Lecture 8 - Inventories

Question 1

What is the IAS 2 definition of inventory?

Answer 1

‘Assets held for the sale in the ordinary course of business and/or that are in the process of production into finished goods and material and supplies to be consumed in the production process or in the rendering of services’

Question 2

When inventory is initially recognised, it is done so at…

Answer 2

Cost

Question 3

In relation to inventory, there are three elements of cost, what are they?

Answer 3

1. Cost of purchase
2. Cost of conversion
3. Other costs

Question 4

The cost of purchase includes…

Answer 4

• The purchase price
• Import duties and other taxes (if irrecoverable)
• Transport, handling and other directly attributable costs
• Trade discounts to be deducted

Question 5

What is meant by the term ‘cost of conversion’?

Answer 5

The costs that are directly related to production

Question 6

The cost of conversion consists of two main costs, what are they?

Answer 6

• Direct costs of production (direct labour, raw materials)

- Overheads (Fixed and variable)

Question 7

When ascertaining the cost of conversion, some costs are excluded, what are they?

Answer 7

• Cost of abnormal wastage (waste of mats, labour. These costs are subtracted).
• Storage costs (unless these costs are necessary before a further stage of production. They’re excluded by being ignored)
• Administrative costs (that do not contribute to bringing inventories to their present location and condition)
• Selling costs (everything after production is not included)

Question 8

The problem when allocating inventories at the end of the period lies between…

Answer 8

Closing inventory and Cost of goods sold

Question 9

The identification of inventory, COGS and Goods for available is difficult when goods are…

Answer 9

Homogenous

Question 10

IAS 2 allows two different methods of inventory processing, what are they?

Answer 10

1. First in first out (FIFO)

2. Average weighted cost (AVCO)

Question 11

Under FIFO the first inventory purchases will be…

Answer 11

The first inventory to be sold.

Question 12

Opening inventory + Purchases =

Answer 12

Goods available for sale

Question 13

At the end of a period, goods available for sale can be split into…

Answer 13

Closing inventory and COGS

Question 14

Under the average weighted cost inventory method…

Answer 14

A particular order to the inventory is not assumed. Instead an average of the cost is calculated.

Question 15

FIFO and AVCO are best used when the inventories are…

Answer 15

Homogenous

Question 16

The choice between FIFO and AVCO is a matter of….. and is dependent on 3 main factors, what are they?

Answer 16

The choice is a matter of management judgement.
The choice is dependent on:
1. The nature if the inventory.
2. The actual flow of inventory items.
3. The information needed by management and F/S users.

Question 17

When choosing a cost formula for inventory, it is important to remember…

Answer 17

It cannot be switched randomly from one to the other.

Question 18

Under what circumstances is it acceptable to change the cost formula used for inventory?

Answer 18

When the nature of the inventory changes

Question 19

What does IAS 2 stipulate regarding the subsequent measurement of inventory?

Answer 19

Inventories should be measured at the lower of cost or Net realisable value (NRV), whichever is lowest.

Question 20

What is meant by the term ‘net realisable value’?

Answer 20

Net realisable value is the “estimated selling price in the ordinary course of business less the estimated costs of completion and the estimated costs to necessitate the sale”

Question 21

Give 4 reasons why NRV may fall below cost:

Answer 21

• Decrease in selling price (fashion comes in and out of style quickly)
• Physical deterioration (fruit and veg)
• Product obsolescence (computers decrease in value the older they are)
• The decision to sell at a loss as part of a marketing strategy

Question 22

When the NRV of inventory falls lower than the cost, what is done?

Answer 22

The inventory is written-down, if possible on an item-by-item basis.

Question 23

What is the formula for an inventory write-down?

Answer 23

NRV - Cost = write-down

Question 24

What is the journal entry for an inventory write-down?

Answer 24

Dr: inventory write down (expense)
Cr: inventory (write down NRV)

Question 25

What is the journal entry for a reversal of inventory?

Answer 25

Dr: inventory
Cr: Reversal of inventory write down (income)