UFAS2

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IAS 2 Inventories Revised 1993 - Raw materials – in the form of materials

and supplies to be consumed in the


PREVIEW production process
Inventories should be measured at the lower of cost All goods to which the enterprise has legal title at
and net realizable value. inventory date, regardless of their location at that time,
SIC-1 requires an enterprise to use the same cost should be included in the inventory.
formula for all inventories having a similar nature and
use to the enterprise. Expense – represents a decrease in assets or increase in
liabilities which results in a decrease in equity, other
OBJECTIVE than those relating to distributions to equity
To explain how an enterprise accounts for inventories in participants.
the context of a historical cost system. Net realizable value – represents the estimated selling
price less the cost to complete and dispose of an item.
SCOPE Measurement of Inventories
IAS 2 should be applied in accounting for inventories Inventories should be measured at the lower of cost
under an historical cost system. IAS 2 does not apply to: and net realizable value.
• work in progress arising under construction
contracts; REVENUE RECOGNITION RULE
• financial instruments; or According to IAS 18 Revenue, revenue from the sale of
• inventories such as livestock, agricultural and goods should be recognized when all the following
forest products and mineral ores to the extent conditions have been satisfied:
that they are measured at net realizable value • the enterprise had transferred to the
in accordance with established industry buyer the significant risks and rewards
practices. of ownership of the goods,
INVENTORIES • the enterprise retains neither
Inventories are assets: continuing managerial involvement to
• held for sale in the ordinary course of business; the degree usually associated with
• in the process of production for such sale; or ownership nor effective control over
• in the form of materials or supplies to be the goods sold,
consumed in the production process or in • the amount of revenue can be
rendering services. measured reliably,
The matching concept requires that the cost of unsold • it is probable that the economic
or unconsumed stocks and work in progress inventories benefits associated with the transaction
are carried forward to match future sales. will flow to the enterprise, and
• the costs incurred or to be incurred in
Depending on the nature of the company, inventories respect of the transaction can be
can consist of: measured reliably.
- Trading companies: goods purchased for resale • Generally, it is only at the point of sale that the
- Manufacturing companies: Inventories can be conditions of revenue recognition are met for
subdivided into: inventories.
- Finished goods – ready for sale to • Except for some established practices such as
customers. the construction industry, inventory should not
- Work-in-progress – in the process of be reported at estimated selling price when
production for subsequent sale such amount exceeds cost.
REVENUE EXPENSE Some expenses should not be included in costs of
 When inventories are sold, the carrying amount production:
should be recognized as an expense in the same • abnormal amounts of wasted material,
period. labor or other production cost,
 In the case of write-downs to net realizable • storage costs (unless necessary in the
value or all other losses of inventories, the production process prior to a further
expenses should be recognized in the period production stage),
they occur. • administrative overhead that does not
 In case of reversals of write-downs, they should contribute to bringing inventories to
be recognized in the period in which the their present location and condition and
reversals occurs as a reduction in the amounts • selling costs.
of inventories recognized as an expense.
Interest may be capitalized as part of the historical cost
COST INVENTORIES of assets for which a period of time is required to get
Cost – is the total expenditure that has been incurred in them ready for their intended use.
bringing the product or service to its present location Examples of so-called qualifying assets are:
and condition. - assets that are produced for an enterprise’s
The general categories of expenditure considered as own use,
cost are: - assets intended for sale that are produced as
 Purchase cost discrete projects (for example ships, real estate
 Production cost/costs of conversion developments), and
 Other costs incurred in bringing the inventories - assets which require a maturation process in
to their present location and condition order to bring them into a saleable condition
(eg, whisky).
Purchase costs: includes
• purchase price of materials, If an enterprise chooses to capitalize interest, that
• purchase price of outside manufacturing, treatment should be applied consistently to all
• other expenses of obtaining material, borrowing costs that are directly attributable to the
• import duties and other taxes, acquisition, construction or production of all qualifying
• transport and handling costs, assets of the enterprise.
• other costs directly attributable to the (SIC-2 Consistency – Capitalization of
acquisition of finished goods, materials and Borrowing Costs).
services.
Discounts, rebates and other similar items are Cost of Formula
deducted. Some of the principal cost bases are as follows:
1. Specific identification- is appropriate when
In a manufacturing company the production inventories are not ordinarily interchangeable,
costs/conversion costs include: are segregated for specific projects or are not
• Direct labor cost comprised of a large number of homogenous
• Direct material items that are ordinarily interchangeable.
• Other direct costs 2. Cost flow assumptions – For all other
• Overhead inventories, IAS 2 permits the cost of
The allocation of overhead needs to be based on the inventories to be assigned using either a
enterprise’s normal level of activity. benchmark or an allowed alternative treatment.
Benchmark Treatment – the cost of inventories can be of the period are those first purchased
assigned using either the first-in, first-out (FIFO) or the or produced.
weighted average cost formula. • in periods of rising prices, FIFO results in
Allowed Alternative – the cost of inventories can be the highest and LIFO in the lowest
assigned using the last-in, first-out (LIFO) cost formula. valuation.

