FAC2601

LEARNING UNIT 4

INVENTORY – IAS 2

Financial Accounting
for Companies

Open Rubric
CONTENTS
Page
LEARNING UNIT 4: INVENTORY – IAS 2 ........................................................................................... 1
4.1 Definition of inventory ........................................................................................................ 4
4.2 Measurement of inventories ............................................................................................... 5
4.2.1 Cost of inventory ................................................................................................................. 5
4.2.2 Other techniques for the measurement of costs .............................................................. 16
4.3 Cost formula ...................................................................................................................... 16
4.4 Determining net realisable value and recognition at lower of cost and net realisable
value .................................................................................................................................. 18
4.5 Recognition of expense ..................................................................................................... 21
4.6 Disclosure requirements ................................................................................................... 22
4.7 Differences between ‘full IFRS’ and ‘IFRS for SMEs’ ......................................................... 22
4.7.1 Differences between ‘full IFRS’ and ‘Generally Recognise Accounting Practice
(LGRAP)’ ............................................................................................................................. 23
4.9 Examples ............................................................................................................................ 25

2
Learning outcomes

Learners should be able to account for inventory and disclose it in annual

financial statements in accordance with the requirements of International
Financial Reporting Standards (IFRS), IAS 2.

Assessment criteria

After having studied this learning unit, you should be able to:

 apply all the applicable definitions to different scenarios

 calculate the historical cost of inventories
 apply the different cost formulas to measure the cost of inventories
 calculate the net realisable value of inventories
 present and disclose inventories in the annual financial statements in
accordance with the requirements of IAS 2.

Overview of the learning unit

This learning unit prescribes the generally acceptable an used practices and
measures that must be used in the accounting for, and preparation and
presentation of information pertaining to inventory in the financial statements.
Such accounting for and preparation and presentation information of inventory
must be in accordance with the requirements of International Financial
Reporting Standards (IFRS) IAS 2. However, IAS 2 does not apply to certain
categories of inventories and applies only partially to certain inventories.
The standard does not apply to inventory of financial instruments and biological
assets related to agricultural produce and activity. The standard applying to these
inventories are IAS 32: Financial Instruments Presentation, IFRs 9 Financial
Instruments and IAS 41 Agriculture) (IAS2.2).
The information presented in the financial statements may be useful to the users
of the statements since they may use the information to confirm or predict the
economic effect of the entity’s financial transactions and position. The users may
need to confirm or predict, amongst others:
• The capital infusion into inventory and carried forward until the related
revenue is realized, and the profit earned thereof.
• The value of inventory available on hand, such as raw material, work in progress
and finished goods.
The primary issue in accounting for inventory is the amount of cost of inventory
that must be recognised and carried forward until related revenue is recognised
(IAS 2.1). This entails the determination of the following
• The cost and subsequent recognition as expense on sale of inventory.
• The cost formulas that are used to assign cost to inventory
• The write down to net realisable value, when necessary.

3 FAC2601/1
 OVERVIEW OF THE CONTENT

This learning unit is divided into the following:

4.1 Definition of inventory
4.2 Measurement of inventories
4.2.1 Cost of inventory
4.2.2 Other techniques for the measurement of costs
4.3 Cost formula
4.4 Determining net realizable value and recognition at lower of cost and
net realisable value
4.5. Recognition of expense
4.6 Disclosure requirements
4.7 Differences between ‘full IFRS’ and ‘IFRS for SMEs;
4.8 Difference between ‘full IFRS’ and ‘Generally Recognised Accounting
Practice (GRAP)’
4.9 Examples

4.1 DEFINITION OF INVENTORIES

Inventories include both tangible and intangible assets:

• Held for sale in the ordinary course of business,
• In the process of production for sale, or
• In the form of material that is to be consumed in the rendering of services or
process of production.
(IAS 2.6)

The definition classifies assets as inventory based on the purpose. It suggests that item of
assets that may be classified as inventory are material and complete goods held with the
purpose of selling to generate revenue. It also prescribes that material awaiting to be
processed as well as those still in the production process may be considered as inventory.

The purpose of the entity will determine whether an item is classified as inventories or
expense.

EXAMPLE 4.1

How will the newspaper be classified if a newspaper seller utilises a vehicle to distribute
newspapers to customers?

