IAS 2.

Inventories
Valuation of inventory:
1) raw materials and components (used in the production process)
2) finished products (which have been manufactured by the business)
3) products (usually called work in progress – WIP)
4) goods purchased for resale
5) consumable stores (such as oil)

Acquisition cost:
1. Purchase
2. Gift-given
3. Contribution
4. Exchange
5. Surplus (as a result of stocktaking)
6. Creating (producing)

Live circle of every asset:

1) acquisition
2) use within business
3) disposal

Cost:
1) cost of purchase
2) cost of conversion

Cost of purchase:
- purchase price
including import duties, transport and handling costs
- any other directly attributable costs, less trade discounts, rebates and subsidies

Cost of conversation:
- costs which are specifically attributable to units of production, e.g. direct labour, direct
expenses and subcontracted work
- production overheads, which must be based on the normal level of activity
- other overheads, if any, attributable in the particular circumstances of the business to
bringing the product or service to its present location or condition

The following costs should be excluded and charged as expenses of the period in which they
are incurred:
- abnormal waste
- storage costs
 - administrative overheads which do not contribute to bringing inventories to their
present location and condition
- selling costs

example: the entity has bought 1000 pens, cost of purchase - $12 per unit, including VAT.
The delivery was made by the special transport organization. The costs incurred in bringing
the inventories to their current location are $ 600, including VAT. Define the bookkeeping
cost (acquisition cost) per 1 pen.

solution:

1) the entity has bought

Inventory is included in the statement of financial position at:

the lower of cost/net realizable value

Net realizable value (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.

Example 1: materials costing $12,000 bought for processing and assembly for a special
order. Since buying these items, the cost price has fallen to $10,000.

Solution 1:
cost = $12,000
NRV = $10,000
NRV<Cost
Materials = NRV
если мы не используем в производственном цикле мы обязаны их переоценить и
разница будет лосс в стэйтмент ов профит и лосс

Example 2: equipment constructed for a customer for an agreed price of $18,000. This has
recently been completed at a cost of $16,800. It has now been discovered that, in order to
meet certain regulations, conversion with an extra cost of $4,200 will be required. The
customer has accepted partial responsibility and agreed to meet half the extra cost.

Solution 2:

Cost = $16,800
NRV = contract price, $18,000 – our share of modification cost, $2,100
NRV = $18,000 - $4,200 / 2 = $15, 900
NRV < Cost
Finished products = NRV

(затраты и расходы разница)

Net Realisble Value (NRV) is the net amount that would be realized after incurring any
further costs required to make the sale.
In effect, it is the fair value of the item, less any further costs that must be incurred in order
to sell that item.
#This may include, for example, further work and costs required in order to make items of
work in progress into finished goods before they could be sold.

If IAS 2 is applied, when items of inventory are old or obsolete, they are likely to be valued
at the net realizable value, rather than cost.

Inventory valuation methods:

1) unit cost – this is the actual cost of purchasing identifiable units of inventory – not
ordinary interchangeable
2) FIFO – first items of inventory received are assumed to be used the first ones. The cost
of closing inventory is the cost of the most recent purchases of inventory.
3) AVCO – the cost of an item of inventory is calculated by taking the average of all
inventory held.

Unit cost:
only used when items of inventory are individually:
- distinguishable
- and of high value

AVCO: the average cost can be calculated

periodically and continuously

AVCO: Periodic weighted average cost

Within this inventory valuation method, an average cost per unit is calculated based upon the
cost of opening inventory plus the cost of all purchases made during the accounting period.
This method of inventory valuation is calculated at the end of an accounting period when the
total quantity and cost of purchases for the period is unknown.
AVCO: continuous weighted average cost
With this inventory valuation method, an updated average cost per unit is calculated
following a purchase of goods.
The cost of any subsequent sales are then accounted for at that weighted average cost per
unit.
This procedure is repeated whenever a further purchase of goods is made during the
accounting period.
Note: When using either of the two methods of weighted average cost to determine inventory
valuation, it is possible that small rounding differences may arise. They do not affect the
validity of the approach used and can normally be ignored.

