IFA-I Chapter 4 (2) — Inventory Accounting (PDF)

Chapter 4: Inventories International Accounting Standard (IAS-2) learning objectives  Nature and classification of inventory  Physical goods and costs included in inventory  Valuation of inventories: A cost-basis approach  Special inventory valuation methods  Lower-of-cost-or-n...

Chapter 4: Inventories International Accounting Standard (IAS-2) learning objectives  Nature and classification of inventory  Physical goods and costs included in inventory  Valuation of inventories: A cost-basis approach  Special inventory valuation methods  Lower-of-cost-or-net realizable value (LCNRV) method  Gross profit method  Retail-inventory method 11/18/2024  INVENTORIE Focus areas: S 1. Prescribing the Accounting Treatment for Inventories, & 2. Introducing the Guidance in relation to: A. Determination of Inventory Cost, and the Cost Formulas to be used to assign costs to inventories. B.Recognition of Expense including: 2 11/18/2024  Applicable Standards 1.IAS 2 – Inventories represent:  Assets held for sale in the ordinary course of business,  In the process of production for such sale or  In the form of material or supplies to be consumed: 3 - In the production process, or EEU-IFRS Project Office  Applicable Standards (Continued) 1.IAS 1.IAS 38 2.IAS 3838-- Inventory -Inventory Inventory may may include mayinclude include intangible intangible assets that are being assets that are being developed for resale, for example, developed for developed for resale, resale, for for software. example, software. 3.IAS 40 - Inventory also includes 2.IAS 2.IAS 40 40 -- Inventory Inventory also also properties that have been includes includes properties properties that have purchased, or are being that beenhavepurchased,been purchased, or are being developed, for resale. or are beingfor developed, developed, resale. for 4.IAS 41 - Agricultural produce resale. 4 EEU-IFRS Project Office 11/18/2024  Basic Concepts & Terminologies  Fair Value – the amount for which an asset could be exchanged, or a liability settled, b/n knowledgeable, willing parties in an arm’s length transaction.  Net Realizable Value – the amount that is expected to be realized from the sale of inventory in the ordinary course of business less the 5 EEU-IFRS Project Office 11/18/2024  Categories of Inventory  Raw Materials- are materials: Which are actually used in the FG, and/or Awaiting entry into the production process.  Work In Progress –The inventory of partially completed products.  Finished Goods – Completed manufactured goods that have not yet been sold. 6 11/18/2024  Categories of  SpareInventory (Continued) Parts, Tools & Consumables- machine parts that are used to replace obsolete or non-useful machine parts, tools and consumables!  Promotional & Advertising Materials  If the ff prerequisites are met, the promotional materials can be recorded as inventory: I. Materials are not delivered to the end- consumer. 7 II. Materials are directly linked to sales 11/18/2024  Exclusi The ff items ons shallbe excluded from the inventories of the Company:  Goods delivered sold and awaiting delivery. and awaiting billing.  Non-returnable packaging containers, stationery, or total value whentheir is not significant.  Major spare parts and stand-by equipment when the entity expects to use them for more than one period (capitalized in fixed assets) 8 EEU-IFRS Project Office 11/18/2024  Recognition & Measurement of Inventories I. RECOGNITI Inventories are recognised from the ON date that the entity has/takes the risks and rewards of ownership of the inventory.  Items owned by an entity that are held on consignment at another entity’s premises are included asEEU-IFRS inventory Project Office of the consignor. 11/18/2024 (Not  Recognition & Measurement of Inventories (Continued) II.  MEASUREME Inventories are to be measured NT at the lower of cost and net realizable value.  Comparison of cost with net realizable value should be carried out on an item-by-item basis but groups of similar items may be considered EEU-IFRS Project Office together. 11/18/2024  Recognition & Measurement of Inventories (Continued)  MEASUREMENT – Continued Producers’ of Agricultural and Forest Products and minerals and mineral products may be stated at net realizable value (instead of the lower of cost & NRV) when this is accepted industry practice. If inventories are measured at net realizable value, EEU-IFRS Project Office changes 11/18/2024 in NRV must  Cost of Inventories Cost of Inventories Include: 1. All costsof purchase (purchase price, transport, handling costs, and taxes that are not recoverable...), 2. Costs of Conversion, & 3. Other Costs Incurred in bringing the inventories to their present condition and location. For example, the costs of designing products for specific customers in the cost of inventories. 11/18/2024  Cost of Inventories  Example(Continued) 1:  EEU imported goods at a Cost of 127,000 Birr, 2000 Birr non-refundable import duties and 1000 Birr refundable purchase taxes. The risks & rewards of ownership of the imported goods were transferred to EEU upon collection of the goods from the port (seller’s) warehouse. EEU was required to pay for the goods upon collection. EEU incurred 500 Birr to transport the goods to its warehouse and a further 2000 Birr in delivering the goods to its customer. Further selling costs of 300 Birr were incurred in selling the goods. EEU-IFRS Project Office 11/18/2024  Cost of Inventories (Continued)  Example 1: Answer:  The cost of purchase is 129,500 Birr!  