4
SUGGESTED SOLUTION 4.1
Only the newspaper will be considered inventory if a newspaper seller utilises a vehicle to
distribute newspapers to customers because newspaper is held for sale in the ordinary course
of business. The automobile will be considered an asset.

4.2 MEASUREMENT OF INVENTORIES

Measurement is defined as a process of establishing the quantity of inventory, in monetary

terms, in the financial statement. The quantity of inventory is established as follows:

Inventories are always measured at the lower of cost and net realisable value.
(IAS 2.9)

Inventories may also be measured at standard cost or retail methods. (IAS 2.21
and IAS 2.22)

Cost of inventory is dealt with in 4.2.1, standard cost and retail methods in 4.2.2 and net
realisable value in 4.2.3.

4.2.1 COST OF INVENTORIES

Cost f inventory comprises of the following

• Purchase costs i.e., cost of ordering

• Conversion costs i.e., manufacturing costs, and
• Other costs incurred in bringing the inventories to present location and
condition other than those subsequently recoverable by the entity, such
as input tax.
(IAS 2.10)

Purchase costs are dealt with in a. below, conversion cost in b. and other costs in c.
(a) Purchasing costs
The cost of purchase of inventories comprises of the following, according to par 11 of IAS2:
 Purchase price
Purchase price is the amount of money that an entity pays cash or in agreed terms for finished
goods or raw materials.

5 FAC2601/1
 Import duties and other appropriate taxes
Import duties are taxes or levies that an entity is legally obliged to pay on buying goods from
another country to bring to the home country. However, taxes that are subsequently
recoverable from the authorities are not included in the cost of purchase.
 Transport costs
This is the amount of money that the entity pays for moving finished goods or material from
one place or location or to another, usually the entity’s premises.
 Handling costs
Is an extra money that the entity pays to the supplier for getting finished goods or raw
material ready to be delivered to the entity.
 Any other costs directly attributable to the acquisition of the inventories

Any trade discounts and rebates are deducted from the original cost price.
Where inventories are purchased on deferred settlement terms and arrangement
includes a financing element, that element is recognized as expense over the period
of financing.

EXAMPLE 4.2

Cyclepro Ltd, a bicycle retailer who operates in Pretoria, ordered 1 500 new Western Flyer

Frames from Singapore for their exhibition to be held at the Rand Show. The Western Flyer

Frames were received from their supplier on 1 February 2020. The invoice price of the Western

Flyer Frames was R2 500 each (before a trade discount of 5%) and is payable on

31 March 2020, the year-end of Cyclepro Ltd. A goods in transit insurance was taken out for a

non-refundable R1 500 deposit for delivery of the items to Cyclepro Ltd’s warehouse. On route

to Pretoria, an attempt was made to hijack the delivery truck and 25 of the Western Flyer

Frames were irreparably damaged. A Claim was submitted to the insurance company.

The following cash costs regarding the purchase were:

R
Freight and insurance (excluding the R1 500 above) 150 500
Cartage to Pretoria 10 750
Customs duty 333 250

6
REQUIRED
Calculate the cost of inventory

SUGGESTED SOLUTION 4.2

R
Purchase price: (1 500 x R2 500) 3 750 000
Allowance for trade discount: (R3 750 000 x 5%) (187 500)
Total 3 562 500

Other direct attributable costs:

Freight and insurance – given 150 500
Cartage – given 10 750
Customs duty 333 250
Non-refundable deposit (Goods in transit insurance) 1 500
Goods written off: (R3 562 500 / 1 500) x 25 (59 375)

Total cost of inventories: 3 999 125

Per unit: (1 500 – 25) = 1 475 2 711

(b) Conversion costs

These costs are incurred in the changing of raw materials into finished product by
manufacturing entities. These are costs incurred in the factory and directly related to the units
produced. Direct labour and production overheads are concerned with the production of one
product. However joint cost, main and by‐products are concerned with the production of
more than one product:
(i) Direct labour costs
These are costs incurred by an entity for the work performed by employees, such as wages
and other company benefits. These costs must be directly related to the manufacturing of
finished goods or provision of services in the factory.
(ii) Production overhead costs

These are costs of running or operating of an entity that are believed to be caused by or result
from the process of making finished goods in a factory. Production overhead costs are incurred
in the manufacturing process, but do not form part of direct material or direct labour costs,
for example depreciation of production machinery. The correct allocation of overhead costs is
essential to ensure that the cost of inventories is accurate. These are distinguished on whether
they vary with the production of goods (variable overheads) or not (fixed overheads).