Continued-Cost of Formula SIC-1: Consistency: Different


Retail inventory method: Cost Formulas for Inventories.
• may be used for convenience. • Use the same cost formula for all inventories
• the cost of the inventory is determined having similar nature and use to the enterprise.
by reducing the sales value of the • For inventories with different nature or use,
inventory by the appropriate different cost formulas may be justified.
percentage gross margin. • A difference in geographical location of
Standard cost method: inventories, by itself, is not sufficient to justify
• may be used for convenience. the use of different cost formulas.
• the standard cost is the pre-determined
sum that is obtained by costing the Net realizable value
manufacturing specification of the • should be applied when the cost of inventories
product at pre-determined rates for the may not be recoverable
material, labor and overhead expenses • if those inventories are damaged,
entering the manufacturing process. • if they have become wholly or partially obsolete
or
FIFO (First-in, First-out) – • if their selling prices have declined.
• benchmark treatment, • Inventories are usually written down to net
• assumes that the items of inventory realizable value on an item by item basis.
which were purchased first are sold • However, in some cases it may be appropriate
first, and consequently the items to group similar or related items.
remaining in inventory at the end of the • It is not appropriate to write down inventories
period are those most recently based on a classification of inventory.
purchased or produced. o Example: finished goods, or all the
inventories in a particular industry or
Weighted average method – geographical segment.
• benchmark treatment.
• the cost of each item is determined Estimates of net realizable value
from the weighted average of the cost • are based on the most reliable evidence
of similar items at the beginning of a available at the time the estimates are
period and the cost of similar items made.
purchased or produced during the • take into consideration the purpose for
period. which the inventory is held
Disclosure
LIFO (Last-in, First-out) – The financial statements should disclose:
• alternative treatment. • the accounting policies adopted in
• assumes that the items of inventory measuring inventories, including the
that were purchased or produced last cost formula used;
are sold first, and consequently the • the total carrying amount of inventories
items remaining in inventory at the end and the carrying amount in
classifications appropriate to the costs previously included in the measurement
enterprise; of the items of inventory sold and unallocated
• the carrying amount of inventories production overheads and abnormal amounts
carried at net realizable value; of production costs of inventories.
• the amount of any reversal of any write-
down that is recognized as income in Operating costs applicable to revenue, classified by
the period; their nature.
• the circumstances or events that led to – Nature of expense method
the reversal of a write-down of • an enterprise discloses the amounts of
inventories; and operating costs, applicable to revenues
• the carrying amount of inventories for the period, classified by their nature.
pledged as security for liabilities. • expenses are aggregated in the income
statement according to their nature,
Information about the carrying amounts held in (for example depreciation, purchases of
different classifications of inventories and the extent of materials, transport costs, wages and
the changes in these assets is useful to financial salaries, advertising costs), and are not
statement users. reallocated among various functions
When the cost of inventories is determined using the within the enterprise.
LIFO formula(allowed alternative treatment), the
financial statements should disclose the difference
between the amount of inventories as shown in the
balance sheet and either:
• the lower of the amount arrived at and net
realizable value; or
• the lower of current cost at the balance sheet
date and net realizable value.

The financial statements should also disclose either:


• the cost of inventories recognized as an
expense during the period; or
• the operating costs, applicable to revenues,
recognized as an expense during the period,
classified by their nature.

Costs can classified based on


• the nature of expenses, or
• the function within the enterprise

Costs of inventories recognized as an expense.


• referred to as the function of expense or ‘cost
of sales’ method and
• classifies expenses according to their function
as part of cost of sales, distribution or
administrative activities.
• the cost of inventories recognized as an
expense during the period consists of those

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