1.

IAS 02_ Inventory

2. Valuing Inventories
3. Cost of goods sold
4. Inventory systems

2
1. Inventories are assets:
- Held for sale in the ordinary course of business;
- In the process of production for such sale
- In the form of materials or supplies to be consumed in
the production process or in the rendering of services.
2. Inventories can include any of the following:
- Goods purchased and held for resale
- Finished goods produced
- Work in progress being produced
- Materials and supplies awaiting use in the production
process (raw material)

3
 Costsof inventories consist of:
Purchase
Costs of conversion
Other costs incurred in bringing the
inventories to their present location and
condition.
 Costsof purchase
Purchase price; plus
Import duties and other taxes; plus
Transport, handling and any other cost
directly attributable to the acquisition of
finished goods, services and material; less
Trade discounts, rebates and other similar
amounts.
 Costsof conversion: 2 main parts
Cost directly related to the units of
production, e.g direct material, direct labour,
…
Fixed and variable production overheads
that are incurred in converting materials into
finished goods, allocated on systematic
basis.
 Notes:

Fixed production overheads are those

indirect costs of production that remain
relatively constant regardless of the volume
of production, e.g the cost of factory
management and administration.
Variable production overheads are those
indirect costs of production that vary
directly, or nearly directly, with the volume of
production, e.g indirect materials and labour.
 Fixed production overheads must be allocated to items of
inventory on the basis of the normal capacity of the
production facilities:
Nomal capacity is the expected achivable production
based on the average over several periods/seasons,
under nomal circumstances.
The above figure should take account of the capacity lost
through planned maintenance.
If it approximates to the normal level of activity then the
actual level of production can be used.
Low production or idle plant will not result in a higher
fixed overhead allocation to each unit.
Unallocated overheads must be recognised as an
expense in the period in which they were incurred.
When production is abnormally high, the fixed prodution
overhead allocated to each unit will be reduced, so
avoiding inventories being stated at more than cost.
The allocation of variable production overheads to each
unit is based on the actual use of production facilities.
 Other costs:
Any other costs should only be recognised if they are
incurred in bringing the inventories to their present
location and condition.
Lists types of cost which would not be included in cost
of inventories. Instead, they should be recognised as an
expense in the period they are incurred.
Abnormal amounts of wasted materials, labour or
other production costs.
 Storage costs (except costs which are necessary in
the production process before a further production
stage)
Administrative overheads not incurred to bring
inventories to their present location and condition
Selling costs
Cost formula is that the cost of inventories should
be assigned by using:
1.First-In, First Out (FIFO) method.
2.Last-in, First-Out (LIFO) method.
3.Weighted-Average Cost method.
4. Other (Retail method, specific
identification method)

Notes: LIFO is no longer permitted under IAS 2

10
 Rule:
◦ Assets should not be carried at amounts greater
than those expected to be realised from their sale
or use.
◦ The value of these inventories is then calculated,
taking the lower of cost and NRV for each separate
item or group of inventory items.
◦ Inventory should be valued at the lower of cost and
NRV.
 The value of inventories is calculated at the
lower cost and NRV for each separate item or
group of items.
 Cost can be arrived at by using FIFO or AVCO
 Inventories might be valued at:
◦ Expected selling price.
◦ Net realisable value (NRV) = Expected selling price
– Costs ready to sell.
◦ Historical cost
◦ Replacement cost
 Inventories
valued at

LOWER

COST NRV
Item Quantity Cost per Selling price Cost to Selling
unit per unit complete/ cost/
unit unit

1 10 100 111 14 2
2 25 80 97 11 4

3 8 90 104 12 2
4 15 110 132 15 2
5 6 125 130 13 5
Item COST NRV Lower Note

1
2

3
4
5
Total
Opening inventory value X
Add Cost of Purchases (in the
manufacturing company, the cost of X
production)
Less closing inventory value (LOWER (X)
(COST, NRV))
Equal Cost of goods sold x

It is fundamental the principle of accounting

 Carriage inwards is included in the cost of
purchases.
 Carriage outwards is a selling and

distribution expenses in the IS.