7 FAC2601/1
Variable production overhead costs should be allocated to units produced by using the number of
units produced. The effect of this is that all variable production overhead will be absorbed in
the units produced

Fixed production overhead costs should be allocated to the cost of units produced using normal
production capacity and budgeted fixed production overhead cost (recovery rate). Normal
production capacity refers to the expected number of units that the entity can produce under
normal conditions and with available resources. In allocating fixed production overhead costs
to units produced, budgeted fixed production overhead costs absorbed in units produced may
be more than actual fixed production overhead costs incurred (over recovery or budgeted
fixed production overhead costs absorbed in units produced may be less than actual fixed
production overhead costs incurred (under recovery). Under and over recovery is recoded as
expense or income in the cost of sales, respectively.
(iii) Other costs
Other overheads normally are incurred in running the operations of an entity that do not relate
to the production process, for example, office rental and salaries of administrative personnel.

Other overhead costs are therefore not incurred to bring inventories to their present location
and condition and should not be included in the cost of inventories but recognised as
expenses.

The general principle is that only those costs involved in bringing the inventories to
their present location and condition should be included in the cost of inventories.

The following are specifically excluded from the cost of inventory but expenses in the period
in which they are incurred:
 Abnormal spillage
 Allocation of fixed production overhead costs that were not allocated to production
 Storage costs unless it is essential in the production process.
 Administrative expenses not related to the location and condition
 Selling expenses

Even though abnormal spillage and fixed production overhead costs that were not allocated
to units produced, they are included in the cost of sales.

The following, however, are exceptions and if applicable, should be included in the cost of
inventories:
 Design costs, research and development that clearly relate to bringing inventories to
their present location and condition
 Borrowing costs that have been capitalised in respect of inventory where long ageing
processes are required
 Storage costs that are necessary in the production process prior to the further pro‐ duction
stage

8
EXAMPLE 4.3
The company's inventory costs for the year are as follows:
Costs R
Purchase price 280 000
Import duties 30 000
Shipping of raw material to the business 90 000
Manufacturing conversion costs 132 000
Abnormal costs of manufacturing spoilage 60 000
Storage cost of finished goods 18 000
Trade discount 4 000

REQUIRED
Determine the cost of inventory.

SUGGESTED SOLUTION 4.3

Costs
Purchase price 280 000
Import duties 30 000
Shipping of raw material to the business 90 000
Manufacturing conversion costs 132 000
Trade discount from supplier (4 000)
Cost of inventory 528 000

EXAMPLE 4.4
The following balances were extracted from the accounting records of Lekota Ltd for the
financial year ended 28 February 2021:
Lekota Ltd’s inventories as at 28 February 2021 consist of the following:
Opening Closing NRV
R R R
Raw materials 350 000 250 000 225 000
Work in progress 225 000 275 500 265 000
Finished goods 400 000 355 000 385 000
Packaging material 71 500 61 500 60 000

9 FAC2601/1
The following information was extracted from the accounting records for the year ended
28 February 2021:
R
Raw material purchased 750 000
Transport costs – raw material 125 000
Variable production overhead costs 1 250 000
Fixed production overhead costs 2 250 000
Selling expenses 125 500

Lekota Ltd values raw material and work in progress according to the FIFO method. Finished
goods and consumables are valued using the weighted average method. Fixed production
overhead costs are allocated at R140 per unit based on normal capacity of 15 000 units that
were produced
REQUIRED
1. Determine inventory to be disclosed in the statement of financial position at at
28 February 2021.
2. Determine the cost of sales to be disclosed in the statement of profit or loss and other
comprehensive income for the year ended 28 February 2021.
SUGGESTED SOLUTION 4.4
(1) Inventory
R
Raw material 250 000
Work in progress 275 500
Finished goods 355 000
Packaging material (consumables) 60 000
940 500
Workings
Raw Work in Finished
material progress goods
R R R
Opening inventory 350 000 225 000 400 000
Add” Purchases and transfers 750 000 975 000 4 274 000
Add: Other costs 125 000 * 3 350 000 ‐
Deduct: Transfers/sales (975 000) (4 274 500) (4 319 500)
Closing inventory 250 000 275 500 355 000
* 1 250 000 + (140 x 15 000)

