Pas 2 Inventories

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PAS 2 INVENTORY

OVERVIEW
- requirements on how to account for most types of inventory.
- The standard requires inventories to be measured at the lower of cost and net realizable value
(NRV)
- outlines acceptable methods of determining cost, including specific identification (in some cases),
first-in first-out (FIFO) and weighted average cost.

OBJECTIVE
1. prescribe the accounting treatment for inventories.
- primary issue in accounting for inventories is the amount of cost to be recognised as an asset and
carried forward until the related revenues are recognised.
2. It provides guidance for determining the cost of inventories and for subsequently recognizing an
expense, including any write-down to net realisable value.
3. It also provides guidance on the cost formulas that are used to assign costs to inventories.
- IAS 2 excludes certain inventories from its scope: [IAS 2.2]
o work in process arising under construction contracts (see IAS 11 Construction Contracts)
o financial instruments (see IAS 39 Financial Instruments: Recognition and Measurement)
o biological assets related to agricultural activity and agricultural produce at the point of
harvest (see IAS 41 Agriculture).
- IAS 2 does not apply to the measurement of inventories held by: [IAS 2.3]
o 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
(above or below cost) in accordance with well-established practices in those industries.
When such inventories are measured at net realizable value, changes in that value are
recognized in profit or loss in the period of the change
 measured at net realisable value at certain stages of production. These inventories
are excluded from only the measurement requirements of this Standard.
o commodity brokers and dealers who measure their inventories at fair value less costs to
sell. When such inventories are measured at fair value less costs to sell, changes in fair
value less costs to sell are recognized in profit or loss in the period of the change.
 Broker‐traders are those who buy or sell commodities for others or on their
 own account. The inventories principally acquired with the purpose of selling in the
near future and generating a profit from fluctuations in price or broker‐traders’
margin. When these inventories are measured at fair value less costs to sell, they are
excluded from only the measurement requirements of this Standard.

DEFINITIONS [IAS 2.6]

Inventories are assets:


(a) held for sale in the ordinary course of 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 in the rendering
of services.

Net realisable value - 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.
- Estimated selling price = Selling Price – cost to complete – cost to sell
- Freight cost not included- it is a distribution cost (marketing, freight out, delivery expense)

Fair value - the price that would be received to sell an asset or paid to transfer a liability in an orderly
transaction between market participants at the measurement date. (See IFRS 13 Fair Value Measurement.)
FV is entity‐specific value; NRV is not. Net realisable value for inventories may not equal fair value less
costs to sell. [IAS 2.7]

Fundamental principle of IAS 2


Inventories are required to be stated at the lower of cost and net realisable value (NRV). [IAS 2.9]

Measurement of inventories
Cost should include all: [IAS 2.10]
 costs of purchase (including taxes, transport, and handling) net of
trade discounts received
 costs of conversion (including fixed and variable manufacturing
overheads)
 other costs incurred in bringing the inventories to their present
Figure 1 cost of goods sold in
location and condition Periodic

Manufacturing
Raw materials = Beginning Inv. + net purchases (purchases – purchase returns and allowances – purchase
discount) + Freight – in - Raw Materials used (not expensed0
Work-in-process = Beginning Inv. + raw material used + Direct labor + Overhead applied – Cost of Goods
Manufactured (CGM)
- Prime cost = raw material used + Direct labor used

Finished Goods = Beginning Inv. + CGM – Cost of goods sold

Fixed cost – examples: water, rent


- fixed at total amount or normal
capacity)
Actual use – varies in total amount of unit
used
- fixed at per unit
- example: electricity (fixed kilo watt/hour) 1 kW = 10 php 100kWh = 1000 pesos

IAS 23 Borrowing Costs identifies some limited circumstances where borrowing costs (interest) can be
included in cost of inventories that meet the definition of a qualifying asset. [IAS 2.17 and IAS 23.4]

Inventory cost should not include: [IAS 2.16 and 2.18]


 abnormal waste
 storage costs
 administrative overheads unrelated to production
 selling costs
 foreign exchange differences arising directly on the recent acquisition of inventories invoiced in a
foreign currency
 interest cost when inventories are purchased with
deferred settlement terms.

