AFU07303:INTERMEDIATE FINANCIAL
ACCOUNTING
TOPIC
IAS 2- INVENTORY
Mbiku, Mustafa Hassan: Certified Public Accountant (CP A(T))
(NBAA), PhD candidate (UDSM), Master of Finance and Accounting in
Oil and Gas (MFA-OG) (UDSM), Bachelor Degree in Accounting (BAC)
(TIA).
INTRODUCTION
• The objective of this standard is to prescribe
the accounting treatment for inventories.
• A particular focus is the cost to be recognised
for closing inventories.
• The standard guides the determination of cost
and its subsequent recognition as an expense,
including any write-down to net realizable
value.
INTRODUCTION
• It also provides guidance on the formula that are
used to assign costs to inventories.
Definition
• IAS 2 defines inventories as assets that are:-
Held for sale in the ordinary course of business
In the process of production for such sale; or
In the form of materials or supplies to be
consumed in the production process or in the
rendering of services.
SCOPE OF IAS 2
IAS 2 applies to all inventories, expect:
a)Work in progress arising under construction
contracts, including directly related service
contracts (see IFRS 15:Revenue from
contracts with customers)
b)Financial instruments (see IAS 39 Financial
Instruments)
c) Biological assets related to agricultural
activity and agricultural produce at the
point of harvest (see IAS 41 Agriculture)
VALUATION /MEASUREMENT
• Inventories shall be measured at the lower of
cost and net realisable value (NRV).
• Net realisable value is the estimated selling
price in the ordinary course of business less
the estimated costs of completion and the
estimated costs necessary to make the sale.
OR
• Net realisable value is the estimated receipts
from the sale of inventory, less any costs of
completing the goods or costs of sales.
VALUATION /MEASUREMENT
• Inventory is always valued at the lower of
cost or net realisable value (NRV).
• Usually costs of inventory will be lower
than the Net Realisable Value (NRV).
• This is the application of the principles of
prudence as over-valuing the inventory
causes both the profit and the assets to be
over-valued.
• Each item of inventory is valued separately.
VALUATION /MEASUREMENT
• Illustration: 01
• Assume you have been given the following
information relating to goods purchased
• Total purchasing cost TZS 80, 000
• Selling price TZS 92,500
• Completion cost TZS 5,000
• Cost to sell =10% of Selling price
• Determine the value of inventory
• LC and NRV = TZS. 78,250
VALUATION /MEASUREMENT
Illustration: 02
• Suppose a company has three items of
inventories on hand at the year-end. Their
costs and NRVs are as follows:
VALUATION /MEASUREMENT
ITEM COST NRV LOWER
TYPE TZS TZS COST/NRV
TZS
A 36 40
B 28 24
C 46 48
TOTAL 110 112
VALUATION /MEASUREMENT
• Calculate the closing value of inventory at
the year-end
• Suggested solutions
ITEM COST NRV LOWER COST/NRV
TYPE TZS TZS TZS
A 36 40 36
B 28 24 24
C 46 48 46
TOTAL 110 112 106
Class activity 1: Lower of cost and NRV
• Finished Goods of dissimilar items at 31
December 2012 are valued as below:
Item Cost TZS NRV TZS Value TZS
1 1,000 1,400
2 800 700
3 2,500 2,800
4 1,800 1,700
5 200 300
6 300 250
6,600 7,150
Class activity 1: Lower of cost and NRV
• Required:
• Value of inventory which should be recorded
in the financial statements on 31st December
2012.
COST OF INVENTORY
Inventoriable Costs per IAS 2
Per paragraph 10 of IAS 2, the cost of
inventories shall comprise :-
costs of purchase,
costs of conversion and
other costs incurred in bringing the
inventories to their present location and
condition.
COST OF INVENTORY
Costs of purchase
Costs of purchase comprises of :-
purchase price,
import duties and other taxes and
transport,
handling and other costs directly
attributable to the acquisition of finished
goods, materials and services, less trade
discounts, rebates and other similar items
COST OF INVENTORY
Costs of conversion
Costs of conversion include
Costs which are directly related to units
of production i.e. direct labour, direct
expenses and sub-contracted work
Systematic allocation of fixed and
variable production overheads incurred in
converting materials into finished goods
COST OF INVENTORY
Other costs can be included in the cost of
inventories to the extent incurred in
bringing the inventories to their present
location and condition
i.e. non-production overheads of designing
a product for a specific customer.
NON INVENTORIABLE COSTS
Paragraph 16 of IAS 2 outlines examples of
costs which are excluded from the cost of
inventories and instead recognised as
expenses in the period in which they are
incurred .
Examples include:-
Abnormal amounts of wasted materials,
labour or other production costs;
Storage costs unless these costs are
necessary in the production process
before a further production stage;
NON INVENTORIABLE COSTS
• Administrative overheads that do not
contribute to bringing inventories to their
present location and condition; and
• Selling costs.
– Advertisement
– Marketing
– Delivery and distribution
– Commision
COST FORMULAE
• Per paragraph 23 of IAS 2, the cost of
inventories of items that are not ordinarily
interchangeable and goods or services
produced and segregated for specific projects
shall be assigned by using specific identification
of their individual costs.
• Methods of valuing inventory issues include:
First In First Out (FIFO)
Last In First Out (LIFO)
Average Cost (AVCO)
First In First Out (FIFO)
• The calculation of the cost of
inventories is on the basis that the
first items to be received are the
first to be issued
OR
• Inventory that were purchased or
produced first are sold first.
Weighted Average Cost Method
(AVCO)
• The calculation of the cost of inventories is
determined by using a weighted average price
computed by dividing the total cost of items
by the total number of such items.
• The price is recalculated on a periodic basis or
as each additional shipment is received and
items taken out of inventory are removed at
the prevailing weighted average cost
Last In First Out (LIFO)
• LIFO is not allowed
under IAS 2
Illustration: 02
• On 1st June 2015 a company held 400 units
of finished goods valued at Tshs.22 each.
During June, the following transactions took
place
DATE UNITS COST PER
PURCHASED UNIT (TZS)
10 June 2015 300 23
20 June 2015 400 24
25 June 2015 500 25
Illustration: 02 Cont’d
DATE UNITS SOLD PRICE PER
UNIT (TZS)
14 June 2015 600 30
21 June 2015 400 31
28 June 2015 100 32
Required:
Calculate the value of closing inventories using
FIFO
AVCO
Disclosure Requirements
According to IAS 2, the following disclosures are required in
the notes to the financial statements:-
[Link] accounting policy adopted for measuring inventories,
including the cost valuation method used.
[Link] total carrying amount of inventories, classified
appropriately. (For a manufacturer, appropriate
classifications will be raw materials, work-in progress and
finished goods).
3. The amount of inventories carried at fair value minus costs
to sell.
4. The amount of inventories recognised as an expense
during the period.
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Disclosure Requirements
5. The amount of any reversal of any write-
down that is recognised as a reduction in
the amount of inventories recognised as
expense in the period.
6. Details of any circumstances or events that
have led to the reversal of a write-down of
inventories.
7. The carrying amount of inventories pledged
as security for liabilities.
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THE END
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