10
(2) Cost of sales
R
Finished goods 4 319 500
Fixed production overhead costs – under recovery 150 000
(2 250 000 – 2 100 000
Consumables written off to net realisable value 1 500
(61 500 – 60 000)
4 471 000

(c) Joint costs, main and by‐products

Main and by products emanates from a simultaneous production process that result in
one than one product. Costs incurred in buying live chickens, slaughtering and removal of
feathers by entity that sells chicken pieces are called joint cost because these are not
separately identifiable to each product. This also include the cost of cleaning and cutting
into parts. The main joint products (pieces) after cutting may be wings, drumsticks,
breasts, etc. Gizzards, livers, intestines, and feet may be considered by‐products because
they may have no value to the entity. This section deals with the allocation of joint costs
to each product (pieces).

Joints costs are allocated as follows:

 Between the products on a rational and consistent basis

 By‐products must be measured at a net realizable value and this value deducted from
the cost of main product(s)

IAS 2 par. 14

Basis of allocating joint costs are:

 Physical quantity method.

Joint costs are assigned to products based on a physical measure.

 Sales value at split‐off point.

 Further process cost method, and

 Net realisation method

EXAMPLE 4.5

Moshupi Limited’s manufacturing process produced three main joint products A, B, C, and a
by‐product D. The joint costs at split‐off point were R700 000. The following production and
sales information is available.

11 FAC2601/1
 Selling
price at Further Final Selling and
Production split‐off processing Sales Distribution
Product (Kg) point costs value costs
A 40 000 21 4 31 4
B 60 000 26 6 37 9
C 90 000 32 8 47 8
D 4 000 3 ‐ ‐ ‐
Additional information
There was no opening and closing inventory

REQUIRED
Determine the cost of inventory by apportioning joint costs using the following methods:
(a) Physical quantity
(b) Sales value at split‐off point
(c) Further processing costs
(d) Net realisable value

SUGGESTED SOLUTION 4.5

Write‐off by‐product against joint costs: = R700 000 – R12 000 (4 000 x 3)
= R688 000
(a) Physical quantity
Physical Allocation/
Product quantity apportionment Amount
A 40 000 (40K/190K) x 688 000 144 842
B 60 000 (60K/190K) x 688 000 217 263
C 90 000 (90K/190K) x 688 000 325 895
Total 190 000 688 000

(b) Sales value at split‐off point

Selling
price at
Physical split‐off Total
Product quantity point sales Amount
A 40 000 21 840 000 (1)109 454
B 60 000 26 1 560 000 (2) 203 273
C 90 000 32 2 880 000 (3) 375 273
Total 5 280 000 688 000

12
 (1) (840K/5 280K) x 688 000
(2) (1 560K/5 280K) x 688 000
(3) (2 880K/5 280K) x 688 000

(c) Further processing costs

Further
Physical processing Total
Product
quantity costs sales Amount
A 40 000 4 160 000 (1) 88 774
B 60 000 6 360 000 (2) 199 742
C 90 000 8 720 000 (3) 399 484
Total 1 240 000 688 000

(1) (160K/1 240K) x 688 000

(2) (360K/1 240K) x 688 000
(3) (720K/1 240K) x 688 000

(d) Net realizable value

Total
Final further
Physical sales processing Total
Product quantity value costs sales
A 40 000 31 (1) 8 (4) 920 000
B 60 000 37 (2) 15 (5) 1 320 000
C 90 000 47 (3) 16 (6) 2 790 000
Total 5 030 000

(1) 4 + 4. Further processing plus selling and distribution costs

(2) 6+9
(3) 8+8
(4) (31 – 8) x 40 000 (Final sales less total further processing) x costs quantities
(5) (37 – 15) x 60 000
(6) (47 – 16) x 90 000

13 FAC2601/1
EXAMPLE 4.6
Chemicals Ltd manufactures products based on a series of processes. The company does not
hold large quantities of inventories and a balanced level of production and sales is usually
achieved.
From one process three products, P, R and T jointly emerge in constant proportions; they
proceed immediately to separate further processing operations before being sold. The
planned monthly sales of P, R, and T are 20 000, 8 000 and 4 000 litres with selling prices of
R2, R2.10 and R0.80 per litre respectively.
The joint costs related to the first process for the month in question are:
R
Raw material 6 500
Variable labour and overheads 2 700
Apportioned fixed oveheards 10 000
19 200
The further processing involves no additional material but variable labour and overhead costs
of R5 000, R2 000, R1 000 are incurred respectively for P, R and T. The fixed overhead costs of
this stage are allocated based on 150% of the variable labour and overhead costs of each
process.
REQUIRED
Prepare the trading section of the statement of profit or loss and other comprehensive income
of Chemicals Ltd for each of the three products assuming the common processing costs are
shared on the bases of:
(i) Volume (litters) produced
(ii) Total net realisable value (selling price less further processing costs)

