KAP 5 - Inventories

Question 1

How are Inventories Initially Measured?

Answer 1

Initial measurement

Inventories are initially measured at “COST” The cost Includes:

• Purchase costs
  
  • Import duties
  • Irrecoverable taxes
  • Inbound Transport
  • Handling costs
  • Any other directly attributable costs
  • Less Discounts & Rebates
• Conversion costs include all direct costs of conversion
  
  • (materials, labour, expenses, etc.),
  • Proportion of Fixed production overheads
  • Proportion of Variable production overheads
    
    • Allocation must be based on the normal level of activity.
• Note on excluded costs - Abnormal wastage, storage costs, administration costs and selling costs, must be excluded from the valuation and charged as expenses in the period in which they are incurred.

IAS 2 allows three methods of arriving at the cost of inventories:

• Actual unit cost
• First-in, First-out (FIFO)
• Weighted Average Cost (AVCO).

Actual unit cost must be used where items of inventory are not ordinarily interchangeable.

Question 2

How are Inventories Subsequently Measured?

Answer 2

Subsequent measurement

• Inventories may be sold below cost if they are damaged, declined in demand, or if the market is increasingly competitive.
• Also, items or work in progress is overstated if there has been a rise in the costs required to complete the asset and make the sale.
• “Work in progress” - items in production but not yet completed is accounted for by separating all purchase costs of raw materials, production costs directly attributable)

As such, IAS 2 requires inventories to be written down to the lower:

• COST
• Net Realisable Value (NRV) on a line-by-line basis.​

NET REALISABLE VALUE is measured by:

• Estimated proceeds from selling
  Less: completion costs
  Less: selling costs
  = (NRV)

Question 3

How is NRV calculated?

Hint

evidence base or estimated?

Answer 3

Notes on evidence of NRV

• NRV of inventory held to satisfy a sales contract is normally evidenced by that contract.
• Sales of inventory after the reporting date provide strong evidence about its NRV as at the reporting date.

However, in other cases, NRV must be *estimated.*

• When measuring NRV, similar items to be grouped together, assuming they are sold in the same market.
• **Raw materials are not written down below cost if the finished good they will form will be sold at a profit.
• However, a decline in raw material prices would suggest that their NRV has fallen below purchase cost.**
• *- In such cases, the replacement cost of the raw materials provides evidence of their NRV.**

Question 4

What are the disclosure requirements of IAS 2:

Answer 4

IAS 2:Inventories

Disclosure requirements
Entities should disclose:

• The total carrying amount of inventories by category
• Details of inventories carried at net realisable value