1. Chapter 9
Inventories

2. Objectives Discuss the nature of inventories and how to measure them
Explain what is included in the cost of inventory
Explain cost flow assumptions and apply both FIFO and weighted average cost formulas
Explain the net realizable value basis of measurement
Implement the disclosure requirements of IAS

3. The Nature of Inventories
IAS 2 defines inventories as assets that are:
Held for sale
In the process of production
Materials or supplies to be used in production
Inventories are classified as current assets
Cost of goods sold (COGS) is the expense account used to record the costs of inventory once sold

4. Initial Recognition of Inventory
‘Inventories shall be measured at the lower of cost and net realizable value.’ (IAS 2 para 9)
Cost Components:
Costs of purchase
Costs of conversion
Costs in bringing inventory to present location & condition

5. Determination of Cost The cost of purchase comprises:
The purchase price
Import duties and other transaction taxes
Transport, handling and other directly attributable costs
Any discounts are to be deducted

6. Costs of Conversion
Costs of conversion are those costs directly related to production including:
Direct labor
Systematic allocation of fixed and variable production overheads
Variable overheads: vary with volume of production. Allocated based on actual use of production facilities
Fixed overheads: remain constant regardless of the volume of production. Allocated based on normal production capacity.

7. Assigning Costs to Inventory on Sale
IAS 2 requires the specific identification method be used where possible to assign costs to inventory
Under this method costs are individually identified for each inventory item
Where there are large numbers of homogenous inventory items one of the following two methods should be used:
First-in first-out (FIFO)
Weighted average cost method
NOT Last-in First-out (LIFO)

8. Comparison to US GAAP US GAAP IFRS
Different cost flow assumptions may be used for inventory with a similar nature and use.
LIFO method is allowed.
IFRS
The same cost flow assumptions must be used for inventory with a similar nature and use even if inventory is held in different geographic locations and/or by different entities.
LIFO method is not allowed.

9. Cost Flow Assumptions Analysis of companies as of 2010: Variable Mean
Exxon had a reserve of $21.3 billion in 2010 and $17.1 billion in In 2010, this was 53% of Exxon’s operating income, 70% of its net income and 7% of its assets.
Carpenter Technology Corp. had a reserve balance that was 28 times its operating income and 158 times its net income in 2010.
Variable
Mean
Median
Reserve balance (in millions)
$294
$38
Net income (in millions)
$686
$99
LIFO reserve/operating income
65%
17%
LIFO reserve/net income
129%
24%
LIFO reserve/assets 4% 2%
LIFO reserve/inventory* 8%
14%
*Inventory is the LIFO inventory with the reserve added back.
Analysis of companies as of 2010 using Compustat: 6,423 companies in the sample of which 4,459 companies had inventory of which 302 companies had a LIFO reserve.

10. Lower of Cost or Market US GAAP IFRS Reports at the LCM:
Market is defined as replacement cost with a floor (NRV less normal profit margin) and a ceiling (NRV).
NRV is defined as the estimated selling price less the estimated costs of completion and sale.
Reversals of prior write-downs are not allowed.
IFRS
Reports at the lower of cost or net realizable value (LCNRV):
NRV is defined as the estimated selling price less the estimated costs of completion and sale.
Since replacement cost would typically be less than NRV, IFRS will generally result in lower write-downs than US GAAP.
Reversals of prior write-downs can be made and recognized in income.

11. Net Realizable Value (NRV)
NRV may fall below cost due to:
Fall in selling price
Physical deterioration of inventory
Obsolescence
The costs and NRV of inventories should normally be compared "item by item" (IAS2).
However, similar or related items may be grouped if this is appropriate.

12. Inventory Write-down Example
Example 1 – inventory write-down
Part 1: On December 31, 2012, Jets International had an inventory of five different types of airplane parts. Given the current fuel costs, airplane parts are not as valuable as they once were. The chart on the next slide provides the cost basis, net realizable value, replacement cost and net realizable value less normal profit margin as of December 31, Jets International prepares its inventory valuation comparisons on an item-by-item basis.
What is the amount of write-down (if any) required using US GAAP? Please provide the necessary journal entry.
What is the amount of write-down (if any) required using IFRS? Please provide the necessary journal entry.

