1.

1 IAS 2 - Inventory
Inventories are:
Assets held for sale. For a retailer, these are items that the business sells – its stock-in
trade. For a manufacturer, assets held for sale are usually referred to as ‘finished goods’
Assets in the process of production for sale (‘work-in-progress’ for a manufacturer)
Assets in the form of materials or supplies to be used in the production process (‘raw
materials’ in the case of a manufacturer).

VALUATION:
IAS 2 states that inventories should be valued at the lower of cost and net realizable value

Cost however, consists of all the costs of purchase, plus the costs of conversion and other cost
incurred in bringing the inventories to their present location and condition.
1. Costs of purchase include the cost of the item itself (less any trade discounts) plus
import duties, transport costs and other handling costs.
2. Costs of conversion are the ‘internal costs’ incurred in getting the inventory into its
current state, such as the internal cost incurred in producing finished goods. They
include both direct costs (such as labour and expenses) and a share of production over
heads, where production overhead absorption rates are based on normal levels of
activity.
Net realizable value (NRV) is the estimated selling price of the item minus:
i. All the (estimated) costs to make the item ready for sale, and
ii. All the (estimated) costs necessary to make the sale.

IAS2 comments that the practice of writing down inventories below cost to their net realizable
value is consistent with the view that assets should not have a carrying value in the statement
of financial position that exceeds the amount expected to be realized from their sale/use.

Measuring the cost of inventory

IAS2 allows three methods for measuring the cost of inventories.
 Actual cost
 First-in, first out (FIFO)
 Weighted average cost (AVCO).

On 1 January a company had an opening inventory of 100 units which cost ₦50 each.
During the month it made the following purchases:
5 April: 300 units at ₦60 each (= ₦18,000)
14 July: 500 units at ₦70 each (= ₦35,000)
22 October: 200 units at ₦80 each (= ₦16,000)
During the period it sold 800 units as follows:
9 May: 200 units
25 July: 200 units
23 November: 200 units
12 December: 200 units
The cost of each material issue from store in October and the closing inventory using the FIFO
measurement method is as follows:
Example 1: Purchase cost
Kaduna Consumer Electrics (KCE) buys goods from an overseas supplier.
It has recently taken delivery of 1,000 units of component X.
The quoted price of component X was ₦1,200 per unit but KCE has negotiated a trade
discount of 5% due to the size of the order.
The supplier offers an early settlement discount of 2% for payment within 30 days and KCE
intends to achieve this.
Import duties of ₦60 per unit must be paid before the goods are released through custom.
Once the goods are released through customs KCE must pay a delivery cost of ₦5,000 to
have the components taken to its warehouse.

Example 2: Purchase cost

Kaduna Consumer Electrics (KCE) manufactures control units for air conditioning systems.
The following information is relevant:
Each control unit requires the following:
1 component X at a cost of ₦ 1,205 each
1 component Y at a cost of ₦ 800 each
Sundry raw materials at a cost of ₦150.
The company faces the following monthly expenses: ₦
Factory rent 16,500
Energy cost 7,500
Selling and administrative costs 10,000
Each unit takes two hours to assemble. Production workers are paid ₦300 per hour.
Production overheads are absorbed into units of production using an hourly rate. The normal
level of production per month is 1,000 hours.

Example: valuation at lower of cost and net realizable value

A business has four items of inventory. A count of the inventory has established
that the amounts of inventory currently held, at cost, are as follows:
Cost Sales price Selling costs
Inventory item A1 8,000 7,800 500
Inventory item A2 14,000 18,000 200
Inventory item B1 16,000 17,000 200
Inventory item C1 6,000 7,500 150

Example: Timing of inventory counts

Sokoto Trading has a 31 December year end. It carried out an inventory count on 5th January
2014. The count was valued at ₦2,800,000.
The following transactions took place between the 31 December and 5 January.
1. Sales of goods for ₦120,000. These goods cost ₦96,000.
2. Purchases of goods for ₦136,000.
The inventory at the reporting date is calculated as follows:

1.3 Scope
The following items are excluded from the scope of the standard.
Work in progress under construction contracts (covered by IAS 11 Construction
contracts)
Financial instruments (ie shares, bonds)
Biological assets
Certain inventories are exempt from the standard's measurement rules, ie those held by:
Producers of agricultural and forest products

1.1 Introduction to IAS 8

The aim of IAS 8: Accounting policies, changes in accounting estimates and errors is to
enhance comparability of the entity’s financial statements to previous periods and to the
financial statements of other entities It does this by prescribing:
the criteria for selecting accounting policies; and,
the accounting treatment and disclosure of:
changes in accounting policies;
changes in accounting estimates; and
errors.
Much of IAS 8 is concerned with how changes or corrections should be reported in the
financial statements.

