Inventories Flashcards
Which accounting standard prescribes the treatment for inventories?
IAS 2
It provides guidance for determining the cost of inventories and for subsequently recognising them as an expense, including any write-down to net realisable value.
What is a write-down to net realisable value?
A write-down is a situation that occurs when the Cost of inventory is greater than it’s NRV
What causes a write-down to occur?
- Obsolescence
- Damage
- Decline in Market Value
- Excessive stock levels
What should you do in the event a write-down occurs?
- it should be recognised as an expense in the period in which it occurs.
*Any reversals should be recognised in the income statement in the period in which the reversals occur
What is NRV?
It is the estimated selling price in the ordinary course of business, less the estimated cost of completion and the estimated costs necessary to make the sale
NRV = Fair value - costs to sale
What is fair value?
This 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.
Define inventory?
Inventories are goods and materials that are held for the purpose of sale, production or consumption in the ordinary course of business.
Why are inventories considered assets?
They are considered a current asset on a company’s balance sheet because they are expected to be sold or used within a short period, usually within a year.
What are the different types of Inventories?
- Raw materials
- these are the basic materials used in production. - Work-in-Progress
- these are goods in the production process for sale - Finished Goods
- these are completed products ready for sale to customers
What are the inventories excluded from the scope of IAS 2
- Work in process arising under construction contracts IAS 11 👷🏾♂️🏗️
- financial instruments IAS 39 💵💷
- biological assets related to agricultural activity and agricultural produce at the point of harvest IAS 41🌴🌳🚜
How are inventories recognised?
Inventories are required to be stated at the lower of cost and net realisable value.
How do you measure the cost of inventories?
The cost of inventories is measured by including the cost purchase plus any directly attributable costs.
What are directly attributable costs?
- Costs associated with purchase, such as: taxes, transport, handling etc.
- Costs of conversion, such as: fixed and variable manufacturing overheads.
- Costs incurred in bringing the inventories to their present location and condition.
What costs should not be included when measuring the cost of Inventories?
F.A.S.A.S
- Abnormal waste.
- Storage costs.
- Administrative overheads unrelated to production.
- Selling costs.
- Foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a foreign currency. ➕➖💹💵
How is the cost measured for inventory items that are not interchangeable?
Specific Identification Method
- this is where each item is assigned it’s actual cost
What are inventory items that are not interchangeable?
This means that items are unique or not identical.
For instance, custom made furniture.
Why is the Specific Identification Method used for unique items of inventory?
- to ensure accurate cost tracking of such items.
- helps in precise profit calculation when selling each item.
What are the Inventory Valuation methods allowed under IAS 2?
- FIFO (First-in-First-Out) Method.
- This valuation method assumes that the oldest inventory is sold first. - Weighted Average Cost Method.
- Calculates an average cost per unit after each purchase
- suitable for industries with large, homogeneous inventory (e.g., fuel, grains).
Name a few disclosure requirements for inventories?
- amounts of any write-downs to NRV
- amounts of any write-down reversals
- the carrying amount of any inventories carried at NRV
- accounting policy for inventories
Notes regarding write-down reversals
- Reversals cannot exceed original cost, IAS 2 prohibits it.
- Reversals must be disclosed.
What are the advantages and disadvantages of using FIFO?
Advantages
1. Better reflection of current asset values as FIFO values ending inventory based on the cost of the most recent purchases, thus reflecting prices closer to current market conditions.
- FIFO is simpler to apply as it mirrors the natural flow of goods in many businesses.
- Higher net income during inflation.
Disadvantages
1. Higher tax burden during inflationary periods.
- Less matching of costs and revenue as it does not match the most recent costs with current revenues, which can distort profitability during inflation.
What are the advantages and disadvantages of using the Weighted Average Cost Method?
Advantages
1.Reduces the impact of price volatility in raw materials or inventory purchases.
- For businesses with frequent inventory purchases at varying prices, it provides a realistic value on the balance sheet.
Disadvantages
- Not ideal for unique or high value items, since it blends costs together.
- Does not reflect the latest market prices.
What is the formula to find the average cost to each unit of inventory?
Average Cost per unit = Total cost of inventory / total units available
