EU Accounting Rule 9: Inventories PDF

EUROPEAN COMMISSION Budget Budget execution Accounting EUROPEAN UNION ACCOUNTING RULE 9 Inventories  EUROPEAN COMMISSION Budget Budget execution Acc...

EUROPEAN COMMISSION Budget Budget execution Accounting EUROPEAN UNION ACCOUNTING RULE 9 Inventories  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 2 of 10 INDEX 1. Objective.......................................................................................................................................3 2. Scope.............................................................................................................................................3 3. Definitions.....................................................................................................................................3 4. Definition of inventories................................................................................................................3 5. Measurement.................................................................................................................................3 5.1 Cost of inventories................................................................................................................3 5.2 Cost formulas........................................................................................................................3 5.3 Net realisable value..............................................................................................................3 6. Recognition as an expense.............................................................................................................3 7. Disclosures....................................................................................................................................3 8. Effective date.................................................................................................................................3 9. Reference to other rules.................................................................................................................3  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 3 of 10 1. Objective The objective of this EU accounting rule is to prescribe the accounting treatment of inventories. A primary issue in accounting for inventories is the amount of cost to be recognised as an asset and carried forward until the related revenues are recognised. This accounting rule provides guidance on the determination of cost and its subsequent recognition as an expense, including any write-down to net realisable value. It also provides guidance on the cost formulas that are used to assign costs to inventories. 2. Scope This EU accounting rule applies to accounting for all inventories in the financial statements of the European Union and its consolidated entities, except:  Work in progress arising under construction contracts;  Financial instruments;  Inventories from agricultural production; and  Work in progress of services to be provided for no or nominal consideration directly in return from the recipients. 3. Definitions The following terms are used in this rule with the meanings specified: 1) Assets are resources controlled by an entity as a result of past events and from which future economic benefits or service potential are expected to flow to the entity. 2) Inventories are assets: (a) In the form of materials or supplies to be consumed in the production process; (b) In the form of materials or supplies to be consumed or distributed in the rendering of services; (c) Held for sale or distribution in the ordinary course of operations; or (d) In the process of production for sale or distribution. 3) Current replacement cost is the cost the entity would incur to acquire the asset on the reporting date. 4) Exchange transactions are transactions in which one entity receives assets or services, or has liabilities extinguished, and directly gives approximately equal value (primarily in the form of cash, goods, services, or use of assets) to another entity in exchange.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 4 of 10 5) Non-exchange transactions are transactions that are not exchange transactions. In a non- exchange transaction, an entity either receives value from another entity without directly giving approximately equal value in exchange, or gives value to another entity without directly receiving approximately equal value in exchange. 6) Fair value is the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction. 7) Net realisable value is the estimated selling price in the ordinary course of operations less the estimated costs of completion and the estimated costs necessary to make the sale, exchange or distribution. 4. Definition of inventories 1) Net realisable value refers to the net amount that an entity expects to realise from the sale of inventory in the ordinary course of operations. Fair value reflects the amount for which the same inventory could be exchanged between knowledgeable and willing buyers and sellers in the marketplace. The former is an entity-specific value; the latter is not. Net realisable value for inventories may not equal fair value less costs to sell. 2) Inventories encompass goods purchased and held for resale including, for example, merchandise purchased by an entity and held for resale, or land and other property held for sale. Inventories also encompass finished goods produced, or work in progress being produced, by the entity. Inventories also include materials and supplies awaiting use in the production process and goods purchased or produced by an entity, which are for distribution to other parties for no charge or for a nominal charge; for example, educational books produced by the publications office for information of citizens. In many EU entities inventories will relate to the provision of services rather than goods purchased and held for resale or goods manufactured for sale. 3) Inventories in EU entities may include: (a) Consumable stores; (b) Maintenance materials; (c) Spare parts for plant and equipment other than those dealt with in accounting rule 7; (d) Strategic stockpiles (for example, energy reserves, vaccination); (g) Work in progress, including: (i) Educational/training course materials; and (ii) Client services (for example, auditing services) where those services are sold at arm’s length prices. 