Chapter 7: Inventories

Question 1

[C7/1] How cost of goods sold are calculated?

Answer 1

Using formula:

Opening Inventory + purchases - less closing inventory

Question 2

[C7/1/1.5]Carriage Inwards? Carriage outwards?

Answer 2

• Carriage inwards is delivering goods into business
• Carriage outwards is delivering business to customer
• Carriage inwards is included in cost of purch.
• Carriage outwards is selling expense/ distribution expense.

Question 3

[C7/1/1.7] The values of inventories should be written down/off to what and in what cases?

Answer 3

They are written down/off to:

• nothing if they are worthless
• net realisable value (if less that original cost)

This happens in case:

• goods stolen, lost
• damaged, thrown away
• obsolete, out of fashion.

Question 4

[C7/1/1.8]What is amount written down?

Answer 4

Amount written down is the amount good lose in its original price.

Question 5

[C7/3]

- How do you manage to get a precise(accurate) count of inventory in hand at any one time?

Answer 5

• If business holds small amounts, the quantity of inventories is established by means of a physical count.
• If business holds large amounts, business apply continuous inventory count.

Question 6

[C7/2.2]

- Do we need to keep inventory account, and how often do we use it?

Answer 6

• The inventory account kept only for being used once a year: at the end of accounting period.

Question 7

[C7/4]How we value inventories?

Answer 7

• Calculated at the lower of cost and Net Realisable Value.

- Cost is determined using FIFO, and AVCO.

Question 8

[C7/4.1] There are several methods which MIGHT be used. Name them.

Answer 8

• Inventories might be valued at their expected selling price.
• Valued at their exp. selling price, less any cost still to be incurred to get them ready for sale and then selling them. (NRV)
• Valued at their historical cost/original cost of buy
• Valued at the amount it would to cost to replace them. Current replacement cost.

Question 9

[C7/4.1]What is the normal basis of inventory valuation?

In which cases we cease using this method?

Answer 9

• Historical cost is only method we normally apply when value inventories.
• The only time when historical cost is not used, is where it is prudent to use a lower value.

Question 10

[C7/4.1] Important rule referring how should we value inventories according to IAS 2 Inventories?

Answer 10

Inventories shall be measured at the lower cost and net realisable value.
!!(cost, or, if lower, NRV).!!

Question 11

[C7/4.3] How to determine purchase cost?

Answer 11

• FIFO (first in, first out). Components are used in the order in which they are received from suppliers. Related their receipts. [issuing components for price of receipt related to it]
• AVCO (average cost). As purchase prices change with each new consignment, the avg. price of components held is constantly changed.
• LIFO (last in, first out). Assuming components/goods used are part of the most recent consignment, and inventories are the oldest receipts. [issuing the latest one, for price of the oldest receipt]

Question 12

[C7/4/4.4] Inventories related Formula?

Answer 12

cost of materials issued+closing inventory=cost of purchases+opening inventory

Question 13

[C7/4/4.5] 2 types of AVCO?

Answer 13

• Cumulative or continuous weighted average pricing method. (Continuously received goods changes inventory value).
• Periodic weighted average pricing method. (Received goods average value calculated at the end of the àcc. period).

Question 14

[C7/5]What does lays out the required accounting treatment for inventories under IFRS?

Answer 14

IAS 2 Inventories.

IAS 2 Inventories lays out the required accounting treatment for inventories under IFRS.

Question 15

[C7/5/5.2] What are inventories according to IAS2?

Answer 15

• Assets held for sale in the ordinary course of business
• In the process of production for sale in the ordinary course of business
• In the form of materials or supplies to be consumed in the production or in the rendering services.
• Resale goods
• Finished goods
• WIP (Work in progress)
• Materials awaiting use in the production

Question 16

[C7/5/5.4] Cost of inventories and costs of purchase?

Answer 16

Inventories:

• Purchase
• Costs of conversion
• Costs incurred in bringing the inventories to their present location and condition.

Purchase:

• Purchase price
• Import duties and other taxes
• Transport, handling any other cost !directly attributable! to the acquisition of finished goods, services and materials.
• Less any trade discounts, rebated and other similar amounts.

Question 17

[C7/5/5.4.2] Costs of conversion?

Answer 17

• Costs directly related to the units of production (materials, direct labour).
• Fixed, variable production overheads that are incurred in converting materials into finished goods, allocated on a systematic basis.

Question 18

[C7/5/5.4.2] Fixed production overheads?

Variable production overheads?

Answer 18

• Indirect costs of production that remain relatively constant regardless of the volume of production. Cost of factory management and adm.
• Variable production overheads those indirect costs of production that vary directly, or nearly directly, with the volume of production. Indirect materials and labour.

Question 19

[C7/5/5.4.2] What and how fixed production overheads must be allocated to?

Answer 19

On the basis of the normal capacity of the production facilities:

• Normal capacity (expected achievable production based on average)
• Aware of the capacity lost through planned maintenance
• Aware of the normal level of activity
• Unallocated overheads must be recognised as an expense
• Low production or idle plant will NOT result in higher fixed overhead allocation to each unit
• Abnormally high production will reduce overhead allocation, so avoiding inventories being stated at more than cost

Question 20

[C7/5/5.4.3]Other Costs?

Answer 20

Recognised if they are incurred in bringing the inventories to their present location and condition, and are not included in cost of inventories. Recognised as an expense.

Standard list:

• Abnormal amounts of wasted materials, labour or other production cost.
• Storage costs (except stage of production)
• Administrative overheads not incurred to bring inventories to their present location and condition
• Selling costs

Question 21

[C7/5/5.5]What is the retail method of cost determining?

Answer 21

Method often used in retail industry for measuring inventories of large numbers of rapidly changing items with similar margins.

1) Retail industry
2) Large inventories
3) Rapid items change
4) Similar margins

The cost of the inventory is determined by reducing the sales value of the inventory by the percentage gross margin.

Question 22

[C7/5/5.5.1] How IAS 2 advises to value inventories consist of interchangeable items?

Answer 22

Using following methods:

• FIFO
• AVCO

Question 23

[C7/5/5.4.2] What is overhead?

Answer 23

Overhead includes all ongoing business expenses not including or related to direct labor or direct materials used in creating a product or service. A company must pay overhead on an ongoing basis, regardless of how much or how little the company is selling. It is important for budgeting purposes, but also for determining how much a company must charge for its products or services to make a profit.

Example: a service-based business with an office has overhead expenses, such as rent, utilities, and insurance that are in addition to direct costs of providing its service.

Question 24

[C7/5/5.6] In which case NRV is likely to be less than cost?

Answer 24

• Increase in costs or a fall in selling price
• Physical deterioration
• Obsolescence
• Part of a company’s marketing strategy to sell products at a loss
• Errors on production or purchasing

Question 25

[C7/5/5.7]Recognition as an expense?

Answer 25

• Carrying amount
• Amounts written down of inventories
• Amounts reversed written down of inventories, arising from an increase in NRV

Question 26

[C7/5/5.8] What should be disclosed when valuing inventories?

Answer 26

• Accounting policies adopted in measuring inventories.
• Total carrying amount of inventories, and classification.
• Carrying amount of inventories carried at NRV.