IAS 2 disclosure requirements:

1) According to IAS 1 Presentation of Financial Statements entities are required to
disclosure the accounting policies adopted in preparing their financial statements,
including those used to account for inventories
2) IAS 2 also requires that the total carrying amount of inventories are broken down into
appropriate sub-headings or classifications and that the total amount of inventory
carried at net realizable value is disclosed.

An example of a specimen disclosure note is as follows:

inventories are valued at the lower of cost and net realisable value for each separate
product or item. Cost is determined by recognizing all costs required to get inventory to its
location and condition at the reporting date and is applied on a “first in, first out” basis.
Net realisable value is the expected selling price of inventory, less any further costs expected
to be incurred to achieve the sale.
raw materials - $200
work in progress - $600
finished products - $ 350
within the carrying amount of inventories, the amount carried at net realisable value is
$150,000.

Inventory in the financial statements

a business can calculate exactly how much inventory it has used in the year to calculate cost
of sales

The standard proforma for calculating sales, cost of sales and gross profit:
Revenue X
Opening inventory X
Purchases X
Less: closing inventory (X)
Cost of sales (X)
Gross profit X

Inventory in the financial statements

When calculating gross profit we match the revenue generated from the sales of goods in the
year with the costs of manufacturing those goods.
You should appreciate that the costs of the unused inventories should not be included in this
figure.
These costs are carried forward into the next accounting period where they will be used to
manufacture goods that are sold in the period.
The goods carried forward are classified as assets on the statement of financial position.
(!!!) Inventory costs are matched to the revenues they help generate.

Example:
At the beginning of the financial year a business has $1500 of inventory left over from the
preceding accounting period. During the year it purchases additional goods costing $21,000
and make sales totaling $25,000. At the end of the year there are $3,000 of goods left that
have not been sold.
What is the gross profit for the year?

Solution:
The unsold goods are referred to as closing inventory. This inventory is deducted from
purchases in the statement of profit or loss.
Revenue 25 000
Opening inventory 1 500
Purchases 21 000
Less: closing inventory (3 000)
Cost of sales (19 500)
Gross profit 5 500

The impact of valuation methods on profit and the statement of financial position:
1. Different valuation methods will result in different closing inventory values. This
impacts both profit and statement of financial position asset value.
2. Foe this reason it is important tat once a method has been selected it is applied
consistently.
3. It is not appropriate to keep switching between methods to manipulate reported profits.
4. Similarly any incorrect valuation of inventory will impact the financial statement:
- if inventory is overvalued then: assets are overstated in the statement of financial
position profit is overstated in the statement of profit or loss 9as cost of sales is too
low)
- if inventory is undervalued then: assets understated in the statement of financial
position profit is understated in the statement of profit or loss (as cost of sales is too
high)
 IAS 37. Provisions, Contingent Liabilities and Contingent Assets

Provision:
is a liability
- of uncertain timing
- or amount
Liability:
is a present obligation as a result of past event

1) ”A present obligation as a result of past event”

The obligation needs to exist because of events which have already occurred at the year-end
and give rise to a potential outflow of economic resources.

This obligation can either be:

(a) legal/contractual
(b) constructive

Legal obligation:
is an obligation that derives from:
- the terms of a contract,
- legislation,
- or other operation of law

Constructive obligation:
is an obligation that derives from an entity’s actions where:
- by an established pattern of past practice, published policies, or a sufficiently specific
current statement, the entity has indicated to other parties that it will accept certain
responsibilities,
- and as a result, the entity has created a valid expectation on the part of those other
parties that it will discharge those responsibilities

Example: a retail store has a policy of refunding purchases by dissatisfied customeers, even
though it is under no legal obligation to do so. Its policy of making refunds is generally
known. Should a provision be made at the year?

solution:
- the policy is well known and creates a valid expectation
- there is a constructive obligation
- it’s probable some refunds will be made
- these can be measured using expected values
conclusion: a provision is required
 2) “a reliable estimate can be made”
provisions should be recognized at the best estimate
If the provision relates to one event, such as the potential liability from a court case, this
should be measured using the most likely outcome.
If the provision is made up of numerous events, such as a provision to make repairs on goods
within a year of sale, then the provision should be measured using expected values.

