14 Inventories and biological assets Flashcards
The use of LIFO is allowed under IAS 2.
The use of LIFO is prohibited under IAS 2.
Scope The following items are excluded from the scope of the standard.
Work in progress under long-term contracts (covered by IFRS 15 Revenue from contracts with customers Financial instruments (ie shares, bonds) Biological assets
Inventories are assets: (3 points)
– Held for sale in the ordinary course of 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.
Define Net realisable vale and fair value
Net realisable 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. (IAS 2) Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.
Inventories can include any of the following
Goods purchased and held for resale, eg goods held for sale by a retailer, or land and buildings held for resale Finished goods produced Work in progress being produced Materials and supplies awaiting use in the production process (raw materials)
Cost of inventories The cost of inventories will consist of all costs of:
Purchase Costs of conversion Other costs incurred in bringing the inventories to their present location and condition
Costs of purchase The standard lists the following as comprising the costs of purchase of inventories.
Purchase price PLUS Import duties and other taxes PLUS Transport, handling and any other cost directly attributable to the acquisition of finished goods, services and materials LESS Trade discounts, rebates and other similar amounts
Costs of conversion Costs of conversion of inventories consist of two main parts
(a) Costs directly related to the units of production, eg direct materials, direct labour (b) Fixed and variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic basis.
Define Fixed production overheads & Variable production overhead
Fixed production overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, eg the cost of factory management and administration. Variable production overheads are those indirect costs of production that vary directly, or nearly directly, with the volume of production, eg indirect materials and labour.
The standard emphasises that fixed production overheads must be allocated to items of inventory on the basis of the normal capacity of the production facilities. This is an important point.
(a) Normal capacity is the expected achievable production based on the average over several periods/seasons, under normal circumstances. (b) The above figure should take account of the capacity lost through planned maintenance. (c) If it approximates to the normal level of activity then the actual level of production can be used. (d) Low production or idle plant will not result in a higher fixed overhead allocation to each unit. (e) Unallocated overheads must be recognised as an expense in the period in which they were incurred. (f) When production is abnormally high, the fixed production overhead allocated to each unit will be reduced, so avoiding inventories being stated at more than cost. (g) The allocation of variable production overheads to each unit is based on the actual use of production facilities.
Other costs Any other costs should only be recognised if they are incurred in bringing the inventories to their present location and condition. The standard lists types of cost which would not be included in cost of inventories. Instead, they should be recognised as an expense in the period they are incurred.
(a) Abnormal amounts of wasted materials, labour or other production costs (b) Storage costs (except costs which are necessary in the production process before a further production stage) (c) Administrative overheads not incurred to bring inventories to their present location and conditions (d) Selling costs
Techniques for the measurement of cost Two techniques are mentioned by the standard, both of which produce results which approximate to cost, and so both of which may be used for convenience.
(a) Standard costs are set up to take account of normal production values: amount of raw materials used, labour time etc. They are reviewed and revised on a regular basis. (b) Retail method: this is often used in the retail industry where there is a large turnover of inventory items, which nevertheless have similar profit margins. The only practical method of inventory valuation may be to take the total selling price of inventories and deduct an overall average profit margin, thus reducing the value to an approximation of cost. The percentage will take account of reduced price lines. Sometimes different percentages are applied on a department basis.
Cost formulae Cost of inventories should be assigned by specific identification of their individual costs for:
(a) Items that are not ordinarily interchangeable (b) Goods or services produced and segregated for specific projects
Specific costs should be attributed to individual items of inventory when they are segregated for a specific project, but not where inventories consist of a large number of interchangeable (ie identical or very similar) items. In the latter case the rule is as specified below.
Net realisable value (NRV) As a general rule assets should not be carried at amounts greater than those expected to be realised from their sale or use. In the case of inventories this amount could fall below cost when items are damaged or become obsolete, or where the costs to completion have increased in order to make the sale. In fact we can identify the principal situations in which NRV is likely to be less than cost, ie where there has been:
(a) An increase in costs or a fall in selling price (b) A physical deterioration in the condition of inventory (c) Obsolescence of products (d) A decision as part of the company’s marketing strategy to manufacture and sell products at a loss (e) Errors in production or purchasing
A write down of inventories would normally take place on an item by item basis, but similar or related items may be grouped together. This grouping together is acceptable for, say, items in the same product line, but it is not acceptable to write down inventories based on a whole classification (eg finished goods) or a whole business. T/F
A write down of inventories would normally take place on an item by item basis, but similar or related items may be grouped together. This grouping together is acceptable for, say, items in the same product line, but it is not acceptable to write down inventories based on a whole classification (eg finished goods) or a whole business.