It includes the costs incurred in bringing the goods to their sale location, i.e.  The 127,000 Birr purchase price  The non-refundable import duties (2000 Birr) & The transport cost to Warehouse (500 Birr). EEU-IFRS Project Office 11/18/2024  Cost of Inventories (Continued)  Example 2  EEU buys a good priced at 500 Birr per unit. However, the supplier awards EEU a 20 % discount on orders of 100 units or more. EEU buys 100 units in a single order. ↑ What is 11/18/2024 EEU-IFRS Project Office the cost of  Cost of Inventories (Continued)  Example 2: Answer:  EEU measures the cost of inventory at 40,000 the Birr!  [I.e. 100 units x (500 Birr list Price less 20% of 500 Birr volume discount)] EEU-IFRS Project Office 11/18/2024  Cost of Inventories (Continued)  If inventories are purchased on deferred settlement terms:  it is not overvalued by inclusion of the interest cost inherent in the purchase arrangement;  rather the d/c b/n the purchase price normal for credit & the terms settlement deferred is interestamount recognised as 17 expense. EEU-IFRS Project Office 11/18/2024  Cost of Inventories (Continued)  Example 3  EEU acquired an item of inventory for 2,000,000 Birr on credit. The identical item is available in the same market for 1,654,000 Birr if payment is made within 30 days of the date of purchase (i.e. normal credit terms). What is the cost of inventory? EEU-IFRS Project Office 11/18/2024  Cost of Inventories (Continued) ↑ Example 3, Answer:  The cost of the inventory is 1,654,000 Birr (I.e. the purchase price for normal credit terms). EEU-IFRS Project Office 11/18/2024  Costs of Conversion  The costs of Conversion of Inventories include: 1. DM and DL Costs directly related to the units of production. 2. MOH costs that are incurred in converting materials into FGs. EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued)  Rules for Calculation of Conversion Costs:  Fixed production OHs should be allocated to Cost of conversion on the basis of the normal capacity of the production facilities! EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued)  Rules for Calculation of C.C (Continued)  The amount of fixed overhead allocated to each unit of production should not increase as a consequence of low production or idle plant! 22 EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued)  Rules for Calculation of C.C (Continued)  In periods of abnormally high production the amount of Fixed OH allocated to each unit of production is decreased so that inventories are not measured above cost! 23 EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued)  Rules for Calculation of C.C (Continued)  Example 4 OHs of  EEU incurred 900,000 Fixed Production Birr during a one-month period in which it manufactured 250,000 units of production. (When operating at normal capacity EEU manufactures 250,000 units of production per month) ↑How much fixed OH cost should EEU allocates to each unit produced 24 EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued)  Rules for Calculation of C.C (Continued) Example 4: Answer:  EEU allocates 3.6 Birr Fixed OH Cost to each unit produced during the month.  [Calculation: 900,000 Birr Fixed Production OH ÷ 250,000 units (i.e. normal capacity) EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued)  Rules for Calculation of C.C (Continued) Example 5  If in a similar situation, EEU may produce only 200,000 units of production; ↑ The allocated Fixed Production OHs would be how much? EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued) Rules for Calculation of C.C (Continued) ↑ Example 5: Answer:  Fixed Production OHs would be 720,000 Birr (I.e. 200,000 units produced x 3.6 Birr allocation rate based on normal production rate) The unallocated Fixed Production OHs of 180,000 Birr must be recognised as an Expense in the profit or 11/18/2024 EEU-IFRS Project Office loss. (900,000  Costs of Conversion (Continued)  Rules for Calculation of C.C (Continued) Example 6 Units Ifof EEUmanufactured 300,000 instead 250,000 or 200,000 units during the month; this level of production is abnormally high! ↑ How much is allocated to Fixed OH Cost? EEU-IFRS Project Office 11/18/2024  Costs of Conversion (Continued)  Rules for Calculation of C.C (Continued) Example 6: Answer:  EEU should allocate 3 Birr fixed OH cost to each unit produced during the month. (Calculation: 900,000 Birr ÷ 300,000 units (actual production) = 3 Birr per unit EEU-IFRS Project Office produced) 11/18/2024  Costs Excluded from Inventories a)Abnormal amounts of wasted materials, labour or other production costs! b)Storage costs, unless those costs are necessary during the c) production process OHs that before a do not Administrati further contribut production stage! bringing vetheir e inventories present location and to condition! to 36 d)EEU-IFRS Selling costs! Project Office 11/18/2024  Cost  Use Formulas Identification Specific Method of Inventory Costing, for;  Items that are not ordinarily interchangeable (unique) &  Goods or services produced & segregated for specific projects.  