Accounting for Inventory and Tangible Non-Current Assets

Question 1

accounting for inventory - the prudence concept

Answer 1

• how inventory is accounted for has a fundamental impact on the profit a company makes
• there is an overlap between how inventory is accounted for and the prudence concept
• remember the cost of sales calculation and its impact on gross profit
• cost of sales = opening inventory value + cost of purchases - closing inventory value

Question 2

cost of sales =?

Answer 2

cost of sales = opening inventory value + cost of purchases - closing inventory value

Question 3

valuation

Answer 3

• inventory should be valued in the financial statements at the lower of:

cost –> cost includes:
- purchase price
- delivery costs
- import taxes
- duties
- conversion costs
- (costs incurred to bring the item to its present location and condition)

net realisable value
- this represents: the expected selling price less any costs to be incurred to make that sale

Question 4

tangible non-current assets - cost
how do we measure an asset’s cost

Answer 4

cost of property, plant and equipment includes:
- all amounts incurred to acquire the asset
- any amounts directly attribute to bringing the asset to the location and condition necessary for it to be capable of operating in the way intended by management
- directly attributable costs include: purchase price, delivery costs, professional fees (e.g. legal fees), costs of testing
- items that cannot be included in the cost of property, plant and equipment include: repairs, renewals, repainting, administration, training costs, wastage etc

Question 5

how do we account for an asset’s cost

Answer 5

if the asset was purchased with cash:
a) increase non current assets (property, plant + equipment) - statement of financial position
b) decrease current assets (cash + cash equivalents) - statement of financial position

if the asset was purchased on credit:
a) increase non current assets (property, plant and equipment) - statement of financial position
b) increase current liabilities (trade and other payables) - statement of financial position

Question 6

tangible non current assets - depreciation
depreciation is:

Answer 6

• the systematic allocation of the cost of an asset, less its residual value over its useful life
• posted to the statement of profit or loss as an expense
• residual value = estimated disposal value of the asset at the end of it’s useful life
• useful life = estimated number of years during which the business will use the asset

Question 7

tangible non current assets - depreciation
why we depreciate?

Answer 7

• we depreciate non-current assets as it allows the business to spread the cost over a long period of time, making the costs less each year rather than a high cost in one year, also matches the cost of using the asset to the income generated by it over its useful life
• the purpose of depreciation is NOT to show the asset at its current value in the statement of financial position
• depreciation is a method of allocating the cost of the asset over the periods estimated to benefit from its use (i.e. it’s useful life)

Question 8

depreciation methods
straight line method

Answer 8

• depreciation charge for the period = (cost - residual value)/useful life
• rate of depreciation may also be expressed as a percentage of cost
• this method results in the same depreciation charge each period
• used whenever the pattern of use of an asset is consistent throughout its life, e.g. buildings

Question 9

depreciation methods
reducing balance method

Answer 9

• depreciation charge for the period = rate of depreciation x carrying amount of the asset at the beginning of the period
• this method results in a constantly reducing depreciation charge throughout the life of the asset
• used to reflect the expectation that the asset will be used less and less as it ages (e.g. vehicles)

Question 10

key points

Answer 10

• inventory is valued at the lower of cost and net realisable value

depreciation:
- is an application of the accruals concept
- impacts both the statement of financial position and the statement of profit or loss
1. decreases the carrying amount (net book value) of the asset
2. decreases profit because of an increase in expenses
- can be calculated using straight line or reducing balance method