SUGGESTED SOLUTION 4.6

(i) Physical quantity
Chemicals Ltd
Statement of profit or loss and other comprehensive income of Chemical Ltd for the year
ended ………….
PRODUCTS TOTAL
P R T
Revenue G 40 000 16 800 3 200 60 000
Cost of sales (24 500) (9 800) (4 900) (39 200)
‐ Joint costs B (12 000) (4 800) (2 400) (19 200)
‐ Overhead costs J (12 500) (5 000) (2 500) (20 000)
2

Gross profit 15 500 7 000 (1 700) 20 800

14
(ii) Total net realisable value
Chemicals Ltd
Statement of profit or loss and other comprehensive income of Chemical Ltd for the year
ended ………….
PRODUCTS TOTAL
P R T
Revenue G 40 000 16 800 3 200 60 000
Cost of sales (25 700) (10 664) (2 836) (39 200)
Joint costs D (13 200) (5 664) (336) (19 200)
Overhead costs J (12 500) (5 000) (2 500) (20 000)

Gross profit 14 300 6 136 364 20 800

Workings
a. Physical quantity apportionment
Allocation
basis:
Physical Allocation/
Product quantity apportionment Amount
A B
P 20 000 (20K/32K) x 19 200 12 000
R 8 000 (8K/32K) x 19 200 4 800
T 4 000 (4K/32K) x 19 200 2 400
Total 32 000 19 200

b. Net realisable value apportionment

Allocation
basis:
Physical Allocation/
Product quantity apportionment Amount
C D
P 27 500 (27.5K/40K) x 19 200 13 200
R 11 800 (11.8K/40K) x 19 200 5 664
T 700 (0.7K/40K) x 19 200 336
Total 40 000 19 200

15 FAC2601/1
c. Net realizable value and further processing
Price Total Total
Product Volume per unit sales costs NRV
E F G: (E x F) J: (H+I) K: (G – J)
P 20 000 2.00 40 000 12 500 27 500
R 8 000 2.10 16 800 5 000 11 800
T 4 000 0.80 3 200 2 500 700
Totals 32 000 60 000 20 000 40 000

Product V+L Costs Fixed Costs

H I
P 5 000 7 500
R 2 000 3 000
T 1 000 1 500

4.2.2 OTHER TECHNIQUES FOR THE MEASUREMENT OF COSTS

Standard cost is the estimated or expected cost of products of inventory based on

predetermined information of normal levels of material and supplies, labour, and
operations’ efficiency and capacity utilization. A regular review is required and
where changes occur, changed where necessary.
Retail method determines the cost of products of inventory by reducing the sales
price of products by their approximate average profit. It is used when complete
records of purchases and inventories are not kept.

Standard cost or retail methods may be used to measure inventory when they fit well with the
entity and result in approximate cost of inventory.

4.3 COST FORMULAS

 The cost of inventories shall be allocated by using the first‐in, first‐out (FIFO)
or weighted average cost formula (IAS 2.25).
 Where goods and services produced and segregated for specific projects are
not ordinary interchangeable, cost of inventory allocated using by using
specific identification of their individual costs (IAS 2.23).

The value of inventories on hand at the end of a financial period should be determined by
using one of the following cost formulas:

16
First‐in, first‐out
Unit costs are applied to units sold in the order in which they are received. To compute the
cost of a unit, the oldest or first‐in unit costs are applied. The units in ending inventory are
assigned the remaining unit costs.

Weighted average method

In both cost of goods sold and ending inventory, the cost of all units in inventory is determined
and utilized to value the units.

Specific identification
Allocate costs to separately identified items that were acquired or manufactured for a specific
project.

The determination of cost can be subject to manipulation in practice, especially with regard to
the allocation of overhead costs and application of cost formulas, as the choice of cost formula
can significantly impact on the profit for the year.
The same cost formula should thus be used for inventories with the same nature and use.