When there are large numbers of items of inventory that are ordinarily 37 interchangeable/replaceable EEU-IFRS Project Office 11/18/2024 use  Cost Formulas (Continued)  The last-in, first-out method (LIFO) is not permitted by IFRS.  An entity shall use the same cost formula for all inventories having a similar nature & use to the entity.  For inventories with a d/t nature EEU-IFRS Project Office 11/18/2024  Net Realizable Value (NRV) Measurement  Estimates of net realizable value of inventories:  are based on the most reliable evidence available as at the time estimates are made of the amount on which the inventories are expected to realize.  When measuring the NRV for inventories invoiced in the foreign currency 11/18/2024  Net Realizable Value Measurement  Estimates (Continued) of NRV of inventories: (Continued)  Take into consideration the purpose for which the inventories are held:  For example, the NRV of inventory held to satisfy firm sales or service contract is based on the contract price.  If quantities specified in the contract are for less than the inventory 11/18/2024 Write Down of Inventories to NRV Inventories are written down when the NRV of the inventories is less than the cost of the inventories. Inventories are not to be carried in excess of amounts expected to be 11/18/2024 realized  Write Down of Inventories to NRV (Continued)  The write down amount:  is the d/c b/n the cost of the inventories and the NRV &  is expensed immediately in profit or loss in the period the write- down occurs. 11/18/2024  Write Down of Inventories to NRV (Continued) RMs & other Supplies held for use in the production of inventories are not written down their finished below cost, products are if expected to be sold at or above cost! 11/18/2024  Write Down of Inventories to NRV (Continued) Inventories are written down to NRV:  Item by Item or  By Grouping of Similar or Related Items- when the individual write downs may not be realistic or possible! 11/18/2024  Adjust inventory to Lower of Cost & NRV  To reduce the value of inventory to a NRV that is lower than the cost recorded in the company records: Loss on Inventory Valuation xx Inventory xx 11/18/2024  Example of NRV Units Raw Attributable Attribut Expected materi production able selling al cost overheads sellin g costs Item 300 160 15 12 185 A Item B 250 50 10 10 75 At what amount will inventories be stated in the statement of financial position in accordance with IAS 2? Units Cost NRV Lower Total Item 300 175 173 173 51,900 A Item B 250 60 65 60 15,000 11/18/2024  Reversal of Write Downassessment of When subsequent NRV indicates that the circumstances that led to the previous write down of inventories below cost no longer exist, the previous write-down of inventories is reversed. Inventory xx Loss on Inventory Valuation 11/18/2024  Reversal of Write Down (Continued)  The amount of the write down is reversed (i.e. the reversal is limited to the amount of the original write down), so that the new carrying amount is the lower of the cost and the revised net realizable value! 11/18/2024  Accounting Policies  The cost of perishable produce is calculated using the First-in, First-out (FIFO) method. The Weighted Average or Specific Identification Method cost formula is used for all other inventories! 11/18/2024  Presentation and Disclosure An entity shall disclose the following with regard to inventories: 1.The accounting policies adopted in measuring inventories, including the cost formula used. 2.The total carrying amount of inventories and the carrying 11/18/2024 orie Presentation and s Disclosure An entity (Continued) shall disclose…… 3. The amount of inventories recognised as an expense during the period. 4. Impairment losses recognised or reversed in profit or loss. 5. The total carrying amount of inventories 11/18/2024  US GAAP (Concerning Inventory Vs. IFRS Accounting) 1.Similarities  In both methods primary basis of accounting for inventory is cost!  Both define inventory as assets held for sale in the ordinary course of business, in the process of production for such sale or to be consumed in the production of goods or services! 11/18/2024  US GAAP Vs. IFRS (Continued)  Similarities (Continued)  The cost of inventory includes all direct expenditures to ready inventory for sale, including allocable overhead!  Selling costs are excluded from the cost of inventories, as are most storage costs and general administrative costs! 11/18/2024  US GAAP Vs. IFRS (Continued) 2. Significant Method Differences US IFRS s/ GAAP (IAS) Treatme nts 1. LIFO is an 1. LIFO is accepta prohibited. Costi ble ng method. Metho 2. Consistent 2. Same cost ds cost formula formula for all must be inventories applied to all 11/18/2024  US GAAP Vs. IFRS 2. Significant (Continued) Differences Method(Continued) US IFRS s/ GAAP (IAS) Treat me n ts 1. Inventory is 1. Inventory is carried at carried at Mea the lower of cost the lower of or market. cost or net su realizable reme value. nt 2.Market is defined 2. Net realizable as value 11/18/2024  US GAAP Vs. IFRS (Continued) Differences 2. Significant (Continued) Method US IFRS s/ GAAP (IAS) Treatme nts Any write-down Previously Revers of recognized al of inventory to impairment losses the lower of are reversed up to the amount of invent cost or market the original ory creates a new impairment loss cost basis that write- when the reasons 11/18/2024  THE END Thank You!!! 11/18/2024