Notes:
◦ Carriage = cost of transporting purchased goods
 Tring trading as Clickety Clocks, imports and resells
clocks. He pays for the costs of delivering the clocks from
his suppliers in Switzerland to his shop in Wales.
 He resells the clocks to other traders throughout the
country, paying the costs of carriage for the consignments
from his business premises to his customers.
 On 1 July 20X1, he had clocks in inventory valued at
$17,000. During the year to 30 June 20X2 he had
purchased more clocks at a cost of $75,000. Carriage
inwards amounted to $2,000. Sales for the year were
$162,100. Other expenses of the business amounted to
$56,000 excluding carriage outwards which cost $2,500.
Tring took drawing of $20,000 from business during the
course of the year. The value of the goods in inventory at
the year end was $15,400.
 Required: Prepare the income statement of Clickety Clocks
for the year ended 30 June 20X2.
Sales
Opening inventory
Purchases
Carriage inwards

Less closing inventory

Cost of goods sold
Gross profit
Carriage outwards
Other expenses

Net profit
 Goods might:
(a) Be lost or stolen
(b) Be dammaged, become worthless and so be
thrown away
(c) Become absolete or out of fashion. These might
be thrown away, or sold off at a very low price in a
clearance sale.
- (a) and (b): Make a loss
- (c) Make a loss if their clearance sale value is less
than their cost.
 If, at the end of an accounting period, a
business still has goods in inventorywhich
are either worthless or worth less than their
orginal cost, the value of the inventories
should be written down to:
(a) Nothing, if they are worthless
(b) Their net realisable value, if this is less than
their orginal cost.
 Lucas trading as Fairlock Fashion, ends his
financial year on 31 March. At 1 April 20X1 he
had goods in inventory valued at $8,800.
During the year to 31 March 20X2, he
purchased goods costing $48,000. At 31
March 20X2 fashion goods which cost $2,100
were still in inventory, and Lucas believes that
these could only now be sold at a sale price
$400. The goods still held in inventory at 31
March 20X2 (including the fashion goods) had
an original purchase cost of $7,600. Sales for
the year were $81,400.
 Required: Calculate the gross profit of Fairlock
Fashion for the year ended 31 March 20X2.
 Initial calculation of closing inventory
values :
INVENTORY At cost Realisable Amount
ACCOUNT value written down
$ $ $
Fashion goods
Other goods
(balancing figure)
Total
Sales
Opening inventory
Purchases

Less closing inventory

Cost of goods sold
Gross profit
A. Perpetual Inventory System.
B. Periodic Inventory System.

26
 Applying either the periodic inventory system or
the perpetual inventory system and select a cost
flow assumption to determine the value of
inventories.
 Both inventory systems require a physical count
of inventory at the end of a period to determine
the units which can be included in the inventory
count.

27
Perpetual system Periodic System
At purchase
Inventory xxx Purchases xxx
A/P xxx A/P
xxx

At sale:
CGS xxx None
Inventory xxx
A/R xxx A/R xxx
Sales xxx Sales xxx

28
 1. Definition
 2. Cost of PPE
 3.Depreciation and Accounting for

Depreciation
 4. Revaluation of non-current
assets
 5. Disposal of non - current assets
 PPE are tangible assets that:
◦ As held by an entity for use in the
production or supply of goods or
services, for rental to others, or for
administrative purposes; and
◦ Are expected to be used during more
than one period.
 PPE are also called:

◦ Plant assets.
◦ Fixed assets.
 Itis propable that future economic
benefits associated with the asset
will flow to the entity.
 The cost of the asset to the entity

can be measured reliably.

 Cost consists of all expenditures necessary to
acquire the asset and make it ready for its
intended use.
 For example:

◦ The cost of factory machinery includes the

purchase price, freight costs paid by the
purchaser, and installation costs.
◦ Once cost is established, the company uses
that amount as the basis of accounting for
the PPE over its useful life.
 Measurement of PPE
- Initial measurement: At cost
- Measurement subsequent to initial
recognition.
 Initial measurement: At cost
Dr Non current asset – Cost xxx
Cr Cash/Payables xxx
 Measurement subsequent to initial
recocgnition: 2 options:

Revaluation model
Cost model
Carry the assets at
Carry the assets at revalued amount:
its cost less Fair value at the
accumulated date of the
depreciation and revaluation less
any accumulated subsequent
impairment losses. Acc.Dep and Acc
Impairment losses.
IAS 36 – Impairment of assets
-Asset is impaired when:

Carrying amount > Recoverable amount

Recoverable amount = higher (FV –cost to sell,

Value in use)
 Value in use

1. Future cash flows 2. Discounting

 Cost model
= Cost - Accumulated depreciation
 Revaluation model

= Revaluated amount - Subsequent

accumulated depreciation – accumulated
impairment losses.
= Fair value at the date of the
revaluation- Subsequent accumulated
depreciation – accumulated impairment
losses
 Purchase price less any trade discount and
rebate;
 Initial estimated of the costs of dismantling

and removing the item and restoring the

site on which it is located;
 Delivery attributable costs of bring the asset

to working condition for its intended use:

◦ Cost of site preparation
◦ Installation costs
◦ Initial delivery & handling costs
◦ Professtional fees
 Assume that Hayes Manufacturing Company
acquires real estate at a cash cost of
$100,000.
The property contains an old warehouse that
is razed at a net cost of $6,000 ($7,500 in
costs less $1,500 proceeds from salvaged
materials).
Additional expenditures are the attorney’s
fee, $1,000, and the real estate broker’s
commission, $8,000.
The cost of the land ???
 LAND
Cash price of property
Net removal cost of warehouse
Attorney’s fee
Real estate broker’s commission
Cost of land

Recording the above transaction?

 Depreciation is the process of
allocating to expense the cost of a PPE
over its useful (service) life in a
rational and systematic manner.
 Cost allocation enables companies to

properly match expenses with

revenues in accordance with the
expense recognition principle.
 Depreciable assets are assets:
◦ Are expected to be used during more than 1accounting period;
◦ Have a limitted useful life; &
◦ Are held by an enterprise for use in the production or supply of goods & service, for rental to
others, or for administrative purposes.
 Useful life is either:
◦ The period over which a depreciable asset is expected to be used by the enterprise); or
◦ The number of production or similar units expected to be obtained from the asset by the
enterprise.
 Depreciable amount of a depreciable asset =Historical cost (othes substituted cost) – Estimated
residual value.

 0
 Depreciation does not apply to land because
its usefulness and revenue-producing ability
generally remain intact over time.
 In fact, in many cases, the usefulness of land

is greater over time because of the scarcity

of good land sites. Thus, land is not a
depreciable asset.
 Initial cost: All expenditures necessary to
acquire the asset and make it ready for
intended use.
 Estimated residual value/ Salvage value:

Estimate of the asset's value at the end of

its useful life.
 Expected Useful Life: Estimate of the
expected life based on need for repair,
service life, and vulnerability to
obsolescence.
 1. Straight-line method
 Allocate an equal amount to each period.

 2. Units-of-activity method (Production units method)

 Depreciation based on volume of output.

 3. Reducing balance method (Declining-balance

method)
◦ Produces a decreasing annual depreciation expense
over the asset’s useful life.
4. Sum of Year Digit (SYD):  The sum of the years' digits
method will result in greater depreciation in the
earlier years of an asset's useful life and less in the
later years
 Depreciable Asset - Truck
 Invoice price $20,000
 Trade discount 2%
 Modifications $3,400
 Estimated residual value $2,000
 Useful life - 4 years or 200,000 miles
 Acquisition date - January 8, 20X2
Cost - Estimated Residual Value Depreciation
=
Expected Useful Life Expense
 Expense Accum
20X2:($23,000 - $2,000)/4=$5,250 $5,250

20X3:($23,000 - $2,000)/4=$5,250 $10,500

20X4:($23,000 - $2,000)/4=$5,250 $15,750

20X5:($23,000 - $2,000)/4= $5,250 $21,000

Cost - Estimated Residual Value Depreciation
= Expense
Expected Useful Life in Units per Unit