EXAMPLE 4.7
Booi Ltd was formed on 1 December 2020. The following inventory information of product T
is available from the accounting record:

Units Cost per unit

R
3 January 2021 (Opening 1 500 18,00
inventory)
Purchases:
4 January 2021 2 500 30,00
24 January 2021 2 300 31,00
15 February 2021 1 000 32,00
15 March 2021 1 700 34,00

2 000 units were on hand during physical count of inventory on 31 March 2021.
REQUIRED
Determine the cost inventory to be presented in the statement of profit or loss and other
comprehensive income under the following inventory methods.
(a) First‐in‐first out (FIFO)
(b) Weighted average
Show the cost schedule that supports the cost of inventory presented.

17 FAC2601/1
SUGGESTED SOLUTION 4.7
(a) First‐in‐first‐out (FIFO)

Units Cost/unit Total Cost

15 March 2021 1 700 34 57 800
15 February 20121 300 32 9 600

31 March 2021, inventory 2 000 67 400

(b) Weighted average

Units Cost/unit Total Cost
3 January 2021 (Opening inventory) 1 500 18,00 27 000
4 January 2021 2 500 30,00 75 000
24 January 2021 2 300 31,00 71 300
15 February 2021 1 000 32,00 32 000
15 March 20121 1 700 34,00 57 800
9 000 263 100
31 March 2021, inventory 2 000 (1) 29,23 58 467

(1) Unit cost on weighted average: 263 000/9 000 = 29,23

4.4 DETERMINING NET REALISABLE VALUE AND RECOGNITION AT LOWER OF

COST AND NET REALISABLE VALUE

Net realizable value is the estimated selling price in the normal course of business,
less:
 costs to complete the inventories
 trade and other discounts allowed
 advertising
 sales commission
 packaging costs
 transport costs

18
Inventories are therefore valued at cost at the end of a reporting period, which should not
exceed the net amount expected to be realised from sales. Should the cost exceed this
estimated amount, it implies that inventories are expected to be sold at a loss, and this
estimated loss should be recognised in accordance with the prudence concept as it is probable
and can be measured. The cost is then reduced to net realisable value and the write‐off is
immediately shown in the statement of profit or loss and other comprehensive income.

The write‐off is normally done on an item‐by‐item basis, but if the following is applicable, it can
be done on a group‐by‐group basis:
 Items that relate to the same product range and
 Have a similar purpose
 That are marketed in the same geographical area

A new assessment of net realisable value is made each financial year‐end and adjustments might
be as a result of:

 damaged inventories
 obsolete inventories
 decline in selling prices
 increases in costs to complete products
 increases in selling costs

Net realisable value is an entity‐specific amount realised from the sale of

inventories in the ordinary course of business, and therefore does not represent
the fair value.

EXAMPLE 4.8
The following information was taken from the financial records of Komphela (Pty) Ltd
“Komphela”, a manufacturing company on 31 December 2018:
Inventories (note 5) 630 000

Additional information
Inventories (at cost) consist of:

R
- Raw materials 380 000
- Work in progress 250 000

Additional Information
Just before year-end, there was damage to the storeroom in which some inventory was stored.
The damage resulted in 40% of the raw material being damaged. It was determined that the
net realisable value of the raw material that was not damaged was 15% below the cost thereof.

19 FAC2601/1
None of the work in progress was damaged and the net realisable value of the work in progress
was estimated to be R280 000.

1. Value of inventory as at 31 December 2019

2. Determine the value of write‐off that must be shown in the statement of profit or loss and
other comprehensive income.

SUGGESTED SOLUTION 4.8

Inventories
443 800

- Raw materials (380 000 x 60%) x 85% 193 800

- Work in progress 250 000

EXAMPLE 4.9
Koopman Ltd extracted the following balances from its financial records on
31 December 2020:
Inventory at cost 668 050
Additional information
The cost price of the inventory on hand on 31 December 2019 consisted of finished goods of
R325 050, work in progress of R203 000 and raw materials of R140 000. The net realisable
value of finished goods was determined to be 10% below the cost of finished goods. The net
realisable value of raw material and work in progress was estimated to be the same as cost.
Inventory is recorded at the lower of cost and net realisable value.
REQUIRED
1. Value of inventory as at 31 December 2019
2. Determine the value of write‐off that must be shown in the statement of profit or loss and
other comprehensive income.