The reasons why inventory is held must also be taken into account. Some inventory, for example, may be held to satisfy a firm contract and its NRV will therefore be the contract price. Any additional inventory of the same type held at the period end will, in contrast, be assessed according to general sales prices when NRV is estimated. Net realisable value must be reassessed at the end of each period and compared again with cost. If the NRV has risen for inventories held over the end of more than one period, then the previous write down must be reversed to the extent that the inventory is then valued at the lower of cost and the new NRV. This may be possible when selling prices have fallen in the past and then risen again. T/F
The reasons why inventory is held must also be taken into account. Some inventory, for example, may be held to satisfy a firm contract and its NRV will therefore be the contract price. Any additional inventory of the same type held at the period end will, in contrast, be assessed according to general sales prices when NRV is estimated. Net realisable value must be reassessed at the end of each period and compared again with cost. If the NRV has risen for inventories held over the end of more than one period, then the previous write down must be reversed to the extent that the inventory is then valued at the lower of cost and the new NRV. This may be possible when selling prices have fallen in the past and then risen again.
Recognition as an expense The following treatment is required when inventories are sold.
(a) The carrying amount is recognised as an expense in the period in which the related revenue is recognised. (b) The amount of any write-down of inventories to NRV and all losses of inventories are recognised as an expense in the period the write-down or loss occurs. (c) The amount of any reversal of any write-down of inventories, arising from an increase in NRV, is recognised as a reduction in the amount of inventories recognised as an expense in the period in which the reversal occurs.
Consistency – different cost formulas for inventories IAS 2 allows two cost formulas (FIFO or weighted average cost) for inventories that are ordinarily interchangeable or are not produced and segregated for specific projects. The issue is whether an entity may use different cost formulas for different types of inventories. True/ False
Consistency – different cost formulas for inventories IAS 2 allows two cost formulas (FIFO or weighted average cost) for inventories that are ordinarily interchangeable or are not produced and segregated for specific projects. The issue is whether an entity may use different cost formulas for different types of inventories.
The main reason for developing a standard on agriculture was because there was great diversity in practice in accounting for agriculture at both a transnational and national level. It is quite difficult to apply traditional accounting methods to agricultural activities, which explains why agriculture is excluded from many IFRSs
(a) When and how do you account for the critical events associated with biological transformation (growth, procreation, production and degeneration), which alter the substance of biological assets? (b) Statement of financial position classification is made difficult by the variety and characteristics of the living assets of agriculture. (c) The nature of the management of agricultural activities also causes problems, particularly determination of the unit of measurement, ie whether biological assets are a perpetual group of assets or a number of limited life assets.
Define the ff terms: Agricultural activity Agricultural produce Biological assets Biological transformation group of biological asset Harvest Fair value Carrying amount
Agricultural activity is the management by an entity of the biological transformation of biological assets for sale, into agricultural produce or into additional biological assets. Agricultural produce is the harvested product of an entity’s biological assets. Biological assets are living animals or plants. Biological transformation compromises the processes of growth, degeneration, production and procreation that cause qualitative and quantitative changes in a biological asset. A group of biological assets is an aggregation of similar living animals or plants. Harvest is the detachment of produce from a biological asset or the cessation of a biological asset’s life processes. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. (IFRS 13) Carrying amount is the amount at which an asset is recognised in the statement of financial position
What are the key parts of the definition of agriculture
(a) Biological: agriculture relates to ‘life phenomena’, living animals and plants with an innate capacity of biological transformation which are dependent upon a combination of natural resources (sunlight, water, etc). (b) Transformation: agriculture involves physical transformation, whereby animals and plants undergo a change in biological quantity (fat cover, density, etc) and/or quantity (progeny, live weight etc) over time, which is measured and monitored (increasingly objectively) as part of management control. (c) Management: biological transformation is managed. (i) Conditions are stabilised or enhanced. (ii) The transparency of the relationship between inputs and outputs is determined by the degree of control (intensive versus extensive). (iii) It is different from exploitation through extraction, where no attempt is made to facilitate the transformation.(iv) Biological assets are managed in groups of plant or animal classes, using individual assets to ensure the sustainability of the group. (v) Sustainability of an agricultural activity is a function of quality and quantity. (d) Produce: agricultural produce is diverse and may require further processing before ultimate consumption.
Scope The standard applies to the three elements that form part of, or result from, agricultural activity.
Biological assets Agricultural produce at the point of harvest Government grants The standard does not apply to agricultural land or intangible assets related to agricultural activity (IAS 38). After harvest, IAS 2 is applied
Biological assets We have seen the definition given above. Biological assets are the core income-producing assets of agricultural activities, held for their transformative capabilities. Biological transformation leads to various different outcomes:
Asset changes: – Growth: increase in quantity and or quality – Degeneration: decrease in quantity and/or quality
Creation of new assets: – Production: producing separable non-living products – Procreation: producing separable living animal
We can distinguish between the importance of these by saying that asset changes are critical to the flow of future economic benefits both in and beyond the current period, but the relative importance of new asset creation will depend on the purpose of the agricultural activity. The IAS distinguishes therefore between two broad categories of agricultural production system.
(a) Consumable: animals/plants themselves are harvested. (b) Bearer: animals/plants bear produce for harvest. A few further points are made: (a) Biological assets are usually managed in groups of animal or plant classes, with characteristics (eg male/female ratio) which allow sustainability in perpetuity. (b) Land often forms an integral part of the activity itself in pastoral and other land-based agricultural activities.