Depreciation Units Depreciation

Expense x Produced = Expense
per Unit
($23,000 - $2,000)/200,000 = $0.105 per mile
Exp Accum
20X2: 50,000 miles x $0.105= $5,250 $5,250
20X3: 40,000 miles x $0.105= $4,200 $9,450
20X4: 60,000 miles x $0.105= $6,300 $15,750
20X5: 10,000 miles x $0.105= $1,050 $16,800
20X6: 20,000 miles x $0.105= $2,100 $18,900
20X7: 20,000 miles x $0.105= $2,100 $21,000
 Net Book Reducing Annual
Value x Balance = Depreciation
At beginning Rate Expense
of year
 Expense Accum
20X2: ($23,000 -$0) x 50% = $11,500 $11,500
20X3: ($23,000 - $11,500)x50% = $5,750 $17,250
20X4: ($23,000 - $17,250)x50% = $2,875 $20,125
20X5: ($23,000 - $20,125)x50% = $1,438 $21,623
over depreciated
20X5: ($23,000 - $2,000) - $20,125 = $875 $21,000
 Because the reducing balance method
produces higher depreciation expense in the
early years than in the later years, it is
considered an accelerated-depreciation
method.
 It matches the higher depreciation expense in

early years with the higher benefits received

in these years.
 It also recognizes lower depreciation expense

in later years, when the asset’s contribution

 to revenue is less.
Calculate the reducing balance rate:

SV
Dr  1  n
P
Dr: Reducing balance rate
N: Number of depreciated year
SV: Estimated salvage value
P: Cost
 2000
Dr  1  4
23000

= 50%
SYD = n(n+1)/2 (n is expected useful life)
Depreciated value: Cost – Salvage value.
Remain useful Accumulated
Year life SYD Depreciated value Depreciation

1 4 4/10 8,400 8,400

2 3 3/10 6,300 14,700

3 2 2/10 4,200 18,900

4 1 1/10 2,100 21,000

 Many corporations use straight-line in their
financial statements to maximize net income.
 At the same time, they use a special
accelerated-depreciation method (reducing
balance method) on their tax returns to
minimize their income taxes.
 Taxpayers must use on their tax returns either
the straight-line method or a special
accelerated-depreciation method called the
Modified Accelerated Cost Recovery System
(MACRS).
 When a change in an estimate is required,
the company makes the change in current
and future years. It does not change
depreciation in prior periods.
 To determine the new annual depreciation

expense, the company first computes the

asset’s depreciable cost at the time of the
revision. It then allocates the revised
depreciable cost to the remaining useful
life.
Net Book Value – Residual Value New
= Depreciation
Revised Useful Life Expense
 When NCA is revalued, depreciation is
charged on the revalued amount.
 When an item of PPE is revalued, the whole

class of assets to which it belongs should be

revalued
 Revalued at the same time (at the end of the

financial year).
 Revalued amount is carried out by
professionally qualified valuers or based on
the market value.
 Accounting entries:
◦ Dr Property, plant & equipment (PPE) - Cost
◦ Dr Property, plant & equipment (PPE) – Accu. Dep
◦ Cr Revaluation reserve (RR_Owner’ equity)
 Depreciation on revalued assets:
New Revalued amount
Depreciation =
Expense Remaining useful life
 On 1 January 20X2, the Company X purchased
business permises at cost of $50,000.
 For the purpose of accounting for depreciation, the
Company decided the following:
 (a) The land :$20,000_ not be depreciated.
 (b) The buiding: $30,000, depreciated by the straight-
line method to a nil residual value over 30 yrs.
 On 1 January 20X7, the Co. X decides its business
permises are now worth $150,000, divided into: Land
$75,000 & Building $75,000 (remaining useful life 25
yrs).
 Require: Calculate the annual charge for depreciation
in each of the 30 year of its life & extraction of SOFP ?
 Before the revaluation:
◦ Annual depreciation charge is $1,000 per annum
on the building.
◦ As at 31.12.X6:
 Building – Cost: $30,000
 Land – Cost: $20,000
 Accumulated depreciation (Building): ($5,000)
 Net book value as at 31.12.X6 $45,000
 Extraction of SOFP
◦ 31.12.X2: $49,000
◦ 31.12.X3: $48,000
◦ 31.12.X6: $45,000
 When the revaluation takes place as at 1.1.X7:
-The amout of the revaluation :
 Net asset value: $150,000
 Carrying value as at end of 20X6 : $ 45,000
 Amount of revaluation: $105,000
- Annual depreciation charge X7:
$75,000 : 25yrs = 3,000 p.a
 Extraction of SOFP
◦ 31.12.X7 ($150 – $3k): $147,000
◦ 31.12.X8 (….
◦ …..
a. Methods of NCA disposal
 Sale :

◦ NCA is sold to another party

 Retirement:

◦ NCA is scrapped or discarded

 Exchange

◦ Existing NCA is traded for new NCA.