4) Where an EU entity controls the rights to create and issue various assets these items of inventory are recognised as inventories for the purposes of this accounting rule. They are not reported at face value, but measured in accordance with paragraph 1 of point 5.1, that is at their printing or minting cost.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 5 of 10 5) When an EU entity maintains strategic stockpiles of various reserves for use in emergency or other situations (for example, natural disasters or other civil defense emergencies), these stockpiles are recognised as inventories for the purposes of this accounting rule and treated accordingly. 5. Measurement 5.1 Cost of inventories 1) Inventories shall be measured at the lower of cost and net realisable value, except where inventories are acquired through a non-exchange transaction, their cost shall be measured at their fair value as at the date of acquisition. 2) Inventories shall be measured at the lower of cost and current replacement cost where they are held for: (a) Distribution at no charge or for a nominal charge; or (b) Consumption in the production process of goods to be distributed at no charge or for a nominal charge. 3) The cost of inventories shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition. 4) The costs of purchase of inventories comprise the purchase price, import duties and other taxes (other than those subsequently recoverable by the entity from the taxing authorities), and transport, handling and other costs directly attributable to the acquisition of finished goods, materials and supplies. Trade discounts, rebates and other similar items are deducted in determining the costs of purchase. The costs of converting work-in-progress inventories into finished goods inventories are incurred primarily in a manufacturing environment. 5) Other costs are included in the cost of inventories only to the extent that they are incurred in bringing the inventories to their present location and condition. For example, it may be appropriate to include non-production overheads or the costs of designing products for specific customers in the cost of inventories. Examples of costs excluded from the cost of inventories and recognised as expenses in the period in which they are incurred are: (a) Abnormal amounts of wasted materials, labor, or other production costs; (b) Storage costs, unless those costs are necessary in the production process before a further production stage; (c) Administrative overheads that do not contribute to bringing inventories to their present location and condition; and (d) Selling costs.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 6 of 10 6) An entity may purchase inventories on deferred settlement terms. When the arrangement effectively contains a financing element, that element, for example a difference between the purchase price for normal credit terms and the amount paid, is recognised as interest expense over the period of the financing. 7) To the extent that service providers have inventories except those referred to in point 2, they measure them at the costs of their production. These costs consist primarily of the labor and other costs of personnel directly engaged in providing the service, including supervisory personnel, and attributable overheads. The costs of labor not engaged in providing the service are not included. Labor and other costs relating to sales and general administrative personnel are not included but are recognised as expenses in the period in which they are incurred. The cost of inventories of a service provider does not include surplus margins or non-attributable overheads that are often factored into prices charged by service providers. 8) Techniques for the measurement of the cost of inventories, such as the standard cost method or the retail method, may be used for convenience if the results approximate cost. Standard costs take into account normal levels of materials and supplies, labor, efficiency and capacity utilisation. They are regularly reviewed and, if necessary, revised in the light of current conditions. 9) Inventories may be transferred to the entity by means of a non-exchange transaction. Under such circumstances, the cost of inventory is its fair value as at the date it is acquired. 5.2 Cost formulas 1) The cost of inventories of items that are not ordinarily interchangeable and goods or services produced and segregated for specific projects shall be assigned by using specific identification of their individual costs. 2) Specific identification of costs means that specific costs are attributed to identified items of inventory. This is an appropriate treatment for items that are segregated for a specific project, regardless of whether they have been bought or produced. However, specific identification of costs is inappropriate when there are large numbers of items of inventory which are ordinarily interchangeable. In such circumstances, the method of selecting those items that remain in inventories could be used to obtain predetermined effects on the net surplus or deficit for the period. 3) An EU entity shall use the same cost formula for all inventories having similar nature and use to the entity. For inventories with different nature or use, different cost formulas may be justified. A difference in geographical location of inventories, by itself, is not sufficient to justify the use of different cost formulas. 4) The cost of inventories, other than those dealt with in paragraph 8 of point 5.1, shall be assigned by using the first-in, first-out (FIFO) or weighted average cost formulas. An entity shall use the  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 7 of 10 same cost formula for all inventories having a similar nature and use to the entity. For inventories with a different nature or use, different cost formulas may be justified. 