Financial Accounting II Lecture 11

Inventories

First in First Out (FIFO) Last in First Out (LIFO) Specific identification of cost Weighted Average Methods of Stock Vlauation

Benchmark Treatment – Cost of inventories should be assigned using FIFO or Weighted Average Method. Selection of Method – IAS 2

Allowed Alternative – The cost of inventories may be measured using LIFO method. Selection of Method – IAS 2

The cost of inventories may not be recoverable if those inventories are damaged, if they have become wholly or partially obsolete, or if their selling price has declined. The cost of inventories may also not be recoverable if the estimated cost to complete and sell them has increased. Cost and Net Realizable Value

In such case the inventories are written down to net realizable value. Cost and Net Realizable Value

The estimation of NRV of inventories is made in each accounting period. Cost and Net Realizable Value

When the circumstances which previously caused the inventories to be written down to net realizable value no longer exist the amount of write down is reversed so that the new carrying amount is the lower of cost and net realizable value. Cost and Net Realizable Value

When the inventories are sold the carrying amount of those inventories should be recognized as an expense in the period in which the related revenue is recognized. Recognition of Expense – IAS 02

The amount of any write down of inventories to NRV and all losses of inventories should be recognized as an expense in the period the write down or the loss occurs. Recognition of Expense – IAS 02

The amount of any reversal of write down of inventories arising from an increase in the NRV should be recognized as a reduction in the amount of inventories recognized as expense in the period in which the reversal occurs. Recognition of Expense – IAS 02

The accounting policy adopted The total carrying amount and the carrying amount in classification appropriate to the enterprise. The carrying amount of the inventories carried at NRV. Disclosure Requirements – IAS 02

The amount of any reversal of any write down that is recognized as the income. The circumstances and events that led to the reversal of write down The carrying amount of any stocks pledged for security. Disclosure Requirements – IAS 02

If the inventories are recorded using allowed alternative treatment then the difference of inventories under benchmark treatment and allowed alternative treatment is also required to be disclosed. The financial statements should also disclose the cost of inventories recognized as expense during the period. Disclosure Requirements – IAS 02

Trading concerns Stock in Trade (Finished inventory only) Manufacturing Concerns Raw Material Work in Process Finished Goods Types Stock in Trade

Receipt of inventory is Debited to Stock Account. Issues are Credited to Stock Account and Debited to Material Consumption Account. Value is assigned to every issue according to selected valuation policy. Material Consumption Account becomes part of Trading OR Work in Process Account. Perpetual Inventory System

Receipt of inventory is Debited to Purchases Account. No recording is made for individual issue in the General Ledger. Available balance of stock in trade at the end of the period is valued according to selected policy and closing stock is recorded by Debiting the Stock Account and Crediting Trading Account OR Work in Process Account. Periodic Inventory System

Trading Concerns (Periodic Inventory) Stock In Trade Account Receipt / Purchase are Debited (At Cost) Sales / Issues are Credited (At Cost) Balance of Stock is Shown in Balance Sheet Trading Account Cost of Items Sold is Debited (From Stock Account) Selling Price of Items Sold is Credited (At Selling Price) Balance is Gross Profit

Trading Concerns (Perpetual Inventory) Purchases Account Receipt / Purchase are Debited (At Cost) Balance is Transferred to Trading Account by Crediting Purchases A/c Trading Account Opening Stock is Debited to Trading Account Purchases are Debited to Trading Account Closing Stock is Credited to Trading Account Balance is Gross Profit Opening Stock O / B (Debit) comes from last year books This balance is transferred to Trading Account by Crediting Stock A/c Closing Stock Value of Closing Stock is Debited in the Stock Account

Movement of Stock in Trade in Accounts Raw Material StockOther Costs Accounts Work in Process Account Finished Goods Account Cost of Goods Sold Account Trading Account

Stock in Trade of Manufacturing Concerns Raw Material:O/S Raw Material + Purchases + Cost Incurred to Purchase RM -C/S Raw Material Cost of Material Consumed Conversion Cost:+ Labour + Factory Overheads Total Factory Cost Work in Process+ O/S of WIP -C/S of WIP Cost of Goods Manufactured Finished Goods+ O/S of Finished Goods -C/S of Finished Goods Cost of Goods Sold Cr. Stock Dr. WIP Cr. Expense Dr. WIP Cr. WIP DR. FG Dr. COS Cr. FG

Cost Incurred to Purchase Raw Material – While considering the cost of RM all costs are included that are incurred to bring the material to the premises of the buyer e.g. freight charges paid to bring the RM to the warehouse, duties and other charges etc. paid.

Advance Taxes (Sales Tax) – Only those taxes are included in the cost of inventory that are not refundable / adjustable. e.g. Sales tax paid at the time of purchase if adjustable will not be included in the cost of inventory.

Discounts Received – Generally there are two types of discounts; Trade Discounts; and Cash Discounts. Trade discounts are usually received on bulk purchase and are agreed at the time of negotiation of cost. The cost of inventory is recorded net of these discounts. Cash discounts are received on early payment of the outstanding amount. These discounts are conditional and are not reduced from the value of the inventory.