1. Inventories and construction contracts
IAS 2 & IAS 11
Inventories and construction contracts

2. Inventories Learning Objectives
Define the term "inventories" and determine the cost of inventories in accordance with the requirements of IAS2 Inventories  
Apply cost formulas such as first-in, first-out and weighted average cost  
Effect on profits, in the short-term, of different methods of inventory valuation

3. IAS2: Inventories
International standard IAS2 defines inventories as "assets:
(a) held for sale in the ordinary course of business;
(b) in the process of production for such sale; or
(c) in the form of materials or supplies to be consumed in the production process or in the rendering of services".

4. Inventories Companies often have inventories in various forms:
raw materials, for use in a manufacturing business
work-in-progress (partly manufactured goods) and finished goods (ready for sale) of a
manufacturing business
products bought for resale by a retailer
service items, such as stationery, bought for use within a business

5. Inventories - valuation
Fundamental Principle of IAS 2
The standard also prescribes a well-known rule for the valuation of inventories. This rule is that "inventories shall be measured at the lower of cost and net realisable value".

6. Inventories – valuation(cont’d)
Inventory can be valued at either:
• cost, which means the purchase price plus any other costs incurred to bring the product (or service) to its present location and condition, Or
• net realisable value, which is the estimated selling price less the estimated costs to get the product
into a condition necessary to complete the sale

7. Cost of Inventories
IAS 2 states that the cost of inventories "shall comprise all costs of purchase, costs of conversion and other costs incurred in bringing the inventories to their present location and condition".

8. Cost of inventory (cont’d)
Cost of purchase = Purchase cost
+ Import duties and other non-recoverable taxes
+ Transport and handling costs
+ Other costs directly attributable to acquisition
– trade discounts/rebates

9. Cost of inventory (cont’d)
Conversion cost includes
cost directly related to the units of production, such as direct labour
systematic allocation of fixed and variable production overheads that are incurred in converting materials to finished goods
the allocation of fixed production overheads is based on the normal capacity of the production facilities

10. Cost of inventory (cont’d)
Other costs are costs incurred in bringing the inventories to their present location and condition.
costs which can not be included are e.g.:
abnormal amounts of waste
storage costs
administrative overhead
selling costs

11. Cost formulas In general,
IAS2 requires that the cost of inventory items should be ascertained "by using specific identification of their individual costs".
In other words, each item of inventory should be considered separately and its cost should be individually established.
There are two cost formula’s

12. Inventory formulas . Cost Formulas First-in-first-out (FIFO)
Weighted Average
Last-in-first-out
(LIFO)
permitted by IAS 2
oldest purchases sells first
permitted by IAS 2
unit cost = weighted average
permitted by IAS 2
newest purchases sells first

13. Cost formulas – First in First Out
First-in, first-out (FIFO). The FIFO formula assumes that inventory items which are purchased or produced first are sold or used first, so that the items remaining at the end of an accounting period are those most recently purchased or produced.

14. Cost formulas – Weight Average Cost
Weighted average cost (AVCO). Use of the AVCO formula generally involves computing a new weighted average cost per item after each acquisition takes place.
The cost of the items remaining at the end of an accounting period is then calculated by using the most recently-computed weighted average cost per item.

15. Cost formulas – Last in First Out
It is important to note that IAS2 does not allow the use of last-in, first-out (LIFO).
This cost formula assumes that the newest inventory items are sold or used first, so that the items remaining at the end of an accounting period are the oldest.

16. Disclosures Required disclosures: [IAS 2.36]
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

17. Disclosures Required disclosures: [IAS 2.36]
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).

18. IAS 11 Construction Contracts

19. Construction contracts
Learning Objectives
Appraise IAS 11 requirements relating to construction contracts 
Define construction contracts, attributable profits and foreseeable losses
Calculate the amounts to be disclosed in financial statements relating to construction contracts

20. Construction contracts – accounting issues at stake
Construction contracts generally last over a long period of time, certainly longer than one accounting period.
Such contracts involve all the difficulties discussed earlier in the context of inventories, with one major addition.
This is the question of profit allocation over the various accounting periods.

21. What is a construction contract?
A construction contract is a contract specifically negotiated for the construction of an asset or a group of interrelated assets. [IAS 11.3]
IAS 11 defines two types of construction contracts
fixed price contract
cost plus contract

22. Fixed price contract
A fixed price contract is a construction contract in which the contractor agrees to a fixed contract price or a fixed rate per unit of output, which in some cases is subject to cost escalation clauses

23. Cost plus contract
A cost plus contract is a construction contract in which the contractor is reimbursed for allowable or otherwise defined costs, plus a percentage of these costs or a fixed fee.

24. What is included in contract revenue and costs?

25. Contract Revenue Contract revenue should include:
the amount agreed in the initial contract, plus revenue from alternations in the original contract work,
plus claims and incentive payments that
are expected to be collected and
that can be measured reliably. [IAS 11.11]

26. Contract Costs Contract costs comprise:
costs that relate directly to the specific contract
costs that are attributable to contract activity in general and can be allocated to the contract
such other costs as are specifically chargeable to the customer under the terms of the contract

27. Contract Costs (cont’d)
Not to be included in contract costs:
general administration costs for which reimbursement is not specified in the contract
selling costs
research and development costs for which reimbursement is not specified in the contract
depreciation of idle plant and equipment that is not used on a particular contract

28. Accounting
If the outcome of a construction contract can be estimated reliably, revenue and costs should be recognised in proportion to the stage of completion of contract activity.
This is known as the percentage of completion method of accounting. [IAS 11.22]

29. Accounting (cont’d)
To be able to estimate the outcome of a contract reliably, the entity must be able to make a reliable estimate of total contract revenue, the stage of completion, and the costs to complete the contract. [IAS ]
If the outcome cannot be estimated reliably, no profit should be recognised. Instead, contract revenue should be recognised only to the extent that contract costs incurred are expected to be recoverable and contract costs should be expensed as incurred. [IAS 11.32]

30. Accounting (cont’d)
The stage of completion of a contract can be determined in a variety of ways – including:
the proportion that contract costs incurred for work performed to date bear to the estimated total contract costs,
surveys of work performed,
or completion of a physical proportion of the contract work. [IAS 11.30]

31. Disclosures Disclosure
amount of contract revenue recognised; [IAS11.39(a)]
method used to determine revenue; [IAS 11.39(b)]
method used to determine stage of completion; [IAS 11.39(c)]

32. Disclosures Disclosure and:
for contracts in progress at balance sheet date: [IAS 11.40]
aggregate costs incurred and recognised profit
amount of advances received
amount of retentions