At point of harvest = Bio asset


After harvest = inventory
The standard cost and retail methods may be used for the measurement of cost, provided that the results
approximate actual cost. [IAS 2.21-22]

For inventory items that are not interchangeable, specific costs are attributed to the specific individual
items of inventory. [IAS 2.23]

For items that are interchangeable, IAS 2 allows the FIFO or weighted average cost formulas. [IAS 2.25]
The LIFO formula, which had been allowed prior to the 2003 revision of IAS 2, is no longer allowed.

The same cost formula should be used for all inventories


with similar characteristics as to their nature and use to the
entity. For groups of inventories that have different
characteristics, different cost formulas may be justified.
[IAS 2.25]

Write-down to net realisable value


 NRV - the estimated selling price in the ordinary
course of business, less the estimated cost of
completion and the estimated costs necessary to
make the sale. [IAS 2.6]
o COST > NRV = Write down (similar to
impairment in PPE)
o NRV = SP – COST TO COMPLETE – COST
TO SELL
 COST TO COMPLETE = Direct
labor Fixed OH + Variable OH
 COST TO SELL = Cost to Repair
Normal Spoilage (directly
attributable)
 Any write-down to NRV should be recognised
as an expense in the period in which the write-
down occurs.
 Any reversal should be recognised in the income statement in the period in which the reversal
occurs. [IAS 2.34]

Expense recognition
- IAS 18 Revenue addresses revenue recognition for the sale of goods.
o When inventories are sold and revenue is recognised
o the carrying amount of those inventories is recognised as an expense (often called cost-of-
goods-sold).
o Any write-down to NRV and any inventory losses are also recognised as an expense when
they occur. [IAS 2.34]

Disclosure
Required disclosures: [IAS 2.36]
 accounting policy for inventories
 carrying amount, generally classified as merchandise, supplies, materials, work in progress, and
finished goods. The classifications depend on what is appropriate for the entity
 carrying amount of any inventories carried at fair value less costs to sell
 amount of any write-down of inventories recognised as an expense in the period amount of any
reversal of a write-down to NRV and the circumstances that led to such reversal
 carrying amount of inventories pledged as security for liabilities
 cost of inventories recognised as expense (cost of goods sold).
IAS 2 acknowledges that some enterprises classify income statement expenses by nature (materials,
labour, and so on) rather than by function (cost of goods sold, selling expense, and so on).

Accordingly, as an alternative to disclosing cost of goods sold expense, IAS 2 allows an entity to disclose
operating costs recognised during the period by nature of the cost (raw materials and consumables,
labour costs, other operating costs) and the amount of the net change in inventories for the period). [IAS
2.39] This is consistent with IAS 1 Presentation of Financial Statements, which allows presentation of
expenses by function or nature.

Who owns inventory in:


- Held out on consignment (POV: Consignor) – consignor (consigned the goods to consigned)
- Held on consignment (POV: consignee) – Consignor (consignee hold and sell the goods consigned
o Consignee shall exclude consigned goods in hisher inventory
- Sales out on approval/trial – seller (until buyer decides/consents to buy the goods)
- Sales with buyback agreement – Seller (transfers when buyback period expires/terminated)
- Sales with right to return – Buyer (until gusto niyang ibalik) (special assignment)
- Sales on installment – buyer
- Special order-goods – customized (once the product is finished even if not delivered)
- Hold for shipping instructions – Seller (undecided if FOB shipping point or destination)

SITUATION OWNERSHIP
FOB Shipping point Sle risk and rewards are transferred at warehouse
FOB Destination  until risk and rewards are transferred

o FAS – Once the seller drops of the dock, the buyer owns the goods buyer responsible to put the
merchandise on the cargo)
- Buyer owns the good at the dock
o CIF – seller own goods until it transfers the
merchandise or loaded at the cargo
- When loaded at the cargo, buyer own goods
o Ex-ship – Seller transfers ownership when
goods are dropped, delivered, or unloaded at
buyer’s dock
- Opposite of FAS
Weighted to FIFO (as if at the beginning)

Regardless of the current price, the agreed


price shall prevail

PFRS 15

Purchase commitment – at commencement


date no entry but disclosed

Loss on purchase commitment (P&L)

- Increase in value when goods are


received
3. If the value increases when
goods are received:
- Liability - At agreed price
- Purchases – at the lower of purchase
commitment (agreed price parin)
If the value remains decreased:
- Purchases at that price
- Liability remains at agreed price
4. Purchases - no gain or loss
Liability - At agreed price
- Gain on market recovery (similar to reversal)

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