Chapter 16

Question 1

What problems do inventories have?

Answer 1

• we have to determine the value of the inventories, taking into account that the number of items in inventory changes constantly over time.
• when inventory items are sold, we need to determine the cost of goods sold and recognize the related revenue.

Question 2

What does inventories include?

Answer 2

• goods or other assets purchased for resale
• consumable stores
• raw materials and components purchased for incorporation into products for sale
• products and services in the intermediate stages of completion
• finished goods.

Question 3

Why does evaluating inventories require care?

Answer 3

The valuation of inventories requires care as it is a key determinant of the cost of goods sold and therefore in determining net income. We need to include in our valuation of inventory the following items: costs of purchase and costs of conversion, including both direct and indirect overhead costs.

Question 4

What are ways to calculate inventories?

Answer 4

• Unit cost
• First-in, first-out (FIFO)
• Last-in, first-out (LIFO)
• Weighted average

Question 5

What does unit cost method mean?

Answer 5

• Unit cost, here we assume that we know the actual physical units that have moved in or out. Each unit must be individually distinguishable. we simply add up the recorded costs of those units sold to give the cost of sales and of those units left to give closing inventory.

Question 6

What does FIFO mean?

Answer 6

• First-in, first-out (FIFO) Here it is assumed that the units moving out are the ones that have been in the longest. The units remaining will therefore be regarded as representing the latest units purchased.

Question 7

What does LIFO mean?

Answer 7

• Last-in, first-out (LIFO) We act as if the units moving out are the ones which came in most recently. The units remaining will therefore be regarded as representing the earliest units purchased.

Question 8

What does weighted average mean?

Answer 8

• Weighted average Here, we apply the average cost, weighted according to the different proportions at the different cost levels, to the items in inventory. In practice, an average cost of purchases figure is often used rather than an average cost of inventory figure. This approximation reduces the need for calculation to a periodic, maybe even annual, requirement.

Question 9

What are the two different inventory systems?

Answer 9

1. Periodic systems
2. Perpetual systems

Question 10

What does periodic systems mean?

Answer 10

Periodic systems; Within this system, inventory is determined by a physical count at a specific date. The inventory shown in the statement of financial position is determined by the physical count and is priced by the inventory method used. The net charge between the beginning and ending inventories enters into the computation of the cost of goods sold.

Question 11

What does perpetual systems mean?

Answer 11

Perpetual system: inventory records are maintained and updated continuously as items are purchased and sold. The system has the advantage of providing inventory information on a timely basis but requires the maintenance of a full set of inventory records.

Question 12

Which assumption needs to be made when calculating the inventory costs?

Answer 12

Are the determination of the cost of the unit and the matching of these costs with the items sold.

Question 13

When are inventories defined as assets?

Answer 13

(a) held for sale in the ordinary course of the business
(b) in the process of production for such sale or
(c) in the form of materials or supplies to be consumed in the production process or the rendering of services.

Question 14

What is excluded from the scope, based on IAS2?

Answer 14

Excluded from the scope are construction contracts, financial instruments, and agricultural produce at the point of harvest. IAS 2 mentions further that the Standard does not apply to producers of agricultural and forest products, agricultural produce after harvest, and minerals and mineral products, to the extent that they are measured at NRV by well-established practices in those industries.

Question 15

What is also excluded from IAS 2?

Answer 15

Neither does the standard apply to commodity broker-traders who measure their inventories at the fair value less costs to sell.

Question 16

What does NVR mean?

Answer 16

NVR (net realizable value) is defined as 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.

Question 17

How is fair value defined for aasets?

Answer 17

Fair value is defined as the amount for which an asset could be exchanged, or a liability settled, between knowledgeable, willing parties in an arm’s length transaction.

Question 18

For industrial companies what does IAS 2 not permit?

Answer 18

IAS 2 does not permit exchange differences arising directly from the recent acquisition of inventories invoiced in a foreign currency to be included in the costs of purchase of inventories. The cost of purchase applies to the inventories in commercial companies as well as to all materials used in the production process of industrial companies and materials awaiting use in the production process.

Question 19

What does cost of conversion include by industrial companies?

Answer 19

Costs of conversion include direct labour, the systematic allocation of fixed production overheads and the allocation of variable production overheads.

Question 20

To where are variables overhead allocated by industrial companies?

Answer 20

Variable overheads are allocated to the units produced based on the actual use of production facilities.

Question 21

What is important to know about fixed overheads by industrial companies?

Answer 21

Remember here that fixed overheads are those indirect costs of production that remain relatively constant regardless of the volume of production, whereas variable overheads are those that vary directly or nearly with the volume of production.

Question 22

On what is the allocation of fixed overheads based by industrial companies?

Answer 22

The allocation of fixed overheads is based on the normal capacity of production facilities, taking into account the loss of capacity resulting from planned maintenance. If the production is lower than the normal production capacity, the amount of unallocated overhead will then be treated as an expense in the period in which it is incurred. When the production is higher than the normal capacity, the costs of the products should still be measured at their normal production cost.

Question 23

When should the cost of inventories be recognised by industrial companies?

Answer 23

• abnormal amounts of wasted materials, labour and other production costs
• storage costs, unless those costs are necessary in the production process before a further production stage
• administrative overheads that do not contribute to bringing inventories to their present location and condition
• selling costs.

Question 24

When is the retail method used?

Answer 24

The retail method is generally used in the retail industry where there are large numbers of rapidly changing items that have similar margins. The cost of the inventory is determined by reducing the sales value of the inventory by the appropriate gross profit margin.

Question 25

How do industrial companies determine the NVR?

Answer 25

To determine the NRV, the company deducts from the selling price in the ordinary course of the business the estimated costs of completion and the estimated costs necessary to make the sale. When the cost of inventory will not be recoverable due to damage, the cost of the inventory will be written down to NVR.

Question 26

How should the amount be recognised from the NVR?

Answer 26

The amount of any write-down of inventories to NRV and all losses of inventories shall be recognized as an expense in the period in which the write-down or loss occurs.

Question 27

How are biological produce be recognised?

Answer 27

Biological produce at harvest is recognized and measured according to IAS 41 Agriculture. When biological produce is further processed after harvest, it will be recognized and measured according to IAS 2 Inventories.

Question 28

What is a characteristic of biological produce?

Answer 28

Biological produce can be sold immediately after harvest without any further processing or can be sold after further processing.

Question 29

What does the IAS 41 state?

Answer 29

States that agricultural produce harvested from an entity’s biological assets shall be measured at its fair value less costs to sell at the point of harvest.