Chapter

07 Inventories
Definition of Inventories
these are assets
A. held for sale in the normal course of business
B. in the process of production for such sale
C. in the form of materials or supplies to be consumed in the production process or in the
rendering of services

Classification of Inventories
1. Merchandising Business
Merchandise Inventory or Inventory- goods purchased by a trading company for resale in the
enterprise's ordinary course of business.

2. Manufacturing Business

A. Raw materials inventory

tangible goods purchased for direct use in the manufacture of goods for sale

B. Work in process Inventory

manufactured items requiring further processing

C. Finished goods inventory

manufactured goods completed and ready for sale

D. Manufacturing supplies Inventory

Items purchased for indirect use in the manufacture of goods for resale

3. Service Provider Business

Measurement of Inventories
Initial Measurement
-inventories are Initially measured at historical cost. The cost of Inventories should include all
costs of purchase, cost of conversion, and other costs incurred in bringing the inventories to
their present location and condition.

Cost of purchase includes the purchase price, import duties and other taxes (other than those
subsequently recoverable by the enterprise from the taxing authorities), transport, handling, and
other costs directly attributable to the acquisition of finished goods, materials, and services.
Trade discounts, rebates, and other similar items are deducted in determining the cost of
purchase. Inventories may be purchased on terms, whereby payment is deferred for a specified
period. Where such terms effectively constitute a financing arrangement the cost of inventories
represents the present value of all the related payments
Cost of Conversion
Includes costs directly related to the units of production, such as direct labor and systematic
allocation of fixed and variable production overheads that are incurred in the production
process.

Cost of agricultural produce harvested from biological assets

are measured on initial recognition at their fair value less estimated point of sale cost at the
point of harvest

Cost of inventories of a Service provider

the labor and other costs of personnel directly engaged in providing the service including
supervisory personnel and attributable overhead cost excluding any profit margins or non-
attributable overheads

Joint Products and By-products

More than one product may be produced in the production process. When the purchase cost of
raw materials or costs of conversion for different products cannot be separately identified, the
cost is allocated between the products on a reasonable and consistent basis. The allocation
may be based, for example, on the relative sales price of the final products or the values when
the products become separately identifiable. The standard states that most by-products, by their
nature are immaterial. To determine the costs of the main product, the selling price less cost to
complete and sell the by-products should be deducted from the production costs.

The following are excluded from the cost of Inventories

A. Abnormal amounts of wasted materials, labor, or other production costs
B. Storage Cost unless these costs are necessary for the production process prior to a further
production stage
C. Administrative overheads that do not contribute to bringing inventories to their present
location and condition and
D. Selling Cost

Balance Sheet Measurement

Should be measured at the lower of cost or net realizable value. The net realizable value is the
net selling price in the course of the business less the estimated cost of completion and the
estimated cost necessary to make the sale. Inventories are usually written down to net
realizable value on an individual basis. In some cases, however, it may be appropriate to group
similar or related items that can be properly valued on aggregate.

Materials and other supplies held for use in the production of Inventories are not written down
below cost if the finished products in which they will be incorporated are expected to be sold at
cost or above cost. However, when a decline in the price of materials indicates that the cost of
the finished products exceeds the net realizable value the materials are written down to net
realizable value. In such circumstances, the replacement cost of the materials may be the best
available measure of their net realizable value (PAS2, par 32)
When an item of inventory has been written down to its net realizable value and if in the
subsequent balance sheet period the same item of inventory still on hand a new assessment of
net realizable value should be made. If there is clear evidence of an increase in net realizable
value because of a change in the economic condition the amount of the write-down should be
reversed. the amount of reversal should not exceed the original amount of write0down that was
recognized previously.

Establishment of the Year-End Inventory:

The periodic system of recording inventories calls for the physical counting of goods while the
perpetual system provides a record of the cost and units remaining as of a particular date,
physical counting is necessary to determine the accuracy of the records.

When a physical count is not possible or practicable it would be necessary to estimate the value
of the inventory.

Include in the year-end inventory all items of inventories owned and controlled by the enterprise
that is in good, usable, and salable condition within or outside the enterprise's premise. The
following items of inventories should be considered:

1. Merchandise in Transit

A. if the term of shipment is shipping point, include as inventory of the buyer

B. If the term is of shipment destination include as inventory of the seller
C. if the term of the contract is Cost of Insurance and Freight the goods should be included as
inventory of the buyer once the merchandise is delivered to the carrier. The CIF contract clearly
stipulates that the buyer agreed to pay the lump sum cost of the merchandise the insurance and
as well as the freight cost.
D. If the term of the contract is free alongside the vessel the seller is required to bring the goods
alongside the vessel or carrier and the cost of bringing the merchandise to the side of the vessel
or carrier is borne by the seller. Once the carrier takes possession of the merchandise title to
the goods passes to the buyer

2. Goods on consignment
include as inventory of the consignor

3. Sales on Approval
Goods sent on approval to a potential buyer should remain as inventory of the seller until
payment is received for items kept by the buyer.

4. Special sales Contract

A. Product- Financing
also known as "Park Sale" because the seller parks (transfers) its inventory in the buyer's
premises thru a sales contract that clearly specifies to purchases back the same inventory over
a specified period of time at a specified amount Include as inventory of the seller

B. Sale but the buyer is given the right to return

the revenue from the sales transaction shall be recognized at the point of sale only if all the
following conditions are met:
(a) the seller's price to the buyer is substantially fixed or determinable at the date of sale
(b) the buyer has paid the seller or the buyer is obligated to pay the seller and the
obligation is not contingent on the resale of the product
(c) the buyer's obligation to the seller would not be changed in the event of theft or
physical destruction or damage to the product
(d) the buyer acquiring the product for resale has economic substance apart from that
provided by the seller
(e) the seller does not have significant obligations for future performance directly about
the resale of the product by the buyer and
(f) the amount of future returns can be reasonably estimated. If the above conditions are
not met the seller should continue to recognize the inventory

C. Installment Sales
good should be considered sold or removed from inventory even though the legal title has yet to
pass to the buyer Include as Inventory of the buyer

D. Segregated Goods
mere segregation does not exclude such inventory, however, if the segregation is due to sales
contract such as special order such inventory is excluded in the inventory of the seller

Techniques for the Measurement of Cost

The retail method or standard cost method may be used for convenience if the results
approximate cost. Standard cost takes into account normal levels of materials and supplies,
labor efficiency, and capacity utilization, but a regular review is a requirement and if necessary,
revised in the light of current conditions

The retail method is often used in the retail industry for measuring inventories of large numbers
of rapidly changing items with similar margins for which it is impracticable to use other costing
methods. The cost of inventory is determined by reducing the sales value of the inventory by the
appropriate percentage of gross margin

The Cost Formulas For inventory

The cost of inventory that is not ordinarily interchangeable and goods or services produced ad
segregated for specific projects shall be assigned using specific identification of their individual
costs.

The cost of inventories that are ordinarily interchangeable shall be assigned by using the FIFO
or weighted average method
An entity shall use the same cost formula for all inventories having a similar nature and use. For
inventories with a different nature or use different cost formulas may be justified.

Difference between IFRS for SMEs and Full IFRS

IFRS FOR SMEs Full IFRS

Less guidance on measuring estimated Guidance on measuring estimated selling

selling costs less cost to complete and sell costs fewer costs to complete and sell

Capitalization of borrowing costs is not Capitalization of borrowing costs is required

allowed

Less disclosure is required More comprehensive disclosure