Definition: Accounting policies

Accounting policies are the specific principles, bases, conventions, rules and practices applied
by an entity in preparing and presenting financial statements.

Selection of accounting policies

Selection of accounting policies – Areas covered by IFRS
If an IFRS (or an Interpretation) applies to an item in the financial statements, the accounting
policy or policies applied to that item must be determined by applying the Standard or
Interpretation and any relevant implementation guidance issued.
Selection of accounting policies – Area not covered by IFRS
If there is no rule in IFRS that specifically applies to an item in the financial statements,
management must use its judgement to develop and apply an accounting policy that results in
information that is:
relevant to the decision-making needs of users; and
reliable in that the financial statements;
represent faithfully the results and financial position of the entity;
reflect the economic substance of transactions and other events and not merely the legal
form;
are neutral, i.e. free from bias;
are prudent; and
are complete in all material respects.

1.4 Changes in accounting policies

The same accounting policies must be applied within each period and from one period to the
next unless a change in accounting policy meets one of the following criteria. A change in
accounting policy is permitted only if the change is:
required by IFRS; or
results in the financial statements providing reliable and more relevant financial information.

Definition: Retrospective application

Retrospective application is applying a new accounting policy to transactions, other events and
conditions as if that policy had always been applied.

It might be impracticable to retrospectively apply an accounting policy. This could be because

the information necessary for the application of the policy to earlier periods is not available.
And so, it would be difficult to determine the period specific effects and/or cumulative effect of
an accounting policy.

Prospective application of a change in accounting policy:

Applying the new accounting policy to transactions, other events and conditions occurring
after the date as at which the policy is changed.

ACCOUNTING ESTIMATES
An estimate is therefore based, to some extent, on management’s judgement. Management
estimates might be required, for example, for the following items:
bad debts;
inventory obsolescence;
the fair value of financial assets or liabilities;
the useful lives of non-current assets;
the most appropriate depreciation pattern (depreciation method, for example straight line or
reducing balance) for a category of non-current assets;
measurement of warranty provisions.

Recognising the effect of a change in an accounting estimate

Recognising the effect of the change in the accounting estimate in the current and future
periods affected by the change.

Illustration1: Accounting policy vs accounting estimate

Accounting policy: Depreciating plant and equipment over its useful life IAS 16: Property, plant
and equipment allows the use of the cost model or the revaluation model for measurement
after recognition.

Accounting estimate: How to apply the policy. For example whether to use the straight line
method of depreciation or the reducing balance method is a choice of accounting estimate.

A non-current asset was purchased for ₦200,000 two years ago, when its expected economic
life was ten years and its expected residual value was nil. The asset is being depreciated by
the straight-line method.
A review of the non-current assets at the end of year 2 revealed that due to technological
change, the useful life of the asset is only six years in total, and the asset therefore has a
remaining useful life of four years.

Illustration2
Kano Transport Company (KTC) is preparing its financial statements for 2014.
The draft statement of changes in equity is as follows:
Share Share Retained Total
Capital premium earnings
₦000 ₦000 ₦000 ₦000
Balance at 31/12/11 500 50 90 640
Profit for the year - - 150 150
Balance at 31/12/12 500 50 240 790
2013
Dividends (100) (100)
Profit for the year 385 385
Balance at 31/12/13 500 50 525 1,075
KTC has now discovered an error in its inventory valuation. Inventory was overstated by
₦70,000 at 31 December 2013 and by ₦60,000 at 31 December 2012. The rate of tax on
profits was 30% in both 2012 and 2013.

Disclosure Requirement – changes in accounting policy

Certain disclosures are required when a change in accounting policy has a material effect on
the current
period or any prior period presented, or when it may have a material effect in subsequent
periods.
(a) Reasons for the change
(b) Amount of the adjustment for the current period and for each period presented
(c) Amount of the adjustment relating to periods prior to those included in the comparative
information
(d) The fact that comparative information has been restated or that it is impracticable to do so
An entity should also disclose information relevant to assessing the impact of new IFRS on
the financial
statements where these have not yet come into force.