Example 1:
An entity sells goods within a warranty covering customers for the cost of repairs of any
defects that are discovered within the first two months after purchase.
Past experience suggests that 88% of the goods sold will have no defects, 7% will have
minor defects and 5% will have major defects. If minor defects were detected in all products
sold, the cost of repairs would be $24,000. If major defects were detected in all products
sold, the cost would be $200,000.
What amount of provision should be made?

Solution:
the expected value of the cost of repairs is
$11680= (7%*24000) + (5%*200000)

3) “There is a probable outflow of economic resources”

If the likelihood of the event is not probable, no provision should be made. If there is a
possible liability, then the company should record a contingent liability instead.

A contingent liability is:

- a possible obligation that arises from past events and whose existence will be
confirmed only by the occurrence or non-occurrence will be confirmed only by the
occurrence or non-occurrence of one or more uncertain future events not wholly
within the control of the entity
- or a present obligation that arises from past events but is not recognized because:
1) it is not probable that an outflow of resources embodying economic benefits will be
required to settle the obligation, an,
2) or the amount of obligation cannot be measured with sufficient reliability

Accounting for contingent liability:

- should not be recognized in the statement of financial position

- should be disclosure in a note unless the possibility of a transfer of economic benefits
is remote
A contingent asset:
is a possible asset that:
- arises from past events,
- and whose existence will be confirmed only by the occurrence or non-occurrence of
one or more uncertain future events
- not wholly within the control of the entity

Accounting for contingent asset:

- Contingent asset should not generally be recognized, but if the possibility of inflows
of economic benefits is probable, they should be disclosed.
- If a gain is virtually certain, it falls within the definition of an asset and should be
recognized as such, not as a contingent asset.

Summary
the accounting treatment can be summarized in a table:
Degree of probability Outflow Inflow
Virtually certain Recognise liability Recognise asset
Probable Recognise provision Disclose contingent asset
Possible Disclose contingent Ignore
liability
Remote Ignore Ignore

Warranty provisions:
A warranty is often given in manufacturing and retailing businesses. There is either a legal or
constructive obligation to make good or replace faulty products.
A provision is required at the time of the sale rather than the time of the repair/replacement
as the making of the sale is the past event which gives rise to an obligation.

This requires the seller to analyze past experience so that they can estimate:
- how many claims will be made – if manufacturing techniques improve, there may be
fewer claims in the future than there have been in the past
- how much each repair will cost – as technology becomes more complex, each repair
may cost more

The provision set up at the time of sale:

- is the number of repairs expected in the future multiplied by the expected cost of each
repair
 - should be reviewed at the end of each accounting period in the light of further
experience
-
Guarantees:
In some instances (particularly in groups) one entity will make a guarantee on behalf of
another to pay off a loan, etc. if the other entity is unable to do so.
A provision should be made for this guarantee it is probable that the payment will have to be
made. It may otherwise require disclosure as a contingent liability.

Future operating losses/future repairs:

no provision may be made
for future operating losses or repairs because they arise un the future and can be avoided
(close the division that is making losses or sell the asset that may need repair) and therefore
no obligation exists.

Onerous contracts:
- an onerous contract is a contract in which the unavoidable costs of meeting the
obligation under the contract exceed the economic benefits expected to be received
under it
- the signing of the contract is the past event giving rise to the obligation to make the
payments and those payments, discounted if the affect is material, will be the measure
of the excess of cost over the benefits

A provision for this net cost can be recognized as an expense in the statement of profit and
loss in the period when the contract becomes onerous. In subsequent periods, this provision
will be increased by the unwinding of the discount (recognized as a finance charge) and
reduced by any payments made.

Environmental provisions:
a provision will be made for future environmental costs
if there is either a legal or constructive obligation to carry out the work
This will be discounted to present value at a pre-tax market rate.

Restructuring provisions:

a restructuring is a programme that that is planned and controlled by management, and

materiality changes either:
- the scope of a business undertaken by an entity
- or the manner in which that business is conducted

A provision may only be made if:

 1) a detailed, formal and approved plan exists
2) and the plan has been announced to those affected.

The provision should:

- include direct expenditure arising from restricting
- exclude costs associated with ongoing activities