Recognise the need for
adjustments for inventory in preparing financial
statements.
Ø
Matching principle:
In order to be able to prepare a set of financial statements,
inventory must be accounted for at the end of the period. Opening inventory must
be included in cost of sales as these goods are available for sale along with
purchases during the year. Closing inventory must be deducted from cost of
sales as these goods are held at the period end and have not been sold.
Record opening and
closing inventory.
Ø
Inventory is only recorded
in the ledger accounts at the end of the accounting period.
Ø
In the inventory ledger
account the opening inventory will be the brought forward balance from the
previous period. This must be transferred to the income statement ledger
account with the following entry.
Dr. Income statement (Ledger account)
Cr. Inventory
Ø
The closing inventory is
entered into the ledger accounts with the following entry:
Dr. Inventory (Ledger account)
Cr. Income statement (Ledger account)
Ø
Once these entries have been
completed, the income statement ledger account contains both opening and
closing inventory and the inventory ledger account shown the closing inventory
for the period to be shown in the statement of financial position.
Identify the alternative
methods of valuing inventory.
Inventory is included in the statement of financial position at:
The lower of Cost and Net realisable value
Ø
Cost: All the expenditure
incurred in bringing the product or service to its present location and condition.
This includes cost of purchase – material costs, import duties, freight and
cost of conversion – this includes direct costs and production overheads.
Ø
Net realisable value –
Revenue expected to be earned in the future when the goods are sold, less any
selling costs.
Recognise which costs
should be included in valuing inventories.
Costs include all the expenditure incurred in bringing the product
or service to its present location and condition.
This includes:
Cost of purchase – material costs, import duties, freight
Cost of conversion – this includes direct costs and production
overheads
Costs which must be excluded from the cost of inventory are:
-
Selling costs
-
Storage costs
-
Abnormal waste of materials,
labour or other costs
-
Administrative overheads
Understand the use of
continuous and period end inventory records.
The quantity of inventories held at the year end is established by
means of a physical count of inventory in an annual counting exercise, or by a
'continuous' inventory count.
In simple cases, when business holds
easily counted and relatively small amounts of inventory, quantities of
inventories on hand at the
reporting date can be
determined by physically counting them in an inventory count.
In more complicated cases,
where a business holds considerable quantities of varied inventory, an
alternative approach to establishing quantities is to maintain continuous
inventory records.
This means that a card is
kept for every item of inventory, showing receipts and issues from the stores,
and a running total.
A few inventory items are
counted each day to make sure their record cards are correct – this is called a
'continuous' count because it is spread out over the year rather than completed
in one count at a designated time.
Calculate the value of
closing inventory using FIFO (first in, first
out) and AVCO (average cost).
FIFO method - for costing
purposes, the first items of inventory received are assumed to be the first
ones sold. The cost of closing inventory is the cost of the younger inventory.
AVCO method – The cost of an item of inventory is calculated by
taking the average of all inventory held. The average cost can be calculated periodically
or continuously.
Unit cost – This is the actual cost of purchasing identifiable
units of inventory. Only used when items of inventory are individually
distinguishable and high value.
Understand the impact of
accounting concepts on the valuation of
inventory.
The concept of matching justifies the carrying forward of
purchases not sold by the end of the accounting period, to leave the remaining
purchase to be matched with sales. Prudent concept requires the application of
a degree of caution in making estimate under conditions of uncertainty.
An entity shall use the same cost formula for all inventories
having a similar nature and use to the entity. For inventories with a different
nature or use, different cost formulas may be justified. However, the cost of
inventories of items that are not ordinarily interchangeable and goods or
services produced and segregated for specific projects shall be assigned by
using specific identification of their individual costs.
When inventories are sold, the carrying amount of those
inventories shall be recognised as an expense in the period in which the
related revenue is recognised. The amount of any write-down of inventories to
net realizable value and all loses of inventories shall be recognised as an
expense in the period the write-down or loss occurs. The amount of any reversal
of any write-down of inventories, arising from an increase in net realizable
value, shall be recognised as a reduction in the amount of inventories
recognised as an expense in the period in which the reversal occurs.
Identify the impact of
inventory valuation methods on profit and on
assets.
Different valuation methods
will result in different closing inventory values. This will in turn impact
both profit and statement of financial position assets value. Similarly any
incorrect valuation of inventory will impact the financial statement.
Ø
If inventory is overvalued
then assets are overstated in the statement of financial position and profit is
overstated in the income statement (as cost of sales is too low)
Ø
If inventory is undervalued
then assets are understated in the statement of financial position and profit
is understated in the income statement (as cost of sales is too high)
Expense recognition
IAS 18 Revenue addresses
revenue recognition for the sale of goods. When inventories are sold and
revenue is recognised, the carrying amount of those inventories is recognised
as an expense (often called cost-of-goods-sold). Any write-down to NRV and any
inventory losses are also recognised as an expense when they occur. [IAS 2.34]
Disclosure
accounting policy for inventories
carrying amount, generally classified as merchandise, supplies,
materials,
WORK
in
progress, and finished goods. The classifications depend on what is appropriate
for the entity
carrying amount of any inventories carried at fair value less
costs to sell
amount of any write-down of inventories recognised as an expense
in the period
amount of any reversal of a write-down to NRV and the
circumstances that led to such reversal
carrying amount of inventories pledged as security for liabilities
cost of inventories recognised as expense (cost of goods sold).
IAS 2 acknowledges that some enterprises classify
INCOME statement
expenses by nature (materials, labour, and so on) rather than by function (cost
of goods sold, selling expense, and so on). Accordingly, as an alternative to
disclosing cost of goods sold expense, IAS 2 allows an entity to disclose
operating costs recognised during the period by nature of the cost (raw
materials and consumables, labour costs, other operating costs) and the amount
of the net change in inventories for the period). [IAS 2.39] This is consistent
with
IAS 1 Presentation
of Financial Statements, which allows presentation of expenses by function or
nature.
Sources
F3 Financial Accounting –
Kaplan publishing
IAS 2 Technical Summary