NOTE: The standard highlights two types of event which do not constitute changes in
accounting policy.
(a) Adopting an accounting policy for a new type of transaction or event not dealt with
previously by
the entity.
(b) Adopting a new accounting policy for a transaction or event which has not occurred in the
past or
which was not material.

Disclosure Requirement – changes in accounting estimate

The following information must be disclosed:
The nature and amount of a change in an accounting estimate that has an
effect in the current period or is expected to have an effect in future
periods, except for the effect on future periods when it is impracticable to
estimate that effect.
The fact that the effect in future periods is not disclosed because estimating
it is impracticable (if this is the case).

Disclosure Requirement – prior period errors

The following information must be disclosed:
the nature of the prior period error;
for each period presented in the financial statements, and to the extent
practicable, the amount of the correction for each financial statement item
and the change to basic and fully diluted earnings per share;
the amount of the correction at the beginning of the earliest prior period in
the statements (typically, a the start of the previous year);
if retrospective re-statement is not practicable for a prior period, an
explanation of how and when the error has been corrected.
IAS 8 therefore requires that a note to the financial statements should disclose
details of the prior year error, and the effect that the correction has had on ‘line
items’ in the prior year.

QUESTION 2
a. An entity is required to apply the accounting policies standard that applies to a transaction,
item or event. However, management are allowed to develop and apply accounting policies
where no one exists.
State FOUR conditions to be met before the policy developed could be considered reliable.
5 Marks

b. The Financial Accountant of AVENUE Limited encountered the following during the process
of preparing the financial statement of the company for the year 2016.
While carrying out the inventory taking exercise, an error in the previous year inventory was
discovered. The actual inventory figure brought forward at the beginning of the year was
N360m and not N400m as stated in the trial balance. The retained earnings figure at the
beginning of the year was N260m and profit was N700m.
You are required to:
i. Adjust the inventory. (3 Marks)
ii. Show the extract of the statement of changes in equity at 31 December
2016. (4½ Marks)

CORRECTION OF ERRORS – further discussions

Errors are clerical mistakes that are unintentional. Due to imperfection of human beings, it is
inevitable that errors in recording transactions would exist in the accounting records; they can
only be reduced (for example, by engaging a well trained personnel to maintain accounting
records).

Types of Errors
Errors are of two kinds:
a. those which would not prevent Trial Balance from balancing; and
b. those which would cause the Trial Balance not to balance.

Errors not Affecting Trial Balance

a. Error of Original Entry
This is an error in which the value (amount) of a transaction is recorded wrongly at the
beginning of the recording process. That is, when the source document is being raised
or when the source document is being posted to the appropriate subsidiary book.
b. Error of Omission
this is an error involving failure to post a transaction into the accounts. That is, no debit
nor credit entry.
c. Error of Principle
This is an error whereby a transaction is posted to the wrong class of accounts. For
example, the cost of an office air-conditioner debited (wrongly) to office expenses
account.
d. Errorr of Commission
This is an error involving the posting of a transaction to the correct class of accounts but
the wrong account within that class. For example, payment to a supplier named
Omololu debited (wrongly) to the account of another supplier named Omolola.
e. Error of Complete Reversal of entry
This is an error involving the complete reversal of the normal double entry for a
transaction. For example, payment by cheque for stationery, debited (wrongly) to bank
account and credited (wrongly) to stationery account.
f. Compensating Errors
This is a situation in which errors cancel each other out. For example an overcast of
discount received canceling out an overcast of discount allowed.
NB: corrections of errors not affecting trial balance would be posted into the (two)
ledgers accounts affected by the error.

Errors Affecting Trial Balance

When a trial balance does not balance and there is no time or it is inconvenient to immediately
locate and correct the errors because the final accounts are urgently required, the Trial
Balance can be made to balance by inserting the balancing figure, and describe it as
Suspense Account.

Suspense Account
A suspense account is opened with either a debit balance or a credit balance.
The balance entered into the suspense account should be an amount that makes the total
debit balances equal to total credit balances on all the general ledger accounts (including the
balance on the suspense account).