SUGGESTED SOLUTION 4.9

1. Inventory
R
Raw material 140 000
Work in progress 203 000
Finished goods (325 050 x 90%) 292 545
635 545

2. Write‐off: 325 050 x 10% = R32 505

20
 The following are exceptions to this general rule:

Firm sales contracts

The net realisable value of these inventories should be based on contract price and not
on the normal sales price.

Raw materials
If it will be incorporated in the finished product and the finished product is expected to
sell at more than the original cost, the raw material is not written down below their cost.
If, however, the finished product is expected to sell at less than cost, it should be written
down to net realisable value.

4.5 RECOGNITION OF EXPENSE

When inventories are sold, the carrying amount of inventories shall be

allocated as an expense in the period in which the related revenue is recorded.

The following are systems of recognising expenses”

Perpetual inventories system: recognise sales and corresponding expenses throughout the
financial period.
Periodic inventories system: only recognise sales and corresponding expenses at the end of
the financial period.

The amount of write‐down of inventory to net realizable value shall be allocated to cost of
sales expense, recognised in statement of profit or loss and other comprehensive income and
disclosed separately in the notes to the annual financial statements. However, the amount
of write‐down of inventory as a result of inventory losses, the difference between physical
inventories on hand and the inventories records, shall be allocated to cost of sales expense,
recognised in statement of profit or loss and other comprehensive income, but not necessary
to disclosed separately in the notes to the annual financial statements

The amount of reversal of inventory net realizable value write‐down shall be reduced from the
cost of sales expense and recognised in statement of profit or loss and other comprehensive
income with separate disclosure.

21 FAC2601/1
4.6 DISCLOSURE REQUIREMENTS
The financial statements shall disclose

 The accounting policy with regard to measurement and cost formula used
 The total carrying amount of inventories, with applicable classification
 The carrying amount of inventories carried at fair value less costs to sell
 The amount recognised as cost of sales in current financial year
 The amount of any write‐downs recognised as an expense
 The reversal of any subsequent write‐downs in previous financial period
 The amount of any inventories pledged as security

Please note: It is not required to disclose the fact that carrying amount of inventories is
at net realisable value.

Since we prefer to prepare the profit or loss section of the statement of profit or loss and other
comprehensive income according to the functions of income and expenditure rather than
according to the nature of income and expenditure, the cost of sales will be disclosed as a
separate line item.
Cost of inventories therefore includes all costs incurred in bringing the inventories
to their present location and condition and will be disclosed in the statement of
financial position at the end of the financial period and then carried forward to the
following financial period, until the revenue is recognised.

4.7 DIFFERENCES BETWEEN ‘full IFRS’ AND ‘IFRS FOR SMEs’

South African legislation, National Small Business Act No. I 02 of 1996, classifies some
businesses as small and medium‐size enterprises (SMEs). Size or class of enterprise, total full‐
time equivalent of paid employees, total annual turnover and total gross asset are considered
in distinguishing SMEs from other enterprises. SMEs are further distinguished between micro,
very small, small and medium enterprises using the same criteria.

International Accounting Standards Board (IASB) developed separate financial reporting

standards for SMEs because SMEs found it difficult and costly to prepare financial statements
that comply with full IFRS. This section seeks to identify differences between reporting
standards of SMEs and other enterprises.

22
The reporting standards of companies are the same as that of small and medium‐size
enterprises (SMEs) except for the following”

IFRS for SMEs: section 23 Full IFRS: IAS 2

Scope The standard does not apply to work Not applicable in IAS 2
in progress resulting from
construction contracts and service
contracts thereof.
Measurement The statement uses the word The statement uses the word
“estimated selling price less costs to “net realisable value”.
complete and sell”
However, the words mean the same
thing.
Other acceptable technique of Not mentioned in IAS 2
measuring inventory is “most recent
purchase price”

4.8 DIFFERENCES BETWEEN ‘full IFRS’ AND GENERALLY RECOGNISED

ACCOUNTING PRACTICE (GRAP)

GRAP 12 IAS 2
Scope The standard does not apply to: Not applicable in IAS 2
a. Work in progress resulting from
construction contract (including
directly related service contracts).
b. Work in progress of services to
be provided, directly in return
from the recipients, through a
non‐exchange transaction
c. water that occurs naturally and
minerals, oils, gas and other non‐
regenerative resources which
have not been extracted
d. heritage assets
e. to the initial recognition and
initial measurement of
inventories acquired
 in a transfer of functions
between entities under
common control
 in a transfer of functions
between entities not under
common control
 merger

