Chapter
19
Inventories
Learning checks
A stocktake of inventory is performed at least once a year, and is conducted irrespective of the inventory system — periodic or
perpetual — adopted.
The different shipping terms, particularly EXW and DDP, have a bearing on who owns the inventory and therefore whether the
inventory should be included in the stocktake.
Goods held on consignment for others should not be included in the stocktake of the consignee.
The cost of inventory on hand at the end of a period includes the cost of purchase, the cost of conversion and other costs
needed to bring the inventory to its present location and condition ready for sale.
Under a periodic inventory system, cost flow assumptions are needed in accounting for inventory because of the rise and/or fall
in inventory cost prices during a reporting period.
The different cost flow assumptions allowed by IAS 2/AASB 102 are FIFO, weighted/moving average, and specific identification.
The standard does not permit the use of the LIFO costing method in general-purpose financial statements.
The impact on financial statements of inventory accounting under different cost flow assumptions is considerable in terms of
the effect on profit and inventory balances.
Under the perpetual inventory system, cost flow assumptions are needed in accounting for inventory because of the change in
inventory cost prices during a reporting period.
The weighted average cost flow assumption is referred to as a moving average in a perpetual system.
The same cost flow assumption in accounting for inventory can produce a different answer under a perpetual inventory system
from that under a periodic inventory system.
The cost flow assumptions that provide the same profit outcomes under both inventory systems are the specific identification
and FIFO assumptions.
One reason the LIFO method is not included as an acceptable method by the accounting standard is because it can cause
inventory in the balance sheet to be recorded in out-of-date prices during inflation.
An entity must apply the lower of cost and net realisable value rule to ensure that inventory is not overvalued, as a result of the
standard applying a concept of prudence to ensure a reliable measure.
The rule is to be applied on an item-by-item basis if possible.
Inventories can be written upwards only if net realisable value rises, and only if the inventory had been written down previously
to net realisable value.
Inventory cannot be revalued above cost.
Under the FIFO and moving average cost flow assumptions, sales returns in a perpetual inventory system are recorded as a
negative cost of sales in the inventory record.
Under the FIFO and moving average cost flow assumptions, purchases returns in a perpetual inventory system are recorded as
negative purchases in the inventory record, and are costed at the price paid for the original batch.
Inventory errors can occur for many reasons — failure to record goods in transit or to consider shipping terms, failure to
record correctly in the accounts or in the inventory records. Many errors are detected by comparing inventory records with the
stocktake.
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Chapter 19 Inventories
The effects of inventory errors in one accounting period can result in errors in the next accounting period as well, if not
corrected.
Estimates of the amount of inventories using a retail inventory system rely on keeping detailed records of mark-ups, markdowns and cancellations, as well as staff discounts given.
The gross profit method of estimating inventories is only an approximate measure for insurance purposes when inventory is lost
as a result of theft, fire or flood.
It is important to provide information about an entity’s inventory to users of financial statements as inventory is usually a
significant asset in most entities.
Information about inventories to be disclosed in external financial reports includes its subcategories of finished goods, raw
materials and work in process, and the valuation method for each subcategory.
Different cost flow assumptions affect important ratios used in the decision-making process.
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Chapter 19
Inventories