour Depreciation of machinery Factory rates Sundry factory expenses Production storage costs Total cost Units manufactured Unit cost Number of units on hand at year end Value of closing inventory 3,000 4,000 2,000 1,000 2,000 1,000 13,000 10,000 €1.30 1,000 €1,300

8. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.2: Valuing inventory (2) The following information related to Unipoly plc, a manufacturer of can openers, for the year ended 31 December 2012. There was no finished goods inventory at the start of the year and no work in progress. There were 250,000 units in finished goods at the year end. The normal annual level of production is 750,000 can openers. However, in the year ended 31 December 2012, only 450,000 were produced because of a labour dispute. Requirement Calculate the cost of finished goods at 31 December 2012 in accordance with IAS 2 Inventories. (See costs on next slide)

9. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.2: Valuing inventory (2) (Cont’d) € Direct materials cost per unit Direct labour costs per unit Direct expenses per unit Production overheads per year Administration overheads per year Selling overheads per year Interest payments per year 1 600,000 200,000 300,000 100,000

10. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.2: Valuing inventory (2) Solution Cost per unit € Direct material 1.00 Direct labour 1.00 Direct expenses 1.00 Production overhead (€600,000 / 750,000 units)0.80 3.80 Value of closing inventory: 250,000 units x €3.80 €950,000

11. Connolly – International Financial Accounting and Reporting – 4 th Edition NET REALISABLE VALUE The estimated selling price in the ordinary course of business less the estimated costs of completion and less the estimated costs necessary to make the sale If the cost is not recoverable, then value at NRV

12. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.3: Lower of cost and NRV (1) Finished Goods of dissimilar items at 31 December 2012: Inventory should be recorded in the financial statements at 31 December at: ItemCost € NRV € Value € 11,0001,400 2 800 700 32,5002,800 41,8001,700 5 200 300 6 6,600 250 7,150

13. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.3: Lower of cost and NRV (1) Solution: Finished Goods of dissimilar items at 31 December 2012: ItemCost € NRV € Value € 11,0001,4001,000 2 800 700 32,5002,8002,500 41,8001,700 5 200 300 200 6 300 6,600 250 7,150 250 6,350

14. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.4: Lower of cost and NRV (2) Patches Ltd values inventory at the lower of cost and net realisable value in accordance with IAS 2 Inventories, and at 31 December 2012 the company’s entire inventory is valued at cost in the draft financial statements for the year ended 31 December 2012. One of Patches Ltd products ‘Poang’, is manufactured in two stages and there is a market for the unfinished stage one product. Details relating to Poang are as follows: No of units in Inventory as at 31.12.12 Cost per unit € Selling price per unit € Poang – stage one10,000500600 Additional costs250 Poang - Finished24,000750800

15. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.4: Lower of cost and NRV (2) (Cont’d) The selling costs associated with both the stage one and finished products are €20 per unit. Following the introduction of a similar product on to the market in November 2012 by a foreign competitor. Patches Ltd has had to reduce the selling price of both stage one and finished products to €475 and €700 per unit, respectively, from January 2013. Requirement Calculate the value of the closing inventory of Poang at 31 December 2012 and show any adjustments required.

16. Connolly – International Financial Accounting and Reporting – 4 th Edition Example 11.4: Lower of cost and NRV (2) Solution In accordance with IAS 2 Inventories, the decline in selling price of both the stage one and finished products should be accounted for at 31 December 2012 as the change in selling price confirms conditions that existed at the end of the reporting period. The NRV is based on the selling price of the finished product. Dr Cost of Sales €2,380,000 Cr Inventory €2,380,000 ProductCostNRVValueChangeTotal Poang – Stage One500430 (70)1,680,000 Poang – Finished Product 750680 (70)700,000 2,380,000

17. Connolly – International Financial Accounting and Reporting – 4 th Edition Techniques for the measurement of cost Standard cost – normal level of activity and reviewed regularly Retail method – sales value less % gross margin

18. Connolly – International Financial Accounting and Reporting – 4 th Edition Cost Formulae Methods of valuing inventory issues are:  First In First Out (FIFO)  Last In First Out (LIFO)  Weighted Average LIFO is not allowed under IAS 2 See Chapter 11, Examples 11.5 and 11.6

19. Connolly – International Financial Accounting and Reporting – 4 th Edition Reversal of a write down to NRV Example: As at 31 December 2012, inventory was included in the financial statements valued at its net realisable value of €15,600. The inventory item had originally cost €18,900. As at 31 December 2013, the item of inventory was still on hand but its selling price has increased due to improved economic conditions. It is now selling for €22,350. Requirement How will this item be valued in the financial statements as at 31 December 2013. What are the journals required?

20. Connolly – International Financial Accounting and Reporting – 4 th Edition Reversal of a write down to NRV Solution The write down to net realisable value that took place on 31 December 2012 can be reversed. The amount of the reversal is limited to the amount of the original write down. Amount of write down €3,300 (€18,900 – €15,600) Dr Inventory (SFP) €3,300 Cr Cost of Goods Sold €3,300 To reverse write down to NRV

21. Connolly – International Financial Accounting and Reporting – 4 th Edition Disclosure Accounting policy adopted in measuring inventories, including cost formulas Carrying amount of inventories under major headings (e.g. raw materials, WIP and finished goods) Carrying amount of inventories at fair value less costs to sell Amount expended in the period Amount of any write downs of inventories Amount of any reversal of write downs Cause of write downs Carrying amount of inventories pledged as security