SESSION 14 – IAS INVENTORIES OVERVIEW Objective To prescribe the accounting treatment for inventories under historical cost To provide practical guidance on: determination of cost; expense recognition (including any write-down to net realisable value); cost formulas BASICS Objective Scope Definitions Measurement NET REALISABLE VALUE COST Need for Considerations Materials Timing Meaning of cost Components of cost Techniques Cost formulas RECOGNITION DISCLOSURE As an expense As an asset In financial statements Expense recognition 1401 SESSION 14 – IAS INVENTORIES BASICS 1.1 Objective To prescribe the accounting treatment for inventories Primary issue – the amount of cost to be recognised as an asset and carried forward until related revenue is recognised IAS provides guidance on: cost determination; subsequent recognition as expense (including any write-down to net realisable value); cost formulas used to assign costs to inventories 1.2 Scope All inventories except: contract work in progress (IAS 11); financial instruments (IASs 32 and 39); biological assets related to agricultural activity and agricultural produce at the point of harvest (IAS 41) These inventories are entirely outside the scope of IAS Some inventories that are within the scope of the Standard with regard to disclosure, but not measurement The measurement provisions of IAS not apply to inventories held by: producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at net realisable value in accordance with well-established industry practices; commodity broker-traders who measure their inventories at fair value less costs to sell Commentary When such inventories are measured at net realisable value, changes in that value are recognised in profit or loss in the period of the change 1402 SESSION 14 – IAS INVENTORIES 1.3 Definitions Inventories are assets: held for resale in the ordinary course of business (e.g merchandise purchased by retailer); or in the process of production for resale (e.g finished goods, work in progress, raw materials); or in the form of materials or supplies to be consumed in the production process or rendering of services Net realisable value is the estimated selling price in ordinary course of business less the estimated cost of completion, and estimated costs necessary to make the sale 1.4 Measurement Inventories are measured at the lower of cost and net realisable value COST 2.1 Meaning of cost Cost includes all costs involved in bringing the inventories to their present location and condition Components of cost: purchase costs costs of conversion other costs 2.2 Components of cost Purchase costs Purchase price Import duties/nonrefundable taxes Transport/handling Deduct trade discounts/rebates Conversion costs Direct production costs Production Overheads Based On normal capacity – i.e expected on average under normal circumstances Joint product costs (deduct net realisable value of by-products) Other costs Only if incurred in bringing inventories to present location and condition e.g nonproduction overheads (e.g storage in whiskey distillers) and specific design costs Borrowing costs in limited circumstances (in accordance with IAS 23) 1403 SESSION 14 – IAS INVENTORIES The following expenditures are excluded: abnormal amounts of wasted materials, labour and other production costs; storage costs unless necessary to the production process; administrative overheads; and selling costs For service providers the cost of inventories consists primarily of labour including supervisory personnel and attributable overheads Commentary But not profit margins or non-production costs that are often factored into prices charged by service providers 2.3 Techniques for measurement of cost Two costing methods can be used for convenience if results approximate actual cost Standard cost Takes into account normal levels of materials, labour, efficiency and capacity utilisation Standards must be regularly reviewed and revised as necessary This is a management tool which may need to be adapted to conform to IAS 2.4 Cost formulas 2.4.1 Specific identification Retail method For inventories of large numbers of rapidly changing items with similar margins Reduces sales value by appropriate percentage gross margin This is a practical means of measurement for financial reporting purposes An average percentage for each retail department is often used Specific identification of individual costs is required for: items not ordinarily interchangeable; and goods/services produced and segregated for specific projects Commentary This is not practicable in many businesses 1404 ... practical means of measurement for financial reporting purposes An average percentage for each retail department is often used Specific identification of individual costs is required for: items not... non-production costs that are often factored into prices charged by service providers 2.3 Techniques for measurement of cost Two costing methods can be used for convenience if results approximate actual... which may need to be adapted to conform to IAS 2.4 Cost formulas 2.4.1 Specific identification Retail method For inventories of large numbers of rapidly changing items with similar margins Reduces