5) The FIFO formula assumes that the items of inventory that were purchased first are sold first, and consequently the items remaining in inventory at the end of the period are those most recently purchased or produced. Under the weighted average cost formula, the cost of each item is determined from the weighted average of the cost of similar items at the beginning of a period and the cost of similar items purchased or produced during the period. The average may be calculated on a periodic basis, or as each additional shipment is received, depending upon the circumstances of the entity. 5.3 Net realisable value 1) The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling prices have declined. The cost of inventories may also not be recoverable if the estimated costs of completion or the estimated costs to be incurred to make the sale, exchange or distribution have increased. The practice of writing inventories down below cost to net realisable value is consistent with the view that assets are not to be carried in excess of the future economic benefits or service potential expected to be realised from their sale, exchange, distribution or use. 2) Inventories are usually written down to net realisable value on an item by item basis. In some circumstances, however, it may be appropriate to group similar or related items. This may be the case with items of inventory that have similar purposes or end uses and cannot practicably be evaluated separately from other items in that product line. Service providers generally accumulate costs in respect of each service for which a separate selling price is charged. Therefore, each such service is treated as a separate item. 3) Estimates of net realisable value also take into consideration the purpose for which the inventory is held. For example, the net realisable value of the quantity of inventory held to satisfy firm sales or service contracts is based on the contract price. If the sales contracts are for less than the inventory quantities held, the net realisable value of the excess is based on general selling prices. 4) Materials and other supplies held for use in the production of inventories are not written down below cost if the finished products in which they will be incorporated are expected to be sold, exchanged or distributed at or above cost. However, when a decline in the price of materials indicates that the cost of the finished products exceeds net realisable value, the materials are written down to net realisable value. In such circumstances, the replacement cost of the materials may be the best available measure of their net realisable value. 5) A new assessment is made of net realisable value in each subsequent period. When the circumstances that previously caused inventories to be written down below cost no longer exist or when there is clear evidence of an increase in net realisable value because of changed economic circumstances, the amount of the write-down is reversed (i.e. the reversal is limited to  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 8 of 10 the amount of the original write-down) so that the new carrying amount is the lower of the cost and the revised net realisable value. This occurs, for example, when an item of inventory, that is carried at net realisable value, because its selling price has declined, is still on hand in a subsequent period and its selling price has increased. 6) An EU entity may hold inventories whose future economic benefits or service potential are not directly related to their ability to generate net cash inflows. These types of inventories may arise when a EU entity has determined to distribute certain goods at no charge or for a nominal amount. In these cases, the future economic benefits or service potential of the inventory for financial reporting purposes is reflected by the amount the entity would need to pay to acquire the economic benefits or service potential if this was necessary to achieve the objectives of the entity. Where the economic benefits or service potential cannot be acquired in the market, an estimate of replacement cost will need to be made. If the purpose for which the inventory is held changes, then the inventory is valued using the provisions of paragraph 1 of point 5.1. 6. Recognition as an expense 1) When inventories are sold, exchanged or distributed the carrying amount of those inventories shall be recognised as an expense in the period in which the related revenue is recognised. If there is no related revenue, the expense is recognised when the goods are distributed or related service is rendered. The amount of any write-down of inventories and all losses of inventories shall be recognised as an expense in the period the write-down or loss occurs. The amount of any reversal of any write-down of inventories shall be recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs. 2) For a service provider, the point when inventories are recognised as expenses normally occurs when services are rendered, or upon billing for chargeable services. 3) Some inventories may be allocated to other asset accounts, for example, inventory used as a component of self-constructed property, plant or equipment. Inventories allocated to another asset in this way are recognised as an expense during the useful life of that asset. 7. Disclosures An EU entity shall disclose: (a) The accounting policies adopted in measuring inventories, including the cost formula used; (b) The total carrying amount of inventory; (c) The carrying amount of inventories carried at fair value less costs to sell; (d) The amount of any material write-down of inventories recognised as an expense in the period; (e) The amount of any reversal of any material write-down that is recognised in the statement of financial performance in the period; and  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 9 of 10 (f) The circumstances or events that led to the reversal of a write-down of inventories.  EUROPEAN COMMISSION Budget Budget execution Accounting Version: 2 EU ACCOUNTING RULE 9: INVENTORIES Date: December 2011 Page 10 of 10 8. Effective date This rule shall be effective for annual financial statements covering periods beginning on or after 1 January 2012. 9. Reference to other rules This accounting rule is based on the following IPSAS standard: IPSAS 12 "Inventories"