IAS 2 (Inventories)

IAS 2: Provides us guidance about the valuation of inventories. Inventory can be described as assets which are used in normal course of business. These may be (1) Raw material (2) Work in progress (3) Finished goods As monetary value is required to record inventory so this value can be cost, selling price, scrape value, replacement or part exchange value. IAS-2 will guide us at which value to record stock. According to IAS 2 inventories should be valued at lower of cost and net realizable value (N.R.V).The recommendation of lower of cost and N.R.V is application of prudence concept which states that assets should not be overstated. Lower of

Cost

N.R.V

Note: IAS-2 recommends lowers of cost and N.R.V it does not mean at lowest possible value and this criteria is for all units of stocks which can be identify separately i.e. if one units cost is less than its N.R.V then this should be recorded at cost and if any other unit has N.R.V less than its cost this should be recorded at N.R.V. Example 1 Alpha motors are going to produce its financial statements for the year ended 31 August 2010. Some stock adjustments are required at year end and accountant is unsure how to deal with the stock. The following detail is available for stock.

Compiled by: Atif Ghaffar

Cost Car 1 Car 2 Car 3 15,000 20,000 15,000

N.R.V 12,000 31,000 19,500

Required: At which value the stock should be recorded in accounts?

According to IAS-2 stock should be recorded at lower of cost and N.R.V and this rule is applicable for each separately identifiable unit. So car 1 should be recorded at N.R.V as it is lower Car 2 should be recorded at cost and car 3 also at cost so the total value of stock is 12,000+20,000+15000 = 47,000 Example 2 ABC has closing stock 160,000 which include a unit with cost 30,000 and N.R.V 22,000,
Required: At which value the stock should be recorded in accounts?

As total value of stock is 160,000 at cost it mean above unit is also included at cost which have N.RV lower than its cost so adjustment is required 160,000-30,000+22,000 = 152,000

Cost
Inventory cost consist of purchase cost, conversion cost and any other cost which are incurred in bringing the inventory in present location or condition. Here cost of purchase will comprise. (1) Price (2) Import duties (3) Non-refundable VAT (4) Carriage inwards (5) Handling cost

Compiled by: Atif Ghaffar

(6) Any cost directly attributed to the acquisition of inventory. EXAMPLE ABC Ltd. Purchase inventory with price $500. Carriage inward will cost $100 in addition ABC Ltd. Paid 50 as non recoverable tax. It will cost 200 to store inventory. At what cost the inventory will be recorded. SOLUTION Cost will only include price and carriage inward, and non recoverable tax storage cost will not form part of it. So inventory value will be $500+$100+$50 =$650

For work in progress and finished goods, fixed and variable production overheads will be included in cost according to their proportion. These costs include. (1) Direct material cost (2) Direct labour cost (3) Foreman or Factory supervisor wages (4) Plant depreciation (5) e.t.c

The cost which will not include normally while valued inventories will be.

(1) Abnormal wastage (2) Storage cost (3) Admin expenses (4) Selling costs

Compiled by: Atif Ghaffar

Costing Methods
(1) (2) (3) (4) (5) FIFO AVCO UNIT COST LIFO( Not a recommended method of valuing stock according IAS-2) Selling price less estimated profit margin may also be used to arrive at cost

N.R.V
N.R.V can be define as net proceeds to business It can be calculated as Selling price selling expenses any cost which is necessary to bring inventory in condition of sale. Normally N.R.V will be greater than cost but in some cases it may be less then cost. For example: (1) Increase in cost in material (2) A physical deterioration (3) Obsolescence (4) Errors in production or purchasing (5) Destroy a part of inventory.

EXAMPLE An item of inventory was purchased for $500. It is expected to be sold for $1200 although $250 will spent on it to bring it in condition of sale. Selling expenses will be $100. What is N.R.V of inventory?

Compiled by: Atif Ghaffar

Solution Sale price Less: Less: Repairing expense selling expenses N.R.V 1200 (250) (100) 850

Different costing methods will leads to different cost figures for stock as closing stock will also be included in income statement. So its selection of valuation method will have effect on profit as. Effect of Inventory on profit

Op. Inventory Op.Inventory

COS COS

Profit Profit

Cl.Inventory Cl.Inventory

COS COS

Profit Profit

Note:

1. In time of rising prices closing inventory value using FIFO will be higher than AVCO. 2.In time of decreasing prices closing inventory value using FIFO will be lower than AVCO.

The above notes are for the students of F3 and TT6 only

Compiled by: Atif Ghaffar

Compiled by: Atif Ghaffar