Chapter 7: Inventory

1. Types of inventories: Raw materials; work in progress and finished goods.

• Raw Materials: These are the basic ingredients or components that a
company uses to produce its products. Think of it like the flour, sugar, and
eggs in a bakery; they are the starting materials needed to make cakes and
cookies.

• Work in Progress (WIP): This refers to items that are in the process of
being manufactured but are not yet complete. Continuing with the bakery
example, a cake that has been mixed and baked but not yet iced or
decorated would be considered work in progress. It's more than just raw
materials, but it's not yet a finished product.

• Finished Goods: These are the completed products, ready for sale to
customers. In our bakery, this would be the fully baked, decorated, and
packaged cakes and cookies. They are no longer raw materials or half-
finished products; they are the final output of the production process.

2. Initial Measurement: Inventory = Quantity x Value

Purchase Costs:
• Initial purchase price net off trade discount.
• Cash discount is not included in inventory cost.
• Import duties
• Irrecoverable value added taxes
• Transportation (carriage inwards) costs paid to buy inventories.
• Handling costs the business pays to move inventories into the production line.
• Any other cost directly attributable to the acquisition of finished goods,
services and materials such as specific storage, insurance costs and specific
packaging costs for inventories purchased.

Conversion Costs:
• Labour and overhead costs.
• Variable and fixed production overhead incurred in converting materials into
finished goods. For instance, electricity, other utility costs, factory rents as
well as property taxes.

Costs Should not be Included in Inventories According to IAS 2

• Abnormal wastage of materials, labour, or other production costs such as
machine breakdown repair expenses.
• General storage costs incurred not specifically for purchased inventories
such as general rent expenses in the warehouse.
• Administrative overhead not incurred to bring inventories to their present
location, and costs such as security guard salary and CCTV.
• Selling costs to sell those inventories such as salespersons’ salaries
and wages, commissions, payroll taxes and advertising costs.

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3. Subsequent Measurement (at year ended): Valuing Closing Inventory = Quantity x Value
Total inventories costs should be valued at the lower of cost and net realizable value.

Individual inventory cost should be valued at the lower of cost or net realizable value.

• Cost: This is the total expense incurred to get the inventory to its current
location and condition. It includes the purchase price, conversion costs, and
other costs like transport.

• Net Realizable Value (NRV): This is the estimated selling price of the inventory
in the normal course of business minus any additional costs needed to
complete and sell the inventory, such as finishing costs or sales commissions.

Net realizable value = Expected selling price - Expected costs to sell and
complete

Cost can be calculated using:

1. Specific cost method
2. First in, first out (FIFO) method*
3. Weighted average cost method

*In the period of rising prices, FIFO method gives a higher profit figure than
weighted average cost method.

Stocktaking:
If the stocktaking takes place after the year end, the number of inventories to be
included in the account should be the value as at the year end.

• Year end inventories + purchased (after the year end) - sales (after the year
end) = After the year end inventories

Notes:
Purchases: Dr Purchases Cr Payables
Opening inventories should be added to the costs of sales
Closing inventories adjustment:
Dr Inventories (current asset in the SOFP)
Cr Costs of sales (P/L)

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