2023/03/01

IAS 2 Inventories

Things to remember….

1. Objective of IAS 2
2. Scope
3. Definitions
4. Recognition as an expense
5. Measurement
6. Disclosure

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 Know and apply the definitions relevant to inventory

 Record inventory transactions by using the perpetual or periodic recording
method.
 Calculate the cost of inventory.
 Calculate the cost of interchangeable inventory items using either the FIFO or WA
costing formula.
 Understand that inventory should be recognised at the lower of cost or NRV
 Calculate the NRV for inventory on hand at the reporting date, and record any
adjustments required to the carrying amount of inventory.
 Draft an appropriate accounting policy note for inventory in the financial
statements of an entity to meet the disclosure requirements of IAS2, Inventories.

 To prescribe the accounting treatment of inventories.

 Primary Issue - The amount of cost is recognised as an asset and carried forward
until related revenue is recognised.
 It provides guidance on the determination of cost and its subsequent recognition as
an expense, including write-downs to net realisable values.

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Inventory is defined as assets that:

 Are held for sale in the ordinary course of business; or
 Are in the process of production for such sale; or
 In the form of material or supplies to be consumed in the production process or in
the rendering of services.

Net realisable value is:

 The estimated selling price in the ordinary course of business;
 less the estimated cost of completion; and

 less the estimated cost necessary to make the sale.

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Fair value is –
 The price that would be received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants at the measurement date.

PERIODIC RECORDING METHOD

VS PEPERTUAL RECORDING
METHOD

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Inventories should be measured at the lower of:

 cost and
 net realisable value (NRV) ( Remember definition of NRV)

The cost should comprise:

 all costs of purchase
 costs of conversion and
 other costs incurred in bringing the inventories to their
present location and condition

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Purchase price :
Less
 trade discounts, rebates & subsidies deducted from purchase price
Excluding:
 VAT
 Interest
Add:
 Import duties and other taxes (only those that we cannot
subsequently recover from tax authorities, e.g.VAT)
 Transport, handling and other costs directly attributable to the
acquisition of inventories

AB Ltd imported 50 laptops from USA. Invoice price per laptop = $4 000. A 25% trade discount was
granted.Spot rate : $1 = R5.
Import charges incurred:
- Freight & marine insurance 63 000
- Import duty 100 000
- Clearing agents charges 26 500

During the year AB sold 35 laptops @ R45 000 each and took one laptop for usage in the business,
sold further 5 laptops to a client and paid R12 500 for the courier charges .Salesmen are entitled to a 5%
commission on all laptops sold (all laptops are sold by salesmen)
Required:
(a) Compute the cost at which AB’s inventory acquired must be recorded.
(b) Computed the profit that must be realised on the sales made.

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Cost price of inventory:

Landed cost of laptops (50xR20 000x75%) 750 000

Freight & marine insurance 63 000
Import duty 100 000
Clearing agents charges 26 500
939 500

Dr Inventory/purchases 939 500

Cr Bank 939 500

Thus cost per unit: 939 500/50 = R18 790

Profit realised on laptops sold:

Revenue (40xR45 000) 1 800 000
Cost of inventory sold(40xR18 790) 751 600
Gross profit 1 048 400
Selling expenses (12 500)
Commission(1 800 000*5%) (90 000)
Profit realised on laptops sold 945 900

What about laptop taken into use in business?

Dr Computer equipment 18 790
Cr Inventory 18 790

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 Conversion costs are the costs incurred during the manufacturing process (i.e.
where raw materials are converted to finished goods).
 Conversion costs can be split into:
 Direct cost (e.g. direct raw materials / direct labour).
 Indirect cost (i.e. manufacturing overheads)
 indirect fixed manufacturing overheads (allocated on normal capacity but limited to
actual costs incurred); and
 indirect variable manufacturing overheads (allocated on actual use).

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 Costs incurred in the normal production process of the

entity = cost of inventory
 However, when exceptional wastage occur these costs
should not be included in the cost of inventory
 Should be written off/expensed in I/S (SOCI)

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Normal capacity: 100 000 units

Fixed overheads: R 100 000
Allocation rate : R 100 000 / 100 000 units
= R1 per unit
Actual units : 80 000 units

Normal capacity: 100 000 units

Fixed overheads: R 100 000
Allocation rate :R 100 000 / 100 000 units
= R1 per unit
Actual units : 80 000 units

The allocation rate is NOT adjusted in terms of IAS 2. The unallocated portion of R20 000 is
taken to the P&L immediately

Journal
Dr Inventories (80 000 x R1) R 80 000
Dr Expense – I/S (20 000 x R1) R 20 000
Cr Bank R 100 000