Errors affecting Trial Balance consist of the following:

a. Casting Error
This is an error involving wrong addition of figures
b. Error of partial reversal of entry
This is an error involving reversal of one leg of double entry for a transaction. For
example, a transaction might be recorded as a debit entry in two accounts, instead of as
a debit entry in one account and a credit entry in the other account.
c. Omission or Misstatement of Account Balance
This is the omission or misstatement of account(s) balances while drawing up a trial
balance
d. Posting Only One Leg of a Transaction
This is an error whereby on aspect of the double-entry for a transaction is posted
without the corresponding opposite entry.
NB: corrections of errors affecting trial balance would be posted into the suspense
account, and the other leg, into the ledger account affected by the error.

CORRECTING ERRORS
In order to correct errors properly, you need to be able to identify the error; and for each account
affected by an error, you can prepare two sets of memorandum
T accounts for:
(1) What accounting entries have been made in the accounts, and
(2) What the accounting entries should have been.

Illustration: Errors not affecting trial balance (Journal entries : Ledgers)

The following errors were discovered from the books of Aramide:
(a) Rent received of ₦500 had been entered in the sales account
(b) Sales were overcast by ₦50 as also were wages.
(c) Payment of motor expenses ₦10 was mistakenly entered in motor vehicle account.
(d) Purchase of goods from Funice ₦1,000 was completely omitted from the accounts.
(e) Sales of goods to Alata ₦305 were entered in Alabi’s account, both of whom are
customers of Aramide
You are required to show the journal entries to correct the errors

Illustration: errors affecting trial balance (Journal Entries : Suspense Account)

The Trial balance of a firm showed a difference of ₦11,100 and this has been carried to the
credit side of a Suspense account. Further information revealed the following errors.
(a) Sales day book was overcast by ₦2,500
(b) An invoice for ₦2,750 received from a supplier was correctly entered in the purchases
day book, but was posted to the debit side of supplier’s account
(c) A customer who owned a sum of ₦1,200 died without leaving anything behind. This
amount was written off his account as a bad debt, but no other entry was made in the
books.
 (d) A machine was bought for ₦7,500 and the payment was made by cheque. This fact was
recorded only in the machinery account.
(e) A payment of ₦1,300 for wages was entered correctly in the cash book, but was
recorded as ₦3,100 in the wages account
You are required to show the:
(a) Journal entries necessary to correct these errors
(b) Suspense account duly balanced.

QUESTION 3
The books of Fanny Enterprises revealed that the trial balance showed a difference of
GH¢2,406,640 which has been transferred to the debit side of a suspense account. Further
investigation revealed the following:
(i) Purchases of office equipment for GH¢255,000 was debited to office expenses account.
(ii) Sales day book was overcast by GH¢360,000
(iii) An invoice for GH¢197,400 received from a supplier was entered correctly in the purchases
day book, but was posted to the debit side of the supplier’s account.
(iv) A credit note for GH¢216,000 issued to a debtor was entered in the returns inward book as
GH¢126,000 and was posted to the ledger accordingly.
(v) A debtor who owed a sum of GH¢4,200 died without leaving anything behind. This amount
was written off his account as bad debt but no other entry was made in the books.
(vi) Cash drawings amounting to GH¢90,000 have not been recorded in the books.
(vii) A payment of GH¢28,000 for electricity was entered correctly in the cash book but as
GH¢82,000 in the electricity account.
(viii) A motor vehicle was bought for GH¢2,500,000 by cheque. This transaction was only
recorded in the cash book.
(ix) Discounts received GH¢8,760 have not been posted from the cash book to ledgers.
You are required to prepare:
a. Journal entries with narrations to correct the errors.
b. Suspense account.

The trial balance of Makeup Enterprises as at 31 December 2018 failed to agree. A suspense
account was opened for the difference. Draft final accounts were prepared that revealed a net
profit of L$80,000 for the year ended 31 December 2018. The following errors were
subsequently discovered:
(i) The purchases day book total of L$160,000 had been posted to the ledger as L$320,000
(ii) The sales account has been undercasted by L$240,000
(iii) Discounts received of L$14,000 had been debited to discounts allowed account
(iv) An accrued salaries and wages of L$12,000 was omitted
(v) Loose tools bought for L$8,000 had been debited to purchases account
(vi) Purchases of inventory for L$140,000 had not been posted to the ledger
(vii) Bad debts of L$19,000 written off in the trade receivables account had not been treated in
the expense account.
(viii) The proprietor had withdrawn goods that cost L$6,000 for personal use. No entries had
been made in the books
You are required to prepare:
a. The journal entries to correct the errors. (6 Marks)
b. The suspense account and show the difference in the books. (3 Marks)
c. A statement to show the correct net profit for the year. (3½ Marks)