 Remove asset cost and related
accumulated depreciation from the
records
 Book value

=Cost – Accumulated depreciation

 Determine gain or loss on disposal
 Gain: Received more than book value
 Loss: Received less than book value
 Sale price of the asset:
◦ Dr Receivable account / cash: xxx
◦ Cr Disposal of NCA : xxx
 Cost of the asset disposed of:

◦ Dr Disposal of NCA : xxx

◦ Cr NCA : xxx
 Accumulated depreciation on the asset as at

of the sale:
◦ Dr Accumulated depreciation: xxx
◦ Cr Disposal of NCA : xxx
 Overland Trucking has an old truck that cost
$30,000, and it has accumulated depreciation
of $16,000 on this truck.
 Overland has decided to sell the truck.

◦ (a) What entry would Overland Trucking make

to record the sale of the truck for $17,000
cash?
◦ (b) What entry would Overland trucking make
to record the sale of the truck for $10,000
cash?
 (a) Sale of truck for cash at a gain:

 (b) Sale of truck for cash at a loss:

 Always recognize any gain or loss.
 Question 3.8:

◦ To illustrate the retirement of plant assets, assume

that Hobart Enterprises retires its computer
printers, which cost $32,000.
◦ The accumulated depreciation on these printers is
$32,000.
◦ The equipment, therefore, is fully depreciated (zero
book value).
◦ Dr Acc. Dep. /Cr Equipment: $32,000
 Question 3.9:
◦ Sunset Company discards delivery
equipment that cost $18,000 and has
accumulated depreciation of $14,000.
◦ Dr Acc. Dep. —Equipment $14,000
◦ Dr Loss on Disposal of Plant Assets 4,000
◦ Cr Equipment: $18,000
 Always recognize loss
 Recognize gain only if exchange of

dissimilar assets
 If gain on exchange of similar assets

◦ Reduce cost of new asset by gain

 An intangible asset is an identifiable non-
monetary asset without physical substance.
The asset must be:
◦ Controlled by the entity as a result of events
in the past, and
◦ Something fromwhich the entity expects
future economic benefits to flow.
 Intangible assets are rights, privileges,
and competitive advantages that result
from the ownership of long-lived assets
that do not possess physical substance.

 Evidence of intangibles may exist in the
form of contracts or licenses.
 Intangibles may arise from the following
sources:
1. Government grants, such as patents,
copyrights, licenses, trademarks, and trade
names.
2. Acquisition of another business, in which the
purchase price includes a payment for goodwill.
3. Private monopolistic arrangements arising
from contractual agreements, such as franchises
and leases.
 Research and development costs are
expenditures that may lead to patents,
copyrights, new processes, and new
products.
 Many companies spend considerable sums

of money on research and development

(R&D).
 For example, in a recent year IBM spent

over $5.1 billion on R&D.

 Research
-Activities aimed at
obtaining new knowledge.
-The search for application
of research findings or
other knowledge.
- The search for product or
process alternatives.
- The formulation &
design of possible new or
improved product or
process alternatives.
Development
- The design, construction and
testing or pre-production
prototypes and models.
- The design of tools, jigs, mould
& dies involving new technology.
- The design, construction&
operation of a pilot plant that is
not of a scale economically
feasible for commercial
production.
- The design construction and
testing of a chosen alternative for
new/improved materials.
 Components of R & D costs: Include all costs that are:
◦ Directly attributable to R& D activities, or
◦ Allocated on a reasonable basis.
 Costs include:
◦ Salaries, wages& other employment related costs of
personnel engaged in R & D activities.
◦ Costs of materials & services consumed in R & D
activities.
◦ Depreciation of PPE to the extent that these assets
are used for R & D activities.
◦ Overhead costs related to R & D activities.
◦ Other costs (such as the amortization of patents and
license ) related to R & D activities.
Research costs Development costs

Expenses Capitalisation

-Completing the intangible asset.

- Ability to use or sell the intangible asset.
- Generating future economic benefits.
-Availability of resources to complete the
intangible asset.
- Measuring reliably the expenditure.
 Intangible assets :
◦ Capitalised in the account
◦ Amortised
 Amortisation : Write off the assets over

economic life
Amortised Cost – Residual value
cost =
Estimated useful life