IAS 2
INVENTORIES
Orhan Balıkçı
Introduction
• The Standard prescribes the accounting treatment for
inventories.
• The main issue with respect to accounting for inventory is
the amount of cost to be recognized as an asset.
• In addition, the Standard provides guidance on the
determination of the cost and subsequent recognition of
expense (including write-down of inventory to its net
realizable value).
• In April 2001 the International Accounting Standards
Board (IASB) adopted IAS 2 Inventories
Objective and scope
This Standard applies to all inventories other than;
• Work in progress under construction contracts and
directly related service contracts
• Financial instruments
• Biological assets related to agricultural activity and
agricultural produce at the point of harvest
Definitions
• Inventories are assets: held for sale in the ordinary course of
business; in the process of production for such sale; or in
the form of materials or supplies to be consumed in the
production process or in the rendering of services.
• Net realisable value (NRV) is the estimated selling price in
the ordinary course of business minus any cost to
complete and to sell the goods.
• Fair value is 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
Cost of Inventories
The cost of inventories comprises all;
• Costs of purchase
• Costs of conversion
• Other costs
Cost of Inventories
The costs of purchase constitute all of
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The purchase price
Import duties
Transportation costs
Handling costs directly pertaining to the acquisition
of the goods
Cost of Inventories
• Cost of conversion of inventory includes costs directly
attributable to the units of production, for example, direct
labor. The conversion costs could also include variable
and fixed manufacturing overhead incurred in converting
raw material into finished goods.
• Other costs in valuing inventories include those costs that
are incurred in bringing the inventories to their present
location and condition. An example of such “other costs”
is costs of designing products for specific customer needs.
Inventories of Service Providers
• Inventories of service providers are measured at
costs of their production. These costs consist
primarily of labor and other costs of personnel
directly used in providing the service, including cost
of supervisory personnel, and attributable overheads.
Techniques of Measurement of
Costs
• The standard cost method takes into account normal
levels of material, labor, efficiency, and capacity
utilization.
• The retail method is often used by entities in the
retail industry for which large numbers of inventory
items have similar gross profit margins.
Cost Formulas
The cost of inventories should be measured using
either
• The FIFO (first-in, first-out) method; or
• The LIFO (last in, first out)
• The weighted-average cost method.
Example of The FIFO
• XYZ Inc. is a newly established international trading company. It commenced its
operation in 2005. XYZ imports goods from China and sells in the local market. It
uses the FIFO method to value its inventory.
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Listed next are the purchases and sales made by the entity during the year 2005:
Purchases:
January 1 10 units @ $ 25 each
January 3 15 units @ $ 30 each
January 25 20 units @ $ 35 each
Sales:
January 10 15 units
January 30 20 units
Example of The FIFO
Date
Purchases
January 1
10 @ $ 25
250$
January 3
15 @ $ 30
250+450=
700$
January 10
January 25
January 30
Sales
Balance
10*25$+5*30$ 300$
=400$
20 @ $ 35
700+300=
1000$
10*30$+10*35 350$
$=$650
Example of The LIFO
• Use The LIFO method on valuing inventory of XYZ Inc.
Date
Purchases
January 1
10 @ $ 25
250$
January 3
15 @ $ 30
250+450=
700$
January 10
January 25
January 30
Sales
Balance
10*30$+5*25$ $275
=$425
20 @ $ 35
700+275=
$975
20*$35=$700
$275
Example of The Weighted-Average
Cost Method
Date
Purchases
January 1
10 @ $ 25
250$
January 3
15 @ $ 30
250+450=
$700
January 10
January 25
January 30
Sales
15 @
$28=$420
20 @ $ 35
Balance
$280
700+280=
$980
20*$32=$640
$340
Net Realizable Value
• Inventories are written down to net realizable value
(NRV) on the basis that assets should not be carried
in excess of amounts likely to be realized from their
sale or use.
• Write-down of inventories becomes necessary for
several reasons; for example, inventories may be
damaged or become obsolete or their selling prices
may have declined after year-end or period-end
Disclosure
•
The financial statements should disclose;
 Accounting policies adopted for measuring inventories and the cost flow assumption
(i.e., cost formula) used
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Total carrying amount as well as amounts classified as appropriate to the entity
Carrying amount of any inventories carried at fair value less costs to sell
Amount of inventory recognized as expense during the period
Amount of any write-down of inventories recognized as an expense in the period
Amount of any reversal of a write-down to net realizable value and the circumstances
that led to such reversal
 Circumstances requiring a reversal of the write-down
 Carrying amount of inventories pledged as security for liabilities
IAS 7
Statement of Cash Flows
Introduction
• IAS 1 makes it incumbent upon entities preparing
financial statements under International Financial
Reporting Standards (IFRS).