23 FAC2601/1
Definition Inventories include assets, in a Not applicable in IAS 2
form of materials or supplies, to
be distributed in the rendering of
services
Inventories Inventories, in public sector, include: Not applicable in IAS 2
a. Spare parts for plant and equipment
not included in Property, plant and
equipment.
b. Work in progress of client services
sold at arm’s length prices.
c. strategic stockpiles (such as energy
reserves
Recognition Inventories to be recognised if: Not applicable in IAS 2
(a) it is probable that future economic
benefits or service potential
associated with the item will flow
to the entity; and
(b) the cost of the inventories can be
measured reliably.
Recognition Inventories to be recognised if: Not applicable in IAS 2
(a) it is probable that future economic
benefits or service potential
associated with the item will flow
to the entity; and
(b) the cost of the inventories can be
measured reliably.
Measurement at The cost of inventories acquired on a Not applicable in IAS 2
recognition non‐exchange transaction be
measured at their fair value as at the
date of acquisition.
Cost of inventory Cost of inventory of a service Not applicable in IAS 2
provider, except those in (b) in the
above section of the scope, to be
measured at cost of the production
(labour and other costs of
personnel directly engaged in
providing the service, including
supervisory personnel, and
attributable overheads).

24
Measurement after  Inventories to be measured at the Not applicable in IAS 2
recognition lower of cost and current
replacement cost where they are
held for:
a. distribution through a non‐
exchange transaction; or
b. consumption in the production
process of goods to be distributed
at no charge or for a nominal
charge
 For financial reporting purposes:
 the future economic benefits or
service potential of the inventory
of goods distributed at no charge
or for a nominal charge is to be
reflected by the amount the entity
would need to pay to acquire the
economic benefits or service
potential, if this was necessary to
achieve the objectives of the
entity.
an estimate of replacement cost will
need to be made where the economic
benefits or service potential cannot be
acquired in the market,

4.9 EXAMPLES
QUESTION 1
XYZ (Pty) Ltd manufactures Product A for resale. The manufacturing cost per Product A is
R1 350. Finished units of Product A are sold at R1 550 per unit. The following costs accrued
with the manufacturing of Product A:

Cost to complete inventories R

Packaging cost 260 per unit
Advertising 40 per unit
Salaries of administrative staff 35 per unit
Sales commission 1 000 per month
Trade discount allowed 90 per unit
55 per unit

25 FAC2601/1
The closing inventories of Product A on hand for the year ended 31 December 20.9
amounted to 5 000 units.

REQUIRED

Calculate the value of the inventories (Product A) according to the requirements of IAS 2.

QUESTION 2
Doggy Ltd manufactures dog baskets and dog kennels. The following information on
inventory is available:
Total net
Total net realisable
cost price value
R R
Dog baskets 46 000 44 000
Small 18 000 20 000
Large 28 000 24 000
Dog kennels 175 000 164 000
Small 78 000 54 000
Medium 65 000 72 000
Large 32 000 38 000
Total 221 000 208 000

REQUIRED

SOLUTION 1
R
Net realisable value (NRV) of product A:
Selling price 1 550
Cost to complete inventories (260)
Packaging cost (40)
Advertising (35)
Sales commission (90)
Trade discount allowed (55)
1 070

26
The carrying amount of closing inventories is measured at the lower of cost or NRV.
Therefore, it is measured at the NRV of R1 070 per unit.
Value of inventories at 31 December 20.9.
Closing inventories 5 000 units x R1 070 (NRV) = R5 350 000

SOLUTION 2
According to IAS 2, paragraph 28, decreases in the value of inventory are calculated separately
for individual items, groups of similar items, inventory categories, etc.

Alternative 1 (individual items)

Type of product Lower of cost
price or net
realisable value
R
Dog baskets – Small 18 000
– Large 24 000
Dog kennels – Small 54 000
– Medium 65 000
– Large 32 000
193 000

Alternative 2 (groups of similar items)

Lower of cost
price or net
realisable value
Group R
Dog baskets 44 000
Dog kennels 164 000
208 000

27 FAC2601/1