Chapter 9

Inventories

Prepared by
Kent Wilson
 Objectives

1. Discuss the nature of inventories and how to

measure them

2. Explain what is included in the cost of

inventory

3. Account for inventory transactions using both

the periodic and perpetual methods

4. Application of end of period procedures

 Objectives

5. Explain cost flow assumptions and apply both

FIFO and weighted average cost formulas

6. Explain the net realisable value basis of

measurement

7. Identify inventory expense inclusions

8. Implement the disclosure requirements of IAS 2

The Nature of Inventories

 IAS 2 defines inventories as assets that are:

 Held for sale
 In the process of production
 Materials or supplies to be used in production

 Inventories are classified as current assets

 Cost of goods sold (COGS) is the expense account

used to record the costs of inventory once sold
 Initial Recognition of
Inventory

‘Inventories shall be measured at the lower of

cost and net realisable value.’ (IAS 2 para 9)

 Cost Components:
 Costs of purchase
 Costs of conversion
 Costs in bringing inventory to present location & condition
 Determination of Cost

 The cost of purchase comprises:

 The purchase price
 Import duties and other transaction taxes
 Transport, handling and other directly attributable
costs
 Any discounts are to be deducted
 Costs of Conversion

 Costs of conversion are those costs directly related to

production including:
 Direct labour
 Systematic allocation of fixed and variable production overheads

 Variable overheads: vary with volume of production.

Allocated based on actual use of production facilities

 Fixed overheads: remain constant regardless of the

volume of production. Allocated based on normal
production capacity.
Accounting for Inventory

 Periodic Method
 Balance of inventory determined periodically (normally annually)
 Amount of inventory determined via physical count (# of units X
unit cost)
 Cost-effective and easy to apply, but inexact day-to-day quantity
and cost

 COGS determined as follows:

Opening inv. + purchases – purchase returns – closing inventory = COGS
 Accounting for Inventory

 Perpetual Method
 Balance of inventory determined each time a transaction
occurs
 Requires subsidiary ledger linked to general ledger
 Up-to-date but more complicated and expensive than
periodic method
End-Of-Period Accounting

 The following steps are normally undertaken to ensure

that reported figures for inventory and COGS are
accurate and complete:
 Physical count
 End-of-year
 Accounting for goods in transit and consignment inventory
 Control account/subsidiary ledger reconciliation procedures
(needed only under perpetual method)
Assigning Costs to Inventory
on Sale

 IAS 2 requires the specific identification method be used

where possible to assign costs to inventory
 Under this method costs are individually identified for each
inventory item

 Where there are large numbers of homogenous inventory

items one of the following two methods should be used:
 First-in first-out (FIFO)
 Weighted average cost method
Assigning Costs to Inventory
on Sale
FIFO
 Assumes that items of inventory purchased/produced
first are sold first
 Items remaining in inventory are those most recently
purchased/produced

Weighted average
 The cost of each item is determined from the cost of
similar items purchased during the period
 May be a weighted average or a moving average
Net Realisable Value

 IAS 2 requires that inventories are recorded at the

lower of cost and net realisable value (NRV)

 NRV is the amount the entity expects to realise from the

sale of the inventory in the ordinary course of business

 NRV may fall below cost due to:

 Fall in selling price
 Physical deterioration of inventory
 Obsolescence
 Disclosure

 IAS 2 para 36 - 37 outline requirements:

 Need to classify into categories
 Common classifications:
Merchandise
Production supplies
Materials
Work in progress
Finished goods