• IAS 7, Cash Flow Statements, lays down rules
regarding cash flow statement preparation and
reporting.
Scope
• All entities, regardless of the nature of their
activities, should prepare a cash flow statement in
accordance with the requirements of IAS 7. The cash
flow statement should be presented as an integral
part of the financial statements for each period for
which the financial statements are presented.
Definitions
• Cash Comprises: cash on hand and demand deposits with banks.
• Cash equivalents: Short-term, highly liquid investments that are readily
convertible into known amounts of cash and that are subject to an
insignificant amount of risk of changes in value.
• Operating activities: Principal revenue-producing activities of the entity
and other activities that are not investing or financing activities.
• Investing activities: Activities of the entity that relate to acquisition and
disposal of long lived assets and other noncurrent assets (including
investments) other than those included in cash equivalents.
• Financing activities: Activities that result in changes in the size and
composition of the equity capital and borrowings of an entity
Benefits of Presenting a Cash Flow
Statement
A cash flow statement provides this additional information
to users of financial statements:
• A better insight into the financial structure of an entity,
including its liquidity and solvency, and its ability to affect
the amounts and timing of cash flows in order to adapt to
changing circumstances and opportunities; and
• Enhanced information for the purposes of evaluation of
changes in assets, liabilities, and equity of an entity.
Cash and cash equivalents
• Cash equivalents are held by the entity for meeting
short-term commitments. According to the
definition, cash equivalents are required to possess
these two attributes:
• They should be “short term” in nature;
• They should be “highly liquid investments”
Presentation of a Statement of Cash
Flow
• The statement of cash flow shall report cash flows
during the period classified by operating, investing
and financing activities.
• Classification by activity provides information that
allows users to assess the impact of those activities
on the financial position of the entity and the
amount of its cash and cash equivalents. This
information may also be used to evaluate the
relationships among those activities
1. Operating Activities
• Cash flows from operating activities are primarily
derived from the principal revenue-producing
activities of the entity. This is a critical indicator of
the financial strength of an entity because it is an
important source of internal finance.
2. Investing activities
• Investing activities include the purchase and disposal of
property, plant, and equipment and other long-term
assets, such as investment property.
• Examples of cash flows arising from investing activities
are cash payments to acquire property, plant and
equipment, intangibles and other long-term assets.
• When a contract is accounted for as a hedge of an
identifiable position, the cash flows of the contract are
classified in the same manner as the cash flows of the
position being hedged.
3. Financing activities
• The separate disclosure of cash flows arising from financing
activities is important because it is useful in predicting claims on
future cash flows by providers of capital to the entity.
Examples of cash flows arising from financing activities are:
• cash proceeds from issuing shares or other equity instruments;
• cash payments to owners to acquire or redeem the entity’s
shares;
• cash proceeds from issuing debentures, loans, notes, bonds,
mortgages
Reporting cash flows from operating
activities
• An entity shall report cash flows from operating
activities using either:
• the direct method, whereby major classes of gross cash
receipts and gross cash payments are disclosed; or
• the indirect method, whereby profit or loss is adjusted for
the effects of transactions of a non-cash nature, any
deferrals or accruals of past or future operating cash
receipts or payments, and items of income or expense
associated with investing or financing cash flows.
Example of Direct Method
Example of Indirect Method
Reporting Cash Flows on a Gross
Basis versus a Net Basis
• IAS 7 permits financial institutions to report cash flows arising
from certain activities on a net basis. These activities, and the
related conditions under which net reporting would be
acceptable, are set out below:
• Cash receipts and payments on behalf of customers when the cash
flows reflect the activities of the customers rather than those of the
bank; for example, the acceptance and repayment of demand deposits
• Cash flows relating to deposits with fixed maturity dates
• Placements and withdrawals of deposits from other financial
institutions
• Cash advances and loans to bank customers and repayments thereon
Foreign Currency Cash Flows
• Cash flows arising from transactions in a foreign
currency shall be recorded in an entity’s functional
currency by using the rate of exchange between the
functional currency and the foreign currency on the
date of the cash flow.
• Foreign subsidiaries must prepare separate cash flow
statements and translate the statements to the
functional currency at the exchange rate prevailing on
the date of cash flow
Acquisitions and Disposals of
Subsidiaries and Other Business
Units
• IAS 7 recognizes that an entity may acquire or
dispose subsidiaries or other business units during
the year and thus requires that the aggregate cash
flows from acquisitions and from disposals of
subsidiaries or other business units should be
presented separately as part of the investing activities
section of the statement of cash flows.
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