INVENTORY VALUATION (IAS 2)

Definition
 According to IAS 2 the following are
the terms used
Inventories are assets:
• Held for sale in the ordinary course of
business.
• In the process of production of such sale; or
• In the form of materials or supplies to be
consumed in the production process or in the
rendering of services.
 Inventories encompass

• Goods or other assets purchased for resale;

• Consumable stores;
• Raw materials and components purchased for
incorporation into products for sale.
• Products and services in intermediate stages
of completion;
• Finished goods;
 COST OF INVENTORIES

The cost of inventories should comprise :

• all costs of purchase
• costs of conversion and costs incurred in bringing
the inventories to their present location and
condition.
The cost of purchases will include the “purchase
price, import duties, transport and handling costs
and any other directly attributable costs, less
trade discounts, rebates and subsidies”.
 COST OF INVENTORIES….CONT.
• Accounting for inventories normally follows
the “cost concept” which means inventories
are recorded at acquisition cost.
 Classification Inventories in the
statement of financial position
Inventories are classified as current assets in the
statement of financial position as it is
expected that this merchandise will be sold
and replaced within one accounting period.
 Measurement

• Inventories should be measured at the lower

of cost and net realizable value.
• NET REALIZABLE VALUE Is the estimated
selling price in the ordinary course of business
less estimated cost of completion and the
estimated costs necessary to make the sale.
 Illustration

Stock categories cost Net realizable value

A TZS 10,000 TZS 8,000

A 12,000 15,000

A 20,000 25,000

B 21,000 19,000

B 24,000 16,000

C 32,000 35,000

C 11,000 22,000

Total 130,000 140,000

 Illustration cont…
Required:
Using category and Article method determine
the value of ending stock/inventory
 
 INVENTORY VALUATION SYSTEMS

The two principal inventory systems are:

a.Periodic – System of inventory control in
which no continuous record of changes
(receipts and issues of inventory items) is kept.
INVENTORY VALUATION SY…CONT.
b.Perpetual – System of inventory control in
which the number of units of any inventory
item (and the total value of inventory) on any
day can be obtained from the stock records.
In this method (1) all additions (purchases)
and withdrawals (sales or consumption) are
recorded in inventory cards as they occur to
provide a running balance of quantity and
cost of items,
INVENTORY VALUATION SY…CONT.
• The perpetual inventory system is often used
by trading firms with fewer sales transactions
of merchandise with relatively high unit cost.
For example; motor vehicles, office
equipment, household appliances, furniture,
etc.
 PHYSICAL STOCKTAKING
• Physical stocktaking or the taking of a physical
inventory of merchandise is the process of
determining the quantity of all items of
merchandise owned by the business firm at a
certain date, usually the end of the accounting
period. This involves the actual accounting,
measuring and weighing of all items of unsold
merchandise in the store, shop or warehouse.
 INVENTORY COSTING METHODS
• After determining the quantity of the
merchandise inventory at the end of the
accounting period, (the balance sheet date),
the next step is to assign a cost to each item
of merchandise in order to arrive at the value
of the ending inventory to be presented in the
financial statements.
 INVENTORY COSTING METHODS
There are four inventory costing methods
a.First in First Out method---(FIFO)
This formula assumes that items of
inventories which were purchased first are
sold first, and consequently the items
remaining in inventory at the end of the period
are those most recently purchased or
produced.
 INVENTORY COSTING METHODS
b. Last In First Out—(LIFO)
Assumes that the items of inventory which
were purchased or produced last are sold
first, and consequently the items remaining
in the inventory at the end of the period are
those first produced or purchased.
 INVENTORY COSTING METHODS
c. Weighted Average Method (AVCO) and
Under the weighted average cost formula, the
cost of each item is determined from the
weighted average of the cost of similar items
at the beginning of a period and the cost of
similar items purchased or produced during
the period. Under the perpetual system, the
weighted average cost is calculated each time
a purchase is made.
INVENTORY VAL. METHOD CONT..
d. Specific Identification Method
The specific identification method refers to
the tracking and costing of inventory based on
the movement of specific, identifiable
inventory items in and out of stock. This
method is applicable when individual items
can be clearly identified, such as with a serial
number, stamped receipt date, or RFID tag.
 EXAMPLE ON (SIM) METHOD
NUMBER OF PAIR TYPE OF SHOES COST
50 100,000
Pairs men’s shoes @ TZS.
50
Pairs women’s shoes @ TZS. 80,000
30
Pairs boys’ shoes @ TZS 50,000
30
Pairs girls’ shoes @ TZS 40,000
The stock on hand at 31 December, 2013 consists of
15 pairs men’s shoes and 10 pairs girls’ shoes.
Required
Find the value of closing stock to be presented in the
financial statements.
 ILLUSTRATION
Purchases
Date Units Units Cost Total Cost
10 January 60 300 18,000

