Chapter 9
Inventories
Prepared by Kent Wilson
Learning Objectives
1.
2.
3.
4.
5.
Discuss the nature of inventories
Explain how to measure inventories
Explain what is included in the cost of inventory
Account for inventory transactions using both the
periodic and the perpetual methods
Explain and apply end-of-period procedures for
inventory under both periodic and perpetual
methods
Learning Objectives
6. Explain why cost flow assumptions are required
and apply both FIFO and weighted average cost
formulas
7. Explain the net realisable value basis of
measurement and account for adjustments to net
realisable value
8. Identify the amounts to be recognised as inventory
expenses
9. Implement the disclosure requirements of IAS 2
The Nature of Inventories
 IAS 2 defines inventories as assets that are



Held for sale
In the process of production
Materials or supplies to be used in production
 Inventories are classified as current assets
 Cost of goods sold (COGS) is the expense account
used to record the costs of inventory once sold
Initial Recognition of Inventory
 ‘Inventories shall be measured at the lower of cost
and net realisable value.’
(IAS 2 para 9)
 Cost components:



Costs of purchase
Costs of conversion
Costs in bringing inventory to present location
and condition
Determination of Cost
 The cost of purchase comprises:




The purchase price
Import duties and other transaction taxes
Transport, handling and other directly attributable
costs
Any discounts are to be deducted
Costs of Conversion
 Costs of conversion are those costs directly related
to production including:
 Direct labour
 Systematic allocation of fixed and variable
production overheads
 Variable overheads: vary with volume of
production. Allocated based on actual use of
production facilities
 Fixed overheads: remain constant regardless of
the volume of production. Allocated based on
normal production capacity.
Accounting for Inventory
 Periodic method
 Balance of inventory determined periodically (normally
annually)
 Amount of inventory determined via physical count (#
of units × unit cost)
 Cost-effective and easy to apply, but inexact day-today quantity and cost
 COGS determined as follows:
Opening inv. + purchases – purchase returns – closing inventory = COGS
Accounting for Inventory
 Perpetual method
 Balance of inventory determined each time a
transaction occurs
 Requires subsidiary ledger linked to general
ledger
 Up-to-date but more complicated and expensive
than periodic method
End-Of-Period Accounting
 The following steps are normally undertaken to
ensure that reported figures for inventory and
COGS are accurate and complete:
1.
2.
3.
4.
Physical count
End-of-year cut-off
Accounting for goods in transit and
consignment inventory
Control account/subsidiary ledger reconciliation
procedures (needed only under perpetual
method)
Assigning Costs to Inventory
on Sale
 IAS 2 requires the specific identification method be
used where possible to assign costs to inventory
 Under this method costs are individually identified
for each inventory item
 Where there are large numbers of homogeneous
inventory items one of the following two methods
should be used:
1.
First-in first-out (FIFO)
2.
Weighted average cost method
Assigning Costs to Inventory
on Sale
 FIFO

Assumes that items of inventory
purchased/produced first are sold first
 Items remaining in inventory are those most
recently purchased/produced
 Weighted average

The cost of each item is determined from the
cost of similar items purchased during the
period
 May be a weighted average or a moving
average
Net Realisable Value
 IAS 2 requires that inventories are recorded at
the lower of cost and net realisable value (NRV)
 NRV is the amount the entity expects to realise
from the sale of the inventory in the ordinary
course of business
 NRV may fall below cost due to, inter alia:



Fall in selling price
Physical deterioration of inventory
Obsolescence
 Write-downs made on an item-by-item basis
Disclosure
 IAS 2 paras 36‒37 outline requirements:
 Need to classify into categories
 Common classifications:
o Merchandise
o Production supplies
o Materials
o Work in progress
o Finished goods
CHAPTER 9 - END OF SHOW