7. Inventory valuations (identifiable goods)

Question 1

What is full costing?

Answer 1

The process of calculating the total product costs by transforming manufacturing overheads into product costs for identifiable goods.
This method includes both variable direct costs and fixed manufacturing overheads. Full costing is especially important when it comes to pricing and assessing profitability. A firm can only make a profit if it recovers all its production costs, not just the variable ones.

Question 2

What is the rationale for full costing?

Answer 2

Matching principle: Costs associated with revenues should be recognised in the same periods in which the revenues are recognised.
Manufacturing overheads are necessary to produce the goods that are sold. These costs should be treated as product costs rather than period costs.

Question 3

What are two important consequences of full costing to reporting?

Answer 3

• A shift in the recognition of expenditure on inventory (in the SoPL) from the period in which it was made to the period in which the goods are sold.
• Profit affected by production: Changes in profits can be caused by changes in the number of units sold and by changes in the number of units produced (e.g., when production is higher than normal a revised absorption rate based on actual numbers is used, and when production is below normal, an adjustment for the unallocated manufacturing overheads is taken through the income statement).

Question 4

What are treasury shares?

Answer 4

An entry in statement of financial position which represents the cost of own shares that the firm has bought back from the market. It is subtracted from equity.

Question 5

What is the principle for valuation of inventories?

Answer 5

Inventory is valued at either its original cost or current market value, whichever is less.