CHAPTER 11
INVENTORIES
Connolly – International Financial Accounting and Reporting – 4th Edition
11.1 INTRODUCTION
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Inventory refers to:
 Raw materials
 Work-in-progress
 Finished goods produced
 Goods purchased and held for resale
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Why hold inventory?
 Time
 Uncertainty
 Economies of scale
Connolly – International Financial Accounting and Reporting – 4th Edition
11.2 IAS 2 INVENTORIES
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The key points:
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Inventory is measured at the lower of cost and net
realisable value (NRV)
NRV is 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
Therefore how are cost and NRV measured?
Connolly – International Financial Accounting and Reporting – 4th Edition
COST
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Cost includes:
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

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cost of purchase (exclude trade discounts and rebates)
cost of conversion (include ‘normal’ production
overheads)
other costs necessary to bring to present location and
condition
Fixed production overheads must be allocated to items of
inventory on the basis of normal capacity of the
production facilities
Connolly – International Financial Accounting and Reporting – 4th Edition
COST
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Cost excludes:
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
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abnormal amounts of wasted materials, labour or other
production costs
storage costs, unless necessary in the production
process before the next production stage
administrative overheads
selling costs
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.1: Valuing inventory (1)
DEF Plc manufactures mechanical parrots, which trade under the name
‘Parker’. In the year ended 31 December 2012, 10,000 Parkers are
manufactured and the related costs were:
€
Materials
Labour
Depreciation of Machinery
Factory rates
Sundry factory expenses
Production storage costs
Selling expenses
Expenses at head office
3,000
4,000
2,000
1,000
2,000
1,000
2,000
4,000
19,000
Requirement
At 31 December 2012, there were 1,000 Parkers in inventory. Assuming that
these have a resale value of €4 each, what value should be placed on the
closing inventory?
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.1: Valuing inventory (1)
Solution
€
Materials
Labour
Depreciation of machinery
Factory rates
Sundry factory expenses
Production storage costs
Total cost
3,000
4,000
2,000
1,000
2,000
1,000
13,000
Units manufactured
Unit cost
10,000
€1.30
Number of units on hand at year end
Value of closing inventory
1,000
€1,300
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.2: Valuing inventory (2)
The following information related to Unipoly plc, a manufacturer
of can openers, for the year ended 31 December 2012.
There was no finished goods inventory at the start of the year
and no work in progress. There were 250,000 units in finished
goods at the year end. The normal annual level of production is
750,000 can openers. However, in the year ended 31
December 2012, only 450,000 were produced because of a
labour dispute.
Requirement
Calculate the cost of finished goods at 31 December 2012 in
accordance with IAS 2 Inventories.
(See costs on next slide)
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.2: Valuing inventory (2) (Cont’d)
€
Direct materials cost per unit
Direct labour costs per unit
Direct expenses per unit
1
1
1
Production overheads per year
600,000
Administration overheads per year
200,000
Selling overheads per year
300,000
Interest payments per year
100,000
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.2: Valuing inventory (2)
Solution
Cost per unit
Direct material
Direct labour
Direct expenses
Production overhead (€600,000 / 750,000 units)
Value of closing inventory:
250,000 units x €3.80
Connolly – International Financial Accounting and Reporting – 4th Edition
€
1.00
1.00
1.00
0.80
3.80
€950,000
NET REALISABLE VALUE
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The estimated selling price in the ordinary course of
business less the estimated costs of completion and less the
estimated costs necessary to make the sale
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If the cost is not recoverable, then value at NRV
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.3: Lower of cost and NRV (1)
Finished Goods of dissimilar items at 31 December 2012:
Item
Cost
€
NRV
€
1
1,000
1,400
2
800
700
3
2,500
2,800
4
1,800
1,700
5
200
300
6
300
6,600
250
7,150
Value
€
Inventory should be recorded in the financial statements at 31
December at:
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.3: Lower of cost and NRV (1)
Solution:
Finished Goods of dissimilar items at 31 December 2012:
Item
Cost
NRV
Value
€
€
€
1
1,000
1,400
1,000
2
800
700
700
3
2,500
2,800
2,500
4
1,800
1,700
1,700
5
200
300
200
6
300
6,600
250
7,150
250
6,350
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.4: Lower of cost and NRV (2)
Patches Ltd values inventory at the lower of cost and net
realisable value in accordance with IAS 2 Inventories, and at 31
December 2012 the company’s entire inventory is valued at
cost in the draft financial statements for the year ended 31
December 2012. One of Patches Ltd products ‘Poang’, is
manufactured in two stages and there is a market for the
unfinished stage one product. Details relating to Poang are as
follows:
Poang – stage one
No of units in
Inventory as at
31.12.12
Cost per
unit
€
Selling price
per unit
€
10,000
500
600
Additional costs
Poang - Finished
250
24,000
750
Connolly – International Financial Accounting and Reporting – 4th Edition
800
Example 11.4: Lower of cost and NRV (2) (Cont’d)
The selling costs associated with both the stage one and
finished products are €20 per unit. Following the introduction of
a similar product on to the market in November 2012 by a
foreign competitor.