30 March 140 310 43,400

15 April 80 315 25,200

19 June 120 320 38,400

22 August 200 330 66,000

9 November 50 340 17,000

Total 650 208,000

 SALES
DATE UNITS
2 February 60

6 April 80

12 May 40

4 July 100

8 August 50

6 September 110

12 December 140

580
TOTAL
INVENTORY METHOD RECOMMENDED BY IAS 2

• IAS recommends use of FIFO and AVCO and

prohibit the use of LIFO method.
• LIFO method allocates cost on the basis of
earliest purchases first and only after
inventory from earlier purchases are issued
completely is cost from subsequent purchases
allocated. Therefore value of inventory using
LIFO will be based on outdated prices. This is
the reason the use of LIFO method is not
allowed for under IAS 2
 ESTIMATING INVENTORIES
• Companies sometimes need to determine the
value of inventory when a physical count is
impossible or impractical. Inventory
sometimes requires estimation for two
reasons.
a. companies often require interim statements
(financial statements prepared for periods of
less than one year), but they only annually
take a physical count of inventory.
 ESTIMATING INVENTORIES CONT…
b. companies may require an inventory
estimate if some casualty such as fire or flood
makes taking a physical count impossible.
 WAYS OF ESTIMATING INVENTORIES
• Two ways of estimating inventory levels are
the gross profit method and the retail
inventory method.
a.Gross profit method. The gross profit method
estimates the value of inventory by applying
the company's historical gross profit
percentage to current-period information
about net sales and the cost of goods
available for sale.
 WAYS OF INVE..EST..CONT…
b. Retail inventory method. Retail businesses
track both the cost and retail sales price of
inventory. This information provides another
way to estimate ending inventory.
-The procedure for determination under this
method is as follows:
1. Beginning inventory and purchases must be
recorded at both cost and selling prices.
 WAYS OF INVE..EST..CONT…
2. Total goods available for sale are then computed
on both bases(at cost and Retail prices).
3. Work out ratio of cost to retail value
4. Sales for the period are deducted from the goods
available for sale at selling price.( Ending
inventory at selling/retail price)
5. The value of Ending inventory at cost will be
determined by converting ending inventory at
retail by ratio of cost to retail value.
 DIFFERENCES BETWEEN GROSS
PROFIT AND RETAIL METHOD
• The major difference between the gross profit
method and the retail method is that the former
uses the historical gross profit rates, and the
latter uses the percentage markup from the
current period.
• The gross profit method uses past experience as
a basis, whereas the retail method uses current
experience. The gross profit method is usually
less reliable, because past situations may be
different from current ones.
 DIFFERENCES BETWEEN GROSS
PROFIT AND RETAIL METHOD
• Both Gross Profit and Retail Inventory
Method are useful because they allow the
accountant to prepare interim financial
statements more frequently without taking
the time to physically count the inventory.
However, the annual physical count is always
necessary.
END OF LECTURE