13. Inventory Write-down Example
Part 1 (continued):
Cost
NRV RC
NRV-NPM
Part 1
$ 10,000
$ 20,000
$ 15,000
$ 12,000
Part 2
$ 19,000
$ 18,000
$ 17,000
Part 3
$ 5,000
$ 3,000
$ 4,000
$ 2,000
Part 4
$ 8,000
$ 11,000
Part 5
$ 9,000

14. Inventory Write-down Example
Part 1 solution:
Original cost
NRV RC
NRV- NPM
US GAAP
market
LCM
IFRS LCNRV
Part 1
$10,000
$20,000
$15,000
$12,000
Part 2
20,000
19,000
18,000
17,000
Part 3
5,000
3,000
4,000
2,000
Part 4
8,000
15,000
12,000
11,000
Part 5
9,000
Total
$58,000
$50,000
$52,000

15. Inventory Write-down Example
Part 1 solution (continued):
US GAAP: IFRS:
Original cost 58,000 Original cost $58,000
LCM 50,000 LCNRV ,000
Write-down $ 8,000 Write-down $6,000
US GAAP journal entry: IFRS journal entry:
COGS $8,000 Inventory write-down expense $6,000
Inventory $8, Inventory valuation allowance $6,000
The amount of inventory write down in this example is $8,000 using US GAAP because the LCM is less than the original cost. The amount is to be recorded in the income statement to COGS and directly to inventory because a future reversal of write-downs is not permitted. Using IFRS, the write-down is $6,000 because the LCNRV is less than the original cost. The write-down is not required to be recorded in a specific income statement account. A valuation allowance is used because future reversals of write-downs are permitted.

16. Inventory Write-down Reversal Example
Example 1 – write-down reversal
Part 2: The airline industry’s business was so terrible during 2013 that Jets International still had the same five parts in its inventory as of December 31, However, fuel prices have decreased, so the outlook is more optimistic. As of the end of the year, Jets International’s original cost basis, net realizable value, replacement cost and net realizable value less the normal profit are as shown on the next slide.
What is the amount of write-down reversal (if any) required using US GAAP? Please provide the necessary journal entry.
What is the amount of write-down reversal (if any) required using IFRS? Please provide the necessary journal entry.

17. Inventory Write-down Reversal Example
Part 2 (continued):
Original Cost
NRV RC
NRV-NPM
Part 1
$ 10,000
$ 21,000
$ 16,000
$ 13,000
Part 2
$ 20,000
$ 19,000
$ 18,000
Part 3
$ 5,000
$ 4,000
$ 9,000
$ 3,000
Part 4
$ 8,000
$ 11,000
$ 12,000
Part 5
$ 15,000
$ 14,000

18. Inventory Write-down Reversal Example
Part 2 solution:
Original Cost
IFRS LCNRV December 31, 2012
NRV
IFRS LCNRV December 31, 2013
Part 1
$ 10,000
$10,000
$21,000
Part 2
20,000
19,000
Part 3
5,000
3,000
4,000
Part 4
8,000
16,000
Part 5
15,000
12,000
14,000
Total
$ 58,000
$ 52,000
$56,000

19. Inventory Write-down Reversal Example
Part 2 solution (continued):
No reversal of a write-down is permitted using US GAAP.
IFRS:
December 31, 2013 LCNRV $ 56,000
December 31, 2012 LCNRV 52,000
Write-down $ 4,000
Journal entry:
Inventory valuation allowance $4,000
Inventory write-down expense $4,000
Since the LCNRV at December 31, 2013 exceeds the LCNRV at December 31, 2012 by $4,000, this amount is recorded as a reversal to the previous write-down. The reversal cannot be more than the original write-down.

20. Disclosure IAS 2 para 36 - 37 outline requirements:
Need to classify into categories
Common classifications:
Merchandise
Production supplies
Materials
Work in progress
Finished goods

21. HOMEWORK
Exercise 9.11
DUE THURSDAY, SEPTEMBER 11