Patches Ltd has had to reduce the selling price of both stage
one and finished products to €475 and €700 per unit,
respectively, from January 2013.
Requirement
Calculate the value of the closing inventory of Poang at 31
December 2012 and show any adjustments required.
Connolly – International Financial Accounting and Reporting – 4th Edition
Example 11.4: Lower of cost and NRV (2)
Solution
In accordance with IAS 2 Inventories, the decline in selling
price of both the stage one and finished products should be
accounted for at 31 December 2012 as the change in selling
price confirms conditions that existed at the end of the reporting
period. The NRV is based on the selling price of the finished
product.
Product
Cost
NRV
Value
Change
Total
Poang – Stage One
500
430
430
(70)
1,680,000
Poang – Finished
Product
750
680
680
(70)
700,000
2,380,000
Dr Cost of Sales
Cr Inventory
€2,380,000
€2,380,000
Connolly – International Financial Accounting and Reporting – 4th Edition
Techniques for the measurement of cost
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Standard cost – normal level of activity and reviewed
regularly
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Retail method – sales value less % gross margin
Connolly – International Financial Accounting and Reporting – 4th Edition
Cost Formulae
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Methods of valuing inventory issues are:
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First In First Out (FIFO)
Last In First Out (LIFO)
Weighted Average
LIFO is not allowed under IAS 2
See Chapter 11, Examples 11.5 and 11.6
Connolly – International Financial Accounting and Reporting – 4th Edition
Reversal of a write down to NRV
Example:
As at 31 December 2012, inventory was included in the
financial statements valued at its net realisable value of
€15,600. The inventory item had originally cost €18,900.
As at 31 December 2013, the item of inventory was still on
hand but its selling price has increased due to improved
economic conditions. It is now selling for €22,350.
Requirement
How will this item be valued in the financial statements as at 31
December 2013. What are the journals required?
Connolly – International Financial Accounting and Reporting – 4th Edition
Reversal of a write down to NRV
Solution
The write down to net realisable value that took place on 31
December 2012 can be reversed. The amount of the reversal is
limited to the amount of the original write down.
Amount of write down €3,300 (€18,900 – €15,600)
Dr Inventory (SFP)
€3,300
Cr Cost of Goods Sold
€3,300
To reverse write down to NRV
Connolly – International Financial Accounting and Reporting – 4th Edition
Disclosure
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Accounting policy adopted in measuring inventories,
including cost formulas
Carrying amount of inventories under major headings (e.g.
raw materials, WIP and finished goods)
Carrying amount of inventories at fair value less costs to
sell
Amount expended in the period
Amount of any write downs of inventories
Amount of any reversal of write downs
Cause of write downs
Carrying amount of inventories pledged as security
Connolly – International Financial Accounting and Reporting – 4th Edition