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Normal capacity : 100 000 units

Fixed overheads : R 100 000
Alocation rate : R1/unit
Actual production = 120 000 units due to abnormally high
production

Normal capacity : 100 000 units

Fixed overheads : R 100 000
Alocation rate : R1/unit
Actual production = 120 000 units due to abnormally high production

NOW we must decrease the allocation rate, otherwise inventory will be measured at higher than cost (fictitious cost)

Calculation & Journal

Fixed overheads : R 100 000
Actual production : 120 000 units
New rate : R 0,83 per unit

Journal:
Dr Inventories R100 000
Cr Bank R100 000
(120 000 x 0,83 per unit)

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Includes: Excludes:
 Cost of purchases  Vat
 Import duties & handling fees  Storage costs
 Exchange rate when ownership  Agent’s commissions
passes
 Selling and marketing costs
 Transport cost to place of sale
 Administration costs
 Conversion costs
 Abnormal wastage
 Finance costs
 Borrowing costs
 Trade discounts/rebates

Cost Formulas

 First – In – First – Out (FIFO)

 Weighted Average Costing (WAC)

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Inventories should be measured at the lower of:

 cost and
 net realisable value (NRV) ( Remember definition of NRV)

Why would NRV be lower than cost ?

 Inventory damaged
 Inventory wholly or partially obsolete
 Selling prices have declined
 Estimated cost of completion or selling costs have
increased

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 NRV is assessed at every reporting date

 The amount of any write-down of inventory to NRV and all
losses of inventories, should be recognised as an expense
in the period of occurrence
 If situation turns around, and NRV is higher than cost again,
the amount of the write down is reversed (the reversal is
limited to the amount of the original write down)

Damaged furniture cost R2 500

Other similar desks selling price R3 800
Cost to repair desk R1 500

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Damaged furniture cost R2 500

Other similar desks selling price R3 800
Cost to repair desk R1 500

NRV of desk (R3 800-R1500) R2 300

Thus NRV lower than cost (R2500)

Dr Cost of Sales 200
Cr Inventory 200

All write-downs to NRV, as well a write back up to cost are included in Cost of
Sales as an inventory expense

IAS 21 The effects of changes in foreign exchange rates

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Objective
IAS 21 prescribes the recognition, measurement and disclosure of foreign exchange
transactions.

Foreign currency transactions

These transactions need to be converted to the functional currency of the entity,
using the spot exchange rate on the transaction date.

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The exchange rate is the ratio at which the The spot exchange rate is the exchange The closing rate is the spot exchange rate
currencies of two countries are exchanged at rate for immediate delivery of currencies to at the reporting date.
any given point in time. be exchanged at a particular time.
If foreign currency is required to pay for an
import, the foreign currency must be purchased
from a bank, therefore the selling rate will be
quoted.
If goods are exported and foreign currency is
received, the bank acts as the buyer and thus
the buying rate will be quoted.
Exchange rate can be quoted directly ($1 =
R12,50) or indirectly (R1 = $0,08)
The forward rate is the exchange rate Presentation currency is the currency in Functional currency is defined as the
available in terms of a forward exchange which the financial statements are currency of the primary economic
contract (FEC) agreement for the exchange of presented. environment in which an entity operates. It
two currencies at a future date. reflects the underlying transactions, events
and conditions relevant to the entity.
FEC is a hedge against unfavourable exchange 30
rate fluctuations.

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Recognition and measurement of foreign exchange transactions take place on the

following dates:
- Transaction date
- Reporting date
- Settlement date
 The applicable exchange rate should be applied on each of the above
mentioned dates to translate the foreign exchange transactions into the functional
currency of the entity.
 Any foreign exchange differences arising from the abovementioned translation
are taken to the profit or loss section of the statement of profit or loss and other
comprehensive income.
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Transaction date Reporting date Settlement date

Monetary item Recognise at spot rate Restate to spot rate on Settle at spot rate on
reporting date settlement date

Non-monetary item Recognise at spot rate No adjustment No adjustment

Exchange difference No exchange difference Exchange profit/loss on Exchange profit/loss on

monetary item to the monetary item to the
profit or loss section of profit or loss section of
the statement of profit the statement of profit
or loss and other or loss and other
comprehensive income comprehensive income

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The amount of foreign exchange differences recognised in the profit or loss

section of the statement of profit or loss and other comprehensive income.

18. PROFIT BEFORE TAX

2019 2018

Net foreign exchange gains / losses XXX XXX

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Email :Mpulana.lamola@ul.ac.za
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